<PAGE>1
STATEMENT OF ADDITIONAL INFORMATION
March 1, 1995,
revised as of April 11, 1995
WARBURG PINCUS INSTITUTIONAL FUND, INC.
P.O. Box 9030, Boston, Massachusetts 02205-9030
For information, call (800) 888-6878
Contents
Page
Investment Objectives . . . . . . . . . . . . . . . . . . . . 2
Investment Policies . . . . . . . . . . . . . . . . . . . . . 2
Management of the Fund . . . . . . . . . . . . . . . . . . . 28
Additional Purchase and Redemption Information . . . . . . . 36
Exchange Privilege . . . . . . . . . . . . . . . . . . . . . 36
Additional Information Concerning Taxes . . . . . . . . . . . 37
Determination of Performance . . . . . . . . . . . . . . . . 39
Auditors and Counsel . . . . . . . . . . . . . . . . . . . . 41
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . 41
Financial Statements . . . . . . . . . . . . . . . . . . . . 41
Appendix -- Description of Ratings . . . . . . . . . . . . A-1
Reports of Coopers & Lybrand L.L.P., Independent Auditors . A-4
This Statement of Additional Information is meant to be read in
conjunction with the Prospectus of Warburg, Pincus Institutional Fund, Inc.
(the "Fund") dated March 1, 1995, and is incorporated by reference in its
entirety into that Prospectus. The Fund currently offers one managed
investment fund, the International Equity Portfolio. Shares of the Global
Fixed Income Portfolio are not currently being offered. Because this
Statement of Additional Information is not itself a prospectus, no investment
in shares of the International Equity Portfolio or the Global Fixed Income
Portfolio (the "Portfolios") should be made solely upon the information
contained herein. Copies of the Fund's Prospectus and information regarding
each of the Portfolios' current performance may be obtained by calling Warburg
Pincus Funds at (800) 257-5614. Information regarding the status of
shareholder accounts may be obtained by calling Warburg Pincus Funds at (800)
888-6878 or by writing to Warburg Pincus Funds, P.O. Box 9030, Boston,
Massachusetts 02205-9030.
<PAGE>2
INVESTMENT OBJECTIVES
The investment objective of the International Equity Portfolio is
long-term capital appreciation. The International Equity Portfolio will
pursue its objective by investing in equity securities of non-United States
issuers. The investment objective of the Global Fixed Income Portfolio is to
maximize total investment return consistent with prudent investment management
while preserving capital. The Global Fixed Income Portfolio will pursue its
objective by investing in investment grade fixed income securities of issuers
throughout the world, including United States issuers.
INVESTMENT POLICIES
The following policies supplement the descriptions of each
Portfolio's investment objective and policies in the Prospectus.
Additional Information on Investment Practices
Foreign Investments. Investors should recognize that investing in
foreign companies involves certain risks, including those discussed below,
which are not typically associated with investing in United States issuers.
Since a Portfolio may be investing substantially in securities denominated in
currencies other than the U.S. dollar, and since a Portfolio may temporarily
hold funds in bank deposits or other money market investments denominated in
foreign currencies, a Portfolio may be affected favorably or unfavorably by
exchange control regulations or changes in the exchange rate between such
currencies and the dollar. A change in the value of a foreign currency
relative to the U.S. dollar will result in a corresponding change in the
dollar value of the Portfolio assets denominated in that foreign currency.
Changes in foreign currency exchange rates may 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, to be distributed to
shareholders by each Portfolio.
The rate of exchange between the U.S. dollar and other currencies is
determined by the forces of supply and demand in the foreign exchange markets.
Changes in the exchange rate may result over time from the interaction of many
factors directly or indirectly affecting economic and political conditions in
the United States and a particular foreign country, including economic and
political developments in other countries. Of particular importance are rates
of inflation, interest rate levels, the balance of payments and the extent of
government surpluses or deficits in the United States and the particular
foreign country, all of which are in turn sensitive to the monetary, fiscal
and trade policies pursued by the governments of the United States and other
foreign countries important to international trade and finance. Governmental
intervention may also play a significant role. National governments rarely
voluntarily allow their currencies to float freely in response to economic
forces. Sovereign governments use a variety of techniques, such as
intervention by a country's central bank or imposition of regulatory controls
or taxes, to affect the exchange rates of their currencies.
<PAGE>3
Many of the securities held by a Portfolio will not be registered
with, nor the issuers thereof be subject to reporting requirements of, the
U.S. Securities and Exchange Commission (the "SEC"). Accordingly, there may
be less publicly available information about the securities and about the
foreign company or government issuing them than is available about a domestic
company or government entity. Foreign companies are generally not subject to
uniform financial reporting standards, practices and requirements comparable
to those applicable to U.S. companies. In addition, with respect to some
foreign countries, there is the possibility of expropriation or confiscatory
taxation, limitations on the removal of funds or other assets of the
Portfolio, political or social instability, or domestic developments which
could affect United States investments in those countries. Moreover,
individual foreign economies may differ favorably or unfavorably from the
United States economy in such respects as growth of gross national product,
rate of inflation, capital reinvestment, resource self-sufficiency, and
balance of payments positions. Each of the Portfolios may invest in
securities of foreign governments (or agencies or instrumentalities thereof),
and many, if not all, of the foregoing considerations apply to such
investments as well.
Securities of some foreign companies are less liquid and their
prices are more volatile than securities of comparable U.S. companies.
Certain foreign countries are known to experience long delays between the
trade and settlement dates of securities purchased or sold. Due to the
increased exposure by a Portfolio to market and foreign exchange fluctuations
brought about by such delays, and due to the corresponding negative impact on
a Portfolio's liquidity, the Portfolios will avoid investing in countries
which are known to experience settlement delays which may expose the
Portfolios to unreasonable risk of loss.
The interest payable on the Portfolios' foreign securities may be
subject to foreign withholding taxes, and while investors may be able to claim
some credit for deductions for such taxes with respect to their allocated
shares of such foreign tax payments, the general effect of these taxes will be
to reduce a Portfolio's income. Additionally, the operating expenses of the
Portfolios can be expected to be higher than that of an investment company
investing exclusively in U.S. securities, since the expenses of the
Portfolios, such as custodial costs, valuation costs and communication costs,
as well as the rate of the investment advisory fees, though similar to such
expenses of some other international funds, are higher than those costs
incurred by other investment companies.
Japanese Investments. From time to time depending on current market
conditions, the Fund may invest a significant portion of its assets in
Japanese securities. Like any investor in Japan, the Fund will be subject to
general economic and political conditions in the country. In addition to the
considerations discussed above, these include future political and economic
developments, the possible imposition of, or changes in, exchange controls or
other Japanese governmental laws or restrictions applicable to such
investments, diplomatic developments, political or social unrest and natural
disasters.
The information set forth in this section has been extracted from
various governmental publications and other sources. The Fund makes no
representation as to
<PAGE>4
the accuracy of the information, nor has the Fund attempted to verify it.
Furthermore, no representation is made that any correlation exists between
Japan or its economy in general and the performance of the Fund.
Economic Background. Over the past 30 years Japan has experienced
significant economic development. During the era of high economic growth in
the 1960's and early 1970's the expansion was based on the development of
heavy industries such as steel and shipbuilding. In the 1970's Japan moved
into assembly industries which employ high levels of technology and consume
relatively low quantities of resources, and since then has become a major
producer of electrical and electronic products and automobiles. Moreover,
since the mid-1980's Japan has become a major creditor nation. With the
exception of the periods associated with the oil crises of the 1970's, Japan
has generally experienced very low levels of inflation.
Japan is largely dependent upon foreign economies for raw materials.
For instance, almost all of its oil is imported, the majority from the Middle
East. Oil prices therefore have a major impact on the domestic economy, as is
evidenced by the current account deficits triggered by the two oil crises of
the 1970's. Oil prices have declined mainly due to a worldwide easing of
demand for crude oil. The stabilized price of oil contributed to Japan's
sizeable current account surplus and stability of wholesale and consumer
prices since 1981. While Japan is working to reduce its dependence on foreign
materials, its lack of natural resources poses a significant obstacle to this
effort.
International trade is important to Japan's economy, as exports
provide the means to pay for many of the raw materials it must import.
Japan's trade surplus has increased dramatically in recent years, exceeding
$100 billion per year since 1991 and reaching a record high of $145 billion in
1994. Because of the concentration of Japanese exports in highly visible
products such as automobiles, machine tools and semiconductors, and the large
trade surpluses resulting therefrom, Japan has entered a difficult phase in
its relations with its trading partners, particularly with respect to the
United States, with whom the trade imbalance is the greatest. The United
States and Japan have engaged in "economic framework" negotiations to help
raise United States' share in Japanese markets and reduce Japan's current
account surplus but progress in the negotiations has been hampered by the
recent political upheaval in Japan. Any trade sanctions imposed upon Japan by
the U.S. as a result of the current friction or otherwise could adversely
impact Japan and the Fund's investments there.
