<PAGE> 1
PAYDEN & RYGEL INVESTMENT GROUP
EMERGING MARKETS BOND FUND
EURODIRECT FUND
CALIFORNIA MUNICIPAL INCOME FUND
PROSPECTUS
DECEMBER 17, 1998
1
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<S> <C>
Funds in Review.............................................................. 4
Expense Information.......................................................... 6
Net Asset Value.............................................................. 8
Dividends, Distributions and Taxes........................................... 8
Investment Objectives and Policies........................................... 10
Investment Practices......................................................... 15
Management of the Funds...................................................... 30
Shareholder Services......................................................... 33
Redemption of Shares......................................................... 36
How to Purchase Shares....................................................... 37
Appendix A - Description of Ratings.......................................... 39
</TABLE>
2
<PAGE> 3
PAYDEN & RYGEL INVESTMENT GROUP
333 SOUTH GRAND AVENUE
LOS ANGELES, CALIFORNIA 90071
(800) 5PAYDEN
(213) 625-1900
The Payden & Rygel Investment Group (the "Group") is a professionally managed,
no-load, open-end management investment company. The Group currently consists of
a number of distinct portfolios with separate investment objectives. Information
about three of the portfolios (each a "Fund"), including the investment
objectives of each Fund, the types of securities in which each Fund may invest,
and applicable investment policies and restrictions, is set forth in this
Prospectus. There can be no assurance that a Fund's investment objectives will
be achieved. Because the market value of each Fund's investments will change,
the net asset value per share of each Fund also will vary.
This Prospectus sets forth concisely the information a prospective investor
should know before investing in the Funds. Payden & Rygel (the "Adviser") serves
as investment adviser for each of these Funds. Payden & Rygel has been in the
investment advisory business for 15 years and manages assets of over $27
billion.
A Statement of Additional Information, dated December 17, 1998, containing
additional information about each Fund, has been filed with the Securities and
Exchange Commission and is incorporated by reference into this Prospectus. It is
available without charge and may be obtained by writing the Group at 333 South
Grand Avenue, Los Angeles, California 90071 or by telephone at (213) 625-1900,
or (800) 5PAYDEN (800-572-9336).
SHARES OF THE FUNDS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, NOR ARE THE SHARES FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
This Prospectus should be read and retained for reference to information about
the Funds.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus is December 17, 1998.
3
<PAGE> 4
FUNDS IN REVIEW
This summary is designed to provide a brief overview of each of the Funds,
including their investment objectives. A more detailed discussion of each Fund's
objectives and investment policies may be found under "Investment Objectives and
Policies." There can be no assurance that each Fund's objectives will be
achieved. Complete information on how to purchase, redeem and exchange shares
may be found under "Shareholder Services," "Redemption of Shares" and "How to
Purchase Shares."
FUND DESCRIPTIONS
The objective of the Emerging Markets Bond Fund is a high level of total return.
The Fund seeks to provide a long-term investor a low cost way of investing in a
portfolio of high-yielding emerging market fixed income securities. Under normal
circumstances, the Fund will invest at least 75% of its assets in fixed income
securities issued by, or economically tied to fixed income securities of,
governments, agencies and instrumentalities of emerging market countries, and
corporations organized or headquartered in emerging market countries. Under
normal circumstances, the Fund will seek to invest approximately 25% of its
assets in fixed income securities issued by corporations organized or
headquartered in emerging market countries and may invest up to 50% in these
issues. Substantially all of the fixed income securities purchased by the Fund
may be below investment grade (commonly known as "high yield bonds" or "junk
bonds"). Principal and interest on the Fund's fixed income securities will be
payable primarily in U.S. dollars. However, it may invest up to 30% of its
assets in fixed income securities that pay principal and interest in foreign
currencies. The dollar-weighted average portfolio maturity of the Fund's
portfolio normally will be less than ten years.
The objective of the EuroDirect Fund is long-term capital appreciation. It
allocates its assets among an equity and equity-based securities portfolio, an
investment grade fixed income securities portfolio, and a portfolio of money
market instruments, in proportions which reflect the Adviser's judgment of the
anticipated returns and risks of each asset class. The Fund invests at least 65%
of its equity and equity-based securities portfolio in issuers located in three
or more foreign countries. The Fund maintains at least 25% of the value of its
assets in investment grade fixed income senior securities. There is no limit on
the duration of such securities. The Fund invests primarily in developed
European markets. However, the Fund may invest up to 20% of its assets in
securities of issuers organized or headquartered in European emerging market
countries. Other than the foregoing, there are no limitations on the amount of
the Fund's assets which may be allocated to any of the three asset classes.
The objective of the California Municipal Income Fund is a high level of income,
consistent with preservation of capital and prudent investment management. The
Fund invests primarily in debt obligations the income from which is exempt from
Federal income taxes and California personal income taxes. The Fund may invest
up to 25% of its assets in fixed income securities rated below investment grade
(commonly known as "high yield bonds" or "junk
4
<PAGE> 5
bonds"). The Fund normally maintains a dollar-weighted average portfolio
maturity of between five and ten years.
INVESTMENT RISKS AND CONSIDERATIONS
Because each of the Emerging Markets Bond and California Municipal Income Funds
invests or may invest principally in debt securities, the value of its portfolio
will generally vary inversely with changes in interest rates, and each Fund's
ability to achieve its investment objective will depend, at least to some
extent, on the ability of issuers to pay their debt obligations when due.
The EuroDirect Fund may invest principally in equity and equity-based
securities. Although such securities have a history of long-term growth in
value, their prices fluctuate based on changes in the issuer's financial
condition and prospects, and on overall market and economic conditions. In
addition, equity and equity-based securities of smaller companies involve
greater risks and more volatility than those of larger, more well-capitalized
companies.
The Emerging Markets Bond and EuroDirect Funds each purchases securities of
foreign issuers and debt obligations that are payable in foreign currencies. The
acquisition of securities issued by foreign governments and foreign companies
and denominated in foreign currencies involves investment risks that are
different in some respects from those incurred by a fund that invests only in
securities of U.S. governmental entities and domestic companies, including
differences in reporting standards; adverse changes in investment, exchange or
tax control regulations; political instability; changes in exchange rates;
greater portfolio volatility; additional transaction costs; less government
regulation of securities markets, brokers and issuers; possible difficulty in
obtaining and enforcing judgments in foreign courts; and imposition of
restrictions on foreign investments.
The Emerging Markets Bond Fund invests substantially all of its assets in below
investment grade securities. In addition, each of the California Municipal
Income Fund and EuroDirect Fund may invest up to 25% and 5% of its total assets,
respectively, in below investment grade debt. These securities are regarded by
the rating agencies as predominantly speculative with respect to the issuer's
continuing ability to meet principal and interest payments and generally involve
more risk of loss of principal and income than investment grade securities.
The Emerging Markets Bond Fund will invest at least 75% of its assets in fixed
income securities of issuers that are governments, agencies or instrumentalities
of emerging market countries, and in corporations organized or headquartered in
emerging market countries, which may include developing countries or countries
with new or developing markets. The EuroDirect Fund may also invest up to 20% of
its assets in securities of issuers organized or headquartered in European
emerging market countries. Investing in securities of emerging market countries
involves certain risks and considerations that are not typically associated with
investing in developed foreign countries.
5
<PAGE> 6
Because the California Municipal Income Fund invests primarily in securities of
issuers located in the State of California, the Fund is more vulnerable to
unfavorable developments in California than a fund which does not concentrate
its investments in securities relating to a single state. In addition, the
investments of the Emerging Markets Bond Fund may be concentrated in a small
number of issuers or regions, and the Fund may be more vulnerable to unfavorable
developments of a single issue or region than funds with more diversified
portfolios.
INVESTMENT ADVISER
Payden & Rygel serves as Adviser to each Fund. The Adviser has retained
Metzler-Payden, LLC as Sub-adviser to the EuroDirect Fund. See "Management of
the Funds."
PURCHASE AND REDEMPTION OF SHARES
Each Fund offers its Class R Shares through Payden & Rygel Distributors with no
sales charge. In general, the minimum initial investment is $5,000, and the
minimum additional investment is $1,000. However, tax-sheltered retirement plans
and the Automated Investment Programs require different minimum investments. See
"Shareholder Services" and "How to Purchase Shares." Shares of each Fund may be
exchanged for any class of shares of any other Fund or portfolio of the Group.
Shares of each Fund may be redeemed or exchanged without cost at the net asset
value per share of the Fund next determined after receipt of a request in proper
form. The redemption or exchange price may be more or less than the purchase
price.
EXPENSE INFORMATION
Class R Shares of each Fund are offered to investors on a no-load basis without
any sales commissions or distribution ("12b-1 plan") charges.
ANNUAL FUND OPERATING EXPENSES
For Class R Shares of each Fund, the Advisory Fees, Other Expenses and Total
Fund Expenses, as an estimated percentage of average net assets for the first
year of operation after reimbursement of Advisory fees and Other expenses (but
before taking into consideration the waiver of the advisory fee described
below), are as follows:
<TABLE>
<CAPTION>
EMERGING MARKETS EURODIRECT CALIFORNIA
BOND FUND FUND MUNICIPAL INCOME FUND
---------------- ---------- ---------------------
<S> <C> <C> <C>
Advisory Fees 0.45% 0.65% 0.32%
Other Expenses 0.35% 0.20% 0.18%
---- ---- ----
Total Fund Expenses 0.80% 0.85% 0.50%
</TABLE>
6
<PAGE> 7
The Adviser has agreed to waive its advisory fee for each of the Funds through
June 30, 1999. Actual expenses for Class R Shares of each Fund for the fiscal
year ending October 31, 1999, before waivers and reimbursement by the Adviser,
as described below, are estimated to be the following percentage of average
daily net assets (annualized): Emerging Markets Bond Fund-1.90%; EuroDirect
Fund-1.57%; and California Municipal Income Fund-0.95%.
FUND EXPENSE LIMITS
The Adviser has guaranteed that, for so long as it acts as investment adviser to
a Fund, the total expenses of the Fund, including advisory fees (but excluding
interest, taxes, portfolio transaction expenses, blue sky fees, 12b-1 plan fees
[if any such plan is adopted in the future] and extraordinary expenses), will
not exceed the following percentage of each Fund's average daily net assets on
an annualized basis: Emerging Markets Bond Fund-1.25%; EuroDirect Fund-1.25%;
and California Intermediate Municipal Income Fund-0.80%.
In addition, the Adviser has voluntarily agreed to temporarily limit each Fund's
expense ratio to the following percentage of the Fund's average daily net assets
on an annualized basis (exclusive of interest, taxes, portfolio transaction
expenses, blue sky fees, 12b-1 plan fees [if any such plan is adopted in the
future] and extraordinary expenses): Emerging Markets Bond Fund-0.80%;
EuroDirect Fund-0.85%; and California Intermediate Municipal Income Fund-0.50%.
Such limits may be modified by the Adviser following notification to
shareholders.
Each Fund will reimburse the Adviser for fees foregone or other expenses paid by
it in any fiscal year pursuant to the expense guarantee or voluntary expense cap
at a later date, without interest, so long as such reimbursement will not cause
the annual expense ratio for the year in which it is made to exceed the amount
of the expense guarantee or voluntary expense cap (whichever is in effect at the
time of reimbursement). No Fund will be required to repay any unreimbursed
amounts to the Adviser upon termination of its investment management contract
with respect to the Fund.
EXPENSES PER $1,000 INVESTMENT
The following table illustrates the expenses a shareholder would pay on a $1,000
investment in the Class R Shares of each Fund over various time periods assuming
(1) a 5% annual return, (2) expenses as set forth on the preceding page, and (3)
redemption at the end of each time period. As noted above, there are no Fund
redemption fees of any kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS
------ -------
<S> <C> <C>
Emerging Markets Bond Fund $8 $26
EuroDirect Fund $9 $27
California Municipal Income Fund $5 $16
</TABLE>
7
<PAGE> 8
The information in the table is provided for purposes of assisting current and
prospective shareholders in understanding the various costs and expenses that an
investor will bear, directly or indirectly. The hypothetical annual return of 5%
is used for illustrative purposes only and should not be interpreted as an
estimate of any Fund's annual returns, as there can be no guarantee of any
Fund's future performance.
NET ASSET VALUE
The net asset value per share of Class R Shares of each Fund is determined as of
the close of regular trading on the New York Stock Exchange (normally 4:00 p.m.
Eastern Time) by dividing the difference between the value of assets and
liabilities attributable to the class by the number of shares of the class
outstanding.
Foreign equity securities are valued based upon the last sale price on the
foreign exchange or market on which they are principally traded as of the close
of the appropriate exchange or, if there have been no sales during the day, at
the last bid prices. Equity securities listed or traded on any domestic (U.S.)
securities exchange are valued at the last sale price or, if there have been no
sales during the day, at the last bid prices. Securities traded only on the
over-the-counter market are valued at the latest bid prices.
Domestic and foreign fixed income securities and other assets for which market
quotations are readily available (other than obligations with remaining
maturities of 60 days or less) are valued at market value on the basis of quotes
obtained from brokers and dealers or pricing services, which take into account
appropriate factors such as institutional-sized trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data. Securities for which daily market
quotations are not available may be valued, pursuant to guidelines established
by the Board of Trustees, at fair market value as determined by the Adviser. The
Board of Trustees has determined that debt securities with remaining maturities
of 60 days or less will be valued on an amortized cost basis, unless the Adviser
determines that such basis does not represent fair value at the time. Swaps,
caps and floors are valued on the basis of information provided by the
institution with which the Fund entered into the transaction. Non-U.S. dollar
securities are translated into U.S. dollars using the spot exchange rate at the
close of the London market.
DIVIDENDS, DISTRIBUTIONS AND TAXES
Dividends are generally declared and distributed to shareholders monthly for the
California Municipal Income Fund, quarterly for the Emerging Markets Bond Fund
and semi-annually for the EuroDirect Fund. Any net realized capital gains from
the sale of portfolio securities will be distributed at least once yearly.
Dividend and capital gain distributions of each Fund will be paid in the form of
additional shares of the Fund at the net asset value on the ex-dividend date
unless the shareholder elects to have them paid in cash by completing an
appropriate request form.
8
<PAGE> 9
Each Fund intends to elect and qualify annually to be treated as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). As a regulated investment company, a Fund generally is not subject to
federal income tax on its investment company taxable income (which includes
interest and net short-term capital gains in excess of any net long-term capital
losses) and net capital gain (net long-term capital gains in excess of the sum
of net short-term capital losses and unexpired capital loss carryovers), if any,
that it distributes to shareholders, provided it distributes each taxable year
at least 90% of its investment company taxable income, including any net
interest income excludable from gross income under section 103(a) of the Code.
Each Fund intends to distribute to its shareholders, at least annually,
substantially all such amounts.
The California Municipal Income Fund anticipates that substantially all
dividends paid by it will be exempt from federal income taxes; however, a
portion of the dividends may be a tax preference item for purposes of the
alternative minimum tax. Dividends paid by the other Funds, and distributions
paid by all Funds from long-term capital gains, are taxable. Capital gains
distributions are made when a Fund realizes net capital gains on sales of
portfolio securities during the year. Any short-term capital gains or any
taxable interest income will be distributed as a taxable ordinary dividend
distribution. For the California Intermediate Municipal Income Fund, realized
capital gains or any taxable interest income is not expected to be a significant
or predictable part of investment return. Sale of any Fund's shares is a taxable
event and may result in a capital gain or loss.
Investment income received from sources within foreign countries may be subject
to foreign income taxes. The U.S. has entered into tax treaties with many
foreign countries which entitle certain investors to a reduced rate of tax or to
certain exemptions from tax. Each of the Emerging Markets Bond and EuroDirect
Funds will operate so as to qualify for such reduced tax rates or tax exemptions
whenever practicable. Each of these Funds may qualify for and make an election
permitted under section 853 of the Code so that shareholders will be able to
claim a credit or deduction on their Federal income tax returns for, and will be
required to treat as part of the amounts distributed to them, their pro rata
portion of the income taxes paid by the Funds to foreign countries (which taxes
relate primarily to investment income). The shareholders of each of these Funds
may claim a credit by reason of the Funds' election subject to certain
limitations imposed by section 904 of the Code. However, no deduction for
foreign taxes may be claimed under the Code by individual shareholders who do
not elect to itemize deductions on their Federal income tax returns, although
such a shareholder may claim a credit for foreign taxes and in any event will be
treated as having taxable income in the amount of the shareholder's pro rata
share of foreign taxes paid by the Funds. Although the Group intends to meet the
requirements of the Code to "pass through" such taxes, there can be no assurance
that a Fund will be able to do so.
Prior to purchasing shares of a Fund, an investor should carefully consider the
impact of the dividends or capital gains distributions which are expected to be
or have been announced. Any dividends or distributions paid shortly after a
purchase by an investor will have the effect of
9
<PAGE> 10
reducing the per share net asset value of the investor's shares by the per share
amount of the dividends or distributions.
Distributions may be subject to additional state and local taxes, depending on
each shareholder's particular situation. Shareholders should consult their own
tax advisers with respect to the particular tax consequences to them of an
investment in a Fund. For further discussion of these matters, please see the
Statement of Additional Information.
CAPITALIZATION
The Group was organized as a Massachusetts business trust on January 22, 1992.
Its Declaration of Trust authorizes the Board of Trustees to issue an unlimited
number of shares of beneficial interest in the Group and to classify or
reclassify any unissued shares into one or more series or classes of shares.
Pursuant to such authority, the Board of Trustees has authorized the issuance of
twenty-one series of shares, including the three series of shares which are sold
through this prospectus. Each of the series of the Trust, including the Funds,
currently offers Class R Shares. One series of the Trust also offers Class D
Shares, which bear the expenses of a distribution plan of up to 0.35% of average
annual net assets.
VOTING
Shareholders have the right to vote in the election of Trustees and on any and
all matters on which they may be entitled to vote by law or the provisions of
the Declaration of Trust. Shares entitle their holders to one vote per share
(with proportionate voting for fractional shares). Shareholders will vote in the
aggregate and not by series or class except as otherwise required by law or when
the Board of Trustees of the Group determines that a matter to be voted on
affects only the interest of a particular series or class. Voting rights are not
cumulative, and accordingly the holders of more than 50% of the shares of the
Group may elect all of the Trustees. The Group is not required to hold regular
annual meetings of shareholders and does not intend to do so except when
required by law. The Declaration of Trust provides that the holders of not less
than two-thirds of the outstanding shares of the Group may remove a person
serving as Trustee at a shareholder meeting called by written request of the
holders of not less than 10% of the outstanding shares of any series.
INVESTMENT OBJECTIVES AND POLICIES
EMERGING MARKETS BOND FUND
The objective of the Emerging Markets Bond Fund is a high level of total return.
The Fund seeks to provide long-term investors a low cost way of investing in a
portfolio of high-yielding emerging market debt securities. The Adviser believes
that emerging bond markets will continue to expand and that selected investments
in securities of issuers located or headquartered in emerging market countries
will provide an attractive total return opportunity for long-term investors. The
Adviser seeks to reduce risk through sovereign risk
10
<PAGE> 11
analysis that focuses on current developments and trends in economic, political
and market developments and through credit analysis of issuers.
The Adviser has broad discretion to identify and invest in countries that it
considers to qualify as emerging markets. Generally, however, the Adviser will
consider a securities market located in any country defined by the World Bank
(i.e., the International Bank for Reconstruction and Development), the
International Finance Corporation or the United Nations as an emerging or
developing economy to be an emerging market.
Under normal conditions, the Fund will invest at least 75% of its assets in
fixed income securities issued by, or economically tied to fixed income
securities of, governments, agencies and instrumentalities of emerging market
countries, and corporations organized or headquartered in emerging market
countries. It may invest up to 25% of its assets in other fixed income
instruments, including securities of issuers located in countries with developed
fixed income markets. These limits notwithstanding, the Fund may invest without
limit in U.S. government securities for temporary, defensive or emergency
purposes.
The Fund will invest in a wide variety of high-yielding fixed income
obligations. Under normal circumstances, the Adviser seeks to invest
approximately 25% of the Fund's total assets to securities issued by
corporations organized or headquartered in emerging market countries and may
invest up to 50% of the Fund's total assets in these securities. The relative
scarcity of issuers in certain of these markets may result in the Fund being
highly concentrated in a small number of issuers. To achieve broader portfolio
diversification, the Fund may make use of swaps (including swaps on emerging
market indices, such as J.P. Morgan's Emerging Market Bond Index) or other
securities (including options, futures contracts and their related options) the
returns on which are derived primarily from emerging market securities, if the
Adviser deems it appropriate. In addition, the Fund may invest up to 10% of its
assets in shares of investment companies that invest primarily in emerging
market debt securities.
The Fund will invest primarily in securities whose principal and interest
payments are made in U.S. dollars. However, it may invest up to 15% of its
assets in securities whose principal and interest is denominated in the
currencies of foreign developed markets and up to 15% of its assets in
securities whose principal and interest is denominated in the currencies of
emerging markets.
The Fund will emphasize investments in countries with the potential for rapid
economic growth. In selecting countries for investment, the Adviser will
evaluate such factors as relative interest rates, inflation rates, monetary and
fiscal policies, trade and current account balances, political developments, and
any other factors that the Adviser believes to be relevant. The Adviser will
concentrate its investments in Latin America, Asia and the developing securities
markets of Europe, although it may invest in other areas if it believes
conditions warrant such exposure. Because its investments will be concentrated
in a relatively few regions, the Fund's total return will be susceptible to
political and economic developments in these regions.
11
<PAGE> 12
The Fund may invest substantially all of its assets in securities rated below
investment grade. Investment grade securities are securities rated in one of the
four highest rating categories by at least one of the established rating
agencies (e.g., AAA, AA, A or BBB by Standard & Poor's Corporation). Below
investment grade securities (commonly known as "high yield bonds" or "junk
bonds") are regarded by the rating agencies as predominantly speculative with
respect to the issuer's continuing ability to meet principal and interest
payments and generally involve more risk of loss of principal and income than
investment grade securities. The Fund will restrict its investments to
securities and countries rated B or higher by Moody's or S&P (or, if unrated,
determined by the Adviser to be of comparable quality.) Securities rated B are
considered highly speculative. The Adviser will seek to effect an orderly
disposition of any security whose credit quality declines below the lowest B
rating after the security is purchased. The Fund is not required, however, to
dispose of such debt if the Adviser believes it is in the best interest of the
Fund to maintain the position.
The Fund is not restricted by limits on the maturity of any individual issue and
may invest in securities with stated maturities ranging from overnight to 30
years. The dollar-weighted average maturity of the Fund's portfolio will vary
depending on the Adviser's assessment of economic and market conditions, but
normally will be less than ten years.
The Emerging Markets Bond Fund may also purchase and sell futures or options
contracts on stock indexes, foreign currencies and bonds, and may enter into
index or interest rate swaps.
EURODIRECT FUND
The EuroDirect Fund seeks to earn long-term capital appreciation. It allocates
its assets among an equity and equity-based securities portfolio, a fixed income
securities portfolio, and a portfolio of money market instruments, in
proportions which reflects the Adviser's judgment of the anticipated returns and
risks of each asset class. The Fund maintains at least 25% of the value of its
assets in fixed income senior securities. The Fund invests primarily in the
following European developed markets: Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal,
Spain, Sweden, Switzerland and the United Kingdom. In addition, the Fund may
invest up to 20% of its assets in securities of issuers organized or
headquartered in European emerging market countries, which may include
developing countries or countries with new or developing capital markets.
Currently such markets include the Czech Republic, Hungary, Poland, Russia and
Turkey. Other than the foregoing, there are no limitations on the amount of the
Fund's assets which may be allocated to any of the three asset classes (equity
or equity-based securities, fixed income securities and money market
instruments).
In determining the relative attractiveness of each asset class, the Adviser
takes into account various factors. Once expected return and volatility (risk)
estimates are developed for each asset class, the Adviser attempts to identify
apparent imbalances in the relative pricing of equity or equity-based
securities, fixed income securities and money market instruments
12
<PAGE> 13
compared to risks, using a computer model. The EuroDirect Fund's allocation
among the three asset classes is then adjusted to take advantage of these
perceived imbalances.
At least 65% of the Fund's equity and equity-based allocation will be invested
in issuers headquartered or organized in three or more countries. Equity-based
securities include convertible securities and warrants.
The money market and fixed income securities allocations are invested in both
dollar and non-dollar denominated debt securities. The debt securities held by
the EuroDirect Fund are rated "investment grade" at the time of purchase by at
least one of the established rate agencies (e.g., AAA, AA, A, or BBB by Standard
& Poor's) or, if unrated, are determined to be of comparable quality by the
Adviser. Securities rated BBB are considered to have adequate capacity to pay
interest and repay principal, but adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and
principal than higher rated bonds. There is no restriction as to the final
maturity of a specific investment or the overall maturity of the Fund's fixed
income securities portfolio. However, the money market allocation generally has
an average dollar-weighted maturity of less than one year.
The EuroDirect Fund may also purchase and sell futures or options contracts on
stock indexes, foreign currencies and bonds, and may enter into index, equity,
or interest rate swaps.
Depending on the Adviser's allocation of the EuroDirect Fund's assets among
equity and equity-based securities, fixed income securities, and money market
instruments, investors in the Fund may be exposed to the market risk of various
combinations of equity and equity-based securities and fixed income securities,
as well as to the risks associated with specific securities. Because the
allocation strategy of the Adviser may, at certain times, result in a portfolio
with a primary emphasis on equity and equity-based securities, the EuroDirect
Fund may from time to time exhibit a level of volatility which is more
consistent with an equity portfolio than a balanced portfolio. However, under
normal circumstances, the Adviser expects the volatility of the EuroDirect
Fund's total return to be less than that of a purely common stock portfolio.
Investors should be aware that the investment results of the Fund depend not
only on the Adviser's and Sub-adviser's selection of specific portfolio
securities, but also upon the Adviser's ability to anticipate correctly the
relative performance and risk of equity and equity-based securities, fixed
income securities, and money market instruments. The Fund's investment results
would underperform other European balanced funds, for example, if only a small
portion of the Fund's assets were allocated to equity and equity-based
securities during a significant stock market advance, or if a major portion of
its assets were allocated to equity and equity-based securities during a market
decline. Similarly, the Fund's performance could deteriorate if the Fund were
substantially invested in fixed income securities at a time when interest rates
increased.
13
<PAGE> 14
CALIFORNIA MUNICIPAL INCOME FUND
The California Municipal Income Fund seeks to invest 100%, and as a matter of
fundamental policy invests at least 80%, of its total assets in securities that
pay interest exempt from Federal income taxes. The Fund also seeks to invest at
least 65% of its total assets in securities that pay interest exempt from
California personal income taxes. It is possible, although not anticipated, that
up to 20% of the Fund's total assets could be invested in obligations that pay
interest subject to Federal income taxes, or the alternative minimum tax, and up
to 35% of the Fund's total assets could be invested in securities that pay
interest subject to California personal income taxes.
The Fund intends to achieve its objective by investing primarily in Municipal
Securities, which are debt obligations issued by state and local governments,
territories, and possessions of the U.S., regional government authorities, and
their agencies and instrumentalities, which, in the opinion of bond counsel to
the issuer at the time of original issuance, provide interest income that is
exempt from U.S. Federal income taxes. The Fund invests at least 65% of its
total assets in California Municipal Securities (i.e., obligation issued by the
State of California, local governments and other authorities in California, and
their agencies and instrumentalities, which in the opinion of bond counsel to
the issuer at the time of original issue, provide interest income that is exempt
from California personal income tax). It is possible, although not anticipated,
that up to 35% of the Fund's total assets may be in Municipal Securities of
states, territories or local governments other than California.
The Fund invests in fixed income securities which are generally investment grade
at the time of purchase. Investment grade securities are securities rated in one
of the four highest rating categories by at least one of the established rating
agencies (e.g., AAA, AA, A, or BBB by Standard & Poor's Corporation), or if
unrated, are determined by the Adviser to be of comparable quality. Securities
rated BBB are considered to have adequate capacity to pay interest and repay
principal, but adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and principal than higher
rated bonds. However, the Fund may invest up to 25% of its total assets in fixed
income securities rated below investment grade. Below investment grade
securities (commonly known as "high yield bonds" or "junk bonds") are regarded
by the rating agencies as predominantly speculative with respect to the issuer's
continuing ability to meet principal and interest payments and generally involve
more risk of loss of principal and income than investment grade securities. The
Fund will restrict its investments to securities rated B or higher by Moody's or
S&P (or, if unrated, determined by the Adviser to be of comparable quality.)
Securities rated B are considered highly speculative. The Adviser will seek to
effect an orderly disposition of any security whose credit quality declines
below the lowest B rating after the security is purchased. The Fund is not
required, however, to dispose of such debt if the Adviser believes it is in the
best interest of the Fund to maintain the position.