<PAGE>5
The following table sets forth the composition of Japan's trade
balance, as well as other components of its current account, for the years
1989 to 1993.
CURRENT ACCOUNT
Trade
---------------
<TABLE>
<CAPTION>
Year Exports Imports Trade Balance Current Balance
---- ------- ------- ------------- ---------------
<S> <C> <C> <C> <C>
(U.S. dollars in millions)
1989 269,570 192,653 76,917 57,157
1990 280,374 216,846 63,528 35,761
1991 306,557 203,513 103,044 72,901
1992 330,850 198,502 132,348 117,551
1993 351,292 209,778 141,514 131,448
</TABLE>
Source: Financial Statistics of Japan (1993 ed. and June 1994 supp.),
Institute of Fiscal and Monetary Policy, Ministry of Finance of
Japan
Economic Trends. The following tables set forth Japan's gross
domestic product, wholesale price index and consumer price index for the years
shown.
GROSS DOMESTIC PRODUCT (GDP)
<TABLE>
<CAPTION>
1993 1992 1991 1990 1989
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
GDP (yen billions)
(Expenditures) 468,769.0 463,850.0 451,296.9 24,537.2 396,197.0
Change in GDP
from Preceding
Year
Nominal terms 1.1% 2.8% 6.3% 7.2% 6.7%
Real Terms 0.1% 1.1% 4.3% 4.8% 4.7%
</TABLE>
Source: Financial Statistics of Japan (1993 ed. and June 1994 supp.),
Institute of Fiscal and Monetary Policy, Ministry of Finance of
Japan
<PAGE>6
WHOLESALE PRICE INDEX
<TABLE>
<CAPTION>
Change from
All Preceding
Year Commodities Year
---- ----------- -----------
<S> <C> <C>
(Base year: 1990)
1989 98.0 2.5
1990 100.0 2.0
1991 99.4 (0.6)
1992 97.8 (1.6)
1993 95.0 (2.9)
1994 93.0 2.1
</TABLE>
Source: Financial Statistics of Japan (1993 ed. and June 1994
supp.), Institute of Fiscal and Monetary Policy,
Ministry of Finance of Japan; International Monetary
Fund
CONSUMER PRICE INDEX
<TABLE>
<CAPTION>
Change from
Year General Preceding Year
---- ------- --------------
<S> <C> <C>
(Base Year: 1990)
1989 97.0 2.3
1990 100.0 3.1
1991 103.3 3.3
1992 105.0 1.6
1993 106.4 1.3
1994 107.1 0.7
</TABLE>
Source: Financial Statistics of Japan (1993 ed. and June 1994 supp.),
Institute of Fiscal and Monetary Policy, Ministry of Finance of
Japan; International Monetary Fund
Securities markets. There are eight stock exchanges in Japan. Of
these, the Tokyo Stock Exchange is by far the largest, followed by the Osaka
Stock Exchange and the Nagoya Stock Exchange. These exchanges divide the
market for domestic stocks into two sections, with newly listed companies and
smaller companies assigned to the Second Section and larger companies assigned
to the First Section.
<PAGE>7
The following table sets forth the number of Japanese companies
listed on the three major Japanese stock exchanges as of the end of 1993.
<TABLE>
<CAPTION>
NUMBER OF LISTED DOMESTIC COMPANIES
<S> <C> <C>
Tokyo Osaka Nagoya
----------------------------- ------------------------- --------------------------
1st 2nd 1st 2nd 1st 1st
Sec. Sec. Sec. Sec. Sec. Sec.
---- ---- ---- ---- ---- ----
1,234 433 857 321 432 127
</TABLE>
Source: Tokyo Stock Exchange, Fact Book 1994
The following table sets forth the trading volume and value of
Japanese stocks on the eight Japanese stock exchanges for the years 1989 to
1994.
STOCK TRADING VOLUME & VALUE ON ALL STOCK EXCHANGES
(shares in millions; yen in billions)
<TABLE>
<CAPTION>
Year Volume Value
---- ------ -----
<S> <C> <C>
1989 . . . . . . . . . . . . . . . . . . . . 256,296 [Yen] 386,395
1990 . . . . . . . . . . . . . . . . . . . . 145,837 231,837
1991 . . . . . . . . . . . . . . . . . . . . 107,844 134,160
1992 . . . . . . . . . . . . . . . . . . . . 82,563 80,456
1993 . . . . . . . . . . . . . . . . . . . . 101,172 106,123
1994 . . . . . . . . . . . . . . . . . . . . 105,936 114,622
</TABLE>
Source: Tokyo Stock Exchange, Fact Book 1994; Tokyo Stock Exchange New York
<PAGE>8
Securities Indexes. The Tokyo Stock Price Index ("TOPIX") is a
composite index of all common stocks listed on the First Section of the Tokyo
Stock Exchange. TOPIX reflects the change in the aggregate market value of
the common stocks as compared to the aggregate market value of those stocks as
of the close on January 4, 1968.
The following table sets forth the high, low and year-end TOPIX for
each year from 1989 to 1994.
TOPIX
(January 4, 1968=100)
<TABLE>
<CAPTION>
Year Year-end High Low
---- -------- ---- ---
<S> <C> <C> <C>
1989 2,881.37 2,884.80 2,364.33
1990 1,733.83 2,867.70 1,523.43
1991 1,714.68 2,028.85 1,638.06
1992 1,307.66 1,763.43 1,102.50
1993 1,439.31 1,698.67 1,250.06
1994 1,559.09 1,712.73 1,445.97
</TABLE>
Source: Tokyo Stock Exchange, Fact Book 1994; Tokyo Stock Exchange
Currency Transactions. The value in U.S. dollars of the assets of a
Portfolio that are invested in foreign securities may be affected favorably or
unfavorably by changes in exchange control regulations, and the Portfolio may
incur costs in connection with conversion between various currencies. The
Portfolio, therefore, may engage in currency exchange transactions to protect
against uncertainty in the level of future exchange rates. Income received
could be used to pay the Portfolio's expenses and would increase an investor's
total return. Each Portfolio will conduct its currency exchange transactions
either on a spot (i.e., cash) basis at the rate prevailing in the currency
exchange market, or through entering into forward contracts to purchase or
sell currency. If a devaluation is generally anticipated, the Portfolio may
not be able to contract to sell the currency at a price above the devaluation
level it anticipates. In light of the requirements that the Portfolio must
meet to qualify as a regulated investment company under the Internal Revenue
Code of 1986, as amended (the "Code"), for a given year, each Portfolio
currently intends to limit its gross income from currency transactions to less
than 10% of its gross income for that taxable year.
Forward Currency Contracts. A forward currency contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. These contracts are
entered into in the interbank market conducted directly between currency
traders (usually large commercial banks) and their customers. The use of
forward currency contracts does not eliminate fluctuations in the underlying
prices of the securities, but it does establish a rate of exchange that can be
achieved in the future. In addition, although forward currency contracts
limit the risk of loss due to a decline in the
<PAGE>9
value of the hedged currency, at the same time, they also limit any potential
gain that might result should the value of the currency increase. A
Portfolio's dealings in forward currency exchange for hedging purposes will be
limited to hedging involving either specific transactions or portfolio
positions. Transaction hedging is the purchase or sale of forward currency
with respect to specific receivables or payables of the Portfolio generally
accruing in connection with the purchase or sale of its portfolio securities.
Position hedging is the sale of forward currency with respect to portfolio
security positions denominated or quoted in the currency. The Portfolio may
not position hedge with respect to a particular currency to an extent greater
than the aggregate market value (at the time of making such sale) of the
securities held in its portfolio denominated or quoted in or currently
convertible into that particular currency. If the Portfolio enters into a
forward currency transaction, cash or other liquid high-grade debt securities
will be placed in a segregated account in an amount equal to the value of the
Portfolio's total assets committed to the consummation of the forward
contract. If the value of the securities placed in the segregated account
declines, additional cash or securities will be placed in the account so that
the value of the account will equal the amount of the Portfolio's commitment
with respect to the contract. Hedging transactions may be made from any
foreign currency into U.S. dollars or into other appropriate currencies.
At or before the maturity of a forward contract, the Portfolio may
either sell a portfolio security and make delivery of the currency, or retain
the security and offset its contractual obligation to deliver the currency by
purchasing a second contract pursuant to which the Portfolio will obtain, on
the same maturity date, the same amount of the currency which it is obligated
to deliver. If the Portfolio retains the portfolio security and engages in an
offsetting transaction, the Portfolio, at the time of execution of the
offsetting transaction, will incur a gain or a loss to the extent that
movement has occurred in forward contract prices. Should forward prices
decline during the period between the Portfolio's entering into a forward
contract for the sale of a currency and the date it enters into an offsetting
contract for the purchase of the currency, the Portfolio 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 Portfolio 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.
The cost to a Portfolio of engaging in currency transactions varies
with factors such as the currency involved, the length of the contract period
and the market conditions then prevailing. Because transactions in currency
exchange are usually conducted on a principal basis, no fees or commissions
are involved. The use of forward currency contracts does not eliminate
fluctuations in the underlying prices of the securities, but it does establish
a rate of exchange that can be achieved in the future. In addition, although
forward currency contracts limit the risk of loss due to a decline in the
value of the hedged currency, at the same time, they limit any potential gain
that might result should the value of the currency increase.
Foreign Currency Futures. As described below under "Futures
Activities," a Portfolio may enter into foreign currency futures contracts and
related options.
<PAGE>10
While the values of currency futures and options on futures may be
expected to correlate with exchange rates, they will not reflect other factors
that may affect the value of a Portfolio's investments. A currency hedge, for
example, should protect a Yen- denominated bond against a decline in the Yen,
but will not protect the Portfolio against price decline if the issuer's
creditworthiness deteriorates. Because the value of the Portfolio's
investments denominated in foreign currency will change in response to many
factors other than exchange rates, a currency hedge may not be entirely
successful to mitigate changes in the value of the Portfolio's investments
denominated in that currency over time.
Futures Activities and Commodity Options. A Portfolio may enter
into commodity futures contracts and purchase and write (sell) related
options, including, but not limited to, foreign currency, interest rate and
stock index futures. Such contracts will be entered into on U.S. or foreign
exchanges or boards of trade approved by the Commodity Futures Trading
Commission (the "CFTC"). These transactions may be entered into for "bona
fide hedging" purposes as defined in CFTC regulations and other permissible
purposes including increasing return and hedging against changes in the value
of portfolio securities due to anticipated changes in interest rates, currency
values and/or market conditions. The ability of a Portfolio to trade in
futures contracts may be limited by the requirements of the Code applicable to
a regulated investment company.
A Portfolio will not enter into futures contracts and related
options for which the aggregate initial margin and premiums required to
establish positions other than those considered to be "bona fide hedging" by
the CFTC exceed 5% of the Portfolio's net asset value after taking into
account unrealized profits and unrealized losses on any such contracts it has
entered into. The Portfolio's long and short positions in futures contracts
or options thereon written by it must be collateralized with cash or certain
liquid high-grade debt securities held in a segregated account or otherwise
"covered" in accordance with SEC interpretations in order to eliminate any
potential for leveraging. There is no overall limit on the percentage of a
Portfolio's assets that may be at risk with respect to futures activities.
Futures Contracts. An interest rate futures contract provides for
the future sale by one party and the purchase by the other party of a certain
amount of a specific financial instrument (debt security) at a specified
price, date, time and place. A stock index futures contract is an agreement
between seller and buyer to deliver and take delivery respectively, of a
commodity which is represented by a multiplier times a stock price index at a
future specified date. The delivery is a cash settlement based on the
difference between the original transaction price and the final price of the
index at the termination of the contract. Stock indexes are capitalization
weighted indexes which reflect the market value of the firms listed on the
indexes. A foreign currency futures contract provides for the future sale by
one party and the purchase by the other party of a certain amount of a
specified non-U.S. currency at a specified price, date, time and place.
Foreign currency futures are similar to forward currency contracts, except
that they are traded on commodities exchanges and are standardized as to
contract size and delivery date. In investing in such transactions, the
Portfolio would incur brokerage costs and would be required to make and
maintain certain "margin" deposits.
<PAGE>11
One of the purposes of a Portfolio's entering into a futures
contract may be to protect the Portfolio from fluctuations in value of its
portfolio securities without its necessarily buying or selling the securities.
Of course, since the value of portfolio securities will far exceed the value
of the futures contracts sold by the Portfolio, an increase in the value of
the futures contracts could only mitigate, but not totally offset, the decline
in the value of the Portfolio's assets. No consideration is paid or received
by the Portfolio upon entering into a futures contract. Upon entering into a
futures contract, the Portfolio will be required to deposit in a segregated
account with its custodian an amount of cash or cash equivalents, such as U.S.
government securities or other liquid high-grade debt obligations, equal to
approximately 1% to 10% of the contract amount (this amount is subject to
change by the exchange on which the contract is traded, and brokers may charge
a higher amount). 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 Portfolio upon termination of the futures contract, assuming
all contractual obligations have been satisfied. The broker will have access
to amounts in the margin account if the Portfolio fails to meet its
contractual obligations. Subsequent payments, known as "variation margin," to
and from the broker, will be made daily as the stock index, interest rate or
currencies underlying the futures contract fluctuates, making the long and
short positions in the futures contract more or less valuable, a process known
as "marking-to-market." At any time prior to the expiration of a futures
contract, the Portfolio may elect to close the position by taking an opposite
position, which will operate to terminate the Portfolio's existing position in
the contract.
Positions in futures contracts and options on futures contracts may
be closed out only on the exchange on which they were entered into (or through
a linked exchange). No secondary market for such contracts exists. Although
each Portfolio intends to enter into futures contracts only if there is an
active market for such contracts, there is no assurance that an active market
will exist for the contracts at any particular time. Most futures exchanges
limit the amount of fluctuation permitted in futures contract prices during a
single trading day. Once the daily limit has been reached in a particular
contract, no trades may be made that day at a price beyond that limit. It is
possible that futures contract prices could move to the daily limit for
several consecutive trading days with little or no trading, thereby preventing
prompt liquidation of futures positions and subjecting the Portfolio to
substantial losses. In such event, and in the event of adverse price
movements, the Portfolio would be required to make daily cash payments of
variation margin. In such circumstances, an increase in the value of the
portion of the Portfolio's securities being hedged, if any, may partially or
completely offset losses on the futures contract. However, as described
above, there is no guarantee that the price of the securities being hedged
will, in fact, correlate with the price movements in a futures contract and
thus provide an offset to losses on the futures contract.
If a Portfolio has hedged against the possibility of an event
adversely affecting the value of securities held in its portfolio and that
event does not occur, the Portfolio will lose part or all of the benefit of
the increased value of securities which it has hedged because it will have
offsetting losses in its futures positions. Losses incurred in futures
transactions and the costs of these transactions will affect the Portfolio's
performance. In addition, in
<PAGE>12
such situations, if the Portfolio had insufficient cash, it might have to sell
securities to meet daily variation margin requirements at a time when it would
be disadvantageous to do so. These sales of securities could, but will not
necessarily, be at increased prices which reflect the change in interest
rates, stock indexes or currency values, as the case may be.
Options on Futures Contracts. Each Portfolio may purchase and write
put and call options on interest rate, foreign currency and stock index
futures contracts that are traded on an exchange designated by the CFTC or
consistent with CFTC regulations on foreign exchanges, and may enter into
closing transactions with respect to such options to terminate existing
positions. There is no guarantee that such closing transactions can be
effected.
An option on an interest rate, currency or stock index futures
contract, as contrasted with the direct investment in such a contract, gives
the purchaser the right, in return for the premium paid, to assume a position
in an interest rate, currency or stock index futures contract at a specified
exercise price at any time prior to the expiration date of the option. Upon
exercise of an option, the delivery of the futures position by the writer of
the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account, which represents
the amount by which the market price of the futures contract exceeds, in the
case of a call, or is less than, in the case of a put, the exercise price of
the option on the futures contract. The potential loss related to the
purchase of an option on futures contracts is limited to the premium paid for
the option (plus transaction costs). Because the value of the option is fixed
at the point of sale, there are no daily cash payments by the purchaser to
reflect changes in the value of the underlying contract; however, the value of
the option does change daily and that change would be reflected in the net
asset value of the Portfolio.
There are several risks relating to options on futures contracts.
The ability to establish and close out positions on such options will be
subject to the existence of a liquid market. In addition, the purchase of put
or call options will be based upon predictions as to anticipated trends in
interest rates and securities markets by Warburg, Pincus Counsellors, Inc.,
the Portfolios' investment adviser ("Counsellors"), which could prove to be
incorrect. Even if Counsellors' expectations are correct where options on
futures are used for hedging purposes, there may be an imperfect correlation
between the change in the value of the options and of the portfolio securities
hedged.
Options on Securities. A Portfolio may purchase and write put and
call options on stocks and debt securities that are traded on foreign as well
as U.S. exchanges, as well as over-the-counter ("OTC") options, to the extent
permitted by the policies of state securities authorities in states where
shares of the Portfolio are qualified for offer and sale.
A Portfolio realizes fees (referred to as "premiums") for granting
the rights evidenced by the call options it has written. A put option
embodies the right of its purchaser to compel the writer of the option to
purchase from the option holder an underlying security at a specified price at
any time during the option period. In contrast, a call option embodies
<PAGE>13
the right of its purchaser to compel the writer of the option to sell to the
option holder an underlying security at a specified price at any time during
the option period.
The principal reason for writing covered call options on a security
is to attempt to realize, through the receipt of premiums, a greater return
than would be realized on the securities alone. In return for a premium, a
Portfolio as the writer of a covered call option forfeits the right to any
appreciation in the value of the underlying security above the strike price
for the life of the option (or until a closing purchase transaction can be
effected). Nevertheless, the Portfolio as the call writer retains the risk of
a decline in the price of the underlying security. The size of the premiums
that the Portfolio may receive may be adversely affected as new or existing
institutions, including other investment companies, engage in or increase
their option-writing activities.