14
<PAGE> 15
The California Municipal Income Fund may also purchase and sell futures or
options contracts on indexes and bonds.
Because the Fund invests primarily in securities of issuers located in the State
of California, its performance is subject to economic and political developments
in the State. In addition, the Fund may invest more than 25% of its assets in
Municipal Securities in particular market segments, including but not limited
to, hospital revenue bonds, housing agency bonds, tax-exempt industrial
development bonds, transportation bonds, or pollution control revenue bonds. An
economic, business, political or other change that affects one security may also
affect other securities in the same market segment, thereby potentially
increasing market risk. Examples of changes that may affect certain market
segments include proposed legislation affecting the financing of a project,
shortages or price increases of needed materials, or declining markets or needs
for the projects.
INVESTMENT PRACTICES
The Adviser and Sub-adviser utilize various investment techniques in managing
each Fund's portfolio, including the following:
U.S. TREASURY AND GOVERNMENT AGENCY OBLIGATIONS. Each Fund may invest in
obligations issued by the U.S. Treasury and in obligations issued or guaranteed
by U.S. Government sponsored enterprises and federal agencies. These securities
include Treasury bills, which mature in one year or less, Treasury notes and
bonds that mature in 2 to 30 years, and agency issues, which may have maturities
from one day to 40 years. Securities are generally not callable and normally
have interest rates that are fixed for the life of the security.
MONEY MARKET FUNDS. To maintain liquidity, each Fund may invest in unaffiliated
money market funds. Under normal circumstances, a money market investment made
by the California Municipal Income Fund will be in federal tax-free mutual
funds. No money market fund investment by any Fund will be in excess of 3% of
the total assets of the money market fund. None of the Funds anticipates
investing more than 15% of its net assets in money market funds. An investment
in a money market mutual fund by a Fund will involve payment by the Fund of its
pro rata share of advisory and administrative fees charged by such money market
fund.
MONEY MARKET OBLIGATIONS. Each Fund may invest in U.S. dollar denominated bank
certificates of deposit, bankers acceptances, commercial paper and other
short-term debt obligations of U.S. and foreign issuers, including U.S.
Government and agency obligations. All money market obligations are considered
high quality, meaning that the security is rated in one of the two highest
categories for short-term securities by at least two nationally recognized
rating services (or by one if only one rating service has rated the security)
or, if unrated, is determined by the Adviser (or Sub-adviser) to be of
comparable quality.
15
<PAGE> 16
CORPORATE DEBT SECURITIES. Each Fund may invest in corporate bonds, debentures,
notes and other similar debt instruments of domestic and foreign corporations
which, at the time of purchase, are rated investment grade by at least one of
the established rating agencies or, if unrated, are determined to be of
comparable quality by the Adviser or Sub-adviser. Such obligations may have
interest rates which are fixed, variable or floating. Each Fund may also
purchase long-term debt obligations that have been coupled with an option
allowing the Fund at specified intervals to tender (or "put") such debt
obligations to the issuer and receive an agreed upon amount, usually face value
plus accrued interest.
Credit ratings evaluate the safety of principal and interest payments of
securities, not their market value. The rating of an issuer is also heavily
weighted by past developments and does not necessarily reflect probable future
conditions. There is frequently a lag between the time a rating is assigned and
the time it is updated. As credit rating agencies may fail to timely change
credit ratings of securities to reflect subsequent events, the Adviser (or
Sub-adviser) will also monitor issuers of such securities.
HIGH YIELD BONDS. The Emerging Markets Bond Fund invests substantially all of
its assets in debt rated below investment grade or, if unrated, determined to be
of comparable quality by the Adviser, and each of the California Municipal
Income and EuroDirect Funds may also invest up to 25% and 5%, respectively, of
its total assets in debt rated below investment grade or, if unrated, determined
to be of comparable quality by the Adviser. Lower quality debt securities,
commonly referred to as "high yield bonds" or "junk bonds" are considered to be
speculative and involve a greater risk of default or price changes due to
changes in the issuer's creditworthiness than higher rated securities. High
yield securities are generally subject to greater credit risk than higher-rated
securities because the issuers are more vulnerable to economic downturns, higher
interest rates or adverse issuer-specific developments. In addition, the prices
of high yield securities are generally subject to greater market risk and
therefore react more sharply to changes in interest rates. Their value and
liquidity may also be diminished by adverse publicity and investor perceptions.
Also, legislative proposals limiting the tax benefits to the issuers or holders
of taxable high yield securities or requiring federally insured savings and loan
institutions to reduce their holdings of taxable high yield securities have had
and may continue to have an adverse effect on the market value of these
securities.
Because high yield securities are frequently traded only in markets where the
number of potential purchasers and sellers, if any, is limited, the ability of a
Fund to sell these securities at their fair value either to meet redemption
requests or to respond to changes in the financial markets may be limited. In
such an event, such securities could be regarded as illiquid for the purposes of
the limitation on the purchase of illiquid securities. Thinly traded high yield
securities may be more difficult to value accurately for the purpose of
determining a Fund's net asset value. Also, because the market for certain high
yield securities is relatively new, that market may be particularly sensitive to
an economic downturn or a general increase in interest rates.
16
<PAGE> 17
MORTGAGE-BACKED SECURITIES. Each of the Emerging Markets Bond and EuroDirect
Funds may invest in foreign mortgage-related securities. Payments made on the
underlying mortgages and passed through to a Fund will represent both regularly
scheduled principal and interest payments as well as prepayments of principal.
Investing in such obligations involves special risks as a result of prepayments
(which may require the Fund to reinvest the proceeds at a lower rate), the
illiquidity of certain of such securities and the possible default by insurers
or guarantors.
REPURCHASE AGREEMENTS. For the purpose of maintaining liquidity or realizing
additional income, each Fund may enter into repurchase agreements (agreements to
purchase U.S. Treasury notes and bills, subject to the seller's agreement to
repurchase them at a specified time and price) with well-established registered
securities dealers or banks. Repurchase agreements are the economic equivalent
of loans by a Fund. In the event of a bankruptcy or default of any such dealer
or bank, a Fund could experience costs and delays in liquidating the underlying
securities which are held as collateral, and the Fund might incur a loss if the
value of the collateral held declines during this period.
REVERSE REPURCHASE AGREEMENTS. Each of the Funds may enter into reverse
repurchase agreements (agreements to sell portfolio securities, subject to such
Fund's agreement to repurchase them at a specified time and price) with
well-established registered dealers and banks. A Fund covers its obligations
under a reverse repurchase agreement by maintaining a segregated account
comprised of cash, U.S. Government securities or high-grade debt obligations,
maturing no later than the expiration of the agreement, in an amount (marked to
market daily) equal to its obligations under the agreement. Reverse repurchase
agreements are the economic equivalent of borrowings by a Fund.
VARIABLE AND FLOATING RATE SECURITIES. Each Fund may invest in variable and
floating rate securities of government and corporate issuers. The terms of such
obligations provide that interest rates are adjusted periodically based upon
some appropriate interest rate adjustment index, e.g., the Federal Funds rate.
The adjustment intervals may be regular, and range from daily to annually, or
may be based on an event such as a change in the prime rate. Accordingly,
although such securities provide some protection against changes in interest
rates, depending on the terms of the instrument there may be some interval
between changes in such rates and adjustment of the rate paid by the issuer.
CONVERTIBLE SECURITIES AND WARRANTS. The EuroDirect Fund may invest in
convertible securities and warrants. Convertible securities, such as convertible
preferred stocks and debentures, may be exchanged for or converted into a
predetermined number of shares of the issuer's common stock at the option of the
holder during a specified time period. Convertible securities generally pay
interest or dividends and provide for participation in the appreciation of the
underlying common stock. Convertible securities generally provide higher yields
than the underlying equity securities, but generally offer lower yields than
non-convertible securities of similar quality. The value of a convertible
security is a function of a variety of factors, including its yield in
comparison with comparable non-convertible
17
<PAGE> 18
securities, its value if converted into the underlying common stock, and the
credit standing of the issuer.
Warrants give the holder the right to purchase a specified number of shares of
the underlying stock at any time at a fixed price, but do not pay a fixed
dividend. Investment in warrants involve certain risks, including the possible
lack of a liquid market for resale, potential price fluctuations as a result of
speculation or other factors, and the failure of the price of the underlying
security to reach or have reasonable prospects of reaching a level at which the
warrant can be prudently exercised (in which event the warrant may expire
without being exercised, resulting in a loss of the Fund's entire investment in
the warrant). As a matter of operating policy, the Fund will not invest more
than 5% of its total assets in warrants.
FOREIGN GOVERNMENT OBLIGATIONS. Each of the Emerging Markets Bond and EuroDirect
Funds may invest in foreign government or supranational obligations. Principal
and interest may be payable in either U.S. dollars or a foreign currency. In the
case of the Emerging Markets Bond Fund, such obligations may be below investment
grade.
TAX-EXEMPT OBLIGATIONS. The California Municipal Income Fund may purchase
certain tax-exempt obligations listed below:
GENERAL OBLIGATION NOTES AND BONDS. General obligation notes and bonds are
secured by the issuer's pledge of its full faith, credit and taxing power
for the payment of principal and interest.
REVENUE NOTES AND BONDS. These obligations are payable only from the
revenues derived from a particular facility or, in some cases, from the
proceeds of a special excise tax. Revenue notes and bonds are issued to
finance a wide variety of capital projects including electric, gas, water
and sewer systems; highways, bridges and tunnels; and colleges and
universities.
PUT BONDS. The Fund may invest in tax-exempt securities (including
securities with variable interest rates) which may be redeemed or sold back
("put") to the issuer of the security or a third party prior to stated
maturity ("put bonds"). Such securities will normally trade as if maturity
is the earlier put date, even though stated maturity is longer. Maturity for
put bonds is deemed to be the date on which the put becomes exercisable.
PRIVATE ACTIVITY AND INDUSTRIAL DEVELOPMENT BONDS. The Fund may invest in
private activity and industrial development bonds, which are obligations
issued by or on behalf of public authorities to raise money to finance
various privately owned or operated facilities for business and
manufacturing, housing, sports and pollution control. These bonds are also
used to finance public facilities, such as airports, mass transit systems,
ports, parking or sewage or solid waste disposal facilities. The payment of
the principal and interest on such bonds is generally dependent solely on
the ability of the facility's user to
18
<PAGE> 19
meet its financial obligations and the pledge, if any, of real and personal
property so financed as security for such payment.
MUNICIPAL LEASE OBLIGATIONS AND CERTIFICATES OF PARTICIPATION. The Fund may
invest in lease obligations issued by state or local government authorities
to acquire land and a wide variety of equipment and facilities. These
obligations typically are not fully backed by the municipality's credit, and
their interest may become taxable if the lease is assigned. If funds are not
appropriated for the following year's lease payments, a Fund's only recourse
may be to the leased property securing payment, and disposition of the
property might prove difficult. In addition, as these securities represent a
relatively new type of financing, certain lease obligations may be
considered to be illiquid securities. Certificates of participation are
issued by a particular municipality or municipal authority to evidence a
proportionate interest in base rental or lease payments relating to a
specific project to be made by the municipality or authority.
TAX EXEMPT ZERO COUPON SECURITIES. The Fund may invest in zero coupon
securities, which are debt securities issued or sold at a discount from
their face value. These securities do not entitle the holder to interest
payments prior to maturity or the specified redemption date, but instead are
redeemed at their face value upon maturity. The discount from face value is
amortized over the life of the security, and such amortization will
constitute the income earned on the security for accounting and tax
purposes. Even though income on such securities is accrued on a current
basis, a Fund does not receive such income currently in cash and may have to
sell other portfolio securities to obtain cash needed to make income
distributions. The price volatility of a zero coupon security is greater
than an interest-paying note of identical maturity.
EQUITY SECURITIES. The EuroDirect Fund may invest in equity and equity based
securities, including common and preferred stocks, convertible securities and
warrants. Common stocks, the most familiar type of equity securities, represent
an equity (ownership) interest in a corporation.
Although such equity securities have a history of long-term growth in value,
their prices fluctuate based on changes in the issuer's financial condition and
prospects and on overall market and economic conditions. In addition, small
companies and new companies often have limited product lines, markets or
financial resources, and may be dependent upon one person, or a few key persons,
for management. The securities of such companies may be subject to more volatile
market movements than securities of larger, more established companies, both
because the securities typically are traded in lower volume and because the
issuers typically are more subject to changes in earnings and prospects.
PREFERRED STOCK. The EuroDirect Fund may invest in cumulative and non-cumulative
preferred stock. Preferred stock, unlike common stock, offers a stated dividend
rate payable from a corporation's earnings, and also generally has a preference
over common stock on the distribution of a corporation's assets in the event of
liquidation of the corporation. As a
19
<PAGE> 20
general rule, the market value of preferred stocks with fixed dividend rates and
no conversion rights varies inversely with interest rates and perceived credit
risk, with the price determined by the dividend rate. The market price of
convertible preferred stocks generally reflects an element of conversion value.
In addition, in the absence of credit deterioration, adjustable rate preferred
stocks tend to have more stable market values than fixed rate preferred stocks.
All preferred stocks are subject to the same types of credit risks of the issuer
as are corporate bonds of the issuer.
DELAYED DELIVERY TRANSACTIONS. Each Fund may purchase securities on a
when-issued or delayed delivery basis and sell securities on a delayed delivery
basis. These transactions involve a commitment by a Fund to purchase or sell
securities for a predetermined price or yield, with payment and delivery taking
place more than seven days in the future, or after a period longer than the
customary settlement period for that type of security. No interest will be
earned by a Fund on such purchases until the securities are delivered; however,
the market value of the securities may change prior to delivery. None of the
Funds will invest more than 25% of its total assets in when-issued and delayed
delivery transactions.
RESERVES. Each Fund may establish and maintain reserves when the Adviser or
Sub-adviser determines that such reserves would be desirable for temporary
defensive purposes (for example, during periods of substantial volatility in
interest rates) or to enable it to take advantage of buying opportunities. A
Fund's reserves may be invested in domestic and foreign money market
instruments, including government obligations, commercial paper and short-term
corporate debt issues meeting the quality standards described above; money
market funds, certificates of deposit and bankers' acceptances of banking
institutions described in the Statement of Additional Information; and
repurchase agreements. Although there is no limit on the percentage of a Fund's
assets which may be maintained in such reserves, under normal circumstances no
more than 10% of its total assets is expected to be maintained in such reserves.
ILLIQUID SECURITIES. Some debt obligations can be illiquid, meaning that they
may not be sold in the ordinary course of business within seven days at
approximately the price at which they are valued. A Fund will not invest more
than 15% of its net assets in illiquid securities. In accordance with guidelines
established by the Board, the Adviser or Sub-adviser will determine the
liquidity of each investment using various factors such as (1) the frequency of
trades and quotations, (2) the number of dealers and prospective purchasers in
the marketplace, (3) dealer undertakings to make a market, (4) the nature of the
security (including any demand or tender features) and (5) the likelihood of
continued marketability and credit quality of the issuer.
OPTIONS AND FUTURES CONTRACTS. Each Fund may purchase and sell covered put and
call options on one or more of securities and securities indexes, interest rate,
foreign currency (in the case of the EuroDirect and Emerging Markets Bond Funds)
and index futures contracts (agreements to take or make delivery of a specified
quantity of financial instruments
20
<PAGE> 21
at a specified price and date), and put and call options on such futures
contracts. Such options and futures contracts are derivative instruments which
may be traded on U.S. or foreign exchanges or with broker/dealers which maintain
markets for such investments. Each Fund may also employ combinations of put and
call options, including without limitation, straddles, spreads, collars, and
strangles. Further information regarding these techniques may be found in the
Statement of Additional Information. These techniques are used to hedge against
changes in interest rates, foreign currency exchange rates or securities prices
in order to establish more definitely the effective return on securities or
currencies held or intended to be acquired by a Fund, to reduce the volatility
of the currency exposure associated with investment in non-U.S. securities, or
as an efficient means of adjusting exposure to the bond and currency markets and
not for speculation. In addition to the hedging transactions referred to above,
each of the Funds may enter into options and futures transactions to enhance
potential gain in circumstances where hedging is not involved.
An equity index, such as the S&P 500 Index, is a statistical measure designed to
reflect specified facets of a particular financial or securities market.
An index futures contract is an agreement pursuant to which two parties agree to
take or make delivery of an amount of cash equal to the difference between the
value of the index at the close of the last trading day of the contract and the
price at which the index contract was originally written.
An interest rate or currency futures contract provides for the delivery by one
party and the purchase by another party of a specified quantity of a financial
instrument or currency at a specified future date and price. Although the value
of a futures contract may be a function of the value of certain specified
securities or currencies, no physical delivery of these securities or currencies
is made. Such futures contracts are derivative instruments which may be traded
on U.S. exchanges or with broker-dealers which maintain futures markets. Upon
entering into a futures contract, the Fund will be required to deposit with its
custodian in a segregated account in the name of its futures broker a specified
amount of cash or securities. This amount is known as "initial margin", and is
in the nature of a performance bond or good faith deposit on the contract which
is returned to the Fund upon termination of the contract, assuming all
contractual obligations have been satisfied. Subsequent payments, called
"variation margin" to and from the broker, will be made on a daily basis as the
price of the index fluctuates, making the position in the futures contract more
or less valuable, a process known as "marking to market".
INTEREST RATE, INDEX AND CURRENCY SWAPS. Each of the Emerging Markets Bond and
EuroDirect Funds may enter into interest rate, index and currency swap
transactions and purchase or sell caps and floors. An interest rate, index or
currency swap is a derivative instrument which involves an agreement between a
Fund and another party to exchange payments calculated as if they were interest
on a fictitious ("notional") principal amount (e.g., an exchange of floating
rate payments by one party for fixed rate payments by the other). A cap or floor
is a derivative instrument which entitles the purchaser, in exchange
21
<PAGE> 22
for a premium, to receive payments of interest on a notional principal amount
from the seller of the cap or floor, to the extent that a specified reference
rate or reference index exceeds or falls below a predetermined level.
A Fund usually enters into such transactions on a "net" basis, with the Fund
receiving or paying, as the case may be, only the net amount of the two payment
streams. The net amount of the excess, if any, of a Fund's obligations over its
entitlements with respect to each swap is accrued on a daily basis, and an
amount of cash or liquid assets having an aggregate net asset value at least
equal to the accrued excess is maintained in a segregated account by the Group's
Custodian. If a Fund enters into a swap on other than a net basis, or sells caps
or floors, the Fund maintains a segregated account in the full amount accrued on
a daily basis of the Fund's obligations with respect to the transaction. Such
segregated accounts are maintained in accordance with applicable regulations of
the Securities and Exchange Commission.
EQUITY SWAP CONTRACTS. The EuroDirect Fund may enter into equity swap
transactions. An equity swap is a derivative instrument which involves an
agreement between a Fund and another party to exchange payments calculated as if
they were interest on a fictitious ("notional") principal amount. The Fund will
typically pay a floating rate of interest, such as the three-month London
Interbank Offered Rate, and receive the total return, i.e., price change plus
dividends, of a specified equity index, such as the S&P 500 Index. If the total
return on the equity index is negative for the contract period, the Fund will
pay its counterparty the amount of the loss in the value of the notional amount
plus interest at the floating rate. From time to time, the Fund may wish to
cancel an equity swap contract in order to reduce its equity exposure. Although
the swap contract may be sold back to the Fund's counterparty, it may be more
advantageous to enter into a swap contract in which the Fund would reduce its
equity exposure by agreeing to receive a floating rate of interest and pay the
change in the index. This is sometimes called a "reverse equity swap contract"
and would only be entered into to reduce equity exposure. None of the Funds will
use reverse swap contracts to short the equity market.
A Fund usually enters into such transactions on a "net" basis, with the Fund
receiving or paying, as the case may be, only the net amounts of the two payment
streams. The net amount of the excess, if any, of the Fund's obligations over
its entitlements with respect to each swap is accrued on a daily basis, and an
amount of cash or liquid assets having an aggregate net asset value at least
equal to the accrued excess is maintained in a segregated account by the Fund's
Custodian. If the Fund enters into a swap on other than a net basis, the Fund
maintains a segregated account in the full amount accrued on a daily basis of
the Fund's obligations with respect to the transaction. Such segregated accounts
are maintained in accordance with applicable regulations of the Securities and
Exchange Commission.
DEPOSITORY RECEIPTS. The EuroDirect Fund may invest in foreign issuers through
sponsored American Depository Receipts ("ADRs"), European Depository Receipts
("EDRs") and Global Depository Receipts ("GDRs"). Generally, an ADR is a
dollar-denominated security issued by a U.S. bank or trust company which
represents, and may be converted into,
22
<PAGE> 23
the underlying security that is issued by a foreign company. Generally, an EDR
represents a similar securities arrangement but is issued by a European bank,
while GDRs are issued by a depository. ADRs, EDRs and GDRs may be denominated in
a currency different from the underlying securities into which they may be
converted. Typically, ADRs, in registered form, are designed for issuance in
U.S. securities markets and EDRs, in bearer form, are designed for issuance in
European securities markets.
ADRs may be sponsored by the foreign issuer or may be unsponsored. Unsponsored
ADRs are organized independently and without the cooperation of the foreign
issuer of the underlying securities; as a result, available information
regarding the issuer may not be as current as for sponsored ADRs, and the prices
of unsponsored ADRs may be more volatile than if they were sponsored by the
issuers of the underlying securities.
FOREIGN CURRENCY TRANSACTIONS. Each of the Emerging Markets Bond and EuroDirect
Funds normally conduct their foreign currency exchange transactions either on a
spot (cash) basis at the spot rate prevailing in the foreign currencies or on a
forward basis. Under normal circumstances, the Adviser and Sub-adviser expect
that each of these Funds will enter into forward currency contracts (contracts
to purchase or sell a specified currency at a specified future date and price).
Neither of these Funds will generally enter into a forward contract with a term
of greater than one year. Although forward contracts are used primarily to
protect a Fund from adverse currency movements, they may also be used to
increase exposure to a currency, and involve the risk that anticipated currency
movements will not be accurately predicted and a Fund's total return will be
adversely affected as a result. Open positions in forward contracts are covered
by the segregation with the Group's Custodian of cash, U.S. Government
securities or other debt obligations and are marked-to-market daily.
TEMPORARY DEFENSIVE MEASURES. During times when the Adviser or Sub-adviser
believes that a temporary defensive posture is warranted, each Fund may hold
part or all of its assets in cash, U.S. Government and Government agency
securities, money market obligations, short-term corporate debt securities and
money market funds. When the assets of a Fund are so invested, the Fund may not
be achieving its investment objectives.
ADDITIONAL RISK FACTORS
DIVERSIFICATION. As the Adviser or Sub-adviser may from time to time invest a
large percentage of each Fund's assets in securities of a limited number of
issuers, each Fund has been classified as "non-diversified". As provided in the
Investment Company Act of 1940, a diversified fund has, with respect to at least
75% of its total assets, no more than 5% of its total assets invested in the
securities of one issuer, plus cash, Government securities, and securities of
other investment companies. Accordingly, each Fund may be more susceptible to
risks associated with a single economic, political or regulatory occurrence than
a diversified investment company. However, each Fund intends to qualify as a
"regulated investment company" under the Internal Revenue Code, and therefore
will be subject to diversification limits requiring that, as of the close of
each fiscal quarter, (i) no more than 25% of its total
23
<PAGE> 24
assets may be invested in the securities of a single issuer (other than U.S.
Government securities), and (ii) with respect to 50% of its total assets, no
more than 5% of such assets may be invested in the securities of a single issuer
(other than U.S. Government securities) or invested in more than 10% of the
outstanding voting securities of a single issuer.
STATE RISK FACTORS - CALIFORNIA. Since the California Municipal Income Fund
primarily invests in California Municipal Securities, an investment in the Fund
may involve more risk than an investment in a fund that does not concentrate its
investments in securities relating to a single state. The Fund's performance is
closely tied to the continuing ability of issuers of California Municipal
Securities to meet their debt obligations and to the economic and political
conditions within California.
California's diverse economic base has continued to recover from the recession
of the early 1990's, when the state experienced significant job losses and
general fund deficits. While California's financial performance has improved in
recent years, its fiscal operations have remained vulnerable. Increased funding
for schools, prisons, and social services, and reduced Federal aid levels have
offset some of the growth in revenues that has resulted from the improving
economy. The state's budget approval process, which requires a two-thirds
legislative vote, has also hampered the state's financial stability. In the
past, California voters have passed amendments to the state's constitution and
other measures that have limited the taxing and spending authority of various
government entities in California. Future voter initiatives may adversely affect
issuers of California Municipal Securities.
In recent years, certain issuers of California Municipal Securities have
experienced financial difficulties, such as the 1994 bankruptcy of Orange
County. A recurrence of these financial difficulties could adversely affect the
market values and marketability of certain California Municipal Securities, as
well as the net asset value of the Fund.
For more information about California's economy and the potential risks to the
Fund in investing in California Municipal Securities, please see the Statement
of Additional Information.
SWAPS. No Fund enters into any swap, cap or floor transaction unless the
unsecured senior debt or the claims paying ability of the other party to the
transaction is rated at least "A" at the time of purchase by at least one of the
established rating agencies. The swap market has grown substantially in recent
years, with a large number of banks and investment banking firms acting both as
principals and agents utilizing standard swap documentation, and the Adviser has
determined that the swap market has become relatively liquid. Swap transactions
do not involve the delivery of securities or other underlying assets or
principal, and the risk of loss with respect to such transactions is limited to
the net amount of payments that a Fund is contractually obligated to make or
receive. Caps and floors are more recent innovations for which standardized
documentation has not yet been developed and, accordingly, they are less liquid
than swaps. A Fund will not enter into a swap transaction at any time that the
aggregate amount of its net obligations under such transactions exceeds 15% of
its total assets. The
24
<PAGE> 25
aggregate purchase price of caps and floors held by a Fund may not exceed 5% of
its total assets at the time of purchase, and they are considered by the Fund to
be illiquid assets; it may sell caps and floors without limitation other than
the segregated account requirement described above.
The use of swaps, caps and floors is a highly specialized activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser's forecast of market
values, interest rates, currency rates of exchange and other applicable factors
is incorrect, the investment performance of a Fund will diminish compared with
the performance that could have been achieved if these investment techniques
were not used. Moreover, even if the Adviser's or Sub-adviser's forecasts are
correct, a Fund's swap position may correlate imperfectly with an asset or
liability being hedged. In addition, in the event of a default by the other
party to the transaction, a Fund might incur a loss.
DEBT OBLIGATIONS. Each of the Funds invests, or may invest, primarily in debt
obligations. Because of its investment policies, each Fund may or may not be
suitable or appropriate for all investors. The Funds are not money market funds
and are not appropriate for those whose primary objective is stability of
principal. The value of the portfolio securities of each Fund will fluctuate
based upon market conditions.
In general and except as noted below under "Below Investment Grade Debt
Obligations," all debt securities held by each of the EuroDirect and California
Municipal Income Funds are rated "investment grade" at the time of purchase by
at least one of the established rating agencies (e.g., AAA, AA, A or BBB by
Standard & Poor's) or, if unrated, are determined to be of comparable quality by
the Adviser or Sub-adviser. Securities rated BBB are considered to have adequate
capacity to pay interest and repay principal, but adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity to pay
interest and principal than higher rated bonds.
BELOW INVESTMENT GRADE DEBT OBLIGATIONS. The Emerging Markets Bond Fund will
invest substantially all of its total assets in below investment grade debt
obligations, or in unrated securities determined by the Adviser to be of
comparable quality. In addition, the California Municipal Income Fund may invest
up to 25% of its assets and the EuroDirect Fund may invest up to 5% of its
assets in debt obligations rated below investment grade, or, if unrated,
securities determined by the Adviser to be of comparable quality. Lower quality
debt securities are often considered to be speculative and involve a greater
risk of default or price changes due to changes in the issuer's
creditworthiness. The market prices of these securities may fluctuate more than
investment grade securities and may decline significantly in periods of general
economic difficulty. Further information regarding investment ratings is in the
appendix.
FOREIGN INVESTMENTS. Each of the Emerging Markets Bond and EuroDirect Funds
invests principally in securities of foreign issuers. In addition, each of these
Funds may invest
25
<PAGE> 26
in securities that are denominated in foreign currencies. Investments in foreign
bond and equity securities present opportunities for both increased benefits and
risks as compared to investments in the U.S. securities market.
Securities markets in different countries may offer enhanced diversification of
investors' portfolios because of differences in economic, financial, political
and social factors. Each of the Emerging Markets Bond and EuroDirect Funds
allows an investor to diversify its portfolio by investing in various companies
and economies outside of the U.S., thereby taking advantage of these
differences. However, investing in securities of foreign issuers involves
certain risks and considerations not typically associated with investing in
securities of U.S. issuers. These risks may include less publicly available
information and less governmental regulation and supervision of foreign stock
exchanges, brokers and issuers. Foreign issuers are not usually subject to
uniform accounting, auditing and financial reporting standards, practices and
requirements. Securities of foreign issuers are subject to the possibility of
expropriation, nationalization, confiscatory taxation, adverse changes in
investment or exchange control regulation, political instability and
restrictions in the flow of international capital. Securities of some foreign
issuers are less liquid and their prices more volatile than the securities of
U.S. companies. In addition, the time period for settlement of transactions in
foreign securities may be longer than domestic securities. It may also be more
difficult to obtain and enforce judgments against foreign entities.
Investing in the debt obligations of supranational organizations involves
additional risks and considerations. Such organizations' debt obligations are
generally not guaranteed by their member governments, and payment depends on the
willingness and ability of their member governments to support their
obligations. Continued support of a supranational organization by its government
members is subject to a variety of political, economic and other factors, as
well as the financial performance of the organization.
Changes in foreign exchange rates will affect the value of the securities held
in the Emerging Markets Bond and EuroDirect Funds either beneficially or
adversely. Fluctuations in foreign currency exchange rates will also affect the
value of dividends and interest earned, gains and losses realized on the sale of
securities and net investment income and gains, if any, distributed to
shareholders. Some foreign fixed income markets offering attractive returns may
be denominated in currencies which appear relatively weak or are potentially
volatile compared to the U.S. dollar. Each of these Funds will, when deemed
appropriate by the Adviser or Sub-Adviser, hedge this currency exposure in order
to protect the Fund's share price.
Each of the Emerging Markets Bond and EuroDirect Funds are expected to incur
operating expenses which are higher than those of mutual funds investing
exclusively in U.S. equity securities, since expenses such as brokerage
commissions and custodial fees related to foreign investments are usually higher
than those associated with investments in U.S. securities. In addition,
dividends and interest from foreign securities may be subject to foreign
withholding taxes. See "Dividends, Distributions and Taxes."
26
<PAGE> 27
If the U.S. government were to impose any restrictions, through taxation or
other means, on foreign investments by U.S. investors such as those to be made
through each of the Emerging Markets Bond and EuroDirect Funds, the Board of
Trustees will promptly review the policies of each of these Funds to determine
whether significant changes in the portfolio of the particular Fund is
appropriate.
The Adviser or Sub-adviser employs a variety of investment techniques to control
the exposure of the EuroDirect Fund to foreign currency exchange risks. An
increase in value of a foreign currency relative to the U.S. dollar (the
"weakening" of the dollar) increases the U.S. dollar value of securities
denominated in that foreign currency. Conversely, a decline in the value of a
foreign currency relative to the U.S. dollar (the "strengthening" of the dollar)
causes a decline in the U.S. dollar value of these securities. The Adviser or
Sub-adviser seeks to use combinations of forward foreign currency contracts,
foreign currency futures contracts and options on futures contracts, options on
foreign currencies, and currency swap agreements to offset the impacts of such
movements. These investment techniques involve certain risks described under
"Investment Practices" above.
EMERGING MARKETS. The Emerging Markets Bond Fund will invest substantially all
of its assets, and the EuroDirect Fund may invest a portion of its assets, in
securities of issuers organized or headquartered in emerging market countries,
which may include developing countries or countries with new or developing
capital markets. The considerations noted above under "Foreign Investments" are
generally intensified for these investments. These countries may have relatively
unstable governments, economies based on only a few industries, and securities
markets that trade a small number of securities, thereby making it difficult to
conduct such transactions. Brokerage commissions, custodial services and other
similar investment costs are generally more expensive than in the United States.
In addition, securities of issuers located in these countries tend to have
volatile prices and may offer significant potential for loss as well as gain.
BRADY BONDS. Each of the Emerging Markets Bond and EuroDirect Funds may invest a
portion of its assets in Brady bonds. Brady bonds are bonds issued as a result
of a restructuring of a country's debt obligations to commercial banks under the
"Brady plan." Brady bonds have been issued by the governments of a number of
countries, including Poland, Mexico and the Philippines, as well as other
emerging market countries. Most Brady bonds are currently rated below BBB by S&P
or Baa by Moody's. While the Adviser is not aware of the occurrence of any
payment defaults on Brady bonds, investors should recognize that these debt
securities have been issued only recently and, accordingly, do not have a long
payment history. Brady bonds may be collateralized or uncollateralized, are
issued in various currencies (primarily the U.S. dollar) and are actively traded
in the secondary market for such debt.
OPTIONS AND FUTURES CONTRACTS. Transactions in securities options, futures
contracts and options on futures contracts involve a variety of risks, including
the inability to close out a position because of the lack of a liquid market
and, in the case of futures transactions, lack of correlation between price
movements in the hedging vehicle and the
27
<PAGE> 28
portfolio assets being hedged. To the extent that a Fund enters into futures
contracts, options on futures contracts or options on foreign currencies, in
each case other than for bona fide hedging purposes (as defined by the Commodity
Futures Trading Commission), the aggregate initial margin and premiums required
to establish those positions (excluding the amount by which options are
"in-the-money") will not exceed 5% of the liquidation value of the Fund's
portfolio, after taking into account unrealized profits and unrealized losses on
any contracts the Fund has entered into. Each Fund covers its obligations with
respect to such futures contracts and options by maintaining assets sufficient
(together with its margin deposits) to meet such obligations; depending on the
nature of the contract or option, this cover is in the form of liquid assets,
put or call options, the underlying instruments which are the subject of the
contract or option, or a long or short position in the contract which is the
subject of an option. Options and futures transactions can be highly volatile
and could result in reduction of a Fund's total return, and a Fund's attempt to
use such instruments for hedging purposes may not be successful. The aggregate
market value of a Fund's portfolio securities and foreign currencies covering
put options on securities and currencies written by the Fund will not exceed 50%
of its net assets.
Year 2000
The date-related computer issue known as the "Year 2000 problem" could have an
adverse impact on the quality of services provided to the Funds and their
shareholders. However, the Funds understand that their key service providers,
including the Adviser and its affiliates and the Sub-adviser, are taking steps
to address the issue. In addition, the Year 2000 problem may adversely affect
the issuers in which the Funds invest. For example, issuers may incur
substantial costs to address the problem. They may also suffer losses caused by
corporate and governmental data processing errors. The Funds and the Adviser and
Sub-adviser will continue to monitor developments relating to this issue.
Euro Introduction
On January 1, 1999, the European Union will introduce a single European
currency, the Euro. The first group of countries that will begin to convert
their currencies to the Euro include Austria, Belgium, Finland, France, Germany,
Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. The expected
introduction of the Euro presents unique uncertainties, including: whether the
payment and operational systems of banks and other financial institutions will
be ready by he scheduled launch date; the legal treatment of certain outstanding
financial contracts after January 1, 1999 that refer to existing currencies
rather than the Euro; and the creation of suitable clearing and settlement
payment systems for the new currency. These or other factors, including
political and economic risks, could cause market disruptions before or after the
introduction of the Euro. Each of the Emerging Markets Bond and EuroDirect Funds
understands that the Adviser, Sub-adviser and other key service providers are
taking steps to address Euro-related issues.
28
<PAGE> 29
OTHER INVESTMENT POLICIES
Each Fund's investment program and policies are subject to further restrictions
and risks which are described in the Statement of Additional Information. Each
Fund's investment objective is fundamental and, therefore, may not be changed
without obtaining shareholder approval. A Fund's other investment policies and
practices may be changed without shareholder approval unless otherwise specified
as fundamental policies.
FUNDAMENTAL INVESTMENT POLICIES. As a matter of fundamental policy, a Fund will
not (1) purchase a security of any issuer if, as a result, with respect to 50%
of the Fund's total assets, more than 10% of the outstanding voting securities
of the issuer would be held by the Fund (other than obligations issued or
guaranteed by the U.S. government, its agencies or instrumentalities); (2)
borrow money except for temporary, extraordinary or emergency purposes or for
the clearance of transactions in amounts not exceeding 30% of its total assets
valued at market (For this purpose, reverse repurchase agreements and delayed
delivery transactions covered by segregated accounts as described above are not
considered to be borrowings.); or (3) in any manner transfer as collateral for
indebtedness any security of the Fund except in connection with permissible
borrowings. Each foreign government and supranational organization is considered
to be an industry.
OTHER INVESTMENT POLICIES. As a matter of operating policy, a Fund will not (1)
purchase a security of any one issuer if, as a result, (a) more than 15% of the
value of its net assets would be invested in illiquid securities, including
repurchase agreements which do not provide for payment within seven days or
other securities which are not readily marketable; or (b) with respect to each
of the EuroDirect and California Intermediate Municipal Income Funds, more than
5% of the value of the Fund's total assets would be invested in the securities
of unseasoned issuers which at the time of purchase have been in operation for
less than three years, including predecessors and unconditional guarantors; or
(2) purchase additional securities when borrowings exceed 5% of the Fund's total
assets. In addition, each of the Funds will not purchase any security which
would cause 25% or more of the value of the Fund's total assets at the time of
purchase to be invested in the securities of any one or more issuers conducting
their principal business activities in the same industry, provided that (a)
there is no limitation with respect to U.S. Government obligations and
repurchase obligations secured by such obligations, (b) wholly owned finance
companies will be considered to be in the industries of their parents, and (c)
utilities will be divided according to their services (for example, gas, gas
transmission, electric and telephone will each be considered a separate
industry). Each foreign government and supranational organization is considered
to be an industry.
PORTFOLIO TURNOVER. Securities may be sold without regard to the length of time
held. The portfolio turnover of each Fund may be higher than that of other
mutual funds with less aggressive trading strategies, which would, in turn,
increase each Fund's transaction costs. No Fund can accurately predict its
future annual portfolio turnover rate; however,
29
<PAGE> 30
although it could vary substantially, it will generally not exceed (a) 200% for
the EuroDirect Fund and (b) 100% for each of the Emerging Markets Bond and
California Municipal Income Funds. To the extent that short-term trading results
in the realization of short-term capital gains, shareholders will be taxed on
such gains at ordinary income tax rates.
MANAGEMENT OF THE FUNDS
The business of the Group is managed under the direction of its Board of
Trustees, which establishes the Group's policies and supervises and reviews the
management of the Funds. Information about the Trustees and the Group's
executive officers may be found in the Statement of Additional Information.
INVESTMENT ADVISER
Payden & Rygel serves as investment adviser to the Funds pursuant to an
investment management contract with the Group. The Adviser is an investment
counseling firm founded in 1983, and currently has over $27 billion of assets
under management. Payden & Rygel's address is 333 South Grand Avenue, Los
Angeles, California 90071. It is registered as an investment adviser with the
Securities and Exchange Commission and as a commodity trading adviser with the
Commodity Futures Trading Commission.
The Adviser manages the investment and reinvestment of the assets of the Group's
portfolios and reviews, supervises and administers all investments. Several
teams, each responsible for a group of the Group's portfolios, are responsible
for the day-to-day management of the Group's portfolios within the broad
investment parameters established by the Adviser's Global Investment Policy
Committee (except for the EuroDirect Fund and certain other portfolios of the
Group which are managed by the Sub-adviser). These teams are supervised by the
Executive Committee of the Global Investment Policy Committee, comprised of John
Isaacson, Scott Weiner, Scott King and Christopher Orndorff.
John Isaacson is an Executive Vice President and the Chief Investment Officer of
Payden & Rygel. He joined the Company in 1988 and has 25 years of experience in
the investment business. Scott King is an Executive Vice President and the Head
of Trading at Payden & Rygel. He was one of the original members of the Company
when it was founded in 1983 and has over 17 years of investment experience.
Christopher Orndorff is a Senior Vice President and head of Global Asset
Allocation at Payden & Rygel. He joined the company in 1990 and has 13 years of
experience in the investment business. Mr. Weiner is a Senior Vice President who
joined the Company in 1993 and has 12 years of experience in the investment
business. Mr. Isaacson, Mr. King, Mr. Weiner and Mr. Orndorff are responsible
for defining the broad investment parameters of the Funds, including the types
of strategies to be employed and the range of securities acceptable for
investment.
Each of the teams analyzes investment opportunities and strategies, and makes
portfolio management decisions (subject to prior review of significant decisions
by the Global
30
<PAGE> 31
Investment Policy Committee) and applies them to portfolios. The strategy teams
and the Funds for which they are responsible are the Tax Exempt Group for the
California Municipal Income Fund; and the Bond Strategy Group for the Emerging
Markets Bond Fund.
The Adviser receives a monthly fee from each Fund at the following annual rates:
Emerging Markets Bond Fund, 0.45% of average daily net assets; EuroDirect Fund,
0.65% of the first $1 billion of average daily net assets, and 0.55% thereafter;
and California Municipal Income Fund, 0.32% of the first $1 billion of average
daily net assets and 0.25% thereafter.
THE SUB-ADVISER
The Adviser has entered into a Sub-Advisory Agreement with Metzler-Payden, LLC
("Metzler/Payden"), appointing the latter as sub-investment manager for the
EuroDirect Fund and delegating to Metzler/Payden the day-to-day management
responsibilities for managing the investment and reinvestment of the assets of
the EuroDirect Fund. The Adviser monitors and evaluates the performance of
Metzler/Payden.
Metzler/Payden, located at 333 South Grand Avenue, 31st Floor, Los Angeles,
California 90071, is a joint venture between the Adviser and Metzler Asset
Management GmbH, an affiliate of B. Metzler seel. Sohn & Co. Holding AG
("Metzler") of Frankfurt, Germany, a major German financial institution.
Metzler/Payden is owned 50% by the Adviser and 50% by MP&R Ventures, Inc. a
Metzler affiliate. Metzler Asset Management is one of the leading investment
managers in Germany, managing assets totaling over DM11 billion for
institutional clients and mutual funds, including European equity and balanced
funds.
Metzler/Payden's Investment Policy Committee is comprised of Rolf Knigge, Rainer
Matthes, Klaus Hagedorn and Nader Purschaker from Metzler, and Messrs.,
Isaacson, King, Orndorff and Weiner from the Adviser. Mr. Knigge, with thirteen
years of investment experience, is Head of Equities at Metzler, where he has
worked since 1995. Mr. Matthes joined Metzler in 1993, is head of Conceptual
Portfolio Management and has seven years of investment experience. Mr. Hagedorn,
with twenty-nine years of investment experience, has been at Metzler since 1988
and is Head of Investment Strategy. Mr. Purschaker is Fixed Income Product
Manager at Metzler. He has been there since 1997 and has six years of investment
experience.
The Investment Policy Committee is responsible for setting the broad investment
parameters or policies applicable to each of the firm's clients, including the
EuroDirect Fund. A team of Metzler/Payden personnel is responsible for the
day-to-day management of the Fund within the broad investment parameters
established by the Sub-adviser's Investment Policy Committee. Metzler/Payden,
which is an SEC registered investment adviser, does not currently act as
investment adviser to any other investment company.
The Adviser pays the Sub-adviser a monthly fee equal to 100% of the advisory fee
earned and received by the Adviser for its investment advisory services to the
EuroDirect Fund, The sub-
31
<PAGE> 32
investment management fee is not an additional charge or assessment against the
EuroDirect Fund.
ADMINISTRATOR AND TRANSFER AGENT
Treasury Plus, Inc., a wholly owned subsidiary of the Adviser, serves as the
Administrator to the Funds pursuant to a management and administration contract
with the Group. The Administrator's address is 333 South Grand Avenue, Los
Angeles, California 90071. The Administrator provides administrative services to
each Fund, including administrative and clerical functions, certain shareholder
servicing functions and supervision of the services rendered to each Fund by
other persons.
Investors Fiduciary Trust Company ("IFTC"), a Missouri trust company located at
801 Pennsylvania, Kansas City, Missouri, 64105, provides accounting, dividend
disbursing and transfer agency services to each Fund pursuant to fund accounting
and transfer agency contracts with the Group.
For providing administrative services to the Group, the Administrator receives a
monthly fee at the annual rate of 0.06% of the daily net assets of the Group.
IFTC receives fees for fund accounting services and dividend disbursing and
transfer agency services. Certain out-of-pocket expenses are also reimbursed at
actual cost.
Advisory and administrative fees generally will be charged to each class of
shares based upon the assets of that class. Expenses attributable to a single
class of shares will be charged to that class.
DISTRIBUTOR
Shares of the Funds are distributed through Payden & Rygel Distributors, a
wholly owned subsidiary of Payden & Rygel located at the same address. The
Distributor is a broker-dealer registered with the Securities and Exchange
Commission and is a member of the National Association of Securities Dealers,
Inc.
PERFORMANCE INFORMATION
Each of the Funds may, from time to time, include the yield and total return for
its Class R Shares in advertisements or reports to shareholders or prospective
investors. Yield will be quoted using the SEC definition, which is the
annualized net investment income per share during a particular 30-day (or one
month) period. Quotations of average annual total return will be expressed in
terms of the average annual compounded rate of return of a hypothetical
investment in a Fund over specified periods.
32
<PAGE> 33
OFFERING
Copies of the Group's 1998 Annual Report to Shareholders are available without
charge by writing or calling the Group at the address and phone number listed in
the front of this prospectus.
No dealer, sales representative or other person has been authorized to give any
information or to make any representations, other than those contained in this
Prospectus, in connection with the offer contained herein, and, if given or
made, such other information or representations may not be relied upon as having
been authorized by the Group or the Distributor. This Prospectus does not
constitute an offer by the Group or the Distributor to sell, or a solicitation
of an offer to buy, any of the securities offered hereby in any jurisdiction to
any person to whom it is unlawful to make such offer in such jurisdiction.
SHAREHOLDER SERVICES
TAX-SHELTERED RETIREMENT PLANS
The Funds accept purchases of shares by tax-sheltered retirement plans such as
IRAs, rollover IRAs, Keogh or corporate profit sharing plans, Simplified
Employee Pension plans, 403(b) and 401(k) plans. Please call a Fund
Representative to receive a retirement package which includes a special
application for tax-sheltered accounts. The Group does not provide fiduciary
administration or custody for such plans. The Group currently waives the
Fiduciary Administration Fees charged by IFTC associated with such plans.
EXCHANGE PRIVILEGE
The Group currently consists of twenty-one investment portfolios with varying
investment objectives or policies, and other investment portfolios may be
created. Shares of a Fund may be exchanged for any class of shares of any of the
other investment portfolios of the Group. Exchanges are made on the basis of the
net asset values of the portfolios involved. The minimum amount for any exchange
is $1,000.
Because an exchange is considered a redemption and purchase of shares, the
shareholder may realize a gain or loss for federal income tax purposes. Before
making an exchange into another investment portfolio, a shareholder should
obtain and review a current prospectus of the investment portfolio into which
the shareholder wishes to transfer. When exchanging shares into another
investment portfolio, shareholders should be aware that, among other significant
differences, the portfolios may have different dividend payment dates, minimum
initial investments and minimum additional investments.
Exchanges will be effected upon receipt of written instructions signed by all
account owners. In addition, shareholders who complete the telephone privilege
authorization portion of the
33
<PAGE> 34
Account Registration Form may effect exchanges from a Fund into another class of
the Fund or an identically registered account in one of the other available
portfolios by a telephone call to the Distributor at (213) 625-1900 or (800)
5PAYDEN (800-572-9336). Finally, shareholders may participate in the Automatic
Exchange Plan to automatically redeem a fixed amount from one Fund for
investment in another Fund on a regular basis. See "Automated Investment
Programs."
The Exchange Privilege may be modified or discontinued by the Group at any time
upon 60 days' notice to shareholders. The Group also reserves the right to limit
the number of exchanges a shareholder may make in any year to avoid excessive
Fund expenses. The Exchange Privilege is only available in states where the
exchange may be legally made.
TELEPHONE PRIVILEGE
All shareholders may exchange or redeem shares by telephone if they have elected
this option on the Account Registration Form. If a shareholder calls before 1:00
p.m. (Pacific Time), the exchange or redemption will be at the net asset value
determined that day; if a shareholder calls after 1:00 p.m. (Pacific Time), the
exchange or redemption will be at the net asset value determined on the next
business day. During periods of drastic economic or market changes, it is
possible that the telephone exchange privilege may be difficult to implement. In
this event, shareholders should follow the other exchange and redemption
procedures discussed in this prospectus.
Shareholders should realize that by electing the telephone privilege they may be
giving up a measure of security that they may have if they were to exchange or
redeem their shares in writing. The Group will employ procedures designed to
provide reasonable assurance that instructions communicated by telephone,
telegraph or wire communication are genuine and, if it does not do so, it may be
liable for any losses due to unauthorized or fraudulent instructions. The Group
reserves the right to refuse a telephone, telegraph or wire communication
exchange or redemption request if it believes that the person making the request
is not authorized by the investor to make the request. Neither the Group nor its
agents will be liable for any loss, liability or cost which results from acting
upon instructions of a person reasonably believed to be a shareholder with
respect to the telephone, telegraph or wire communication privilege.
AUTOMATED INVESTMENT PROGRAMS
All shareholders may take advantage of two programs which permit automated
investments in the Group's Funds.
ELECTRONIC INVESTMENT PLAN. If authorized by the shareholder, additional
investments in any Fund may be made using the Automated Clearing House System
("ACH") which transfers money directly from the shareholder's bank account to
the Fund for investment. Initial investments in any Fund may not be made through
ACH.
34
<PAGE> 35
The ACH is an electronic money transfer system that is used throughout the
United States. It is easy, convenient, inexpensive and avoids the potential of
theft of checks from the postal system. It is used by many employers to pay
salaries and is also used by the United States Government to send social
security payments directly into retiree accounts.
Two investment options may be chosen. First, the shareholder may elect to make
investments on a set schedule either monthly or quarterly. Under this option,
the shareholder's financial institution will deduct an amount authorized by the
shareholder which will normally by credited to the Fund on the 15th day of the
month (or next business day if the 15th is a holiday or on a weekend). The
shareholder's bank account will typically be debited the prior business day,
although this varies with each financial institution. The minimum initial
investment, which may be made by check or wire, is $2,500, with additional
investments by ACH of no less than $250.
Under the second option, the shareholder may also elect to authorize ACH
transfers via telephone request. Money will be withdrawn from the shareholder's
account only when authorized by the shareholder. There will be no set schedule
of withdrawals from the shareholder's account. Additionally, the investor may
vary the amount of the investment. Under this option, the minimum initial
investment is $5,000, with additional investments by ACH no less than $1,000.
Due to operational considerations, for telephonic requests received prior to
12:30 p.m. (Pacific Time), the investment will be at the net asset value
determined on the next business day. For telephonic requests received after
12:30 p.m. (Pacific Time), the investment will be at the net asset value
determined on the second business day following receipt of the call.
Please note the following guidelines:
- - The shareholder's financial institution must be a member of the
Automated Clearing House System.
- - The shareholder must complete and return an Automated Investment Program
form along with a voided check or deposit slip at least 15 days prior to
the initial transaction.
- - An account with the Group must be established before the Electronic
Investment Plan goes into effect.
- - The Electronic Investment Plan will automatically terminate if all
shares are redeemed, or if the shareholder's financial institution
rejects the transfer for any reason, e.g., insufficient funds.
- - Termination must be in writing and will become effective the month
following receipt.
35
<PAGE> 36
AUTOMATIC EXCHANGE PLAN. Shareholders may participate in the Automatic Exchange
Plan to automatically redeem a fixed amount from one Fund for investment in
another portfolio of the Group on a regular basis. The shareholder elects this
option by completing an Automated Investment Programs form to determine the
periodic schedule (monthly or quarterly) and exchange amount (minimum amount of
$1,000) and to identify the portfolio of the Group in which the investment is to
be made. The automatic transfer is effected on the 15th day (or the next
business day if the 15th is a holiday or on a weekend) of the month.
SHAREHOLDER INQUIRIES
Shareholders with inquires concerning any of the Funds or other portfolios of
the Group may call the Group at (213) 625-1900, or (800) 5PAYDEN, or write to
Payden & Rygel Investment Group, 333 South Grand Avenue, Los Angeles, CA 90071.
REDEMPTION OF SHARES
Each Fund will redeem its shares at the net asset value next determined
following receipt of the request in proper form. Redemptions may be made in
writing, by calling the Distributor at (800) 5PAYDEN, by telegraph or by other
wire communication. No charge is made for redemptions. Shares redeemed may be
worth more or less than the purchase price of the shares, depending on the
market value of the investment securities held by the Funds at the time of
redemption.
Redemption requests in writing or by telegraph or other wire communications
should be directed to the Group at 333 South Grand Avenue, Attn.: Fund
Distributor, Los Angeles, California 90071. Payment for redemption of recently
purchased shares will be delayed until the Fund is advised that the purchase
check has been honored, which may take up to 15 days after receipt of the check.
If the proceeds of a written request are to be paid to a person other than the
record owner of the shares or are to be sent to an address other than the
address of record, the signature on the request must be guaranteed by a
commercial bank, a trust company or another eligible guarantor institution. A
signature guarantee may be rejected if it is believed to be not genuine or if
there is any reason to believe that the transaction is improper. Payment of the
redemption price will ordinarily be wired to the shareholder's bank or mailed to
the shareholder address of record one business day after receipt of the request.
A $10.00 fee may be charged for any wire transfer, and payment by mail may take
up to seven days. Telephone redemptions may be difficult to implement during
periods of drastic economic or market changes, which may result in an unusually
high volume of telephone calls.
A Fund may suspend the right of redemption or postpone the payment date at times
when the New York Stock Exchange is closed or during certain other periods as
permitted under the federal securities laws.
36
<PAGE> 37
HOW TO PURCHASE SHARES
Shares of the Funds may be purchased at net asset value without a sales charge.
The minimum investment levels per Fund are as set forth below. An account may
only be opened by completing an application and mailing it to the appropriate
address below under "Initial Investment." Shares cannot be purchased until a
properly completed application is received by the Group. If you wish to open a
tax-sheltered retirement plan (such as an IRA), special application forms must
be completed. Please be sure to ask for an IRA information kit. Transaction fees
may be charged for the purchase and/or sale of shares through a broker.
INITIAL INVESTMENT
BY CHECK - ALL FUNDS
- - Complete Application
- - Make check payable to the Fund and mail with application to:
Payden & Rygel Investment Group
P.O. Box 419318
Kansas City, MO 64141-6318
BY FEDERAL FUNDS WIRE
- - Complete application and mail to:
Payden & Rygel Investment Group
P.O. Box 419318
Kansas City, MO 64141-6318
- - Wire Funds as follows when application has been processed:
The Boston Safe Deposit and Trust Company
ABA 011001234
A/C #115762
Mutual Funds #6630
Credit to (name of Payden & Rygel Fund here) For Account of
(insert your account name here)
Please call the Group, at (213) 625-1900 or (800) 5PAYDEN, to advise of any
purchases by wire.
Shares of the Funds are purchased at the net asset value per share for each
class next determined after receipt by the Distributor of an order to purchase
shares in proper form. Purchase orders will be accepted only on days on which
the Funds and the Custodian are open for business, as defined below. The minimum
investment amount may be waived from time to time by the Distributor.
37
<PAGE> 38
All Funds are "open for business" on each day the New York Stock Exchange is
open for trading, which excludes the following holidays: New Year's Day, Martin
Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day.
MINIMUM INVESTMENTS
The minimum initial and additional investments per Fund for each type of account
are as follows:
<TABLE>
<CAPTION>
INITIAL ADDITIONAL
ACCOUNT TYPE INVESTMENT INVESTMENT
- ------------ ---------- ----------
<S> <C> <C>
Regular $ 5,000 $ 1,000
Tax-Sheltered $ 2,000 $ 1,000
Electronic Investment Plan:
Set schedule $ 2,500 $ 250
No set schedule $ 5,000 $ 1,000
</TABLE>
ADDITIONAL INVESTMENTS
Additional investments may be made at any time at net asset value by check, by
ACH, or by calling the Distributor and wiring federal funds to the Custodian as
described above.
OTHER PURCHASE INFORMATION
Purchases of each Fund's shares will be made in full and fractional shares.
Certificates for shares will not be issued. The Group reserves the right, in its
sole discretion, to suspend the offering of shares of any Fund or to reject
purchase orders when, in the judgment of its management, such suspension or
rejection is in the best interest of the Fund; and to redeem shares if
information provided in the client application proves to be incorrect in any
material manner.
38
<PAGE> 39
APPENDIX A
DESCRIPTION OF RATINGS
The following summarizes the descriptions for some of the ratings referred
to in the Prospectus and Statement of Additional Information. The descriptions
for the ratings for municipal securities and commercial paper may be found in
Appendix A to the Statement of Additional Information. Ratings represent only
the opinions of such organizations of the quality of the securities which they
undertake to rate, are general and are not absolute standards of quality.