Options written by a Portfolio will normally have expiration dates
between one and nine months from the date written. The exercise price of the
options may be below, equal to or above the market values of the underlying
securities at the times the options are written. In the case of call options,
these exercise prices are referred to as "in-the-money," "at-the-money" and
"out-of-the-money," respectively. The Portfolio may write (a) in-the-money
call options when Counsellors expects that the price of the underlying
security will remain flat or decline moderately during the option period,
(b) at-the-money call options when Counsellors expects that the price of the
underlying security will remain flat or advance moderately during the option
period and (c) out-of-the-money call options when Counsellors expects that the
premiums received from writing the call option plus the appreciation in market
price of the underlying security up to the exercise price will be greater than
the appreciation in the price of the underlying security alone. In any of the
preceding situations, if the market price of the underlying security declines
and the security is sold at this lower price, the amount of any realized loss
will be offset wholly or in part by the premium received.
So long as the obligation of a Portfolio as the writer of an option
continues, the Portfolio may be assigned an exercise notice by the
broker-dealer through which the option was sold, requiring the Portfolio to
deliver the underlying security against payment of the exercise price. This
obligation terminates when the option expires or the Portfolio effects a
closing purchase transaction. The Portfolio can no longer effect a closing
purchase transaction with respect to an option once it has been assigned an
exercise notice. To secure its obligation to deliver the underlying security
when it writes a call option, the Portfolio will be required to deposit in
escrow the underlying security or other assets in accordance with the rules of
the Options Clearing Corporation (the "Clearing Corporation") and of the
securities exchange on which the option is written.
Prior to their expirations, put and call options may be sold in
closing sale transactions (sales by a Portfolio, prior to the exercise of
options that it has purchased, of options of the same series) in which the
Portfolio may realize a profit or loss from the sale. An option position may
be closed out only where there exists a secondary market for an option of the
same series on a recognized securities exchange or in the over-the-counter
<PAGE>14
market. Each Portfolio expects to purchase and write options on securities
only on U.S. securities exchanges or in the over-the-counter market. In cases
where the Portfolio has written an option, it will realize a profit if the
cost of the closing purchase transaction is less than the premium received
upon writing the original option and will incur a loss if the cost of the
closing purchase transaction exceeds the premium received upon writing the
original option. Similarly, when the Portfolio has purchased an option and
engages in a closing sale transaction, whether the Portfolio realizes a profit
or loss will depend upon whether the amount received in the closing sale
transaction is more or less than the premium the Portfolio initially paid for
the original option plus the related transaction costs.
Although a Portfolio will generally purchase or write only those
options for which Counsellors believes there is an active secondary market so
as to facilitate closing transactions, there is no assurance that sufficient
trading interest will exist to create a liquid secondary market on a
securities exchange for any particular option or at any particular time, and
for some options no such secondary market may exist. A liquid secondary
market in an option may cease to exist for a variety of reasons. In the past,
for example, higher than anticipated trading activity or order flow or other
unforeseen events have at times rendered certain of the facilities of the
Clearing Corporation and various securities exchanges inadequate and resulted
in the institution of special procedures, such as trading rotations,
restrictions on certain types of orders or trading halts or suspensions in one
or more options. There can be no assurance that similar events, or events
that may otherwise interfere with the timely execution of customers' orders,
will not recur. In such event, it might not be possible to effect closing
transactions in particular options. Moreover, a Portfolio's ability to
terminate options positions established in the over-the-counter market may be
more limited than for exchange-traded options and may also involve the risk
that securities dealers participating in over-the-counter transactions would
fail to meet their obligations to the Portfolio. The Portfolios, however,
intend to purchase over-the-counter options only from dealers whose debt
securities, as determined by Counsellors, are considered to be investment
grade. If, as a covered call option writer, a Portfolio is unable to effect a
closing purchase transaction in a secondary market, it will not be able to
sell the underlying security until the option expires or it delivers the
underlying security upon exercise. In either case, the Portfolio would
continue to be at market risk on the security and could face higher
transaction costs, including brokerage commissions.
Securities exchanges generally have established limitations
governing the maximum number of calls and puts of each class which may be held
or written, or exercised within certain time periods by an investor or group
of investors acting in concert (regardless of whether the options are written
on the same or different securities exchanges or are held, written or
exercised in one or more accounts or through one or more brokers). It is
possible that a Portfolio and other clients of Counsellors and certain of its
affiliates may be considered to be such a group. A securities exchange may
order the liquidation of positions found to be in violation of these limits
and it may impose certain other sanctions. These limits may restrict the
number of options a Portfolio will be able to purchase on a particular
security.
<PAGE>15
In the case of options written by a Portfolio that are deemed
covered by virtue of the Portfolio's holding convertible or exchangeable
preferred stock or debt securities, the time required to convert or exchange
and obtain physical delivery of the underlying common stock with respect to
which the Portfolio has written options may exceed the time within which the
Portfolio must make delivery in accordance with an exercise notice. In these
instances, the Portfolio may purchase or temporarily borrow the underlying
securities for purposes of physical delivery. By so doing, the Portfolio will
not bear any market risk, since the Portfolio will have the absolute right to
receive from the issuer of the underlying security an equal number of shares
to replace the borrowed stock, but the Portfolio may incur additional
transaction costs or interest expenses in connection with any such purchase or
borrowing.
Additional risks exist with respect to certain of the securities for
which the Portfolio may write covered call options. If a Portfolio writes
covered call options on mortgage-backed securities, the mortgage-backed
securities that it holds as cover may, because of scheduled amortization or
unscheduled prepayments, cease to be sufficient cover. If this occurs, the
Portfolio will compensate for the decline in the value of the cover by
purchasing an appropriate additional amount of mortgage-backed securities.
In addition to writing covered options for other purposes, including
generating current income, each Portfolio may enter into options transactions
as hedges to reduce investment risk, generally by making an investment
expected to move in the opposite direction of a portfolio position. A hedge
is designed to offset a loss on a portfolio position with a gain on the hedged
position; at the same time, however, a properly correlated hedge will result
in a gain on the portfolio position being offset by a loss on the hedged
position. The Portfolio bears the risk that the prices of the securities
being hedged will not move in the same amount as the hedge. The Portfolio
will engage in hedging transactions only when deemed advisable by Counsellors.
Successful use by the Portfolio of options will be subject to Counsellors'
ability to predict correctly movements in the direction of the stock
underlying the option used as a hedge. Losses incurred in hedging
transactions and the costs of these transactions will affect the Portfolio's
performance.
OTC Options. Each Portfolio may purchase OTC options or dealer
options or sell covered OTC options. Unlike exchange-listed options where an
intermediary or clearing corporation, such as the Clearing Corporation,
assures that all transactions in such options are properly executed, the
responsibility for performing all transactions with respect to OTC options
rests solely with the writer and the holder of those options. A listed call
option writer, for example, is obligated to deliver the underlying stock to
the clearing organization if the option is exercised, and the clearing
corporation is then obligated to pay the writer the exercise price of the
option. If a Portfolio were to purchase a dealer option, however, it would
rely on the dealer from whom it purchased the option to perform if the option
were exercised. If the dealer fails to honor the exercise of the option by
the Portfolio, the Portfolio would lose the premium it paid for the option and
the expected benefit of the transaction.
<PAGE>16
Listed options generally have a continuous liquid market while
dealer options have none. Consequently, a Portfolio will generally be able to
realize the value of a dealer option it has purchased only by exercising it or
reselling it to the dealer who issued it. Similarly, when the Portfolio
writes a dealer option, it generally will be able to close out the option
prior to its expiration only by entering into a closing purchase transaction
with the dealer to which the Portfolio originally wrote the option. Although
the Portfolio will seek to enter into dealer options only with dealers who
will agree to and that are expected to be capable of entering into closing
transactions with the Portfolio, there can be no assurance that the Portfolio
will be able to liquidate a dealer option at a favorable price at any time
prior to expiration. The inability to enter into a closing transaction may
result in material losses to the Portfolio. Until the Portfolio, 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 to cover
the written option until the option expires or is exercised. This requirement
may impair the Portfolio's ability to sell portfolio securities or currencies
at a time when such sale might be advantageous. In the event of insolvency of
the other party, the Portfolio may be unable to liquidate a dealer option.
Stock Index Options. Each Portfolio may purchase exchange-listed
and OTC put and call options on stock indexes, and may write options on such
indexes to hedge against the effects of market-wide price movements. A stock
index measures the movement of a certain group of stocks by assigning relative
values to the common stocks included in the index, fluctuating with changes in
the market values of the stocks included in the index. Some stock index
options are based on a broad market index such as the New York Stock Exchange
("NYSE") Composite index, or a narrower market index such as the Standard &
Poor's 100. Indexes may also be based on a particular industry or market
segment.