MOODY'S INVESTORS SERVICE, INC.
The purpose of Moody's ratings is to provide investors with a single system of
gradation by which the relative investment qualities of bonds may be rated.
BONDS
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 risks appear somewhat larger than in Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium grade obligations.
They are neither highly protected nor poorly secured. Interest payments and
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
39
<PAGE> 40
very moderate, and thereby not well safeguarded during both good and bad times
over the future. Uncertainty of position characterizes bonds in this asset
class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
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
short-comings.
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.
Rating Refinements: Moody's may apply numerical modifiers, 1, 2, and 3 in
each generic rating classification from Aa through B in its bond rating system.
The modifier 1 indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and
modifier 3 indicates that the issue ranks in the lower end of its generic rating
category.
STANDARD & POOR'S CORPORATION
A Standard & Poor's 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
ratings are based on current information furnished by the issuer or obtained by
Standard & Poor's from other sources it considers reliable. Standard & Poor's
does not perform any audit in connection with any rating and may, on occasion,
rely on unaudited financial information. The ratings are based, in varying
degrees, on the following considerations: (a) 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; (b) nature of and
provisions of the obligation; and (c) protection afforded by, and relative
position of, the obligation in the event of bankruptcy and other laws affecting
creditors' rights.
BONDS
AAA: Bonds rated AAA have the highest rating assigned by Standard & Poor's.
The obligor's capacity to meet its financial commitment on the obligation (i.e.,
pay interest and repay principal) is extremely strong.
40
<PAGE> 41
AA: Bonds rated AA differ from the highest-rated obligations only in a small
degree. The obligor's capacity to meet its financial commitment on the
obligation (i.e., pay interest and repay principal) is very strong.
A: Bonds rated A are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation (i.e., pay interest and repay principal) is still
strong.
BBB: Bonds rated BBB exhibit adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity of the obligor to meet its financial commitment on the
obligation (i.e., pay interest and repay principal).
BB: Bonds rated BB are less vulnerable to nonpayment than other speculative
issues. However, they face major ongoing uncertainties or exposure to adverse
business, financial, or economic conditions which could lead to the obligor's
inadequate capacity to meet its financial commitment on the obligation (i.e.,
pay interest and repay principal).
B: Bonds rated B are more vulnerable to nonpayment than obligations rated
BB, but the obligor currently has the capacity to meet its financial commitment
on the obligation (i.e., pay interest and repay principal). Adverse business,
financial, or economic conditions will likely impair the obligor's capacity or
willingness to meet its financial commitment on the obligation.
CCC: An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to nonpayment.
C: The C rating may be used to cover a situation where a bankruptcy petition
has been filed or similar action has been taken, but payments on this obligation
are being continued.
D: An obligation rated D is in payment default. The D rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
The Standard & Poor's ratings may be modified by the addition of a plus (+)
or minus (-) sign to show relative standing within the major rating categories.
41
<PAGE> 42
r: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk-such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
FITCH RATINGS
Fitch investment grade bond 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 issue or class of debt 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 guarantees unless
otherwise indicated.
BONDS
AAA: Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA: Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA." Because bonds rated in the
"AAA" and "AA" categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated "F-1 +".
A: Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Debt rated BBB is considered to be of satisfactory credit quality.
Ability to pay interest and principal is adequate. Adverse changes in economic
conditions and circumstances are more likely to impair timely payment than
higher rated bonds.
BB: Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and
42
<PAGE> 43
financial alternatives can be identified, which could assist in the obligor
satisfying its debt service requirements.
B: Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, 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 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 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.
DDD, DD, and D: Bonds are in default on interest and/or principal payments.
Such bonds 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 on these bonds, and "D" represents
the lowest potential for recovery. Plus (+) and minus (-) signs are used with a
rating symbol to indicate the relative position of a credit within the rating
category. Plus and minus signs, however, are not used in the "DDD," "DD," or "D"
categories.
THOMPSON BANK WATCH
Thompson Bank Watch ratings are based upon a qualitative and quantitative
analysis of all segments of the organization, including holding company and
operating subsidiaries.
ISSUER RATINGS
Thompson Bank Watch assigns only one Issuer Rating to each company, based on
consolidated financials. While the rating is blended to be equally applicable to
all operating entities of the organization, there may, in certain cases, be more
liquidity and/or credit risk associated with doing business with one segment of
the company as opposed to another (i.e., holding company vs. subsidiary).
Bank Watch Issuer Ratings are not merely an assessment of the likelihood of
receiving payment of principal and interest on a timely basis. It is also
important to recognize that the ratings incorporate Thompson Bank Watch's
opinion of the vulnerability of the company to adverse developments, which may
impact the market's perception of the company, thereby affecting the
marketability of its securities.
43
<PAGE> 44
Bank Watch Issuer Ratings are assigned using an intermediate time horizon.
RATING DEFINITIONS
A: Company possesses an exceptionally strong balance sheet and earnings
record, translating into an excellent reputation and very good access to its
natural money markets. If weakness or vulnerability exists in any aspect of the
company's business, it is entirely mitigated by the strengths of the
organization.
A/B: Company is financially very solid with a favorable track record and no
readily apparent weakness. Its overall risk profile, while low, is not quite as
favorable as for companies in the highest rating category.
B: A strong company with a solid financial record and well received by its
natural money markets. Some minor weaknesses may exist, but any deviation from
the company's historical performance levels should be both limited and
short-lived. The likelihood of a problem developing is small, yet slightly
greater than for a higher-rated company.
B/C: Company is clearly viewed as a good credit. While some shortcomings are
apparent, they are not serious and/or are quite manageable in the short-term.
C: Company is inherently a sound credit with no serious deficiencies, but
financials reveal at least one fundamental area of concern that prevents a
higher rating. Company may recently have experienced a period of difficulty, but
those pressures should not be long-term in nature. The company's ability to
absorb a surprise, however, is less than that for organizations with better
operating records.
44
<PAGE> 45
INVESTMENT ADVISER
Payden & Rygel
333 South Grand Avenue
Los Angeles, California 90071
SUB-ADVISER
Metzler-Payden, LLC
333 South Grand Avenue,
Los Angeles, California 90071
ADMINISTRATOR
Treasury Plus, Inc.
333 South Grand Avenue
Los Angeles, California 90071
DISTRIBUTOR
Payden & Rygel Distributors
333 South Grand Avenue
Los Angeles, California 90071
CUSTODIAN
The Boston Safe Deposit and Trust Company
One Boston Place
Boston, Massachusetts 02109
TRANSFER AGENT
Investors Fiduciary Trust Company
801 Pennsylvania
Kansas City, Missouri 64105
AUDITORS
Deloitte & Touche LLP
1700 Courthouse Plaza Northeast
Dayton, Ohio 45402
COUNSEL
Paul, Hastings, Janofsky and Walker LLP
555 South Flower Street
Los Angeles, California 90071
December 17, 1998
45
<PAGE> 46
PAYDEN & RYGEL INVESTMENT GROUP
PAYDEN & RYGEL CALIFORNIA MUNICIPAL INCOME FUND
PAYDEN & RYGEL EMERGING MARKETS BOND FUND
PAYDEN & RYGEL EURODIRECT FUND
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 17, 1998
The Payden & Rygel California Municipal Income Fund ("California Municipal
Fund"), Payden & Rygel Emerging Markets Bond Fund ("Emerging Market Bond Fund")
and Payden & Rygel EuroDirect Fund ("EuroDirect Fund") are series ("Funds") of
The Payden & Rygel Investment Group (the "Group"), a no-load, open-end
management investment company.
This Statement of Additional Information is not a prospectus, and should be used
in conjunction with the Prospectus for the Funds dated December 17, 1998, which
is incorporated herein by reference. A copy of the Prospectus may be obtained
free of charge from the Group at 333 South Grand Avenue, Los Angeles, California
90071 (telephone 213/625-1900 or 800/572-9336).
1
<PAGE> 47
TABLE OF CONTENTS
<TABLE>
<S> <C>
INVESTMENT OBJECTIVES AND POLICIES.................................................... 3
FUNDAMENTAL AND OPERATING POLICIES.................................................... 31
PORTFOLIO TRANSACTIONS................................................................ 33
VALUATION OF PORTFOLIO SECURITIES..................................................... 34
FUND PERFORMANCE...................................................................... 35
TAXATION.............................................................................. 37
MANAGEMENT OF THE GROUP............................................................... 44
PURCHASES AND REDEMPTIONS............................................................. 48
OTHER INFORMATION..................................................................... 49
APPENDIX A - DESCRIPTION OF RATINGS................................................... 52
</TABLE>
2
<PAGE> 48
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives and general investment policies of the Funds are
described in the Prospectus. Additional information concerning the
characteristics of certain of the Funds' investments is set forth below.
EQUITY SECURITIES
PREFERRED STOCKS
Preferred stock, unlike common stock, offers a stated dividend rate payable from
a corporation's earnings. Such preferred stock dividends may be cumulative or
non-cumulative, participating, or auction rate. If interest rates rise, the
fixed dividend on preferred stocks may be less attractive, causing the price of
preferred stocks to decline. Preferred stock may have mandatory sinking fund
provisions, as well as call/redemption provisions prior to maturity, a negative
feature when interest rates decline. Dividends on some preferred stock may be
"cumulative," requiring all or a portion of prior unpaid dividends to be paid.
Preferred stock also generally has a preference over common stock on the
distribution of a corporation's assets in the event of liquidation of the
corporation, and may be "participating," which means that it may be entitled to
a dividend exceeding the stated dividend in certain cases. The rights of
preferred stocks on the distribution of a corporation's assets in the event of a
liquidation are generally subordinate to the rights associated with a
corporation's debt securities.
AMERICAN DEPOSITORY RECEIPTS
American Depository Receipt ("ADRs") may be listed on a national securities
exchange or may trade in the over-the-counter market. ADR prices are denominated
in United States dollars; the underlying security may be denominated in a
foreign currency, and may be subject to foreign government taxes which would
reduce the yield on such securities.
CONVERTIBLE SECURITIES
A convertible security is a fixed income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of the common stock of the same or a different issuer.
Convertible securities are senior to common stocks in an issuer's capital
structure, but are usually subordinated to similar non-convertible securities.
While providing a fixed income stream (generally higher in yield than the income
derivable from common stock but lower than that afforded by a similar
non-convertible security), a convertible security also affords an investor the
opportunity, through its conversion feature, to participate in the capital
appreciation attendant upon a market price advance in the convertible security's
underlying common stock.
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 credit standing of the issuer and other factors
may also affect the investment value of a convertible security. 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
3
<PAGE> 49
investment value. 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 table.
Like other debt securities, the market value of convertible debt securities
tends to vary inversely with the level of interest rates. The value of the
security declines as interest rates increase and increases as interest rates
decline. Although under normal market conditions longer term securities have
greater yields than do shorter term securities of similar quality, they are
subject to greater price fluctuations. Fluctuations in the value of the Fund's
investments will be reflected in its net asset value per share. A convertible
security may be subject to redemption at the option of the issuer at a price
established in the instrument governing the convertible security. 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.
FIXED INCOME SECURITIES
Fixed income securities in which the Funds may invest include, but are not
limited to, those described below.
U.S. TREASURY OBLIGATIONS
U.S. Treasury obligations are debt securities issued by the U.S. Treasury. They
are direct obligations of the U.S. Government and differ mainly in the lengths
of their maturities.
U.S. GOVERNMENT AGENCY SECURITIES
U.S. Government Agency securities are issued or guaranteed by U.S. Government
sponsored enterprises and federal agencies. These include securities issued by
the Federal National Mortgage Association, Government National Mortgage
Association, Federal Home Loan Bank, Federal Land Banks, Farmers Home
Administration, Banks for Cooperatives, Federal Intermediate Credit Banks,
Federal Financing Bank, Farm Credit Bank, and the Tennessee Valley Authority.
Some of these securities are supported by the full faith and credit of the U.S.
Treasury, and others only by the credit of the instrumentality, which may
include the right of the issuer to borrow from the Treasury.
FOREIGN GOVERNMENT OBLIGATIONS
Foreign government obligations are debt securities issued or guaranteed by a
supranational organization or a foreign sovereign government or one of its
agencies, authorities, instrumentalities or political subdivisions, including a
foreign state, province or municipality.
BANK OBLIGATIONS
Bank obligations include certificates of deposit, bankers' acceptances, and
other debt obligations. Certificates of deposit are short-term obligations of
commercial banks. A bankers' acceptance is a time draft drawn on a commercial
bank by a borrower, usually in connection with an international commercial
transaction.
4
<PAGE> 50
A Fund will not invest in any security issued by a commercial bank unless (i)
the bank has total assets of at least $1 billion, or the equivalent in other
currencies, (ii) in the case of U.S. banks, the bank is a member of the Federal
Deposit Insurance Corporation, and (iii) in the case of foreign banks, the
security is, in the opinion of the Adviser or Sub-adviser, of an investment
quality comparable with other debt securities which may be purchased by the
Fund. These limitations do not prohibit investments in securities issued by
foreign branches of U.S. banks, provided such U.S. banks meet the foregoing
requirements.
CORPORATE DEBT SECURITIES
Investments in securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum rating criteria set forth in
the Prospectus. The rate of return or return of principal on some debt
obligations may be linked or indexed to the level of exchange rates between the
U.S. dollar and a foreign currency or currencies.
The Adviser will undertake certain measures including the following, in seeking
to preserve investors' principal. In general, the debt securities in which each
of the EuroDirect and California Municipal Income Funds invests will be
considered "investment-grade" (e.g., rated AAA, AA, A or BBB by Standard &
Poor's Corporation) by at least one of the established rating agencies, or if
not rated, will be determined to be of comparable quality by the Adviser.
However, each of the California Municipal Income and EuroDirect Funds may invest
up to 25% and 5%, respectively, of its total assets in debt securities rated
below investment grade by one of the established rating agencies, or if not
rated, determined to be of comparable quality by the Adviser or Sub-adviser. If
the rating of a debt security in which a Fund has made an investment falls below
the investment grade level in the case of at least 95% of the assets of the
EuroDirect Fund, or below the B level in the case of each of the Emerging
Markets Bond and California Municipal Income Funds, the Fund will discontinue
making investments in that issuer and liquidate any current holdings as soon as
the Adviser or Sub-adviser determines it is in the best interest of the Fund to
do so. The Adviser or Sub-adviser may also use interest rate, stock index and
bond index futures and options on futures contracts, options on securities, and
in the case of each of the Emerging Markets Bond and EuroDirect Funds interest
rate swaps to effect a change in a Fund's exposure to interest rate changes.
These investment techniques involve certain risks described below. There is, of
course, no guarantee these investment strategies will accomplish each Fund's
objectives.
FLOATING RATE AND VARIABLE RATE DEMAND NOTES
The Funds may purchase floating rate and variable rate demand notes and bonds.
These securities may have a stated maturity in excess of one year, but permit a
holder to demand payment of principal plus accrued interest upon a specified
number of days notice. Frequently, such obligations are secured by letters of
credit or other credit support arrangements provided by banks. The issuer has a
corresponding right, after a given period, to prepay in its discretion the
outstanding principal of the obligation plus accrued interest upon a specific
number of days notice to the holders. The interest rate of a floating rate
instrument may be based on a known lending rate, such as a bank's prime rate,
and is reset whenever such rate is adjusted. The interest rate on a variable
rate demand note is reset at specified intervals at a market rate.
5
<PAGE> 51
Each Fund will limit its purchase of securities that bear floating rates and
variable rates of interest to those meeting the rating quality standards set
forth in the Prospectus. Frequently, such obligations are secured by letters of
credit or other credit support arrangements provided by banks. The quality of
the underlying creditor or of the bank, as the case may be, must, as determined
by the Adviser under the supervision of the Board of Trustees, also be
equivalent to the quality standards set forth above. In addition, the Adviser
monitors the earning power, cash flow and other liquidity ratios of the issuers
of such obligations, as well as the creditworthiness of the institution
responsible for paying the principal amount of the obligations under the demand
feature.
OBLIGATIONS WITH PUTS ATTACHED
Each Fund may purchase long-term fixed rate debt obligations that have been
coupled with an option granted by a third party financial institution allowing
the Fund at specified intervals to tender (or "put") such debt obligations to
the institution and receive the face value. These third party puts are available
in many different forms, and may be represented by custodial receipts or trust
certificates and may be combined with other features such as interest rate
swaps. The financial institution granting the option does not provide credit
enhancement. If there is a default on, or significant downgrading of, the bond
or a loss of its tax-exempt status, the put option will terminate automatically.
The risk to the Fund will then be that of holding a long-term bond.
These investments may require that a Fund pay a tender fee or other fee for the
features provided. In addition, a Fund may acquire "stand-by commitments" from
banks or broker dealers with respect to the securities held in its portfolio.
Under a stand-by commitment, a bank or broker/dealer agrees to purchase at the
Fund's option a specific security at a specific price on a specific date. The
Fund may pay for a stand-by commitment either separately, in cash, or in the
form of a higher price paid for the security. The Funds will acquire stand-by
commitments solely to facilitate portfolio liquidity.
REPURCHASE AGREEMENTS
For the purpose of maintaining liquidity, each Fund may enter into repurchase
agreements (agreements to purchase U.S. Treasury notes and bills, subject to the
seller's agreement to repurchase them at a specified time and price) with
well-established registered securities dealers or banks. Repurchase agreements
are the economic equivalent of loans by a Fund. In the event of a bankruptcy or
default of any registered dealer or bank, a Fund could experience costs and
delays in liquidating the underlying securities which are held as collateral,
and a Fund might incur a loss if the value of the collateral declines during
this period.
DELAYED DELIVERY TRANSACTIONS
When delayed delivery purchases are outstanding, a Fund will set aside and
maintain until the settlement date in a segregated account cash, U.S. Government
securities or high grade debt obligations in an amount sufficient to meet the
purchase price. When purchasing a security on a delayed delivery basis, a Fund
assumes the rights and risks of ownership of the security, including the risk of
price and yield fluctuations, and takes such fluctuations into account when
determining its net asset value, but does not accrue income on the security
until delivery. When a Fund sells a security on a delayed delivery basis, it
does not participate in future gains or losses with respect to the security. If
the other party to a delayed delivery transaction fails to deliver or pay for
the securities, a Fund could
6
<PAGE> 52
miss a favorable price or yield opportunity or could suffer a loss. A Fund will
not invest more than 25% of its total assets in when-issued and delayed delivery
transactions.
REVERSE REPURCHASE AGREEMENTS
Each Fund covers its obligations under a reverse repurchase agreement by
maintaining a segregated account comprised of cash, U.S. Government securities
or high-grade debt obligations, maturing no later than the expiration of the
agreement, in an amount (marked-to-market daily) equal to its obligations under
the agreement. Reverse repurchase agreements are the economic equivalent of
borrowing by a Fund, and are entered into by a Fund to enable it to avoid
selling securities to meet redemption requests during market conditions deemed
unfavorable by the Adviser or Sub-adviser.
ILLIQUID SECURITIES
No Fund may invest more than 15% of the value of its net assets in securities
that at the time of purchase have legal or contractual restrictions on resale or
are otherwise illiquid. The Adviser will monitor the amount of illiquid
securities in each Fund's portfolio, to ensure compliance with the Fund's
investment restrictions.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
having a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placement or
restricted securities and are purchased directly from the issuer or in the
secondary market. Mutual funds do not typically hold a significant amount of
these restricted or other illiquid securities because of the potential for
delays on resale and uncertainty in valuation. Limitations on resale may have an
adverse effect on the marketability of portfolio securities and the Fund might
be unable to dispose of restricted or other illiquid securities promptly or at
reasonable prices and might thereby experience difficulty satisfying redemption
requests within seven days. The Fund might also have to register such restricted
securities in order to dispose of them, resulting in additional expense and
delay. Adverse market conditions could impede such a public offering of
securities.
In recent years, however, a large institutional market has developed for certain
securities that are not registered under the Securities Act, including
repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments. If such securities are subject to purchase by institutional buyers
in accordance with Rule 144A promulgated by the Commission under the Securities
Act, the Board of Trustees may determine that such securities are not illiquid
securities notwithstanding their legal or contractual restrictions on resale. In
all other cases, however, securities subject to restrictions on resale will be
deemed illiquid.
FOREIGN INVESTMENTS
The EuroDirect Fund expects to seek investments primarily in the following
European countries: (1) Developed Markets - Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy,
7
<PAGE> 53
the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United
Kingdom; and (2) Emerging Markets - Czech Republic, Hungary, Poland, Russia and
Turkey. The Emerging Markets Bond Fund may seek investments in any country which
is defined by the World Bank or an affiliated institution, the International
Finance Corporation or the United Nations to be an emerging market. A Fund may
elect not to invest in all such countries, and it may also invest in other
countries when such investments are consistent with the Fund's investment
objective and policies
FOREIGN MORTGAGE-RELATED SECURITIES
Foreign mortgage-related securities are interests in pools of mortgage loans
made to residential home buyers domiciled in a foreign country. These include
mortgage loans made by trust and mortgage loan companies, credit unions,
chartered banks, and others. Pools of mortgage loans are assembled as securities
for sale to investors by various governmental, government-related, and private
organizations (e.g., Canada Mortgage and Housing Corporation and First
Australian National Mortgage Acceptance Corporation Limited). Interests in pools
of mortgage-related securities differ from other forms of debt securities, which
normally provide for periodic payment of interest in fixed amounts with
principal payments at maturity or specified call dates. Instead, these
securities provide a monthly payment which consists of both interest and
principal payments. In effect, these payments are a "pass-through" of the
monthly payments made by the individual borrowers on their residential mortgage
loans, net of any fees paid to the issuer or guarantor of such securities.
Additional payments are caused by repayments of principal resulting from the
sale of the underlying residential property, refinancing or foreclosure, net of
fees or costs which may be incurred. Some mortgage-related securities are
described as "modified pass-through." These securities entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
certain fees, at the scheduled payment dates regardless of whether or not the
mortgagor actually makes the payment
Timely payment of interest and principal of these pools may be supported by
various forms of insurance or guarantees, including individual loan, title, pool
and hazard insurance and letters of credit, issued by governmental entities,
private insurers and mortgage poolers. Such insurance and guarantees and the
creditworthiness of the issuers thereof will be considered in determining
whether a mortgage-related security meets a Fund's investment quality standards.
However, there can be no assurance that private insurers or guarantors will meet
their obligations. In addition, the Funds may buy mortgage-related securities
without insurance or guarantees if through an examination of the loan experience
and practices of the originator/services and poolers the Adviser or Sub-adviser
determines that the securities meet the Funds' quality standards.
Although the underlying mortgage loans in a pool may have maturities of up to 30
years, the actual average life of the pool certificates typically will be
substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Prepayment rates vary widely
and may be affected by changes in market interest rates. In periods of falling
interest rates, the rate of prepayment tends to increase, thereby shortening the
actual average life of the pool certificates. Conversely, when interest rates
are rising, the rate of prepayments tends to decrease, thereby lengthening the
actual average life of the certificates. Accordingly, it is not possible to
predict accurately the average life of a particular pool.
8
<PAGE> 54
MUNICIPAL SECURITIES
Under normal market conditions, as a fundamental policy which cannot be changed
without shareholder approval, the California Municipal Income Fund invests at
least 80% of the value of its net assets in a non-diversified portfolio of debt
obligations issued by state and local governments, territories and possessions
of the U.S., regional government authorities, and their agencies and
instrumentalities which provide interest income that, in the opinion of bond
counsel to the issuer at the time of original issuance, is exempt from federal
income taxes ("municipal securities"). Under normal circumstances, at least 65%
of the value of its net assets will be invested in securities of the State of
California, local governments and governmental authorities within California and
their agencies and instrumentalities which provide interest income that, in the
opinion of bond counsel to the issuer at the time of original issuance, is
exempt from California personal income taxes. Municipal securities include both
notes (which have maturities of less than one year) and bonds (which have
maturities of one year or more) that bear fixed or variable rates of interest.
In general, "municipal securities" are debt obligations issued to obtain funds
for a variety of public purposes, such as the construction, repair, or
improvement of public facilities including airports, bridges, housing,
hospitals, mass transportation, schools, streets, water and sewer works.
Municipal securities may be issued to refinance outstanding obligations as well
as to raise funds for general operating expenses and lending to other public
institutions and facilities.
The two principal classifications of municipal securities are "general
obligation" securities and "revenue" securities. General obligation securities
are secured by the issuer's pledge of its full faith, credit, and taxing power
for the payment of principal and interest. Characteristics and methods of
enforcement of general obligation bonds vary according to the law applicable to
a particular issuer, and the taxes that can be levied for the payment of debt
service may be limited or unlimited as to rates or amounts of special
assessments. Revenue securities are payable only from the revenues derived from
a particular facility, a class of facilities or, in some cases, from the
proceeds of a special excise tax. Revenue bonds are issued to finance a wide
variety of capital projects including: electric, gas, water, and sewer systems;
highways, bridges, and tunnels; port and airport facilities; colleges and
universities; and hospitals. Although the principal security behind these bonds
may vary, many provide additional security in the form of a debt service reserve
fund the assets of which may be used to make principal and interest payments on
the issuer's obligations. Housing finance authorities have a wide range of
security, including partially or fully insured mortgages, rent subsidized and
collateralized mortgages, and the net revenues from housing or other public
projects. Some authorities are provided further security in the form of a
state's assurance (although without obligation) to make up deficiencies in the
debt service reserve fund.
The Fund may purchase insured municipal debt in which scheduled payments of
interest and principal are guaranteed by a private, non-governmental or
governmental insurance company. The insurance does not guarantee the market
value of the municipal debt or the value of the shares of the Fund.
The Adviser will undertake certain measures, including the following, in seeking
to preserve investors' principal.
In general, the debt securities in which the California Municipal Income Fund
invests will be considered "investment-grade" (e.g., rated AAA, AA, A or BBB by
Standard & Poor's Corporation) at the time of purchase by at least one of the
following rating agencies: Fitch Investor Services, Moody's
9
<PAGE> 55
Investor Services, Inc. or Standard & Poor's Corporation, or if not rated, will
be determined to be of comparable quality by the Adviser. However, the
California Municipal Income Fund may invest up to 25% of its total assets in
debt securities rated below investment grade by one of these rating agencies, or
if not rated, determined to be of comparable quality by the Adviser. If the
rating of a municipal debt security in which the California Municipal Income
Fund has made an investment falls below the B level, the Fund will discontinue
making investments in that issuer and liquidate any current holdings as soon as
the Adviser determines it is in the best interest of the Fund to do so. In no
event will the California Municipal Income Fund hold an obligation rated below
B. The Adviser may also use interest rate and municipal bond index futures and
options on futures contracts, options on securities, and interest rate swaps to
effect a change in the California Municipal Income Fund's exposure to interest
rate changes. These investment techniques involve certain risks described below.
There is, of course, no guarantee these investment strategies will accomplish
the California Municipal Income Fund's objective. See Appendix A for further
information regarding the ratings referred to above.
Securities of issuers of municipal obligations are subject to the provisions of
bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors, such as the Bankruptcy Reform Act of 1978. In addition, the
obligations of such issuers may become subject to laws enacted in the future by
Congress, state legislatures of referenda extending the time for payment of
principal or interest, or imposing other constraints upon enforcement of such
obligations or upon the ability of municipalities to levy taxes. Furthermore, as
a result of legislation or other conditions, the power or ability of any issuer
to pay, when due, the principal of and interest on its municipal obligations may
be materially affected.
Certain of the municipal securities in which the California Municipal Income
Fund may invest, and certain of the risks of such investments, are described
below.
MORAL OBLIGATION SECURITIES
Municipal securities may include "moral obligation" securities which are usually
issued by special purpose public authorities. If the issuer of moral obligation
bonds cannot fulfill its financial responsibilities from current revenues, it
may draw upon a reserve fund, the restoration of which is a moral commitment but
not a legal obligation of the state or municipality which created the issuer.
ZERO COUPON SECURITIES
The California Municipal Income Fund may invest in zero coupon securities which
are debt securities issued or sold at a discount from their face value. These
securities do not entitle the holder to interest payments prior to maturity or a
specified redemption date, when they are redeemed at face value. Zero coupon
securities may also take the form of debt securities that have been stripped of
their unmatured interest coupons, the coupons themselves, and receipts and
certificates representing interests in such stripped obligations and coupons.
The market prices of zero coupon securities tend to be more sensitive to
interest rate changes, and are more volatile, than interest bearing securities
of like maturity. The discount from face value is amortized over the life of the
security and such amortization will constitute the income earned on the security
for accounting and tax purposes. Even though income is accrued on a current
basis, a Fund does not receive the income currently in cash. Therefore, the Fund
may have to sell other portfolio investments to obtain cash needed to make
income distributions.
10
<PAGE> 56
MORTGAGE BACKED SECURITIES
The California Municipal Income Fund may invest in municipal debt obligations
issued to provide financing for residential housing mortgages to targeted
groups. Payments made on the underlying mortgages and passed through to the Fund
will represent both regularly scheduled principal and interest payments. The
Fund may also receive additional principal payments representing prepayments of
the underlying mortgages. Investing in such municipal debt obligations involves
special risks and considerations, including the inability to predict accurately
the maturity of the Fund's investments as a result of prepayments of the
underlying mortgages (which may require the Fund to reinvest principal at lower
yields than would otherwise have been realized), the illiquidity of certain of
such securities, and the possible default by insurers or guarantors supporting
the timely payment of interest and principal.
MUNICIPAL LEASE OBLIGATIONS
The California Municipal Income Fund may invest in lease obligations or
installment purchase contract obligations of municipal authorities or entities
("municipal lease obligations"). Although lease obligations do not constitute
general obligations of the municipality for which its taxing power is pledged, a
lease obligation is ordinarily backed by the municipality's covenant to budget
for, appropriate and make the payments due under the lease obligation. The Fund
may also purchase "certificates of participation", which are securities issued
by a particular municipality or municipal authority to evidence a proportionate
interest in base rental or lease payments relating to a specific project to be
made by the municipality, agency or authority. However, certain lease
obligations contain "non-appropriation" clauses which provide that the
municipality has no obligation to make lease or installment purchase payments in
any year unless money is appropriated for such purpose for such year. Although
"non-appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of default and foreclosure might prove
difficult. In addition, these securities represent a relatively new type of
financing, and certain lease obligations may therefore be considered to be
illiquid securities.
Subject to its ability to invest in below investment grade municipal securities
as described above, the California Municipal Fund will attempt to minimize the
special risks inherent in municipal lease obligations and certificates of
participation by purchasing only lease obligations which meet the following
criteria: (1) rated A or better by at least one national recognized securities
rating organization; (2) secured by payments from a governmental lessee which
has actively traded debt obligations; (3) determined by the Adviser to be
critical to the lessee's ability to deliver essential services; and (4) contain
legal features which the Adviser deems appropriate, such as covenants to make
lease payments without the right of offset or counterclaim, requirements for
insurance policies, and adequate debt service reserve funds.
SHORT-TERM OBLIGATIONS
The California Municipal Income Fund may invest in short-term municipal
obligations. These securities include the following:
TAX ANTICIPATION NOTES are used to finance working capital needs of
municipalities and are issued in anticipation of various seasonal tax revenues,
to be payable from these specific future taxes.
11
<PAGE> 57
They are usually general obligations of the issuer, secured by the taxing power
of the municipality for the payment of principal and interest when due.
REVENUE ANTICIPATION NOTES are issued in expectation of receipt of other kinds
of revenue, such as federal revenues available under the Federal Revenue Sharing
Program. They also are usually general obligations of the issuer.
BOND ANTICIPATION NOTES normally are issued to provide interim financing until
long-term financing can be arranged. The long-term bonds then provide the money
for the repayment of the notes.
SHORT-TERM DISCOUNT NOTES (tax-exempt commercial paper) are short-term (365 days
or less) promissory notes issued by municipalities to supplement their cash
flow.
FLOATING RATE AND VARIABLE RATE DEMAND NOTES
The California Municipal Income Fund may purchase floating rate and variable
rate demand notes and bonds. These securities may have a stated maturity in
excess of one year, but permit a holder to demand payment of principal plus
accrued interest upon a specified number of days notice. Frequently, such
obligations are secured by letters of credit or other credit support
arrangements provided by banks. The issuer has a corresponding right, after a
given period, to prepay in its discretion the outstanding principal of the
obligation plus accrued interest upon a specific number of days notice to the
holders. The interest rate of a floating rate instrument may be based on a known
lending rate, such as a bank's prime rate, and is reset whenever such rate is
adjusted. The interest rate on a variable rate demand note is reset at specified
intervals at a market rate.
The Fund will limit its purchase of municipal securities that bear floating
rates and variable rates of interest to those meeting the rating quality
standards set forth in the Prospectus. Frequently, such obligations are secured
by letters of credit or other credit support arrangements provided by banks. The
quality of the underlying creditor or of the bank, as the case may be, must, as
determined by the Adviser under the supervision of the Board of Trustees, also
be equivalent to the quality standards set forth above. In addition, the Adviser
monitors the earning power, cash flow and other liquidity ratios of the issuers
of such obligations, as well as the creditworthiness of the institution
responsible for paying the principal amount of the obligations under the demand
feature.
The Fund may also invest in municipal securities in the form of "participation
interests" in variable rate tax-exempt demand obligations held by a financial
institution, usually a commercial bank. Municipal participation interests
provide the purchaser with an undivided interest in one or more underlying
municipal securities and the right to demand payment from the institution upon a
specified number of days' notice (no more than seven) of the unpaid principal
balance plus accrued interest. In addition, the municipal participation
interests are typically enhanced by an irrevocable letter of credit or guarantee
from such institution. Since the Fund has an undivided interest in the
obligation, it participates equally with the institution with the exception that
the institution normally retains a fee out of the interest paid for servicing,
providing the letter of credit or guarantee, and issuing the repurchase
commitment.
12
<PAGE> 58
OBLIGATIONS WITH PUTS ATTACHED
The California Municipal Income Fund may purchase long-term fixed rate municipal
debt obligations that have been coupled with an option granted by a third party
financial institution allowing the Fund at specified intervals to tender (or
"put") such debt obligations to the institution and receive the face value.
These third party puts are available in many different forms, and may be
represented by custodial receipts or trust certificates and may be combined with
other features such as interest rate swaps. The financial institution granting
the option does not provide credit enhancement. If there is a default on, or
significant downgrading of, the bond or a loss of its tax-exempt status, the put
option will terminate automatically. The risk to the Fund will then be that of
holding a long-term bond.
These investments may require that the Fund pay a tender fee or other fee for
the features provided. In addition, the Fund may acquire "stand-by commitments"
from banks or broker dealers with respect to the municipal securities held in
its portfolios. Under a stand-by commitment, a bank or broker/dealer agrees to
purchase at the Fund's option a specific municipal security at a specific price
on a specific date. The Fund may pay for a stand-by commitment either
separately, in cash, or in the form of a higher price paid for the security. The
Fund will acquire stand-by commitments solely to facilitate portfolio liquidity.
SPECIAL RISKS OF INVESTING PRIMARILY IN CALIFORNIA MUNICIPAL SECURITIES
Because the Fund focuses its investments primarily on California municipal
securities, the value of its portfolio investments will be highly sensitive to
events affecting the fiscal stability of the State of California and its
municipalities, authorities and other instrumentalities that issue securities.
There have been a number of political developments, voter initiatives, state
constitutional amendments and legislation in California in recent years that may
affect the ability of the State government and municipal governments to pay
interest and repay principal on the securities they have issued.
It is not possible to predict the future impact of the legislation and economic
considerations described below on the long-term ability of the State of
California or California municipal issuers to pay interest or repay principal on
their obligations. In part that is because of possible inconsistencies in the
terms of the various laws and Propositions and the applicability of other
statutes to these issues. The budgets of California counties and local
governments may be significantly affected by state budget decisions beyond their
control. The information below about these conditions is only a brief summary,
based upon information the Fund has drawn from sources that it believes are
reliable.
The Fund will be affected by any political, economic or regulatory developments
affecting the ability of California issuers to pay interest or repay principal
on their obligations. Various developments regarding the California Constitution
and State statutes which limit the taxing and spending authority of California
governmental entities may impair the ability of California issuers to maintain
debt service on their obligations. The following information constitutes only a
brief summary and is not intended as a complete description.
In 1978, Proposition 13, an amendment to the California Constitution, was
approved, limiting real property valuation for property tax purposes and the
power of local governments to increase real property tax revenues and revenues
from other sources. Legislation adopted after Proposition 13 provided for
assistance to local governments, including the distribution of the then-existing
surplus in
13
<PAGE> 59
the General Fund, reallocation of revenues to local governments, and assumption
by the State of certain local government obligations. However, more recent
legislation reduced such State assistance. There can be no assurance that any
particular level of State aid to local governments will be maintained in future
years. In Nordinger v. Hahn, the United States Supreme Court upheld certain
provisions of Proposition 13 against claims that it violated the equal
protection clause of the Constitution.
In 1979, an amendment was passed adding Article XIIIB to the State Constitution.
As amended in 1996, Article XIIIB imposes an "appropriations limit" on the
spending authority of the State and local government entities. In general, the
appropriations limit is based on certain 1978-79 expenditures, adjusted annually
to reflect changes in the cost of living, population and certain services
provided by State and local government entities. The "appropriations limit" does
not include appropriations for qualified capital outlay projects, certain
increases in transportation-related taxes, and certain emergency appropriations.
If a government entity raises revenues beyond its "appropriation limit" in any
year, a portion of the excess which cannot be appropriated within the following
year's limit must be returned to the entity's taxpayers within two subsequent
fiscal years, generally by a tax credit, refund or temporary suspension of tax
rates or fee schedules. "Debt service" is excluded from these limitations, and
is defined as "appropriations required to pay the cost of interest and
redemption charges, including the funding of any reserve or sinking fund
required in connection therewith, on indebtedness existing or legally authorized
as of January 1, 1979 or on bonded indebtedness thereafter approved [by the
voters]." In addition, Article XIIIB requires the State Legislature to establish
a prudent State reserve, and to require the transfer of 50% of excess revenue to
the State School Fund; any amounts allocated to the State School Fund will
increase the appropriations limit.
In November 1988, California voters approved Proposition 98. This initiative
requires that revenues in excess of amounts permitted to be spent and which
would otherwise be returned by revisions of tax rates or fee schedules, be
transferred and allocated (up to a maximum of 40%) to the State School Fund and
be expended solely for purposes of instructional improvement and accountability.
No such transfer or allocation of funds will be required if certain designated
state officials determine that annual student expenditures and class size meet
certain criteria as set forth in Proposition 98. All funds allocated to the
State School Fund shall cause the appropriation limits to be annually increased
for any such allocation made in the prior year. Proposition 98 also requires the
State of California to provide a minimum level of funding for public schools and
community colleges. The initiative permits the enactment of legislation, by a
two-thirds vote, to suspend the minimum funding requirement for one year.
In November 1996, California voters approved Proposition 218. This initiative
applied the provisions of Proposition 62 to all entities, including charter
cities. It requires that all taxes for general purposes obtain a simple majority
popular vote and that taxes for special purposes obtain a two-thirds majority
vote. Prior to the effectiveness of Proposition 218, charter cities could levy
certain taxes such as transient occupancy taxes and utility user's taxes without
a popular vote. Proposition 218 will also limit the authority of local
governments to impose property-related assessments, fees and charges, requiring
that such assessments be limited to the special benefit conferred and
prohibiting their use for general governmental services. Proposition 218 also
allows voters to use their initiative power to reduce or repeal previously
authorized taxes, assessments, fees and charges.
14
<PAGE> 60
Proposition 9 on the November, 1998, State ballot would overturn certain aspects
of legislation enacted in 1996 and 1997 to deregulate the electric industry in
California. As part of this deregulation, the three investor owned utilities in
California issued about $6 billion in aggregate of "rate reduction bonds" to
finance the stranded costs of certain uneconomic facilities. These bonds are
repaid through a surcharge placed on residential and small business customers'
bills. The legislation authorizing issuance of these bonds included a pledge
that the State would not interfere with the levying of these surcharges without
providing other means to repay the bonds. One part of Proposition 9 would be the
cancellation of the utilities' authority to collect these surcharges. If
proposition 9 is approved by the voters, it is anticipated that litigation will
be filed to declare the initiative unconstitutional. Because of the uncertainty
of litigation, it is not possible to predict whether any State General Fund
moneys eventually might be required to repay the rate reduction bonds. It is
also not possible to predict what effect, if any, passage of Proposition 9 will
have on the marketability of outstanding California State and local obligations
or on the availability of capital for, or cost of, future State and local
borrowing.
Certain tax-exempt securities in which the State Trust may invest, may be
obligations payable solely from the revenues of specific institutions, or may be
secured by specific properties, which are subject to provisions of California
law that could adversely affect the holders of such obligations. For example,
the revenues of California health care institutions may be subject to state
laws, and California law limits the remedies of a creditor secured by a mortgage
or deed of trust on real property.
From 1990 to 1993, California (the "State") faced the worst economic, fiscal and
budget conditions since the 1930s. Construction, manufacturing (especially
aerospace), exports and financial services, among others, were severely
affected. Job losses were the worst of any post-war recession and have been
estimated to exceed 800,000. California's economy has been recovering and
growing steadily stronger since the start of 1994. The rate of economic growth
in California in 1997, in terms of job gains, exceeded that of the rest of the
United States. The State added nearly 430,000 non-farm jobs during 1997. In 1996
California surpassed its pre-recession employment peak of 12.7 million jobs. The
unemployment rate, while still higher than the national average, fell to 5.8% in
June 1998, compared to over 10% during the recession. Many of the new jobs were
created in such industries as computer services, software design, motion
pictures and high technology manufacturing. Business services, export trade and
other manufacturing also experienced growth. All major economic regions of the
State grew. The rate of employment growth for the Los Angeles region indicates
that growth has almost caught up with that in the San Francisco bay region on a
population share basis.
Personal income grew by over 7% in 1996 and by nearly 7% again in 1997. The
residential construction sector of the State's economy remained weak in 1996,
with permits for new housing increasing modestly from the previous year, but
rebounded in 1997 with permits for new construction up by 18%. In addition, the
restructuring and consolidation occurring in California's aerospace and
financial services industries, while aimed at making the companies involved more
efficient and competitive in the longer term, has produced some negative
economic consequences in the shorter term, including an uncertain job outlook
for many workers. The unsettled financial situation occurring in certain Asian
economies, and its spillover effect elsewhere, may adversely the State's
export-related industries and, therefore, the State's rate of economic growth.
The recession affected State tax revenues, which mirror economic conditions. It
has also caused increased expenditures for health and welfare programs. The
State has also been facing a structural
15
<PAGE> 61
imbalance in its budget with the largest programs supported by the General Fund
(K-12 schools and community colleges, health, welfare and corrections) growing
at rates higher than the growth rates for the principal revenue sources of the
General Fund. (The General Fund, the State's main operating fund, consists of
revenues which are not required to be credited to any other fund.) As a result,
the State has experienced recurring budget deficits. With the end of the
recession, the State's financial condition has improved in the 1995-96, 1996-97
and 1997-98 fiscal years, with a combination of better than expected revenues,
slowdown in growth of social welfare programs, and continued spending restraint.
The California Department of Finance estimates that the State's budget reserve
in the Special Fund for Economic Uncertainties (SFEU) totaled $639.8 million as
of June 30, 1997 and $1.782 billion at June 30, 1998. No deficit borrowing has
occurred at the end of the last three fiscal years and the State's cash flow
borrowing was limited to $3 billion in 1997-98.
On December 6, 1994, Orange County, California (the "County"), together with its
pooled investment funds (the "Pools"), filed for protection under Chapter 9 of
the federal Bankruptcy Code. On June 12, 1996, Orange County emerged from
bankruptcy after the successful sale of $880 million in municipal bonds allowed
the county to pay off the last of its creditors. On January 7, 1997, Orange
County returned to the municipal bond market with a $136 million bond issue
maturing in 13 years at an insured yield of 7.23%. In December 1997, Moody's
raised its ratings on $325 million of Orange County pension obligation bonds to
Baa3 from Ba. In February 1998 Fitch assigned outstanding Orange County pension
obligation bonds a BBB rating.
Los Angeles County, the nation's largest county, is also experiencing financial
difficulty. In August 1995 the credit rating of the County's long-term bonds was
downgraded for the third time since 1992 as a result of, among other things,
severe operating deficits for the County's health care system. In addition, the
County was affected by an ongoing loss of revenue caused by state property tax
shift initiatives in 1993 through 1995. In April 1998 the Los Angeles County
Chief Administrative Officer proposed an approximately $13.2 billion 1998-99
budget, which would be 5.3% larger than the 1997-98 budget, and which would not
require cuts in services and jobs to close a projected deficit. In June 1998 the
Los Angeles County Board of Supervisors approved an approximately $13.6 billion
1998-99 budget, reserving the right to make further changes to reflect revenue
allocation decisions in the final State budget.
1998-99 Fiscal Year Budget
The Governor signed the 1998-99 Budget Act on August 21, 1998. The 1998-99
Budget Act is based on projected General Fund revenues and transfers of $57.0
billion (after giving effect to various tax reductions enacted in 1997 and
1998), a 4.2% increase from the revised 1997-98 figures. Special Fund revenues
were estimated at $14.3 billion. The revenue projections were based on the
Governor's May Revision to the 1998-99 Budget and may be overstated in light of
the possible effect on California's economic growth of worsening economic
problems in various international markets.
The Budget Act provides authority for expenditures of $57.3 billion from the
General Fund (a 7.3% increase from 1997-98), $14.7 billion from Special Funds,
and $3.4 billion from bond funds. The Budget Act projects a balance in the SFEU
at June 30, 1999 of $1.255 billion, a little more than 2% of General Fund
revenues. The Budget Act assumes the State will carry out its normal intra-year
cash flow borrowing in the amount of $1.7 billion of revenue anticipation notes
issued in October, 1998.
16
<PAGE> 62
The most significant feature of the 1998-99 budget was agreement on a total of
$1.4 billion of tax cuts. The central element is a bill which provides for a
phased-in reduction of the Vehicle License Fee (VLF). Since the VLF is currently
transferred to cities and counties, the bill provides for the General Fund to
replace the lost revenues. Starting on January 1, 1999, the VLF will be reduced
by 25%, at a cost to the General Fund of approximately $500 million in the
1998-99 Fiscal Year and about $1 billion annually thereafter.
In addition to the cut in the VLF, the 1998-99 budget includes both temporary
and permanent increases in the personal income tax dependent credit ($612
million General Fund cost in 1998-99, but less in future years), a nonrefundable
renters tax credit ($133 million), and various targeted business tax credits
($106 million). About half of the business tax credits will only become
effective if Proposition 7, an initiative measure which includes various tax
credits, is rejected by the voters on the November 3, 1998 ballot.
The 1998-99 Budget Act includes increased funding for schools, higher education,
health, welfare and social service programs, and trial courts and prisons. The
Budget also includes new funding for natural resources projects, dedication of
$376 million of General Fund moneys for capital outlay projects, funding of a 3%
State employee salary increase, funding of 2,000 new Department of
Transportation positions to accelerate transportation construction projects, and
funding of the California Infrastructure and Economic Development Bank ($50
million).
The foregoing discussion of the 1997-98 fiscal year budget and the proposed
1998-99 fiscal year budget is based in large part on statements made in a recent
"Preliminary Official Statement" distributed by the State of California. In that
document, the State indicated that its discussion of the fiscal year budget is
based on estimates and projections of revenues and expenditures for the current
fiscal year and must not be construed as statements of fact. The State noted
further that the estimates and projections are based upon various assumptions
which may be affected by numerous factors, including future economic conditions
in the state and the nation, and that there can be no assurance that the
estimates will be achieved.
State Indebtedness
As of September 1, 1998, the State had over $18.5 billion aggregate amount of
its general obligation bonds outstanding. General obligation bond authorizations
in an aggregate amount of approximately $6.3 billion remained unissued as of
September 1, 1998. The State also builds and acquires capital facilities through
the use of lease purchase borrowing. As of September 1, 1998, the State had
approximately $6.6 billion of outstanding Lease-Purchase Debt.
In addition to the general obligation bonds, State agencies and authorities had
approximately $24.5 billion aggregate principal amount of revenue bonds and
notes outstanding as of June 30, 1998. Revenue bonds represent both obligations
payable from State revenue-producing enterprises and projects, which are not
payable from the General Fund, and conduit obligations payable only from
revenues paid by private users of facilities financed by such revenue bonds.
Such enterprises and projects include transportation projects, various public
works and exposition projects, educational facilities (including the California
State University and University of California systems), housing, health
facilities and pollution control facilities.
17
<PAGE> 63
Litigation
The State is a party to numerous legal proceedings, many of which normally occur
in governmental operations. In addition, the State is involved in certain other
legal proceedings that, if decided against the State, might require the State to
make significant future expenditures or impair future revenue sources.
Ratings
Because of the State's continuing budget problems, the State's General
Obligation bonds were downgraded in July 1994 to Al from Aa by Moody's, to A
from A+ by Standard & Poor's, and to A from AA by Fitch. All three rating
agencies expressed uncertainty in the State's ability to balance the budget by
1996. However, in 1996, citing California's improving economy and budget
situation, both Fitch and Standard & Poor's raised their ratings from A to A+.
In October 1997, Fitch raised its rating from A+ to AA- referring to
California's fundamental strengths, the extent of economic recovery and the
return of financial stability. In October 1998, Moody's raised its rating from
A1 to Aa3 citing the State's continuing economic recovery and a number of
actions taken to improve the State's credit condition, including the rebuilding
of cash and budget reserves.
Year 2000
The State's reliance on information technology in every aspect of its operations
has made Year 2000-related ("Y2K") information technology issues a high priority
for the State. The Department of information Technology ("DOIT"), an independent
office reporting directly to the Governor, is responsible for ensuring the
State's information technology processes are fully functional before the year
2000. The DOIT has created a Year 2000 Task Force and a California 2000 Office
to establish statewide policy requirements, to gather, coordinate, and share
information, and to monitor statewide progress.
Although the DOIT reports that State departments are making substantial progress
overall toward the goal of Y2K compliance, the task is very large and will
likely encounter unexpected difficulties. The State has not predicted whether
all mission critical systems will be ready and tested by late 1999 or what
impact failure of any particular system(s) or of outside interfaces with State
systems might have. There can be no assurance that steps being taken by
California state or local government agencies with respect to the Year 2000
problem will be sufficient to avoid any adverse impact upon the budgets or
operations of those agencies or upon the Fund.
The information summarized above describes some of the more significant aspects
relating to the Fund. The sources of such information are Preliminary Official
Statements and Official Statements relating to the State's general obligation
bonds and the State's revenue anticipation notes, or obligations of other
issuers located in the State of California, or other publicly available
documents. Although the Fund has not independently verified this information, it
has no reason to believe that such information is not correct in all material
respects.
18
<PAGE> 64
OPTIONS AND FUTURES CONTRACTS
The Funds may purchase and sell ("write") both put options and call options on
securities, securities indices and (in the case of each of the Emerging Markets
Bond and EuroDirect Funds) foreign currencies, enter into interest rate and
index futures contracts and (in the case of each of the Emerging Markets Bond
and EuroDirect Funds) foreign currency futures contracts, and purchase and sell
options on such futures contracts ("futures options"). If other types of
options, futures contracts, or futures options are traded in the future, a Fund
may also use those instruments, provided the Board of Trustees determines that
their use is consistent with the Fund's investment objectives, and their use is
consistent with restrictions applicable to options and futures contracts
currently eligible for use by that Fund.
OPTIONS ON SECURITIES OR INDICES
A Fund may purchase and write options on securities and indices. An index is a
statistical measure designed to reflect specified facets of a particular
financial or securities market, a specific group of financial instruments or
securities, or certain economic indicators such as the Merrill Lynch 1 to 3 year
Global Government Bond Index, the JP Morgan Global Government Bond Index, and
the Lehman Brothers Government/Corporate Index.
An option on a security (or an index) is a contract that gives the holder of the
option, in return for a premium, the right to buy from (in the case of a call)
or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option (in the case of "American Style"
options) or at the expiration of the option (in the case of "European Style"
options). The writer of a call or put option on a security is obligated upon
exercise of the option to deliver the underlying security upon payment of the
exercise price or to pay the exercise price upon delivery of the underlying
security, as the case may be. The writer of an option on an index is obligated
upon exercise of the option to pay the difference between the cash value of the
index and the exercise price multiplied by a specified multiplier for the index
option.
A Fund will write call options and put options only if they are "covered." In
the case of a call option on a security, the option is covered if the Fund owns
the security underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or, if additional
cash consideration is required, cash or cash equivalents in such amount are
placed in a segregated account with the Group's Custodian) upon conversion or
exchange of other securities held by the Fund. A call option on an index is
covered if the Fund maintains with its Custodian cash or cash equivalents equal
to the contract value. A call option is also covered if the Fund holds a call on
the same security or index as the call written, and the exercise price of the
call held is (i) equal to or less than the exercise price of the call written,
or (ii) greater than the exercise price of the call written, provided the
difference is maintained by the Fund in cash or cash equivalents in a segregated
account with its Custodian. A put option on a security or an index is covered if
the Fund maintains cash or cash equivalents equal to the exercise price in a
segregated account with its Custodian. A put option is also covered if the Fund
holds a put on the same security or index as the put written, and the exercise
price of the put held is (i) equal to or greater than the exercise price of the
put written, or (ii) less than the exercise price of the put written, provided
the difference is maintained by the Fund in cash or cash equivalents in a
segregated account with its Custodian.
19
<PAGE> 65
If an option written by a Fund expires unexercised, the Fund realizes a capital
gain equal to the premium received at the time the option was written. If an
option purchased by a Fund expires unexercised, the Fund realizes a capital loss
equal to the premium paid.
Prior to the earlier of exercise or expiration, an option may be closed out by
an offsetting purchase or sale of an option of the same series (i.e., of the
type, traded on the same exchange, with respect to the same underlying security
or index, and with the same exercise price and expiration date). A Fund will
realize a capital gain from a closing purchase transaction if the cost of the
closing option is less than the premium received from writing the option; if it
is more, the Fund will realize a capital loss. If the premium received from a
closing sale transaction is more than the premium paid to purchase the option,
the Fund will realize a capital gain; if it is less, the Fund will realize a
capital loss. The principal factors affecting the market value of a put or a
call option include supply and demand, interest rates, the current market price
of the underlying security or index in relation to the exercise price of the
option, the volatility of the underlying security or index, and the time
remaining until the expiration date.
The premium paid for a put or call option purchased by a Fund is an asset of the
Fund. The premium received for an option written by a Fund is recorded as a
deferred credit. The value of an option purchased or written is marked to market
daily and is valued at the closing price on the exchange on which it is traded
or, if not traded on an exchange or no closing price is available, at the mean
between the last bid and asked prices.
FOREIGN CURRENCY OPTIONS
Each of the Emerging Markets Bond and EuroDirect Funds may buy or sell put and
call options on foreign currencies. A put or call option on a foreign currency
gives the purchaser of the option the right to sell or purchase a foreign
currency at the exercise price until the option expires. Each Fund will use
foreign currency options separately or in combination to control currency
volatility. Among the strategies employed to control currency volatility is an
option collar. An option collar involves the purchase of a put option and the
simultaneous sale of a call option on the same currency with the same expiration
date but with different exercise (or "strike") prices. Generally, the put option
will have an out-of-the-money strike price, while the call option will have
either an at-the-money strike price or an in-the-money strike price. Currency
options traded on U.S. or other exchanges may be subject to position limits
which may limit the ability of a Fund to reduce foreign currency risk using such
options.
COMBINATIONS OF OPTIONS
Each of the Funds may employ certain combinations of put and call options. A
"straddle" involves the purchase of a put and call option on the same security
with the same exercise prices and expiration dates. A "strangle" involves the
purchase of a put option and a call option on the same security with the same
expiration dates but different exercise prices. A "collar" involves the purchase
of a put option and the sale of a call option on the same security with the same
expiration dates but different exercise prices. A "spread" involves the sale of
a put option and the purchase of a call option on the same security with the
same or different expiration dates and different exercise prices.
20
<PAGE> 66
RISKS ASSOCIATED WITH OPTIONS
Several risks are associated with transactions in options on securities, indices
and currencies. For example, significant differences between the securities and
options markets could result in an imperfect correlation between those markets,
causing a given transaction not to achieve its objectives. A decision as to
whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when a Fund seeks to
close out an option position. Among the possible reasons for the absence of a
liquid secondary market on an exchange are: (i) insufficient trading interest in
certain options; (ii) restrictions on transactions imposed by an exchange; (iii)
trading halts, suspensions or other restrictions imposed with respect to
particular classes or series of options or underlying securities; (iv)
interruption of the normal operations of an exchange; (v) inadequacy of the
facilities of an exchange or the Options Clearing Corporation to handle current
trading volume; or (vi) a decision by an exchange to discontinue the trading of
options or a particular class or series of options (in which event the secondary
market on that exchange or in that class or series of options could cease to
exist, although outstanding options on that exchange that had been issued by the
Options Clearing Corporation as a result of trades on that exchange would
generally continue to be exercisable in accordance with their terms). If a Fund
were unable to close out an option that it had purchased on a security, it would
have to exercise the option in order to realize any profit. If a Fund were
unable to close out a covered call option that it had written on a security, it
would not be able to sell the underlying security unless the option expired
without exercise. As the writer of a covered call option, a Fund forgoes, during
the option's life, the opportunity to profit from increases in the market value
of the security covering the call option above the sum of the premium and the
exercise price of the call.