Options on stock indexes are similar to options on stock except that
(a) the expiration cycles of stock index options are monthly, while those of
stock options are currently quarterly, and (b) the delivery requirements are
different. Instead of giving the right to take or make delivery of stock at a
specified price, an option on a stock index gives the holder the right to
receive a cash "exercise settlement amount" equal to (i) the amount, if any,
by which the fixed exercise price of the option exceeds (in the case of a put)
or is less than (in the case of a call) the closing value of the underlying
index on the date of exercise, multiplied by (ii) a fixed "index multiplier."
Receipt of this cash amount will depend upon the closing level of the stock
index upon which the option is based being greater than, in the case of a
call, or less than, in the case of a put, the exercise price of the index and
the exercise price of the option expressed in dollars times a specified
multiple. The writer of the option is obligated, in return for the premium
received, to make delivery of this amount. The writer may offset its position
in stock index options prior to expiration by entering into a closing
transaction on an exchange or it may let the option expire unexercised.
The effectiveness of purchasing or writing stock index options as a
hedging technique will depend upon the extent to which price movements in the
portion of a securities portfolio being hedged correlate with price movements
of the stock index selected. Because the value of an index option depends
upon movements in the level of the index rather than
<PAGE>17
the price of a particular stock, whether a Portfolio will realize a gain or
loss from the purchase or writing of options on an index depends upon
movements in the level of stock prices in the stock market generally or, in
the case of certain indexes, in an industry or market segment, rather than
movements in the price of a particular stock. Accordingly, successful use by
each Portfolio of options on stock indexes will be subject to Counsellors'
ability to predict correctly movements in the direction of the stock market
generally or of a particular industry. This requires different skills and
techniques than predicting changes in the price of individual stocks.
There can be no assurance that the use of these portfolio strategies
will be successful. When a Portfolio writes an option on a stock index, the
Portfolio will establish a segregated account with its custodian containing
cash, U.S. government securities and other liquid high-grade debt obligations
in an amount equal to the market value of the option and will maintain the
account while the option is open.
American, European and Continental Depositary Receipts. The assets
of a Portfolio may be invested in the securities of foreign issuers in the
form of American Depositary Receipts ("ADRs") and European Depositary Receipts
("EDRs"). These securities may not necessarily be denominated in the same
currency as the securities into which they may be converted. ADRs are
receipts typically issued by a U.S. bank or trust company which evidence
ownership of underlying securities issued by a foreign corporation. EDRs,
which are sometimes referred to as Continental Depositary Receipts ("CDRs"),
are receipts issued in Europe typically by non-U.S. banks and trust companies
that evidence ownership of either foreign or domestic securities. Generally,
ADRs in registered form are designed for use in U.S. securities markets and
EDRs and CDRs in bearer form are designed for use in European securities
markets.
Short Sales "Against the Box." In a short sale, a Portfolio sells a
borrowed security and has a corresponding obligation to the lender to return
the identical security. A Portfolio may engage in short sales if at the time
of the short sale the Portfolio owns or has the right to obtain an equal
amount of the security being sold short. This investment technique is known
as a short sale "against the box."
In a short sale, the seller does not immediately deliver the
securities sold and is said to have a short position in those securities until
delivery occurs. If a Portfolio engages in a short sale, the collateral for
the short position will be maintained by the Portfolio's custodian or
qualified sub-custodian. While the short sale is open, the Portfolio will
maintain in a segregated account an amount of securities equal in kind and
amount to the securities sold short or securities convertible into or
exchangeable for such equivalent securities. These securities constitute the
Portfolio's long position. Not more than 10% of a Portfolio's net assets
(taken at current value) may be held as collateral for such short sales at any
one time.
The Portfolios do not intend to engage in short sales against the
box for investment purposes. A Portfolio may, however, make a short sale as a
hedge, when it
<PAGE>18
believes that the price of a security may decline, causing a decline in the
value of a security owned by the Portfolio (or a security convertible or
exchangeable for such security), or when a Portfolio wants to sell the
security at an attractive current price, but also wishes to defer recognition
of gain or loss for U.S. federal income tax purposes and for purposes of
satisfying certain tests applicable to regulated investment companies under
the Code. In such case, any future losses in the Portfolio's long position
should be offset by a gain in the short position and, and, conversely, any
gain in the long position should be reduced by a loss in the short position.
The extent to which such gains or losses are reduced will depend upon the
amount of the security sold short relative to the amount the Portfolio owns.
There will be certain additional transaction costs associated with short sales
against the box, but the Portfolios will endeavor to offset these costs with
the income from the investment of the cash proceeds of short sales.
U.S. Government Securities. Each Portfolio may invest in debt
obligations of varying maturities issued or guaranteed by the United States
government, its agencies or instrumentalities ("U.S. Government Securities").
Direct obligations of the U.S. Treasury include a variety of securities that
differ in their interest rates, maturities and dates of issuance. U.S.
Government Securities also include securities issued or guaranteed by the
Federal Housing Administration, Farmers Home Loan Administration,
Export-Import Bank of the United States, Small Business Administration,
Government National Mortgage Association, General Services Administration,
Central Bank for Cooperatives, Federal Farm Credit Banks, Federal Home Loan
Banks, Federal Home Loan Mortgage Corporation, Federal Intermediate Credit
Banks, Federal Land Banks, Federal National Mortgage Association, Maritime
Administration, Tennessee Valley Authority, District of Columbia Armory Board
and Student Loan Marketing Association. Each Portfolio may also invest in
instruments that are supported by the right of the issuer to borrow from the
U.S. Treasury and instruments that are supported by the credit of the
instrumentality. Because the U.S. government is not obligated by law to
provide support to an instrumentality it sponsors, a Portfolio will invest in
obligations issued by such an instrumentality only if Counsellors determines
that the credit risk with respect to the instrumentality does not make its
securities unsuitable for investment by the Portfolio.
Securities of Other Investment Companies. Each Portfolio may invest
in securities of other investment companies to the extent permitted under the
Investment Company Act of 1940, as amended (the "1940 Act"). Presently, under
the 1940 Act, a Portfolio may hold securities of another investment company in
amounts which (a) do not exceed 3% of the total outstanding voting stock of
such company, (b) do not exceed 5% of the value of the Portfolio's total
assets and (c) when added to all other investment company securities held by
the Portfolio, do not exceed 10% of the value of the Portfolio's total assets.
Repurchase Agreements. A Portfolio may enter into repurchase
agreements with member banks of the Federal Reserve System or certain non-bank
dealers. Repurchase agreements are contracts under which the buyer of a
security simultaneously commits to resell the security to the seller at an
agreed-upon price and date. Under each repurchase
<PAGE>19
agreement, the selling institution will be required to maintain the value of
the securities subject to the repurchase agreement at not less than their
repurchase price. Repurchase agreements involve certain risks in the event of
default or insolvency of the other party, including possible delays or
restrictions upon a Portfolio's ability to dispose of the underlying
securities.
Lending of Portfolio Securities. A Portfolio may lend portfolio
securities to brokers, dealers and other financial organizations that meet
capital and other credit requirements or other criteria established by the
Fund's Board of Directors (the "Board"). These loans, if and when made, may
not exceed 33-1/3% of a Portfolio's total assets taken at value. A Portfolio
will not lend portfolio securities to E.M. Warburg, Pincus & Co., Inc. ("EMW")
or its affiliates unless it has applied for and received specific authority to
do so from the SEC. Loans of portfolio securities will be collateralized by
cash, letters of credit or U.S. Government Securities, which are maintained at
all times in an amount equal to at least 100% of the current market value of
the loaned securities. Any gain or loss in the market price of the securities
loaned that might occur during the term of the loan would be for the account
of the Portfolio involved. From time to time, a Portfolio may return a part
of the interest earned from the investment of collateral received for
securities loaned to the borrower and/or a third party that is unaffiliated
with the Portfolio and that is acting as a "finder."
By lending its securities, the Portfolio can increase its income by
continuing to receive interest and any dividends on the loaned securities as
well as by either investing the collateral received for securities loaned
in short-term instruments or obtaining yield in the form of interest paid by
the borrower when U.S. Government Securities are used as collateral. Income
received could be used to pay a Portfolio's expenses and would increase an
investor's total return. A Portfolio will adhere to the following conditions
whenever its portfolio securities are loaned: (a) the Portfolio must receive
at least 100% cash collateral or equivalent securities from the borrower; (b)
the borrower must increase such collateral whenever the market value of the
securities rises above the level of such collateral; (c) the Portfolio must be
able to terminate the loan at any time; (d) the Portfolio must receive
reasonable interest on the loan, as well as any dividends, interest or other
distributions on the loaned securities and any increase in market value; (e)
the Portfolio may pay only reasonable custodian fees in connection with the
loan; and (f) voting rights on the loaned securities may pass to the borrower,
provided, however, that if a material event adversely affecting the investment
occurs, the Board of Directors must terminate the loan and regain the right to
vote the securities. Loan agreements involve certain risks in the event of
default or insolvency of the other party including possible delays or
restrictions upon a Portfolio's ability to recover the loaned securities or
dispose of the collateral for the loan.