If trading were suspended in an option purchased by a Fund, the Fund would not
be able to close out the option. If restrictions on exercise were imposed, the
Fund might be unable to exercise an option it has purchased. Except to the
extent that a call option on a security, currency or index written by a Fund is
covered by an option on the same security, currency or index purchased by the
Fund, movements in the index may result in a loss to the Fund; however, such
losses may be mitigated by changes in the value of the Fund's securities during
the period the option was outstanding.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Funds may use interest rate, foreign currency or index futures contracts, as
specified in the Prospectus. An interest rate or foreign currency contract
provides for the future sale by one party and purchase by another party of a
specified quantity of a financial instrument or foreign currency at a specified
price and time. A futures contract on an index is an agreement pursuant to which
two 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 contract was originally
written. Although the value of an index might be a function of the value of
certain specified securities, no physical delivery of these securities is made.
A public market exists in futures contracts covering several indices as well as
a number of financial instruments and foreign currencies, including U.S.
Treasury bonds, U.S. Treasury notes, GNMA
21
<PAGE> 67
Certificates, three-month U.S. Treasury bills, 90-day commercial paper, bank
certificates of deposit, Eurodollar certificates of deposit, the Australian
dollar, the Canadian dollar, the British pound, the German mark, the Japanese
yen, the Swiss franc and certain multi-national currencies such as the European
Currency Unit ("ECU"). Other futures contracts are likely to be developed and
traded in the future. The Fund will only enter into futures contracts and
futures options which are standardized and traded on a U.S. or foreign exchange,
board of trade, or similar entity, or quoted on an automated quotation system.
The Funds may also purchase and write call and put options on futures contracts.
Futures options possess many of the same characteristics as options on
securities and indices. A futures option gives the holder the right, in return
for the premium paid, to assume a long position (call) or short position (put)
in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
As long as required by regulatory authorities the Funds will use futures
contracts and futures options for hedging purposes and not for speculation and
will comply with applicable regulations of the Commodity Futures Trading
Corporation which limit trading of futures contracts (See "Limitations on the
Use of Futures and Options"). For example, a Fund might use futures contracts to
hedge against anticipated changes in interest rates that might adversely affect
either the value of the Fund's securities or the price of the securities which
the Fund intends to purchase. A Fund's hedging activities may include sales of
futures contracts as an offset against the effect of expected increases in
interest rates, and purchases of futures contracts as an offset against the
effect of expected declines in interest rates. Although other techniques could
be used to reduce a Fund's exposure to interest rate fluctuations, a Fund may be
able to hedge its exposure more effectively and at a lower cost by using futures
contracts and futures options.
When a purchase or sale of a futures contract is made by a Fund, the Fund is
required to deposit with its Custodian (or futures commission merchant, if
legally permitted) a specified amount of cash or U.S. Government securities
("initial margin"). The margin required for a futures contract is set by the
exchange on which the contract is traded and may be modified during the term of
the contract. The initial margin is in the nature of a performance bond or good
faith deposit on the futures contract which is returned to the Fund upon
termination of the contract, assuming all contractual obligations have been
satisfied. The Funds expect to earn interest income on their initial margin
deposits. A futures contract held by a Fund is valued daily at the official
settlement price of the exchange on which it is traded. Each day a Fund pays or
receives cash, called "variation margin," equal to the daily change in value of
the futures contract. This process is known as "marking to market." Variation
margin does not represent a borrowing or loan by a Fund but is instead a
settlement between the Fund and the futures commission merchant of the amount
one would owe the other if the futures contract expired. In computing daily net
asset value, the Funds will mark to market their open futures positions.
Each Fund is also required to deposit and maintain margin with respect to put
and call options on futures contracts written by it. Such margin deposits will
vary depending on the nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the option, and other
futures positions held by the Fund.
22
<PAGE> 68
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts
(contracts traded on the same exchange, on the same underlying security or
index, and with the same delivery month). If an offsetting purchase price is
less than the original sale price, the Fund realizes a capital gain; if it is
more, a Fund realizes a capital loss. Conversely, if an offsetting sale price is
more than the original purchase price, a Fund realizes a capital gains; if it is
less, a Fund realizes a capital loss. The transaction costs must also be
included in these calculations.
LIMITATIONS ON USE OF FUTURES AND FUTURES OPTIONS
A Fund will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in-the-money," would exceed 5% of the
Fund's total assets. A call option is "in-the-money" if the value of the futures
contract that is the subject of the option exceeds the exercise price. A put
option is "in-the-money" if the exercise price exceeds the value of the futures
contract that is the subject of the option.
When purchasing a futures contract, a Fund will maintain with its Custodian (and
mark to market on a daily basis) cash, U.S. Government securities, or other
liquid securities that, when added to the amounts deposited with a futures
commission merchant as margin, are equal to the market value of the futures
contract. Alternatively, a Fund may "cover" its position by purchasing a put
option on the same futures contract with a strike price as high or higher than
the price of the contract held by the Fund.
When selling a futures contract, a Fund will maintain with its Custodian (and
mark to market on a daily basis) liquid assets that, when added to the amount
deposited with a futures commission merchant as margin, are equal to the market
value of the instruments underlying the contract. Alternatively, a Fund may
"cover" its position by owning the instruments underlying the contract (or, in
the case of an index futures contract, a portfolio with a volatility
substantially similar to that of the index on which the futures contract is
based), or by holding a call option permitting the Fund to purchase the same
futures contract at a price no higher than the price of the contract written by
the Fund (or at a higher price if the difference is maintained in liquid assets
with the Fund's Custodian).
When selling a call option on a futures contract, a Fund will maintain with its
custodian (and mark to market on a daily basis) cash, U.S. Government
securities, or other liquid securities that, when added to the amounts deposited
with a futures commission merchant as margin, equal the total market value of
the futures contract underlying the call option. Alternatively, a Fund may cover
its position by entering into a long position in the same futures contract at a
price no higher than the strike price of the call option, by owning the
instruments underlying the futures contract, or by holding a separate call
option permitting the Fund to purchase the same futures contract at a price not
higher than the strike price of the call option sold by the Fund.
When selling a put option on a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, or other liquid securities that equal the purchase price of the
futures contract, less any margin on deposit. Alternatively, a Fund may cover
the position either by entering into a short position in the same futures
contract, or by owning a separate put option permitting it to sell the same
futures contract so long as the strike price of the purchased put option is the
same or higher than the strike price of the put option sold by the Fund.
23
<PAGE> 69
In order to comply with applicable regulations of the Commodity Futures Trading
Commission ("CFTC") for exemption from the definition of a "commodity pool,"
each Fund is limited in its futures trading activities to: (1) positions which
constitute "bona fide hedging" positions within the meaning and intent of
applicable CFTC rules, and (2) other positions for the establishment of which
the aggregate initial margin and premiums (less the amount by which such options
are "in-the-money") do not exceed 5% of the Fund's net assets (after taking into
account unrealized gains and unrealized losses on any contracts it has entered
into).
The requirements for qualification as a regulated investment company also may
limit the extent to which the Funds may enter into futures, futures options or
forward contracts. See "Taxation."
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS
There are several risks associated with the use of futures contracts and futures
options as hedging techniques. A purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract. There
can be no guarantee that there will be a correlation between price movements in
the hedging vehicle and in the Fund securities being hedged. In addition, there
are significant differences between the securities and futures markets that
could result in an imperfect correlation between the markets, causing a given
hedge not to achieve its objectives. The degree of imperfection of correlation
depends on circumstances such as variations in speculative market demand for
futures and futures options on securities, including technical influences in
futures trading and futures options, and differences between the financial
instruments being hedged and the instruments underlying the standard contracts
available for trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses, because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when a Fund
seeks to close out a futures contract or a futures option position, in which
event the Fund would remain obligated to meet margin requirements until the
position is closed. In addition, many of the contracts discussed above are
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist.
In the event of the bankruptcy of a broker through which a Fund engages in
transactions in futures contracts or options, the Fund could experience delays
and losses in liquidating open positions
24
<PAGE> 70
purchased or sold through the broker, and incur a loss of all or part of its
margin deposits with the broker.
DEALER OPTIONS
The Funds may engage in transactions involving dealer options on securities,
currencies or indices as well as exchange-traded options. Certain risks are
specific to dealer options. While a Fund would look to a clearing corporation to
exercise exchange-traded options, if a Fund were to purchase a dealer option it
would rely on the dealer from whom it purchased the option to perform if the
option were exercised. Failure by the dealer to do so would result in the loss
of the premium paid by the Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid market while dealer
options may not. Consequently, a Fund may generally be able to realize the value
of a dealer option it has purchased only by exercising or reselling the option
to the dealer who issued it. Similarly, when a Fund writes a dealer option, the
Fund may generally be able to close out the option prior to its expiration only
by entering into a closing purchase transaction with the dealer to whom the Fund
originally wrote the option. While the Funds will seek to enter into dealer
options only with dealers who will agree to and which are expected to be capable
of entering into closing transactions with the Fund, there can be no assurance
that the Fund will be able to liquidate a dealer option at a favorable price at
any time prior to expiration. Unless a Fund, as a covered dealer call option
writer, is able to effect a closing purchase transaction, it will not be able to
liquidate securities (or other assets) used as cover until the option expires or
is exercised. In the event of insolvency of the other party, the Funds may be
unable to liquidate a dealer option. With respect to options written by a Fund,
the inability to enter into a closing transaction may result in material losses
to the Fund. For example, since a Fund must maintain a secured position with
respect to any call option on security it writes, the Fund may not sell the
assets which it has segregated to secure the position while it is obligated
under the option. This requirement may impair the Fund's ability to sell
portfolio securities at a time when such sale might be advantageous.
The Staff of the SEC has taken the position that many purchased dealer options
and the assets used to secure written dealer options are illiquid securities. A
Fund may treat the cover used for these written dealer options as liquid if the
dealer agrees that the Fund may repurchase the dealer option it has written for
a maximum price to be calculated by a predetermined formula. In such cases, the
dealer option would be considered illiquid only to the extent the maximum
purchase price under the formula exceeds the intrinsic value of the option.
Accordingly, the Funds will treat certain dealer options as subject to the
Funds' limitation on illiquid securities. If the SEC changes its position on the
liquidity of dealer options on securities, currencies or indices, the Funds will
change their treatment of such instruments accordingly.
INTEREST RATE AND CURRENCY SWAPS
INTEREST RATE AND INDEX SWAPS
An interest rate swap is a contract between two entities ("counterparties") to
exchange interest payments (of the same currency) between the parties. In the
most common interest rate swap structure, one counterparty agrees to make
floating rate payments to the other counterparty, which in turn makes fixed rate
payments to the first counterparty. Interest payments are determined by
25
<PAGE> 71
applying the respective interest rates to an agreed upon amount, referred to as
the "notional principal amount." In most such transactions, the floating rate
payments are tied to the London Interbank Offered Rate, which is the offered
rate for short-term eurodollar deposits between major international banks. The
same process applies when dealing with an index swap. The buyer of the swap pays
on a floating rate basis and receives a fixed rate payment, based on the total
return of the particular reference index.
CROSS-CURRENCY SWAPS
A cross-currency swap is a contract between two counterparties to exchange
interest and principal payments in different currencies. A cross-currency swap
normally has an exchange of principal at maturity (the final exchange); an
exchange of principal at the start of the swap (the initial exchange) is
optional. An initial exchange of notional principal amounts at the spot exchange
rate serves the same function as a spot transaction in the foreign exchange
market (for an immediate exchange of foreign exchange risk). An exchange at
maturity of notional principal amounts at the spot exchange rate serves the same
function as a forward transaction in the foreign exchange market (for a future
transfer of foreign exchange risk). The currency swap market convention is to
use the spot rate rather than the forward rate for the exchange at maturity. The
economic difference is realized through the coupon exchanges over the life of
the swap. In contrast to single currency interest rate swaps, cross-currency
swaps involve both interest rate risk and foreign exchange risk.
SWAP OPTIONS
Each of the Emerging Markets Bond and EuroDirect Funds may invest in swap
options. A swap option is a contract that gives a counterparty the right (but
not the obligation) to enter into a new swap agreement or to shorten, extend,
cancel or otherwise change an existing swap agreement, at some designated future
time on specified terms. It is different from a forward swap, which is a
commitment to enter into a swap that starts at some future date with specified
rates. A swap option may be structured European-style (exercisable on the pre
specified date) or American-style (exercisable during a designated period). The
right pursuant to a swap option must be exercised by the right holder. The buyer
of the right to pay fixed pursuant to a swap option is said to own a put. The
buyer of the right to receive fixed pursuant to a swap option is said to own a
call.
CAPS AND FLOORS
Each of the Emerging Markets Bond and EuroDirect Funds may also invest in
interest rate caps and floors. An interest rate cap is a right to receive
periodic cash payments over the life of the cap equal to the difference between
any higher actual level of interest rates in the future and a specified strike
(or "cap") level. The cap buyer purchases protection for a floating rate move
above the strike. An interest rate floor is the right to receive periodic cash
payments over the life of the floor equal to the difference between any lower
actual level of interest rates in the future and a specified strike (or "floor")
level. The floor buyer purchases protection for a floating rate move below the
strike. The strikes are typically based on the three-month LIBOR (although other
indices are available) and are measured quarterly. Rights arising pursuant to
both caps and floors are exercised automatically if the strike is in the money.
Caps and floors eliminate the risk that the buyer fails to exercise an
in-the-money option.
26
<PAGE> 72
RISKS ASSOCIATED WITH SWAPS
The risks associated with interest rate and currency swaps and interest rate
caps and floors are similar to those described above with respect to dealer
options. In connection with such transactions, a Fund relies on the other party
to the transaction to perform its obligations pursuant to the underlying
agreement. If there were a default by the other party to the transaction, the
Fund would have contractual remedies pursuant to the agreement, but could incur
delays in obtaining the expected benefit of the transaction or loss of such
benefit. In the event of insolvency of the other party, the Fund might be unable
to obtain its expected benefit. In addition, while each Fund will seek to enter
into such transactions only with parties which are capable of entering into
closing transactions with the Fund, there can be no assurance that a Fund will
be able to close out such a transaction with the other party, or obtain an
offsetting position with any other party, at any time prior to the end of the
term of the underlying agreement. This may impair a Fund's ability to enter into
other transactions at a time when doing so might be advantageous.
FOREIGN CURRENCY TRANSACTIONS
Precise matching of the amount of forward currency contracts and the value of
securities denominated in such currencies of each of the Emerging Markets Bond
and EuroDirect Funds will not generally be possible, since the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Prediction of short-term currency
market movements is extremely difficult, and the successful execution of a
short-term hedging strategy is highly uncertain. Under certain circumstances, a
Fund may commit a substantial portion of its assets to the consummation of these
contracts. Neither Fund will enter into such forward contracts or maintain a net
exposure to such contracts where the consummation of the contracts would
obligate the Fund to deliver an amount of foreign currency in excess of the
value of the Fund's portfolio securities or other assets denominated in that
currency. Under normal circumstances, consideration of the prospect for currency
parities will be incorporated into the longer term investment decisions made
with regard to overall diversification strategies. However, the Adviser and
Sub-adviser believe that it is important to have the flexibility to enter into
such forward contracts when it determines that the best interests of a Fund will
be served by doing so.
At the maturity of a forward contract, a Fund may either sell the portfolio
security and make delivery of the foreign currency, or it may retain the
security and terminate its contractual obligation to deliver the foreign
currency by purchasing an "offsetting" contract obligating it to purchase, on
the same maturity date, the same amount of the foreign currency.
It may be necessary for a Fund to purchase additional foreign currency on the
spot market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Fund is obligated to
deliver.
If a Fund retains a portfolio security and engages in an off-setting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund
27
<PAGE> 73
engages in an offsetting transaction, it may subsequently enter into a new
forward contract to sell the foreign currency. Should forward prices decline
during the period between the date the Fund enters into a forward contract for
the sale of a foreign currency and the date it enters into an offsetting
contract for the purchase of the foreign currency, the Fund will realize a gain
to the extent the price of the currency it has agreed to sell exceeds the price
of the currency it has agreed to purchase. Should forward prices increase, the
Fund will suffer a loss to the extent the price of the currency it has agreed to
purchase exceeds the price of the currency it has agreed to sell.
Each Fund's dealings in forward foreign currency exchange contracts will
generally be limited to the transactions described above. However, each Fund
reserves the right to enter into forward foreign currency contracts for
different purposes and under different circumstances. Use of forward currency
contracts to hedge against a decline in the value of a currency does not
eliminate fluctuations in the underlying prices of the securities. Additionally,
although such contracts tend to minimize the risk of loss due to a decline in
the value of the hedged currency, they also tend to limit any potential gain
which might result from an increase in the value of that currency.
Although each Fund values its assets daily in terms of U.S. dollars, it does not
intend to convert its holdings of foreign currencies into U.S. dollars on a
daily basis. Foreign exchange dealers do not charge a fee for conversion, but
they do realize a profit based on the difference (the "spread") between the
prices at which they are buying and selling various currencies. Thus, a dealer
may offer to sell a foreign currency to a Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to resell that currency to the
dealer.
BORROWING
Each Fund may borrow for temporary, extraordinary or emergency purposes, or for
the clearance of transactions. The Investment Company Act of 1940 (the "1940
Act") requires each Fund to maintain continuous asset coverage (that is, total
assets including borrowings, less liabilities exclusive of borrowings) of 300%
of the amount borrowed. If the 300% asset coverage should decline as a result of
market fluctuations or other reasons, a Fund may be required to sell some of its
portfolio holdings within three days to reduce the debt and restore the 300%
asset coverage, even though it may be disadvantageous from an investment
standpoint to sell securities at that time. To avoid the potential leveraging
effects of a Fund's borrowings, additional investments will not be made while
borrowings are in excess of 5% of the Fund's total assets. Money borrowed will
be subject to interest costs which may or may not be recovered by appreciation
of the securities purchased. The Funds also may be required to maintain minimum
average balances in connection with any such borrowings or to pay a commitment
or other fee to maintain a line of credit, either of which would increase the
cost of borrowing over the stated interest rate.
RISKS OF FOREIGN INVESTING
There are special risks in investing in any foreign securities in addition to
those relating to investments in U.S. securities.
POLITICAL AND ECONOMIC FACTORS
Individual foreign economies of certain countries may differ favorably or
unfavorably from the United States' economy in such respects as growth of gross
national product, rate of inflation, capital
28
<PAGE> 74
reinvestment, resource self-sufficiency, diversification and balance of payments
position. The internal politics of certain foreign countries may not be as
stable as those of the United States.
Governments in certain foreign countries continue to participate to a
significant degree, through ownership interest or regulation, in their
respective economies. Action by these governments could include restrictions on
foreign investment, nationalization, expropriation of goods or imposition of
taxes, and could have a significant effect on market prices of securities and
payment of interest. The economies of many foreign countries are heavily
dependent upon international trade and are accordingly affected by the trade
policies and economic conditions of their trading partners. Enactment by these
trading partners of protectionist trade legislation could have a significant
adverse effect upon the securities markets of such countries.
CURRENCY FLUCTUATIONS
To the extent that a Fund invests in securities denominated in foreign
currencies, a change in the value of any such currency against the U.S. dollar
will result in a corresponding change in the U.S. dollar value of the Fund's
assets denominated in that currency. Such changes will also affect the Fund's
income. The value of a Fund's assets may also be affected significantly by
currency restrictions and exchange control regulations enacted from time to
time.
MARKET CHARACTERISTICS
The Group expects that most foreign securities in which the Funds invest will be
purchased in over-the-counter markets or on bond exchanges located in the
countries in which the principal offices of the issuers of the various
securities are located, if that is the best available market. Foreign bond
markets may be more volatile than those in the United States. While growing in
volume, they usually have substantially less volume than U.S. markets, and the
Funds' portfolio securities may be less liquid and more volatile than U.S.
Government securities. Moreover, settlement practices for transactions in
foreign markets may differ from those in United States markets, and may include
delays beyond periods customary in the United States.
Transactions in options on securities, futures contracts and futures options may
not be regulated as effectively on foreign exchanges as similar transactions in
the United States, and may not involve clearing mechanisms and related
guarantees. The value of such positions also could be adversely affected by the
imposition of different exercise terms and procedures and margin requirements
than in the United States. Foreign security trading practices, including those
involving securities settlement where Fund assets may be released prior to
payment, may expose a Fund to increased risk in the event of a failed trade or
the insolvency of a foreign broker-dealer.
The value of the Funds' portfolio positions may also be adversely impacted by
delays in the Funds' ability to act upon economic events occurring in foreign
markets during non-business hours in the United States.
LEGAL AND REGULATORY MATTERS
Certain foreign countries may have less supervision of securities markets,
brokers and issuers of securities, and less financial information available to
issuers, than is available in the United States.
29
<PAGE> 75
TAXES
The interest payable on certain of a Fund's foreign portfolio securities may be
subject to foreign withholding taxes, thus reducing the net amount of income
available for distribution to the Fund's shareholders. A shareholder otherwise
subject to United States federal income taxes may, subject to certain
limitations, be entitled to claim a credit or deduction for U.S. federal income
tax purposes for his proportionate share of such foreign taxes paid by a Fund.
The Funds intend to sell such bonds prior to the interest payment date in order
to avoid withholding.
COSTS
The expense ratios of Funds investing in foreign securities (before
reimbursement by the Adviser pursuant to the expense limitation described in the
Prospectus under "Management of the Funds -- Expense Guarantee") are likely to
be higher than those of investment companies investing in domestic securities,
since the cost of maintaining the custody of foreign securities is higher.
EMERGING MARKETS INVESTMENTS
Investments by each of the Emerging Markets Bond and EuroDirect Funds in
securities issued by the governments of emerging or developing countries, and of
companies within those countries, involve greater risks than other foreign
investments. Investments in emerging or developing markets involve exposure to
economic and legal structures that are generally less diverse and mature (and in
some cases the absence of developed legal structures governing private and
foreign investments and private property), and to political systems which can be
expected to have less stability, than those of more developed countries. The
risks of investment in such countries may include matters such as relatively
unstable governments, higher degrees of government involvement in the economy,
the absence until recently of capital market structures or market-oriented
economies, economies based on only a few industries, securities markets which
trade only a small number of securities, restrictions on foreign investment in
stocks, and significant foreign currency devaluations and fluctuations.
Emerging markets can be substantially more volatile than both U.S. and more
developed foreign markets. Such volatility may be exacerbated by illiquidity.
The average daily trading volume in all of the emerging markets combined is a
small fraction of the average daily volume of the U.S. market. Small trading
volumes may result in a Fund being forced to purchase securities at a
substantially higher priced than the current market, or to sell securities at
much lower prices than the current market.
AVERAGE MATURITY AND DURATION CALCULATIONS
AVERAGE MATURITY
The portfolio average maturity of each Fund will be computed by weighting the
maturity of each security in the Fund's portfolio by the market value of that
security. For securities which have put dates, reset dates, or trade based on
average maturity, the put date, reset date or average maturity will be used
instead of the final maturity date for the average maturity calculation. Average
maturity is normally used when trading mortgage backed securities and asset
backed securities.
30
<PAGE> 76
DURATION
One common measure of the price volatility of a fixed income security is
duration, a weighted average term-to-maturity of the present value of a
security's cash flows. As it is a weighted term-to-maturity, duration is
generally measured in years and can vary from zero to the time-to-maturity of
the security. Duration is a complex formula that utilizes each cash flow and the
market yield of the security. Bonds of the same maturity can have different
durations if they have different coupon rates or yields.
For securities which pay periodic coupons and have a relatively short maturity,
duration tends to approximate the time to maturity. As the maturity of the bond
extends, the duration also extends but at a slower rate. For example, the
duration of a 2-year security can be about 1.8 years; the duration of a 30-year
bond will be roughly 10 to 11 years. However, the duration of any security that
pays interest only at maturity is the time to maturity. Thus a 30-year zero
coupon bond has a duration of 30 years.
If the duration of the security is divided by the sum of one plus its yield, the
resultant number is called the modified duration of the security. Modified
duration is important to portfolio managers as it is used to determine the
sensitivity of the security to changes in interest rates. For small changes in
yield, the price of a security, as a percentage of its initial price, will move
inversely to the yield change by an amount equal to the modified duration times
the yield change. The market price of a security with a modified duration of ten
years will change twice as much as a security with a with a five year duration.
Modified duration is a much better indicator of price volatility than time to
maturity. For example, the times to maturity for a 30 year bond and a 30 year
zero coupon security are both 30 years. A portfolio manager using average
maturity to judge price volatility would expect to see no difference in
portfolio impact from these two securities (given equal yield). However, the
zero coupon bond will experience a percentage price change roughly three times
greater than the 30 year bond.
FUNDAMENTAL AND OPERATING POLICIES
The Funds have adopted the investment restrictions described below. Fundamental
policies of a Fund may not be changed without the approval of the lesser of (1)
67% of the Fund's shares present at a meeting of shareholders if the holders of
more than 50% of the outstanding shares are present in person or by proxy or (2)
more than 50% of the Fund's outstanding shares. Operating policies are subject
to change by the Board of Trustees without shareholder approval. Any investment
restriction which involves a maximum percentage of securities or assets will not
be considered to be violated unless an excess occurs immediately after, and is
caused by, an acquisition of securities or assets of, or borrowings by, the
Fund.
FUNDAMENTAL POLICIES
As a matter of fundamental policy, a Fund may not:
(1) BORROWING. Borrow money, except as a temporary measure for extraordinary or
emergency purposes or for the clearance of transactions, and then only in
amounts not exceeding 30% of its total
31
<PAGE> 77
assets valued at market (for this purpose, reverse repurchase agreements and
delayed delivery transactions covered by segregated accounts are not considered
to be borrowings).
(2) COMMODITIES. Purchase or sell commodities or commodity contracts, except
that (i) each of the Funds may enter into financial and currency futures
contracts and options on such futures contracts, (ii) each of the Emerging
Markets Bond and EuroDirect Funds may enter into forward foreign currency
exchange contracts (the Funds do not consider such contracts to be commodities),
and (iii) each of the Emerging Markets Bond and EuroDirect Funds may invest in
instruments which have the characteristics of both futures contracts and
securities.
(3) LOANS. Make loans, except that (i) a Fund may purchase money market
securities and enter into repurchase agreements, and (ii) a Fund may acquire
bonds, debentures, notes and other debt securities.
(4) MARGIN. Purchase securities on margin, except that (i) a Fund may use
short-term credit necessary for clearance of purchases of portfolio securities,
and (ii) a Fund other than the U.S. Government Fund may make margin deposits in
connection with futures contracts and options on futures contracts.
(5) MORTGAGING. Mortgage, pledge, hypothecate or in any manner transfer any
security owned by a Fund as security for indebtedness, except as may be
necessary in connection with permissible borrowings and then only in amounts not
exceeding 30% of the Fund's total assets valued at market at the time of the
borrowing.
(6) ASSETS INVESTED IN ANY ISSUER. Purchase a security if, as a result, with
respect to 50% of the value of a Fund's total assets, more than 5% of the value
of its total assets would be invested in the securities of any one issuer (other
than obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities).
(7) SHARE OWNERSHIP OF ANY ISSUER. Purchase a security if, as a result, with
respect to 50% of the value of a Fund's total assets, more than 10% of the
outstanding voting securities of any issuer would be held by the Fund (other
than obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities).
(8) REAL ESTATE. Purchase or sell real estate (although it may purchase
securities secured by real estate partnerships or interests therein, or issued
by companies or investment trusts which invest in real estate or interests
therein) or real estate limited partnership interests.
(9) SHORT SALES. Effect short sales of securities.
(10) UNDERWRITING. Underwrite securities issued by other persons, except to the
extent that a 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 its portfolio
securities in the ordinary course of pursuing its investment program.
OPERATING POLICIES
As a matter of operating policy, a Fund may not:
32
<PAGE> 78
(1) CONTROL OF PORTFOLIO COMPANIES. Invest in companies for the purpose of
exercising management or control.
(2) ILLIQUID SECURITIES. Purchase a security if, as a result of such purchase,
more than 15% of the value of the Fund's net assets would be invested in
illiquid securities or other securities that are not readily marketable,
including repurchase agreements which do not provide for payment within seven
days. For this purpose, restricted securities eligible for resale pursuant to
Rule 144A under the Securities Act of 1933 may be determined to be liquid.
(3) INVESTMENT COMPANIES. Purchase securities of open-end or closed-end
investment companies except in compliance with the 1940 Act.