When-Issued Securities and Delayed-Delivery Transactions. Each
Portfolio may utilize up to 20% of its total assets to purchase securities on
a "when-issued" basis or purchase or sell securities for delayed delivery
(i.e., payment or delivery occur beyond the normal settlement date at a stated
price and yield). When-issued transactions normally settle within 30-45 days.
A Portfolio will enter into a when-issued transaction for the purpose of
<PAGE>20
acquiring portfolio securities and not for the purpose of leverage, but may
sell the securities before the settlement date if Counsellors deems it
advantageous to do so. The payment obligation and the interest rate that will
be received on when-issued securities are fixed at the time the buyer enters
into the commitment. Due to fluctuations in the value of securities purchased
or sold on a when-issued or delayed-delivery basis, the yields obtained on
such securities may be higher or lower than the yields available in the market
on the dates when the investments are actually delivered to the buyers.
When a Portfolio agrees to purchase when-issued or delayed delivery
securities, its custodian will set aside cash, U.S. Government Securities or
other liquid high-grade debt obligations equal to the amount of the commitment
in a segregated account. Normally, the custodian will set aside portfolio
securities to satisfy a purchase commitment, and in such a case the Portfolio
may be required subsequently to place additional assets in the segregated
account in order to ensure that the value of the account remains equal to the
amount of the Portfolio's commitment. It may be expected that the Portfolio's
net assets will fluctuate to a greater degree when it sets aside portfolio
securities to cover such purchase commitments than when it sets aside cash.
When the Portfolio engages in when-issued or delayed-delivery transactions, it
relies on the other party to consummate the trade. Failure of the seller to
do so may result in the Portfolio's incurring a loss or missing an opportunity
to obtain a price considered to be advantageous.
Convertible Securities. Convertible securities in which a Portfolio
may invest, including both convertible debt and convertible preferred stock,
may be converted at either a stated price or stated rate into underlying
shares of common stock. Because of this feature, convertible securities
enable an investor to benefit from increases in the market price of the
underlying common stock. Convertible securities provide higher yields than
the underlying equity securities, but generally offer lower yields than
non-convertible securities of similar quality. Like bonds, the value of
convertible securities fluctuates in relation to changes in interest rates
and, in addition, also fluctuates in relation to the underlying common stock.
Warrants. Each Portfolio may invest up to 5% of net assets in
warrants, provided that not more than 2% of net assets may be invested in
warrants not listed on a recognized U.S. or foreign stock exchange. Because a
warrant does not carry with it the right to dividends or voting rights with
respect to the securities which it entitles a holder to purchase, and because
it does not represent any rights in the assets of the issuer, warrants may be
considered more speculative than certain other types of investments. Also,
the value of a warrant does not necessarily change with the value of the
underlying securities and a warrant ceases to have value if it is not
exercised prior to its expiration date.
Non-Publicly Traded and Illiquid Securities. A Portfolio may not
invest more than 10% of its net assets, in the aggregate, in illiquid
securities, including repurchase agreements which have a maturity of longer
than seven days, time deposits maturing in more than seven days and securities
that are illiquid by virtue of the absence of a readily available market or
legal or contractual restrictions on resale. Repurchase agreements subject to
demand are deemed to have a maturity equal to the notice period.
<PAGE>21
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
placements 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 a mutual fund might be unable to dispose of restricted or other illiquid
securities promptly or at reasonable prices and might thereby experience
difficulty satisfying redemptions within seven days. A mutual 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.
The SEC has adopted Rule 144A which allows for a broader
institutional trading market for securities otherwise subject to restriction
on resale to the general public. Rule 144A establishes a "safe harbor" from
the registration requirements of the Securities Act for resales of certain
securities to qualified institutional buyers. Counsellors anticipates that
the market for certain restricted securities such as institutional commercial
paper will expand further as a result of this new regulation and the
development of automated systems for the trading, clearance and settlement of
unregistered securities of domestic and foreign issuers, such as the PORTAL
System sponsored by the National Association of Securities Dealers, Inc.
Counsellors will monitor the liquidity of restricted securities in a
Portfolio under the supervision of the Board of Directors. In reaching
liquidity decisions, Counsellors may consider, inter alia, the following
factors: (a) the unregistered nature of the security; (b) the frequency of
trades and quotes for the security; (c) the number of dealers wishing to
purchase or sell the security and the number of other potential purchasers;
(d) dealer undertakings to make a market in the security and (e) the nature of
the security and the nature of the marketplace trades (e.g., the time needed
to dispose of the security, the method of soliciting offers and the mechanics
of the transfer).
Borrowing. Each Portfolio may borrow up to 30% of its total assets.
Counsellors may borrow for temporary or emergency purposes, including to meet
portfolio
<PAGE>22
redemption requests so as to permit the orderly disposition of portfolio
securities or to facilitate settlement transactions on portfolio securities.
Investments (including roll-overs) will not be made when borrowings exceed 5%
of the Portfolio's total assets. Although the principal of such borrowings
will be fixed, the Portfolio's assets may change in value during the time the
borrowing is outstanding. Each Portfolio expects that some of its borrowings
may be made on a secured basis. In such situations, either the custodian will
segregate the pledged assets for the benefit of the lender or arrangements
will be made with a suitable subcustodian, which may include the lender.
Other Investment Policies and Practices of the Global Fixed Income Portfolio
Non-Diversified Status. The Portfolio is classified as
non-diversified within the meaning of the 1940 Act, which means that it is not
limited by such Act in the proportion of its assets that it may invest in
securities of a single issuer. The Portfolio's investments will be limited,
however, in order to qualify as a "regulated investment company" for purposes
of the Code. See "Additional Information Concerning Taxes." To qualify, the
Portfolio will comply with certain requirements, including limiting its
investments so that at the close of each quarter of the taxable year (a) not
more than 25% of the market value of its total assets will be invested in the
securities of a single issuer, and (b) with respect to 50% of the market value
of its total assets, not more than 5% of the market value of its total assets
will be invested in the securities of a single issuer and the Portfolio will
not own more than 10% of the outstanding voting securities of a single issuer.
Ratings as Investment Criteria. Up to 5% of the Global Fixed Income
Portfolio's net assets may be invested in securities rated below investment
grade at the time of the investment, but not lower than "B" by Standard &
Poor's Corporation or Moody's Investors Service, Inc. Subsequent to its
purchase by a Portfolio, an issue of securities may cease to be rated or its
rating may be reduced below the minimum required for purchase by the
Portfolio. Neither event will require sale of such securities by a Portfolio,
but Counsellors will consider such event in its determination of whether the
Portfolio should continue to hold the securities.
Other Investment Limitations
The investment limitations numbered 1 through 12, as applied to a
Portfolio, may not be changed without the affirmative vote of the holders of a
majority of the Portfolio's outstanding shares. Such majority is defined as
the lesser of (a) 67% or more of the shares present at the meeting, if the
holders of more than 50% of the outstanding shares of the Portfolio are
present or represented by proxy, or (b) more than 50% of the outstanding
shares. Investment limitations 13 through 16, as applied to a Portfolio, may
be changed by a vote of the Fund's Board of Directors at any time.
A Portfolio may not:
<PAGE>23
1. Borrow money or issue senior securities except that the
Portfolio may (a) borrow from banks for temporary or emergency purposes, and
not for leveraging, and then in amounts not in excess of 30% of the value of
the Portfolio's total assets at the time of such borrowing and (b) enter into
futures contracts; or mortgage, pledge or hypothecate any assets except in
connection with any bank borrowing and in amounts not in excess of the lesser
of the dollar amounts borrowed. Whenever borrowings described in (a) exceed
5% of the value of the Portfolio's total assets, the Portfolio will not make
any investments (including roll-overs). For purposes of this restriction, (a)
the deposit of assets in escrow in connection with certain of the Portfolio's
investment strategies and (b) collateral arrangements with respect to initial
or variation margin for futures contracts will not be deemed to be pledges of
the Portfolio's assets.
2. Purchase any securities which would cause 25% or more of the
value of the Portfolio's total assets at the time of purchase to be invested
in the securities of issuers conducting their principal business activities in
the same industry; provided that there shall be no limit on the purchase of
U.S. Government Securities.
3. Make loans, except that the Portfolio may purchase or hold
publicly distributed fixed income securities, lend portfolio securities and
enter into repurchase agreements.
4. Underwrite any issue of securities except to the extent that the
investment in restricted securities and the purchase of fixed income
securities directly from the issuer thereof in accordance with the Portfolio's
investment objective, policies and limitations may be deemed to be
underwriting.
5. Purchase or sell real estate, real estate investment trust
securities, commodities or commodity contracts, or invest in real estate
limited partnerships, oil, gas or mineral exploration or development programs
or oil, gas and mineral leases, except that the Portfolio may invest in (a)
securities secured by real estate, mortgages or interests therein, (b)
securities of companies that invest in or sponsor oil, gas or mineral
exploration or development programs and (c) futures contracts and related
options and commodity options. The entry into forward foreign currency
exchange contracts is not and shall not be deemed to involve investing in
commodities.