(4) OIL AND GAS PROGRAMS. Purchase participations or other direct interests in
oil, gas, or other mineral exploration or development programs or leases.
(5) OPTIONS. Invest in puts, calls, or any combination thereof, except that a
Fund may invest in or commit its assets to purchasing and selling call and put
options to the extent permitted by the Prospectus and Statement of Additional
Information.
(6) GLOBAL DIVERSIFICATION. Under normal market conditions, the EuroDirect Fund
shall invest at least 65% of the equity and equity-based allocation of the
Fund's assets in securities of issuers headquartered or organized in at least
three countries.
PORTFOLIO TRANSACTIONS
The Funds pay commissions to brokers in connection with the purchase and sale of
equity securities, options and futures contracts. There is generally no stated
commission in the case of fixed-income securities, which are traded in the
over-the-counter markets, but the price paid by a Fund usually includes an
undisclosed dealer commission or mark-up. In underwritten offerings, the price
paid by a Fund includes a disclosed, fixed commission or discount retained by
the underwriter or dealer. Agency transactions involve the payment by a Fund of
negotiated brokerage commissions. Such commissions vary among different brokers.
Also, a particular broker may charge different commissions according to such
factors as the difficulty and size of the transaction. Transactions in foreign
securities involve commissions which are generally higher than those in the
United States.
The Adviser and Sub-adviser place all orders for the purchase and sale of
portfolio securities, options and futures contracts for the Funds they manage
and buy and sell such securities, options and futures for the Funds through a
substantial number of brokers and dealers. In so doing, the Adviser and
Sub-adviser seek the best execution available. In seeking the most favorable
execution, the Adviser and Sub-adviser consider all factors it deems relevant,
including, by way of illustration, price, the size of the transaction, the
nature of the market for the security, the amount of the commission, the timing
of the transaction taking into account market prices and trends, the reputation,
experience and financial stability of the broker-dealer involved and the quality
of service rendered by the broker-dealer in other transactions.
Some securities considered for investment by a Fund's portfolio may also be
appropriate for other clients served by the Adviser or Sub-adviser. If a
purchase or sale of securities consistent with the investment policies of a Fund
is considered at or about the same time as a similar transaction for one
33
<PAGE> 79
or more other clients served by the Adviser or Sub-adviser, transactions in such
securities will be allocated among the Fund and other clients in a manner deemed
fair and reasonable by the Adviser or Sub-adviser. Although there is no
specified formula for allocating such transactions, the various allocation
methods used by the Adviser and Sub-adviser, and the results of such
allocations, are subject to periodic review by the Board of Trustees.
The Adviser and Sub-adviser each manages the Funds without regard generally to
restrictions on portfolio turnover, except those imposed on its ability to
engage in short-term trading by provisions of the federal tax laws (see
"Taxation"). Trading in fixed-income securities does not generally involve the
payment of brokerage commissions, but does involve indirect transaction costs.
The higher the rate of portfolio turnover, the higher these transaction costs
borne by the Funds generally will be. The turnover rate of a Fund is calculated
by dividing (a) the lesser of purchases or sales of portfolio securities for a
particular fiscal year by (b) the monthly average of the value of the portfolio
securities owned by the Fund during the fiscal year. In calculating the rate of
portfolio turnover, all securities, including options, whose maturities or
expiration dates at the time of acquisition were one year or less, are excluded.
Interest rate and currency swap, cap and floor transactions do not affect the
calculation of portfolio turnover.
The Board of Trustees will periodically review the Adviser's and Sub-adviser's
performance of their responsibilities in connection with the placement of
portfolio transactions on behalf of the Funds.
VALUATION OF PORTFOLIO SECURITIES
Equity securities for which the primary market is the U.S. are valued at last
sale price or, if no sale has occurred, at the closing bid price. Equity
securities for which the primary market is outside the U.S. are valued using the
official closing price or the last sale price in the principal market where they
are traded. If the last sale price on the local exchange is unavailable, the
last evaluated quote or last bid price is normally used.
Fixed income securities are valued on the basis of valuations furnished by a
pricing service which utilizes both dealer-supplied valuations and electronic
data processing techniques. Such techniques take into account appropriate
factors such as institutional-size trading in similar groups of securities,
yield, quality, coupon rate, maturity, type of issue, trading characteristics
and other market data, without exclusive reliance upon quoted prices or exchange
or over-the-counter prices, since such valuations are believed to reflect more
accurately the fair value of such securities.
Foreign securities are valued at the closing bid price in the principal market
where they are traded, or, if closing prices are unavailable, at the last traded
bid price available prior to the time a fund's net asset value is determined.
Foreign security prices that cannot be obtained by the quotation services are
priced individually by the pricing service using dealer-supplied quotations.
Short-term obligations that mature in 60 days or less are valued at amortized
cost, which constitutes fair value as determined by the Board of Trustees. All
other securities and other assets are appraised at their fair value as
determined in good faith under consistently applied procedures established by
and under the general supervision of the Board of Trustees.
Generally, trading in corporate bonds, U.S. government securities, foreign
securities, money market instruments and repurchase agreements, is substantially
completed each day at various times prior to the close of regular trading on the
New York Stock Exchange. The values of any such securities held
34
<PAGE> 80
by a Fund are determined as of such times for the purpose of computing the
Fund's net asset value. Foreign currency exchange rates are also generally
determined prior to the close of the New York Stock Exchange. If an
extraordinary event that is expected to affect the value of a portfolio security
materially occurs after the close of an exchange on which that security is
traded, then the security will be valued at fair value as determined in good
faith under procedures established by and under the general supervision of the
Board of Trustees.
FUND PERFORMANCE
The Funds may quote their performance in various ways. All performance
information supplied by a Fund in advertising is historical and is not intended
to indicate future returns. A Fund's share price, yield and total returns
fluctuate in response to market conditions and other factors, and the value of
Fund shares when redeemed may be more or less than their original cost.
Performance information for a Fund may be compared to various unmanaged indices
(such as the Lehman Brothers Municipal Bond Index) or indices prepared by Lipper
Analytical Services and other entities or organizations which track the
performance of investment companies or investment advisers. Comparisons may also
be made to indices or data in publications such as The Bond Buyer, Forbes,
Barron's, The Wall Street Journal, The New York Times, and Business Week. For
example, a Fund may quote Morningstar, Inc. in its advertising materials.
Morningstar, Inc. is a mutual fund rating service that rates mutual funds on the
basis of risk-adjusted performance. Rankings that compare the performance a Fund
to other funds in appropriate categories over specific periods of time may also
be quoted in advertising. Unmanaged indices generally do not reflect deductions
for administrative and management costs and expenses. Payden & Rygel may also
report to shareholders or to the public in advertisements concerning the
performance of Payden & Rygel as adviser to clients other than the Funds, and on
the comparative performance or standing of Payden & Rygel in relation to other
money managers. Such comparative information may be compiled or provided by
independent rating services or other organizations.
Information regarding a Fund may also be included in newsletters or other
general communications by Payden & Rygel to advisory clients and potential
clients. These publications principally contain information regarding market and
economic trends and other general matters of interest to investors, such as:
principles of investing which, among other things includes asset allocation,
model portfolios, diversification, risk tolerance and goal setting, saving for
college or other goals or charitable giving; long-term economic or market
trends; historical studies of gold, other commodities, equities, fixed income
securities and statistical market indices; new investment theories or
techniques; economic and/or political trends in foreign countries and their
impact on the United States; municipal bond market fundamentals and trends;
corporate financing trends and other factors that may impact corporate debt; and
housing trends and other economic factors that may impact mortgage rates and
lending activity. In addition, Payden & Rygel may quote financial or business
publications and periodicals as they relate to fund management, investment
philosophy and investment techniques. Materials may also include discussions
regarding Payden & Rygel's asset allocation services and other Payden & Rygel
funds, products and services.
Ibbotson Associates of Chicago, Illinois ("Ibbotson") provides historical
returns of the capital markets in the United States, including common stocks,
small capitalization stocks, long-term corporate bonds, intermediate-term
government bonds, long-term government bonds, Treasury bills and the U.S. rate
of inflation (based on the Consumer Price Index) and a combination of various
capital
35
<PAGE> 81
markets. The Group may use the long-term performance of these capital markets in
order to demonstrate general long-term risk-versus-reward investment scenarios
or the value of a hypothetical investment in any of these capital markets. The
performance of these capital markets is based on the returns of several
different indices. Ibbotson calculates total returns in the same method as the
Group. Performance comparisons could also include the value of a hypothetical
investment in any of the capital markets.
If appropriate, the Group may compare the performance of a Fund or the
performance of securities in which a Fund may invest to averages published by
IBC USA (Publications, Inc.). These averages assume reinvestment of
distributions. The IBC/Donoghue's Money Fund Averages(TM)/All Taxable, which is
reported in the Donoghue's Money Fund Report(R), covers over 772 taxable money
market funds. The Fund may quote its fund number, Quotron(TM) number and CUSIP
number or quote its current portfolio manager or any member of Payden & Rygel's
market strategy group.
YIELD CALCULATIONS
Yields for each class of shares of a Fund used in advertising are computed by
dividing the interest income of the class for a given 30-day or one month
period, net of expenses allocable to the class, by the average number of shares
of the class entitled to receive dividends during the period, dividing this
figure by the class' net asset value per share at the end of the period and
annualizing the result (assuming compounding of income) in order to arrive at an
annual percentage rate. Income is calculated for purposes of yield quotations in
accordance with standardized methods applicable to bond funds. In general,
interest income is reduced with respect to bonds trading at a premium over their
par value by subtracting a portion of the premium from income on a daily basis,
and is increased with respect to bonds trading at a discount by adding a portion
of the discount to daily income. For a Fund's investments denominated in foreign
currencies, income and expenses are calculated first in their respective
currencies, and converted to U.S. dollars either when they are actually
converted or at the end of the period, whichever is earlier. Capital gains and
losses are generally excluded from the calculation, as are gains and losses from
currency exchange rate fluctuations.
The tax-equivalent yield for the California Municipal Income Fund is the rate
that an investor would have to earn from a fully taxable investment after taxes
to equal the Fund's tax-free yield. Tax equivalent yield is calculated by
dividing the Fund's yield by the result of one minus a stated federal or
combined federal and state tax rate. If only a portion of the Fund's yield is
tax exempt, only that portion is adjusted in the calculation.
Because yield accounting methods differ from the methods used for other
accounting purposes, the Fund's yield may not equal its distribution rate or
income reported in the Fund's financial statements.
TOTAL RETURN CALCULATIONS
Total returns quoted in advertising with respect to a class of shares of the
Fund reflect all aspects of a Fund's return, including the effect of reinvesting
dividends and capital gain distributions, and any change in the class' net asset
value per share over the period. Average annual total returns for each class are
calculated by determining the growth or decline in value of a hypothetical
historical investment in that class of shares of a Fund over a stated period,
and then calculating the annually compounded percentage rate that would have
produced the same result if the rate of growth or decline in value had been
constant over the period. For example, a cumulative return of 100% over ten
years
36
<PAGE> 82
would result from an average annual total return of 7.18%, which is the steady
annual total return that would equal 100% growth on a compounded basis in ten
years. While average annual total returns are a convenient means of comparing
investment alternatives, investors should realize that a Fund's performance is
not constant over time, but changes from year to year, and that average annual
total returns represent averaged figures as opposed to the actual year-to-year
performance of the Fund.
In addition to average annual total returns, a Fund may quote unaveraged or
cumulative total returns for each class of shares reflecting the simple change
in value of an investment over a stated period of time. Average annual and
cumulative total returns may be quoted as a percentage or as a dollar amount,
and may be calculated for a single investment, a series of investments, and/or a
series of redemptions, over any time period. Total returns may be broken down
into their components of income, capital (including capital gains and changes in
share price) and currency returns in order to illustrate the relationship of
these factors and their contributions to total return. Total returns, yields and
other performance information maybe quoted numerically, or in a table, graph or
similar illustration.
TAXATION
Each Fund intends to qualify annually and has elected to be treated as a
regulated investment company under the Internal Revenue Code of 1986, as amended
(the "Code"). To qualify as a regulated investment company, a Fund must, among
other things, (a) derive in each taxable year at least 90% of its gross income
from dividends, interest, payments with respect to securities loans, and gains
from the sale or other disposition of stock, securities or foreign currencies,
or other income (including gains from options, futures and forward contracts)
derived with respect to its business of investing in such stock, securities or
currencies ("Qualifying Income Test"); (b) diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of a Fund's assets is represented by cash, U.S. Government securities, the
securities of other regulated investment companies and other securities, with
such other securities of any one issuer limited for the purposes of this
calculation to an amount not greater than 5% of the value of a Fund's total
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its total assets is invested in the securities of
any one issuer (other than U.S. Government securities or the securities of other
regulated investment companies) (the "Diversification Test"); and (c) distribute
to its shareholders at least 90% of its investment company taxable income (which
includes dividends, interest and net short-term capital gains in excess of any
net long-term capital losses) and 90% of its net exempt interest income each
taxable year. The Treasury Department is authorized to promulgate regulations
under which gains from foreign currencies (and options, futures, and forward
contracts on foreign currency) would constitute qualifying income for purposes
of the Qualifying Income Test only if such gains are directly relating to
investing in stocks or securities. To date, such regulations have not been
issued.
In addition, no definitive guidance currently exists with respect to the
classification of interest rate swaps and cross-currency swaps as securities or
foreign currencies for purposes of certain of the tests described above.
Accordingly, to avoid the possibility of disqualification as a regulated
investment company, a Fund will limit its positions in swaps to transactions for
the purpose of hedging against either interest rate or currency fluctuation
risks, and will treat swaps as excluded assets for purposes of determining
compliance with the Diversification Test.
As a regulated investment company, a Fund will not be subject to U.S. federal
income tax on its investment company taxable income and net capital gains (any
net long-term capital gains in excess of
37
<PAGE> 83
the sum of net short-term capital losses and capital loss carryovers from the
prior eight years) designated by the Fund as capital gain dividends, if any,
that it distributes to shareholders. Each Fund intends to distribute to its
shareholders substantially all of its investment company taxable income monthly
and any net capital gains annually. Investment company taxable income or net
capital gains not distributed by a Fund on a timely basis in accordance with a
calendar year distribution requirement are subject to a nondeductible 4% excise
tax. To avoid the tax, a Fund must distribute during each calendar year an
amount at least equal to the sum of (1) 98% of its ordinary income (with
adjustments) for the calendar year and foreign currency gains or losses for the
calendar year, (2) at least 98% of its capital gains in excess of its capital
losses (and adjusted for certain ordinary losses) for the twelve month period
ending on October 31 of the calendar year, and (3) all ordinary income and
capital gains for previous years that were not distributed during such years. A
distribution will be treated as paid on December 31 of the calendar year if it
is declared by the Fund in October, November, or December of that year to
shareholders of record on a date in such a month and paid by a Fund during
January of the following year. Such distributions will be taxable to
shareholders (other than those not subject to federal income tax) in the
calendar year in which the distributions are declared, rather than the calendar
year in which the distributions are received. To avoid application of the excise
tax, the Funds intend to make their distributions in accordance with the
distribution requirements.
DISTRIBUTIONS
The California Municipal Income Fund intends to qualify to pay "exempt-interest"
dividends to its shareholders, who may exclude those dividends from their gross
income for federal income tax purposes. In order to be able to pay those
dividends, the Fund must satisfy the additional requirement that, at the close
of each quarter of its taxable year, at least 50% of the value of its total
assets must consist of obligations the interest on which is excludable from
gross income under section 103(a) of the Code.
With the exception of the California Municipal Income Fund, dividends paid out
of a Fund's investment company taxable income will be taxable to a U.S.
shareholder as ordinary income. Distributions received by tax-exempt
shareholders will not be subject to federal income tax to the extent permitted
under the applicable tax exemption.
Dividends paid by a Fund generally are not expected to qualify for the deduction
for dividends received by corporations. Distributions of net capital gains, if
any, are taxable as long-term capital gains, regardless of how long the
shareholder has held a Fund's shares and are not eligible for the dividends
received deduction. The tax treatment of dividends and distributions will be the
same whether a shareholder reinvests them in additional shares or elects to
receive them in cash.
HEDGING TRANSACTIONS
Many of the options, futures contracts and forward contracts used by the Funds
are "section 1256 contracts." Any gains or losses on section 1256 contracts are
generally considered 60% long-term and 40% short-term capital gains or losses
("60/40"). Also, section 1256 contracts held by a Fund at the end of each
taxable year (and, for purposes of the 4% excise tax, on certain other dates as
prescribed under the Code) are "marked to market" with the result that
unrealized gains or losses are treated as though they were realized and the
resulting gain or loss is treated as ordinary or 60/40 gain or loss, depending
on the circumstances.
38
<PAGE> 84
Generally, the hedging transactions and certain other transactions in options,
futures and forward contracts undertaken by a Fund, may result in "straddles"
for U.S. federal income tax purposes. The straddle rules may affect the
character of gains (or losses) realized by a Fund. In addition, losses realized
by a Fund on positions that are part of a straddle may be deferred under the
straddle rules, rather than being taken into account in calculating the
investment company taxable income or net capital gain for the taxable year in
which such losses are realized. Because limited regulations implementing the
straddle rules have been promulgated, the tax consequences of transactions in
options, futures and forward contracts to a Fund are not entirely clear. The
transactions may increase the amount of short-term capital gain realized by a
Fund which is taxed as ordinary income when distributed to shareholders.
Each Fund may make one or more of the elections available under the Code which
are applicable to straddles. If a Fund makes any of the elections, the amount,
character and timing of the recognition of gains or losses from the affected
straddle positions will be determined under rules that vary according to the
election(s) made. The rules applicable under certain of the elections operate to
accelerate the recognition of gains or losses from the affected straddle
positions.
Because application of the straddle rules may affect the character of gains or
losses, defer losses and/or accelerate the recognition of gains or losses from
the affected straddle positions, the amount which must be distributed to
shareholders, and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as compared
to a fund that did not engage in such hedging transactions.
The qualifying income and diversification requirements applicable to the Fund's
assets may limit the extent to which a Fund will be able to engage in
transactions in options, futures contracts or forward contracts.
SALES OF SHARES
Upon disposition of shares of a Fund (whether by redemption, sale or exchange),
a shareholder will realize a gain or loss. Such gain or loss will be capital
gain or loss if the shares are capital assets in the shareholder's hands, and
will be long-term, mid-term or short-term generally depending upon the
shareholder's holding period for the shares. Any loss realized on a disposition
will be disallowed by "wash sale" rules to the extent the shares disposed of are
replaced within a period of 61 days beginning 30 days before and ending 30 days
after the disposition. In such a case, the basis of the shares acquired will be
adjusted to reflect the disallowed loss. Any loss realized by a shareholder on a
disposition of shares held by the shareholder for six months or less will be
treated as a long-term capital loss to the extent of any distributions of
capital gain dividends received by the shareholder with respect to such shares.
BACKUP WITHHOLDING
A Fund may be required to withhold for U.S. federal income taxes 31% of all
taxable distributions payable to shareholders who fail to provide the Fund with
their correct taxpayer identification numbers or to make required
certifications, or who have been notified by the Internal Revenue Service that
they are subject to backup withholding. Corporate shareholders and certain other
shareholders specified in the Code generally are exempt from such backup
withholding. Backup
39
<PAGE> 85
withholding is not an additional tax. Any amounts withheld may be credited
against the shareholder's U.S. federal tax liability.
FOREIGN INVESTMENTS
Under the Code, gains or losses attributable to fluctuations in exchange rates
which occur between the time a Fund amortizes or accrues premiums or discounts,
accrues interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities generally are treated as ordinary income or
loss. Similarly, on disposition of debt securities denominated in a foreign
currency and on disposition of certain futures contracts, forward contracts and
options, gains or losses attributable to fluctuations in the value of the
foreign currency between the date of acquisition of the security or contract and
the date of disposition also are treated as ordinary gain or loss. These gains
and losses, referred to under the Code as "Section 988" gains or losses, may
increase or decrease the amount of the Fund's investment company taxable income
to be distributed to its shareholders as ordinary income.
Income received by a Fund from sources within foreign countries may be subject
to withholding and other taxes imposed by such countries. Tax conventions
between certain countries and the U.S. may reduce or eliminate such taxes. In
addition, the Adviser intends to manage the Funds with the intention of
minimizing foreign taxation in cases where it is deemed prudent to do so. If
more than 50% of the value of a Fund's total assets at the close of its taxable
year consists of securities of foreign corporations, the Fund will be eligible
to elect to "pass-through" to the Fund's shareholders the amount of foreign
income and similar taxes paid by the Fund. If this election is made, a
shareholder generally subject to tax will be required to include in gross income
(in addition to taxable dividends actually received) his pro rata share of the
foreign income taxes paid by the Fund, and may be entitled either to deduct (as
an itemized deduction) his or her pro rata share of foreign taxes in computing
his taxable income or to use such amount (subject to limitations) as a foreign
tax credit against his or her U.S. federal income tax liability. No deduction
for foreign taxes may be claimed by a shareholder who does not itemize
deductions. Each shareholder will be notified in writing within 60 days after
the close of a Fund's taxable year whether the foreign taxes paid by the Fund
will "pass-through" for that year. Absent the Fund making the election to "pass
through" the foreign source income and foreign taxes, none of the distributions
may be treated as foreign source income for purposes of the foreign tax credit
calculation.
Investment income received from sources within foreign countries may be subject
to foreign income taxes. The U.S. has entered into tax treaties with many
foreign countries which entitle certain investors to a reduced rate of tax or to
certain exemptions from tax. The Funds will operate so as to qualify for such
reduced tax rates or tax exemptions whenever practicable. The Funds may qualify
for an make an election permitted under section 853 of the Code so that
shareholders will be able to claim a credit or deduction on their Federal income
tax returns for, and will be required to treat as part of the amounts
distributed to them, their pro rata portion of the income taxes paid by the
Funds to foreign countries (which taxes relate primarily to investment income).
The shareholders of the Funds may claim a credit by reason of the Funds'
election subject to certain limitations imposed by Section 904 of the Code.
However, no deduction for foreign taxes may be claimed under the Code by
individual shareholders who do not elect to itemize deductions on their Federal
income tax returns, although such a shareholder may claim a credit for foreign
taxes and in any event will be treated as having taxable income in the amount of
the shareholder's pro rata share of foreign taxes paid by the
40
<PAGE> 86
Funds. Although the Funds intend to meet the requirements of the Code to "pass
through" such taxes, there can be no assurance that the Funds will be able to do
so.
Generally, a credit for foreign taxes is subject to the limitation that it may
not exceed the shareholder's U.S. tax attributable to his or her total foreign
source taxable income. For this purpose, if the pass-through election is made,
the source of a Fund's income will flow through to shareholders of the Fund.
With respect to such election, gains from the sale of securities will be treated
as derived from U.S. sources. The limitation on the foreign tax credit is
applied separately to foreign source passive income, and to certain other types
of income. Shareholders may be unable to claim a credit for the full amount of
their proportionate share of the foreign taxes paid by the Fund. The foreign tax
credit is modified for purposes of the Federal alternative minimum tax and can
be used to offset only 90% of the alternative minimum tax imposed on
corporations and individuals and foreign taxes generally are not deductible in
computing alternative minimum taxable income.
CERTAIN DEBT SECURITIES
Some of the debt securities (with a fixed maturity date of more than one year
from the date of issuance) that may be acquired by a Fund may be treated as debt
securities that are issued originally at a discount. Generally, the amount of
the original issue discount ("OID") is treated as interest income and is
included in income over the term of the debt security, even though payment of
that amount is not received until a later time, usually when the debt security
matures. A portion of the OID includable in income with respect to certain
high-yield corporate debt securities may be treated as a dividend for Federal
income tax purposes.
Some of the debt securities (with a fixed maturity date of more than one year
from the date of issuance) that may be acquired by a Fund in the secondary
market may be treated as having market discount. Generally, any gain recognized
on the disposition of, and any partial payment of principal on, a debt security
having market discount issued after July 18, 1984 is treated as ordinary income
to the extent the gain, or principal payment, does not exceed the "accrued
market discount" on such debt security. Market discount generally accrues in
equal daily installments. A Fund may make one or more of the elections
applicable to debt securities having market discount, which could affect the
character and timing of recognition of income.
Some of the debt securities (with a fixed maturity date of one year or less from
the date of issuance) that may be acquired by a Fund may be treated as having an
acquisition discount, or OID in the case of certain types of debt securities.
Generally, the Fund will be required to include the acquisition discount, or
OID, in income ratably over the term of the debt security, even though payment
of that amount is not received until a later time, usually when the debt
security matures. The Fund may make one or more of the elections applicable to
debt securities having acquisition discount, or OID, which could affect the
character and timing of recognition of income.
A Fund generally will be required to distribute dividends to shareholders
representing discount on debt securities that is currently includable in income,
even though cash representing such income may not have been received by the
Fund. Cash to pay such dividends may be obtained from sales proceeds of
securities held by the Fund.
41
<PAGE> 87
CALIFORNIA TAXATION
In any year in which the California Municipal Income Fund qualifies as a
regulated investment company under the Internal Revenue Code (as in effect
January 1, 1998) and is exempt from federal income tax under such rules, (i) the
Fund will also be exempt from the California corporate income and franchise
taxes to the extent it distributes its income and (ii) provided 50% or more of
the value of the total assets of the Fund at the close of each quarter of its
taxable year consists of obligations the interest on which (when held by an
individual) is exempt from personal income taxation under California law, the
Fund will be qualified under California law to pay "exempt-interest" dividends
which will be exempt from the California personal income tax.
Individual shareholders of the Fund who reside in California will not be subject
to California personal income tax on distributions received from the Fund to the
extent such distributions are attributable to interest received by the Fund
during its taxable year on obligations which (when held by an individual) pay
interest that is exempt from taxation under California law. Distributions from
the Fund which are attributable to sources other than those described in the
preceding sentence will generally be taxable to such shareholders. In addition,
distributions other than exempt-interest dividends to such shareholders are
includable in income subject to the California alternative minimum tax.
The portion of dividends constituting exempt-interest dividends is that portion
derived from interest on obligations which (when held by an individual) pay
interest excludable from California personal income under California law. The
total amount of California exempt-interest dividends paid by the Fund to all of
its shareholders with respect to any taxable year cannot exceed the amount of
interest received by the Fund during such year on such obligations less any
expenses and expenditures (including dividends paid to corporate shareholders)
deemed to have been paid from such interest. Any dividends paid to corporate
shareholders subject to the California franchise tax will be taxed as ordinary
dividends to such shareholders.
Distributions of investment income and long-term and short-term capital gains
will not be excluded from taxable income in determining the California franchise
tax for corporate shareholders. In addition, such distributions may be
includable in income subject to the alternative minimum tax.
Interest on indebtedness incurred or continued by shareholders to purchase or
carry shares of the Fund will not be deductible for California personal income
tax purposes. In addition, as a result of California's incorporation of certain
provisions of the Internal Revenue Code, any loss realized by a shareholder upon
the sale of shares held for six months or less may be disallowed to the extent
of any exempt-interest dividends received with respect to such shares. Moreover,
any loss realized upon the redemption of shares within 6 months from the date of
purchase of such shares and following receipt of a long-term capital gains
distribution will be treated as long-term capital loss to the extent of such
long-term capital gains distribution. Finally, any loss realized upon the
redemption of shares within 30 days before or after the acquisition of other
shares of the same series may be disallowed under the "wash sale" rules.
The foregoing is only a summary of some of the important California income tax
considerations generally affecting the Fund and its shareholders. No attempt is
made to present a detailed explanation of the California personal income tax
treatment of the Fund or its shareholders, and this discussion is
42
<PAGE> 88
not intended as a substitute for careful planning. Shareholders of the Fund
should consult their tax advisers about other state and local tax consequences
of their investments in the Fund and their own California tax situation.
OTHER TAXES
Distributions also may be subject to additional state, local and foreign taxes,
depending on each shareholder's particular situation. Under the laws of various
states, distributions of investment company taxable income generally are taxable
to shareholders even though all or a substantial portion of such distributions
may be derived from interest on certain Federal obligations which, if the
interest were received directly by a resident of such state, would be exempt
from such state's income tax ("qualifying Federal obligations"). However, some
states may exempt all or a portion of such distributions from income tax to the
extent the shareholder is able to establish that the distribution is derived
from qualifying Federal obligations. Moreover, for state income tax purposes,
interest on some Federal obligations generally is not exempt from taxation,
whether received directly by a shareholder or through distributions of
investment company taxable income (for example, interest on Federal National
Mortgage Association Certificates and Government National Mortgage Association
Certificates). Each Fund will provide information annually to shareholders
indicating the amount and percentage of the Fund's dividend distribution which
is attributable to interest on Federal obligations, and will indicate to the
extent possible from what types of Federal obligations such dividends are
derived. Shareholders are advised to consult their own tax advisers with respect
to the particular tax consequences to them of an investment in a Fund.