6. Make short sales of securities or maintain a short position,
except that a Portfolio may maintain short positions in forward currency
contracts, options and futures contracts and make short sales "against the
box."
7. Purchase, write or sell puts, calls, straddles, spreads or
combinations thereof, except that the Portfolio may (a) purchase put and call
options on securities and foreign currencies, (b) write covered call options
on securities and (c) purchase or write options on futures contracts.
<PAGE>24
8. Purchase securities of other investment companies except in
connection with a merger, consolidation, acquisition, reorganization or offer
of exchange, or as otherwise permitted under the 1940 Act.
9. Purchase securities on margin, except that the Portfolio may
obtain any short-term credits necessary for the clearance of purchases and
sales of securities. For purposes of this restriction, the deposit or payment
of initial or variation margin in connection with futures contracts or related
options will not be deemed to be a purchase of securities on margin.
10. With respect to the International Equity Portfolio only,
purchase the securities of any issuer if as a result more than 5% of the value
of the Portfolio's total assets would be invested in the securities of such
issuer, except that this 5% limitation does not apply to U.S. Government
Securities and except that up to 25% of the value of the Portfolio's total
assets may be invested without regard to this 5% limitation.
11. Purchase any security if as a result the Portfolio would then
have more than 5% of its total assets invested in securities of companies
(including predecessors) that have been in continuous operation for fewer than
three years.
12. With respect to the International Equity Portfolio only,
purchase more than 10% of the voting securities of any one issuer; provided
that this limitation shall not apply to investments in U.S. Government
Securities.
13. Invest more than 10% of the value of the Portfolio's net assets
in securities which may be illiquid because of legal or contractual
restrictions on resale or securities for which there are no readily available
market quotations. For purposes of this limitation, (a) repurchase agreements
with maturities greater than seven days and (b) time deposits maturing in more
than seven calendar days.
14. Purchase or retain securities of any company if, to the
knowledge of the Portfolio, any of the Fund's officers or Directors or any
officer or director of Counsellors individually owns more than 1/2 of 1% of
the outstanding securities of such company and together they own beneficially
more than 5% of the securities.
15. Invest in warrants (other than warrants acquired by the
Portfolio as part of a unit or attached to securities at the time of purchase)
if, as a result, the investments (valued at the lower of cost or market) would
exceed 5% of the value of the Portfolio's net assets of which not more than 2%
of the Portfolio's net assets may be invested in warrants not listed on a
recognized U.S. or foreign stock exchange.
16. Invest in oil, gas or mineral leases.
Each Portfolio may make commitments more restrictive than the
restrictions listed above so as to permit the sale of Portfolio shares in
certain states. Should a Portfolio
<PAGE>25
determine that any such commitment is no longer in the best interest of the
Portfolio and its shareholders, the Portfolio will revoke the commitment by
terminating the sale of Portfolio shares in the state involved. If a
percentage restriction is adhered to at the time of an investment, a later
increase or decrease in the percentage of assets resulting from a change in
the values of portfolio securities or in the amount of the Portfolio's assets
will not constitute a violation of such restriction.
Portfolio Valuation
The Prospectus discusses the time at which the net asset value of
each Portfolio is determined for purposes of sales and redemptions. The
following is a description of the procedures used by the Portfolios in valuing
their assets.
Securities listed on a U.S. securities exchange (including
securities traded through the NASDAQ National Market System) or on a foreign
securities exchange will be valued on the basis of the closing value on the
date on which the valuation is made or, in the absence of sales, at the mean
between the closing bid and asked prices. Other U.S. over-the-counter
securities, foreign over-the-counter securities and securities listed or
traded on certain foreign stock exchanges whose operations are similar to the
U.S. over-the-counter market will be valued on the basis of the bid price at
the close of business on each day, or, if market quotations for those
securities are not readily available, at fair value, as determined in good
faith pursuant to consistently applied procedures established by the Board. A
security which is listed or traded on more than one exchange is valued at the
quotation on the exchange determined to be the primary market for such
security. The valuation of short sales of securities, which are not traded on
a national exchange, will be at the mean of bid and asked prices. In
determining the market value of portfolio investments, each Portfolio may
employ outside organizations (a "Pricing Service") which may use a matrix or
formula method that takes into consideration market indexes, matrices, yield
curves and other specific adjustments. The procedures of Pricing Services are
reviewed periodically by the officers of the Fund under the general
supervision and responsibility of the Board, which may replace any such
Pricing Service at any time. Short-term obligations with maturities of 60
days or less are valued at amortized cost, which constitutes fair value as
determined by the Board. The amortized cost method of valuation may also be
used with respect to debt obligations with 60 days or less remaining to
maturity. All other securities and other assets of the Portfolio will be
valued at their fair value as determined in good faith pursuant to
consistently applied procedures established by the Board. In addition, the
Board or its delegates may value a security at fair value if it determines
that such security's value determined by the methodology set forth above does
not reflect its fair value.
Trading in securities in certain foreign countries is completed at
various times prior to the close of business on each business day in New York
(i.e., a day on which the New York Stock Exchange (the "NYSE") is open for
trading). In addition, securities trading in a particular country or
countries may not take place on all business days in New York. Furthermore,
trading takes place in various foreign markets on days which are not business
days in New York and days on which a Portfolio's net asset value is not
calculated. Because
<PAGE>26
of the need to obtain prices as of the close of trading on various exchanges
throughout the world, calculation of the Portfolio's net asset value may not
take place contemporaneously with the determination of the prices of certain
portfolio securities used in such calculation. All assets and liabilities
initially expressed in foreign currency values will be converted into U.S.
dollar values at the prevailing rate as quoted by a Pricing Service. If such
quotations are not available, the rate of exchange will be determined in good
faith pursuant to consistently applied procedures established by the Board.
Events affecting the values of portfolio securities that occur between the
time their prices are determined and the close of regular trading on the NYSE
will not be reflected in the Fund's calculation of net asset value unless the
Board or its delegates deems that the particular event would materially affect
net asset value, in which case an adjustment may be made.
Portfolio Transactions
Counsellors is responsible for establishing, reviewing and, where
necessary, modifying each Portfolio's investment program to achieve its
investment objective. Purchases and sales of newly issued portfolio
securities are usually principal transactions without brokerage commissions
effected directly with the issuer or with an underwriter acting as principal.
Other purchases and sales may be effected on a securities exchange or
over-the-counter, depending on where it appears that the best price or
execution will be obtained. The purchase price paid by a Portfolio to
underwriters of newly issued securities usually includes a concession paid by
the issuer to the underwriter, and purchases of securities from dealers,
acting as either principals or agents in the after market, are normally
executed at a price between the bid and asked price, which includes a dealer's
mark-up or mark-down. Transactions on U.S. stock exchanges and some foreign
stock exchanges involve the payment of negotiated brokerage commissions. On
exchanges on which commissions are negotiated, the cost of transactions may
vary among different brokers. On most foreign exchanges, commissions are
generally fixed. There is generally no stated commission in the case of
securities traded in domestic or foreign over-the-counter markets, but the
price of securities traded in over-the-counter markets includes an undisclosed
commission or mark-up. U.S. Government Securities are generally purchased
from underwriters or dealers, although certain newly issued U.S. Government
Securities may be purchased directly from the U.S. Treasury or from the
issuing agency or instrumentality.
Counsellors will select specific portfolio investments and effect
transactions for each Portfolio. Counsellors seeks to obtain the best net
price and the most favorable execution of orders. In evaluating prices and
executions, Counsellors will consider the factors it deems relevant, which may
include the breadth of the market in the security, the price of the security,
the financial condition and execution capability of a broker or dealer and the
reasonableness of the commission, if any, for the specific transaction and on
a continuing basis. In addition, to the extent that the execution and price
offered by more than one broker or dealer are comparable, Counsellors may, in
its discretion, effect transactions in portfolio securities with dealers who
provide brokerage and research services (as those terms are defined in Section
28(e) of the Securities Exchange Act of 1934) to the Portfolios and/or other
accounts over which Counsellors exercises investment discretion. Research and
other
<PAGE>27
services received may be useful to Counsellors in serving both the Portfolios
and its other clients and, conversely, research or other services obtained by
the placement of business of other clients may be useful to Counsellors in
carrying out its obligations to the Portfolios. The fee to Counsellors under
its advisory agreement with the Fund is not reduced by reason of its receiving
any brokerage and research services.
Investment decisions for each Portfolio concerning specific
portfolio securities are made independently from those for other clients
advised by Counsellors. Such other investment clients may invest in the same
securities as a Portfolio. When purchases or sales of the same security are
made at substantially the same time on behalf of such other clients,
transactions are averaged as to price and available investments allocated as
to amount, in a manner which Counsellors believes to be equitable to each
client, including the Portfolios. In some instances, this investment
procedure may adversely affect the price paid or received by a Portfolio or
the size of the position obtained or sold for a Portfolio. To the extent
permitted by law, Counsellors may aggregate the securities to be sold or
purchased for a Portfolio with those to be sold or purchased for such other
investment clients in order to obtain best execution.