43
<PAGE> 89
MANAGEMENT OF THE GROUP
TRUSTEES AND OFFICERS
The Trustees and officers of the Group are as set forth below. Unless otherwise
indicated, the address of all persons below is 333 South Grand Avenue, Los
Angeles, California 90071.
BOARD OF TRUSTEES:
<TABLE>
<CAPTION>
POSITION WITH PRINCIPAL OCCUPATIONS
NAME THE GROUP DURING PAST FIVE YEARS
- ---- --------- ----------------------
<S> <C> <C>
*Joan A. Payden(1) Chairman of the Board, President, Payden & Rygel
Chief Executive Officer,
Trustee
*Lynda L. Faber Trustee Retired; formerly Senior Vice President, Payden & Rygel
*John Paul Isaacson Trustee Executive Vice President, Payden & Rygel
*Christopher N. Orndorff Trustee Vice President, Payden & Rygel
J. Clayburn La Force Trustee Dean Emeritus, The John E. Anderson Graduate School of
P.O. Box 1009 Management at University of California, Los Angeles;
Pauma Valley, CA 92061 Director, The Timken Company (since February, 1994);
Trustee for PIC Institutional Growth Portfolio, PIC
Institutional Balanced Portfolio and PIC Small Capital
Portfolio (since June, 1992)
Thomas McKernan, Jr. (1) Trustee President and Chief Executive Officer, Automobile Club of
3333 Fairview Road Southern California
Costa Mesa, CA 92626
Dennis C. Poulsen Trustee Chairman of Board since 1997; previously, President and
3900 South Workman Mill Road Chief Executive Officer, Rose Hills Company
Whittier, CA 90601
Stender E. Sweeney Trustee Private Investor since 1994; previously, Vice
President, Finance, Times Mirror Company
W.D. Hilton, Jr. Trustee Managing Trustee, NGC Settlement Trust; previously, Chief
2608 Eastland Avenue, Suite 202 Financial Officer, Texas Association of School Boards and
Greenville, TX 75402 Board Member, First Greenville National Bank
</TABLE>
* An "interested person" of the Group, as defined in the 1940 Act.
44
<PAGE> 90
(1) Ms. Payden is a Director of the Automobile Club of Southern California, of
which Mr. McKernan is President and Chief Executive Officer.
Trustees other than those affiliated with the Adviser or Sub-adviser currently
receive an annual retainer of $20,000, plus $1,500 for each Board of Trustees
meeting and/or audit committee meeting attended and reimbursement of related
expenses. The following table sets forth the aggregate compensation paid by the
Group for the fiscal year ended October 31, 1998, to the Trustees who are not
affiliated with the Adviser and the aggregate compensation paid to such Trustees
for services on the Trust's Board; there are no other funds in the "trust
complex" (as defined in Schedule 14A under the Securities Exchange Act of 1934):
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT ESTIMATED FROM GROUP
BENEFITS ANNUAL AND GROUP
AGGREGATE ACCRUED AS PART BENEFITS COMPLEX
COMPENSATION OF GROUP UPON PAID TO
NAME FROM GROUP EXPENSES RETIREMENT TRUSTEE
- ---- ------------ --------------- ---------- -------------
<S> <C> <C> <C> <C>
Dennis Poulsen $ None N/A $
James Clayburn La Force $ None N/A $
Stender Sweeney $ None N/A $
W.D. Hilton $ None N/A $
Thomas V. McKernan, Jr $ None N/A $
</TABLE>
OFFICERS:
<TABLE>
<CAPTION>
NAME POSITION WITH THE GROUP PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
---- ----------------------- --------------------------------------------
<S> <C> <C>
John C. Siciliano President, Chief Operating Managing Director, Payden & Rygel (since 1998); previously, Dresdner
Officer Kleinwort Benson North America: Senior Vice President and Co-Head,
North American Corporate Finance; Technicolor, Inc.: Executive Vice
President and Chief Financial Officer
Brad Hersh Vice President, Treasurer Controller, Payden & Rygel (since 1998);
David L. Wagner Vice President Portfolio Manager, Payden & Rygel
Gregory P. Brown Vice President Institutional Marketing, Payden & Rygel (since 1996); previously, Vice
President, Corporate Banking at Wells Fargo Bank
Yot Chattrabhuti Vice President Manager, Mutual Fund Operations, Payden & Rygel (since 1997);
previously, Bank of America: Vice President and Manager, Securities
Processing, Assistant Vice President and Manager of various finance
related functions, and Senior Trust Officer, Employee Benefit Trust
Accounts
Edward S. Garlock Secretary General Counsel, Payden & Rygel (since 1997); previously, Senior Vice
President and Group General Counsel, First Interstate Bancorp
</TABLE>
45
<PAGE> 91
ADVISER
Payden & Rygel was founded in 1983 as an independent investment counseling
organization specializing in the management of short term fixed income
securities. The firm is owned by Joan Payden and several other employees. As of
October 31, 1998, its staff consisted of 90 employees, 35 of whom either have
advanced degrees and/or are Chartered Financial Analysts. As of such date, it
had over 200 clients, including pension funds, endowments, credit unions,
foundations, corporate cash accounts and individuals, and managed total assets
of approximately $27 billion, with approximately $5.5 billion invested globally.
The Adviser's focus is the management of fixed income securities in both the
domestic and global markets. These include securities that have absolute or
average maturities out to five years with a bias toward very high quality and
liquidity. Portfolios are actively managed according to client approved
guidelines and benchmarks. Payden & Rygel also utilizes futures and options
strategies, primarily as defensive measures to control interest rate and
currency volatility.
The Adviser provides investment management services to the Funds pursuant to an
Investment Management Agreement with the Group dated as of June 24, 1992 as
amended on June 14, 1994 with respect to Class S shares of the Group. The
Agreement provides that the Adviser will pay all expenses incurred in connection
with managing the ordinary course of a Fund's business, except the following
expenses, which are paid by each Fund: (i) the fees and expenses incurred by a
Fund in connection with the management of the investment and reinvestment of the
Fund's assets; (ii) the fees and expenses of Trustees who are not affiliated
persons of the Adviser; (iii) the fees and expenses of the Trust's Custodian,
Transfer Agent, Fund Accounting Agent and Administrator; (iv) the charges and
expenses of legal counsel and independent accountants for the Group; (v)
brokers' commissions and any issue or transfer taxes chargeable to a Fund in
connection with its securities and futures transactions; (vi) all taxes and
corporate fees payable by a Fund to federal, state or other governmental
agencies; (vii) the fees of any trade associations of which the Group may be a
member; (viii) the cost of fidelity bonds and trustees and officers errors and
omission insurance; (ix) the fees and expenses involved in registering and
maintaining registration of a Fund and of its shares with the SEC, registering
the Group as a broker or dealer and qualifying the shares of a Fund under state
securities laws, including the preparation and printing of the Trust's
registration statements, prospectuses and statements of additional information
for filing under federal and state securities laws for such purposes; (x)
communications expenses with respect to investor services and all expenses of
shareholders' and trustees' meetings and of preparing, printing and mailing
reports to shareholders in the amount necessary for distribution to the
shareholders; (xi) litigation and indemnification expenses and other
extraordinary expenses not incurred in the ordinary course of the Trust's
business, and (xii) any expenses assumed by the Group pursuant to a plan of
distribution adopted in conformity with Rule 12b-1 under the 1940 Act.
The Adviser has agreed that if in any fiscal year the expenses borne by a Fund
exceed the applicable expense limitations imposed by the securities regulations
of any state in which shares of such Fund are registered or qualified for sale
to the public, it will reimburse the Fund for any excess to the extent required
by such regulations. The Administrator will bear a portion of this reimbursement
obligation. Unless otherwise required by law such reimbursement would be accrued
and paid on the same basis that the advisory fees are accrued and paid by the
Fund. To the Trust's knowledge, no such state expense limitation is currently in
effect.
46
<PAGE> 92
The Agreement provides that the Adviser will not be liable for any error of
judgment or mistake of law or for any loss suffered by the Funds in connection
with the performance of the Agreement, except a loss resulting from a breach of
fiduciary duty with respect to the receipt of compensation for services or a
loss resulting from willful misfeasance, bad faith or gross negligence in the
performance of the Adviser's duties or from reckless disregard by the Adviser of
its duties and obligations thereunder. Unless earlier terminated as described
below, the Agreement will continue in effect with respect to each Fund until
June 30, 2000 and thereafter for successive annual periods, subject to annual
approval by the Board of Trustees (or by a majority of the outstanding voting
shares of each Fund as defined in the 1940 Act) and by a majority of the
Trustees who are not interested persons of any party to the Agreement by vote
cast in person at a meeting called for such purpose. The Agreement terminates
upon assignment and may be terminated with respect to a Fund without penalty on
60 days' written notice at the option of either party thereto or by the vote of
the shareholders of the Fund.
SUB-ADVISER
The Sub-adviser provides investment management services to the EuroDirect Fund
pursuant to the Sub-Advisory Agreement with the Adviser dated as of December 16,
1998. The Agreement provides that the Sub-adviser will pay all expenses of its
personnel and facilities required to carry out its duties. Fees payable to the
Sub-adviser for its services are the obligation of the Adviser, and not the
Group, and are not reduced in the event of any voluntary or regulatory
limitation on the adviser's fees.
The Sub-Advisory Agreement contains provisions regarding liability of the
Sub-adviser similar to those of the Investment Management Agreement between the
Group and the Adviser described above. Unless earlier terminated as described
below, the Sub-Advisory Agreement will continue in effect for an initial period
of two years with respect to the EuroDirect Fund, and thereafter for successive
annual periods, subject to annual approval by the Board of Trustees in the same
manner as the Investment Management Agreement. The Sub-Advisory Agreement
terminates upon assignment or upon termination of the Investment Management
Agreement with respect to the EuroDirect Fund, and may be terminated with
respect to the EuroDirect Fund without penalty on 60 days' written notice by the
Adviser or the Board of Trustees or shareholders of the EuroDirect Fund, or upon
90 days' written notice by the Sub-adviser. Upon termination, the Adviser may
continue to manage the Fund pursuant to its Investment Management Agreement, if
it is still in effect.
ADMINISTRATOR, TRANSFER AGENT, AND DIVIDEND DISBURSING AGENT
Treasury Plus, Incorporated, a wholly owned subsidiary of the Adviser serves as
Administrator to the Fund. Under its Administration Agreement with the Group,
the Administrator has agreed to prepare periodic reports to regulatory
authorities, maintain financial accounts and records of the Fund, transmit
communications by the Fund to shareholders of record, make periodic reports to
the Board of Trustees regarding Fund operations, and overview the work of the
fund accountant and transfer agent.
Investors Fiduciary Trust Company ("IFTC") provides fund accounting and transfer
agency services to the Group. IFTC calculates daily expense accruals and net
asset value per share of the Funds, issues and redeems Fund shares, maintains
shareholder accounts and prepares annual investor tax statements.
47
<PAGE> 93
The liability provisions of the Group's agreements with Treasury Plus and IFTC
are similar to those of the Investment Management Agreement discussed above. In
addition, the Group has agreed to indemnify IFTC against certain liabilities.
The respective agreements may be terminated by either party on 90 days notice.
The Administrator has agreed that, if in any fiscal year the expenses borne by
the Fund exceed the applicable expense limitations imposed by the securities
regulations of any state in which shares of the Fund are registered or qualified
for sale to the public, it will reimburse the Fund for a portion of such excess
expenses, which portion is determined by multiplying the excess expenses by the
ratio of (i) the fees respecting the Fund otherwise payable to the Administrator
pursuant to its agreement with the Group, to (ii) the aggregate fees respecting
the Fund otherwise payable to the Administrator pursuant to its agreement and to
the Adviser pursuant to its Investment Management Agreement with the Group.
DISTRIBUTOR
Payden & Rygel Distributors, 333 South Grand Avenue, Los Angeles, California
90071, acts as Distributor to the Group pursuant to a Distribution Agreement
with the Group dated as of June 24, 1992, as amended. The Distributor has agreed
to use its best efforts to effect sales of shares of the Funds, but is not
obligated to sell any specified number of shares. The Distribution Agreement
contains provisions with respect to renewal and termination similar to those in
the Investment Management Agreement described above. Pursuant to the Agreement,
the Group has agreed to indemnify the Distributor to the extent permitted by
applicable law against certain liabilities under the Securities Act of 1933.
No compensation is payable by the Funds to the Distributor for its distribution
services. The Distributor pays for the personnel involved in accepting orders
for purchase and redemption of Fund shares, expenses incurred in connection with
the printing of Prospectuses and Statements of Additional Information (other
than those sent to existing shareholders), sales literature, advertising and
other communications used in the public offering of shares of a Fund, and other
expenses associated with performing services as distributor of the Funds'
shares. Each Fund pays the expenses of issuance, registration and transfer of
its shares, including filing fees and legal fees.
PURCHASES AND REDEMPTIONS
Certain managed account clients of the Adviser or Sub-adviser may purchase
shares of the Funds. To avoid the imposition of duplicative fees, the Adviser or
Sub-adviser may be required to make adjustments in the management fees charged
separately by the Adviser to these clients to offset the generally higher level
of management fees and expenses resulting from a client's investment in a Fund.
The Funds reserve the right to suspend or postpone redemptions during any period
when: (a) trading on the New York Stock Exchange is restricted, as determined by
the Securities and Exchange Commission, or that Exchange is closed for other
than customary weekend and holiday closings; (b) the Securities and Exchange
Commission has by order permitted such suspension; or (c) an emergency, as
determined by the Securities and Exchange Commission, exists, making disposal of
portfolio securities or valuation of net assets of the Fund not reasonably
practicable.
48
<PAGE> 94
Each Fund will redeem shares solely in cash up to the lesser of $250,000 or 1%
of its net assets during any 90-day period for any one shareholder. Each Fund
reserves the right to pay any redemption price exceeding this amount in whole or
in part by a distribution in kind of securities held by the Fund in lieu of
cash. It is highly unlikely that shares would ever be redeemed in kind. If
shares are redeemed in kind, however, the redeeming shareholder would incur
transaction costs upon the disposition of the securities received in the
distribution.
Due to the relatively high cost of maintaining smaller accounts, each Fund
reserves the right to redeem shares in any account for their then-current value
(which will be promptly be paid to the investor) if at any time, due to
shareholder redemption, the shares in the Fund account do not have a value of at
least $5,000. An investor will be notified that the value of his account is less
than the minimum and allowed at least 30 days to bring the value of the account
up to at least $5,000 before the redemption is processed. The Declaration of
Trust also authorizes the Funds to redeem shares under certain other
circumstances as may be specified by the Board of Trustees
OTHER INFORMATION
CAPITALIZATION
Each Fund is a series of The Payden & Rygel Investment Group, an open-end
management investment company organized as a Massachusetts business trust in
January 1992 (initially called P&R Investment Trust). The capitalization of the
Funds consists solely of an unlimited number of shares of beneficial interest.
The Board of Trustees has currently authorized twenty-one series of shares:
Global Fixed Income Fund, Global Short Bond Fund, Short Duration Tax Exempt
Fund, Tax Exempt Bond Fund, Limited Maturity Fund, Short Bond Fund, Investment
Quality Bond Fund, U.S. Government Fund (formerly the U.S. Treasury Fund),
Growth & Income Fund, Market Return Fund, Total Return Fund, Global Balanced
Fund, European Growth & Income Fund, High Income, International Equity Fund,
Value Stock Fund, Growth Stock Fund, Emerging Markets Bond Fund, EuroDirect
Fund, California Municipal Income Fund and Bunker Hill Money Market Fund. The
Board of Trustees may establish additional funds (with different investment
objectives and fundamental policies) at any time in the future. Establishment
and offering of additional portfolios will not alter the rights of the Funds'
shareholders. Shares do not have preemptive rights or subscription rights. In
liquidation of a Fund, each shareholder is entitled to receive their pro rata
share of the assets of the Fund.
Expenses incurred by the Group in connection with its organization and the
initial public offering are being reimbursed to the Adviser, subject to the
expense limitation described in the Prospectus under "Management of the Funds --
Expense Guarantee", and amortized on a straight line basis over a period of five
years. Expenses incurred in the organization of subsequently offered series of
the Group will be charged to those series and will be amortized on a straight
line basis over a period of not less than five years.
DECLARATION OF TRUST
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of a Fund. However, the Declaration
of Trust disclaims liability of the shareholders of a Fund for acts or
obligations of the Group, which are binding only on the assets and property of
the Fund, and requires that notice of the disclaimer be given in each contract
or obligation entered
49
<PAGE> 95
into or executed by a Fund or the Trustees. The Declaration of Trust provides
for indemnification out of Fund property for all loss and expense of any
shareholder held personally liable for the obligations of a Fund. The risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which a Fund itself would be unable to meet its
obligations and thus should be considered remote.
The Declaration of Trust provides further that no officer or Trustee of the
Group will be personally liable for any obligations of the Group, nor will any
officer or Trustee be personally liable to the Group or its shareholders except
by reason of his own bad faith, willful misfeasance, gross negligence in the
performance of his duties or reckless disregard of his obligations and duties.
With these exceptions, the Declaration of Trust provides that a Trustee or
officer of the Group is entitled to be indemnified against all liabilities and
expenses, including reasonable accountants' and counsel fees, incurred by the
Trustee or officer in connection with the defense or disposition of any
proceeding in which he may be involved or with which he may be threatened by
reason of his being or having been a Trustee or officer.
VOTING
Shareholders of the Funds and any other series of the Group will vote in the
aggregate and not by series or class except as otherwise required by law or when
the Board of Trustees determines that the matter to be voted upon affects only
the interests of the shareholders of a particular series or class of shares.
Pursuant to Rule 18f-2 under the 1940 Act, the approval of an investment
advisory agreement or any change in a fundamental policy would be acted upon
separately by the series affected. Matters such as ratification of the
independent public accountants and election of Trustees are not subject to
separate voting requirements and may be acted upon by shareholders of the Group
voting without regard to series or class.
CUSTODIAN
The Boston Safe Deposit and Trust Company serves as Custodian for the assets of
the Funds. The Custodian's address is One Boston Place, Boston, Massachusetts
02109. Under its Custodian Agreement with the Group, the Custodian has agreed
among other things to maintain a separate account in the name of each Fund; hold
and disburse portfolio securities and other assets on behalf of the Funds;
collect and make disbursements of money on behalf of the Funds; and receive all
income and other payments and distributions on account of each Fund's portfolio
securities.
Pursuant to rules adopted under the 1940 Act, the Funds may maintain foreign
securities and cash in the custody of certain eligible foreign banks and
securities depositories. Selection of these foreign custodial institutions is
made by the Board of Trustees following a consideration of a number of factors,
including (but not limited to) the reliability and financial stability of the
institution; the ability of the institution to perform capably custodial
services for the Funds; the reputation of the institution in its national
market; the political and economic stability of the country in which the
institution is located; and risks of nationalization or expropriation of Fund
assets. The Board of Trustees reviews annually the continuance of foreign
custodial arrangements for the Funds. No assurance can be given that the
Trustees' appraisal of the risks in connection with foreign custodial
arrangements will always be correct or that expropriation, nationalization,
freezes, or confiscation of assets that would impact assets of the Portfolio
will not occur, and shareholders bear the risk of losses arising from these or
other events.
50
<PAGE> 96
INDEPENDENT AUDITORS
Deloitte & Touche LLP serves as the independent auditors for the Funds. Deloitte
& Touche provides audit and tax return preparation services to the Group. The
independent auditors' address is 1700 Courthouse Plaza Northeast, Dayton, Ohio
45402-1788.
COUNSEL
Paul, Hastings, Janofsky & Walker LLP pass upon certain legal matters in
connection with the shares offered by the Group, and also act as Counsel to the
Group. Counsel's address is 555 South Flower Street, Los Angeles, California
90071. Paul, Hastings, Janofsky & Walker LLP also acts as counsel to the Adviser
and the Distributor.
LICENSE AGREEMENT
The Adviser has entered into a non-exclusive License Agreement with the Group
which permits the Group to use the name "Payden & Rygel". The Adviser has the
right to require the Group to cease using the name at such time as the Adviser
is no longer employed as investment manager to the Group.
REGISTRATION STATEMENT
This Statement of Additional Information and the Prospectus do not contain all
the information included in the Group's registration statement filed with the
Securities and Exchange Commission under the Securities Act of 1933 with respect
to the securities offered hereby, certain portions of which have been omitted
pursuant to the rules and regulations of the Securities and Exchange Commission.
The registration statement, including the exhibits filed therewith, may be
examined at the offices of the Securities and Exchange Commission in Washington,
D.C.
Statements contained herein and in the Prospectus as to the contents of any
contract or other documents referred to are not necessarily complete, and, in
each instance, reference is made to the copy of such contract or other documents
filed as an exhibit to the registration statement, each such statement being
qualified in all respects by such reference.
51
<PAGE> 97
APPENDIX A
DESCRIPTION OF RATINGS
The following paragraphs summarize the descriptions for the ratings for
municipal securities and commercial paper referred to in the Prospectus and
Statement of Additional Information. Ratings represent only the opinions of such
organizations of the quality of the securities which they undertake to rate, are
general and are not absolute standards of quality.
Moody's Investors Service, Inc.
The purpose of Moody's ratings is to provide investors with a single system of
gradation by which the relative investment qualities of bonds may be rated.
U.S. TAX-EXEMPT MUNICIPALS
Moody's ratings for U.S. Tax-Exempt Municipals range from Aaa to B and utilize
the same definitional elements as are set forth in the Prospectus under the
"Bonds" section of the Moody's descriptions.
Advance refunded issues: Advance refunded issues that are secured by
escrowed funds held in cash, held in trust, reinvested in direct non-callable
United States government obligations or non-callable obligations unconditionally
guaranteed by the U.S. government are identified with a # (hatchmark) symbol,
e.g., # Aaa.
MUNICIPAL NOTE RATINGS
Moody's ratings for state and municipal notes and other short-term loans are
designated Moody's Investment Grade (MIG), and for variable rate demand
obligations are designated Variable Moody's Investment Grade (VMIG). This
distinction recognizes the differences between short-term credit risk and
long-term risk. Loans bearing the designation MIG 1/VMIG 1 are of the best
quality, enjoying strong protection from established cash flows for their
servicing or from established and broad-based access to the market for
refinancing, or both. Loans bearing the designation MIG2/VMIG 2 are of high
quality, with ample margins of protection, although not as large as the
preceding group.
COMMERCIAL PAPER
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:
Prime-1: Issuers rated Prime-1 (or related supporting institutions) have a
superior ability for repayment of short-term promissory obligations. Prime-1
repayment capacity will normally be evidenced by the following characteristics:
(a) leading market positions in well established industries; (b) high rates of
return on funds employed; (c) conservative capitalization structures with
moderate reliance on debt and ample asset protection; (d) broad margins in
earnings coverage of fixed financial
52
<PAGE> 98
charges and high internal cash generation; and (e) well-established access to a
range of financial markets and assured sources of alternate liquidity.
Prime-2: 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.
Prime-3: 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.
Standard & Poor's Corporation
A Standard & Poor's 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
ratings are based on current information furnished by the issuer or obtained by
Standard & Poor's from other sources it considers reliable. Standard & Poor's
does not perform any audit in connection with any rating and may, on occasion,
rely on unaudited financial information. The ratings are based, in varying
degrees, on the following considerations: (a) 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; (b) nature of and
provisions of the obligation; and (c) protection afforded by, and relative
position of, the obligation in the event of bankruptcy and other laws affecting
creditors' rights.
MUNICIPAL BOND RATINGS
AAA - Prime Grade: These are obligations of the highest quality. They have
the strongest capacity for timely payment of debt service.
General Obligations Bonds: In a period of economic stress, the issuers will
suffer the smallest declines in income and will be least susceptible to
autonomous decline. Debt burden is moderate. A strong revenue structure
appears more than adequate to meet future expenditure requirements. Quality
of management appears superior.
Revenue Bonds: Debt service coverage has been, and is expected to remain,
substantial, stability of the pledged revenues is also exceptionally strong
due to the competitive position of the municipal enterprise or to the nature
of the revenues. Basic security provisions (including rate covenant,
earnings test for issuance of additional bonds and debt service reserve
requirements) are rigorous. There is evidence of superior management.
AA - High Grade: The investment characteristics of bonds in this group are
only slightly less marked than those of the prime quality issues. Bonds rated AA
have the second strongest capacity for payment of debt service.
53
<PAGE> 99
A - Good Grade: Principal and interest payments on bonds in this category
are regarded as safe although the bonds are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than bonds
in higher rated categories. This rating describes the third strongest capacity
for payment of debt service. Regarding municipal bonds, the rating differs from
the two higher ratings because:
General Obligation Bonds: There is some weakness, either in the local
economic base, in debt burden, in the balance between revenues and
expenditures, or in quality of management. Under certain adverse
circumstances, any one such weakness might impair the ability of the issuer
to meet debt obligations at some future date.
Revenue Bonds: Debt service coverage is good, but not exceptional. Stability
of the pledged revenues could show some variations because of increased
competition or economic influences on revenues. Basic security provisions,
while satisfactory, are less stringent. Management performance appearance
appears adequate.
Rating Refinements: Standard & Poor's letter ratings may be modified by the
addition of a plus (+) or a minus (-) sign, which is used to show relative
standing within the major rating categories, except in the AAA rating category.
MUNICIPAL NOTE RATINGS
Municipal notes with maturities of three years or less are usually given note
ratings (designated SP-1, or SP-2) to distinguish more clearly the credit
quality of notes as compared to bonds. Notes rated SP-1 have a very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given the designation of SP-1.
Notes rated SP-2 have a satisfactory capacity to pay principal and interest.
COMMERCIAL PAPER
A-1: A short-term obligation rated A-1 is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2: A short-term obligation rated A-2 is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
Fitch Ratings
Fitch investment grade bond 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 issue or class of debt 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
54
<PAGE> 100
credit quality. Fitch ratings do not reflect any credit enhancement that may be
provided by insurance policies or financial guarantees unless otherwise
indicated.
COMMERCIAL PAPER
F-1: Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment. Those issues regarded as having the strongest
degree of assurance of repayment are denoted with a plus (+) sign designation.
IBCA, Limited
IBCA analyzes credit quality of short term debt (maturities of one year or
less).
A: An issuer of impeccable financial condition, with a consistent record of
above average performance.
B: An issuer with a sound risk profile and without significant problems. The
issuer's performance has generally been in line with or better than that of its
peers.
C: An issuer which has an adequate risk profile but possesses one or more
troublesome aspects, giving rise to the possibility of risk developing, or which
has generally failed to perform in line with its peers.
In addition, ratings of "A/B" and "B/C" may be assigned.
Thompson Bank Watch
Thompson Bank Watch ratings are based upon a qualitative and quantitative
analysis of all segments of the organization, including holding company and
operating subsidiaries.
ISSUER RATINGS
Thompson Bank Watch assigns only one Issuer Rating to each company, based on
consolidated financials. While the rating is blended to be equally applicable to
all operating entities of the organization, there may, in certain cases, be more
liquidity and/or credit risk associated with doing business with one segment of
the company as opposed to another (i.e., holding company vs. subsidiary).
Bank Watch Issuer Ratings are not merely an assessment of the likelihood of
receiving payment of principal and interest on a timely basis. It is also
important to recognize that the ratings incorporate Thompson Bank Watch's
opinion of the vulnerability of the company to adverse developments, which may
impact the market's perception of the company, thereby affecting the
marketability of its securities.
Bank Watch Issuer Ratings are assigned using an intermediate time horizon.
RATING DEFINITIONS
55
<PAGE> 101
A: Company possesses an exceptionally strong balance sheet and earnings
record, translating into an excellent reputation and very good access to its
natural money markets. If weakness or vulnerability exists in any aspect of the
company's business, it is entirely mitigated by the strengths of the
organization.
A/B: Company is financially very solid with a favorable track record and no
readily apparent weakness. Its overall risk profile, while low, is not quite as
favorable as for companies in the highest rating category.
B: A strong company with a solid financial record and well received by its
natural money markets. Some minor weaknesses may exist, but any deviation from
the company's historical performance levels should be both limited and
short-lived. The likelihood of a problem developing is small, yet slightly
greater than for a higher-rated company.
B/C: Company is clearly viewed as a good credit. While some shortcomings are
apparent, they are not serious and/or are quite manageable in the short-term.
C: Company is inherently a sound credit with no serious deficiencies, but
financials reveal at least one fundamental area of concern that prevents a
higher rating. Company may recently have experienced a period of difficulty, but
those pressures should not be long-term in nature. The company's ability to
absorb a surprise, however, is less than that for organizations with better
operating records.
56