During the fiscal period or years ended October 31, 1992,
October 31, 1993 and October 31, 1994, the Fund, on behalf of the
International Equity Portfolio, paid an aggregate of approximately $12,602,
$305,110 and $612,312, respectively, in commissions to broker-dealers for
execution of portfolio transactions. The fiscal 1993 and 1994 commission
figures were a result of sharp increases in the volume of share-related
activity as the Portfolio received a large inflow of capital. In no instance
will portfolio securities be purchased from or sold to Counsellors or
Counsellors Securities Inc., the Fund's distributor ("Counsellors
Securities"), or any affiliated person of such companies.
Each Portfolio may participate, if and when practicable, in bidding
for the purchase of securities for the Portfolio's portfolio directly from an
issuer in order to take advantage of the lower purchase price available to
members of such a group. A Portfolio ill engage in this practice, however,
only when Counsellors, in its sole discretion, believes such practice to be
otherwise in the Portfolio's interest.
Portfolio Turnover
The Portfolios do not intend to seek profits through short-term
trading, but the rate of turnover will not be a limiting factor when a
Portfolio deems it desirable to sell or purchase securities. A Portfolio's
portfolio turnover rate is calculated by dividing the lesser of purchases and
sales of its portfolio securities for the year by the monthly average value of
the portfolio securities. Securities with remaining maturities of one year or
less at the date of acquisition are excluded from the calculation. The
decrease in the portfolio turnover rate of the International Equity Portfolio
during the year ended October 31, 1993 was due to the large growth in assets.
<PAGE>28
Certain practices that may be employed by each Portfolio could
result in high portfolio turnover. For example, options on securities may be
sold in anticipation of a decline in the price of the underlying security
(market decline) or purchased in anticipation of a rise in the price of the
underlying security (market rise) and later sold.
MANAGEMENT OF THE FUND
Officers and Board of Directors
The following is a list of the names (and ages) of the Fund's
directors and officers, their addresses, present positions and principal
occupations during the past five years and other affiliations:
Richard N. Cooper* (60) . . . . . Director
Harvard University Professor at Harvard University;
1737 Cambridge Street Director or Trustee of CNA Financial
Cambridge, Massachusetts 02138 Corporation, Circuit City Stores, Inc.
(retail electronics and appliances)
and Phoenix Home Life Insurance Co.
Donald J. Donahue (70) . . . . . Director
99 Indian Field Road Chairman of Magma Copper Company since
Greenwich, Connecticut 06830 January 1987; Director or Trustee of
Northeast Utilities, GEV Corporation and
Signet Star Reinsurance Company; Chairman
and Director of NAC Holdings from September
1990-June 1993.
* Indicates a Director who is an "interested person" of the Fund as defined
in the 1940 Act.
Mr. Cooper has consulting arrangements with Counsellors and an affiliate
of Counsellors. Although these relationships do not appear to require
designation of Mr. Cooper as an interested person, the Fund is currently
making such a designation in order to avoid the possibility that Mr.
Cooper's independence would be questioned.
<PAGE>29
Jack W. Fritz (67) . . . . . . . Director
2425 North Fish Creek Road Private investor; Consultant and
P.O. Box 483 Director of Fritz Broadcasting, Inc. and
Wilson, Wyoming 83014 Fritz Communications (developers and
operators of radio stations); Director of
Advo, Inc. (direct mail advertising).
John L. Furth* (64) . . . . . Director and President
466 Lexington Avenue Vice Chairman and Director of EMW;Associated
New York, New York 10017-3147 with EMW since 1970; Chief Executive
Officer of 11 other investment companies
advised by Counsellors.
Thomas A. Melfe (63) . . . . . . Director
30 Rockefeller Plaza Partner in the law firm of Donovan Leisure
New York, New York 10112 Newton & Irvine; Director of Municipal
Fund for New York Investors, Inc.
Alexander B. Trowbridge (65) . . Director
1155 Connecticut Avenue, N.W. President of Trowbridge Partners, Inc.
Suite 700 (business consulting) from January 1990-
Washington, DC 20036 January 1994; President of the National
Association of Manufacturers from
1980-1990; Director or Trustee of New
England Mutual Life Insurance Co., ICOS
Corporation (biopharmaceuticals), P.H.H.
Corporation (fleet auto management; housing
and plant relocation service), WMX
Technologies Inc. (solid and hazardous
waste collection and disposal), The Rouse
Company (real estate development), Sun
Resorts International Ltd. (hotel and real
estate management), Harris Corp.
(electronics and communications equipment),
The Gillette Co. (personal care products)
and Sun Company Inc. (petroleum refining
and marketing).
* Indicates a Director who is an "interested person" of the Fund as defined
in the 1940 Act.
<PAGE>30
Dale C. Christensen (47) . . . . Vice President of the Fund and Portfolio
466 Lexington Avenue Manager of Global Fixed Income Portfolio
New York, New York 10017-3147 Portfolio Manager or Co-Portfolio Manager
of other Warburg Pincus Funds; Managing
Director of EMW; Associated with EMW since
1989; Vice President at Citibank, N.A. from
1985-1989; Vice President of Counsellors
Securities; President of 6 other investment
companies advised by Counsellors.
Richard H. King (50) . . . . . . Vice President of the Fund and Portfolio
466 Lexington Avenue Manager of International Equity Portfolio
New York, New York 10017-3147 Portfolio Manager or Co-Portfolio Manager
of other Warburg Pincus Funds; Managing
Director of EMW since 1989; Associated with
EMW since 1989; President of 3 other
investment companies advised by
Counsellors.
Arnold M. Reichman (46) . . . . . Executive Vice President
466 Lexington Avenue Managing Director and Assistant Secretary
New York, New York 10017-3147 of EMW; Associated with EMW since 1984;
Senior Vice President, Secretary and Chief
Operating Officer of Counsellors
Securities; Executive Vice President or
Vice President and Secretary of 13 other
investment companies advised by
Counsellors.
Eugene L. Podsiadlo (38) . . . . Senior Vice President
466 Lexington Avenue Managing Director of EMW; Associated
New York, New York 10017-3147 with EMW since 1991; Vice President of
Citibank, N.A. from 1987-1991; Senior Vice
President of Counsellors Securities and 13
other investment companies advised by
Counsellors.
Eugene P. Grace (43) . . . . . . Vice President and Secretary
466 Lexington Avenue Associated with EMW since April 1994;
New York, New York 10017-3147 Attorney-at-law from September 1989-April
1994; life insurance agent, New York Life
Insurance Company from 1993-1994; General
Counsel and Secretary, Home Unity Savings
Bank from 1991-1992; Vice President and
Chief Compliance Officer of Counsellors
Securities; Vice President and Secretary of
13 other investment companies advised by
Counsellors.
<PAGE>31
Stephen Distler (40) . . . . . . Vice President and Chief Financial
466 Lexington Avenue Officer
New York, New York 10017-3147 Managing Director, Controller and Assistant
Secretary of EMW; Associated with EMW since
1984; Treasurer of Counsellors Securities;
Vice President, Treasurer and Chief
Accounting Officer or Treasurer and Chief
Financial Officer of 13 other investment
companies advised by Counsellors.
Howard Conroy (41) . . . . . . . .Vice President, Treasurer and Chief
466 Lexington Avenue Accounting Officer
New York, New York 10017-3147 Associated with EMW since 1992; Associated
with Martin Geller, C.P.A. from 1991-1992;
Vice President, Finance with Gabelli/
Rosenthal & Partners, L.P. from 1990-1992;
Vice President, Treasurer and Chief
Accounting Officer of 13 other investment
companies advised by Counsellors.
Karen Amato (31) . . . . . . . . Assistant Secretary
466 Lexington Avenue Associated with EMW since 1987;
New York, New York 10017-3147 Assistant Secretary of 13 other investment
companies advised by Counsellors.
No employee of Counsellors or PFPC Inc., the Fund's co-administrator
("PFPC") or any of their affiliates receives any compensation from the Fund
for acting as an officer or director of the Fund. Each Director who is not a
director, trustee, officer or employee of Counsellors, PFPC or any of their
affiliates receives an annual fee of $500, and $250 for each meeting of the
Board attended by him for his services as Director and is reimbursed for
expenses incurred in connection with his attendance at Board meetings.
<PAGE>32
Directors' Compensation
(for the fiscal year ended October 31, 1994)
<TABLE>
<CAPTION>
Total Total Compensation from
Compensation from all Investment Companies
Name of Director Fund Managed by Counsellors*
---------------- ----------------- ------------------------
<S> <C> <C>
John L. Furth None** None**
Richard N. Cooper $1,500 $36,500
Donald J. Donahue $1,500 $36,500
Jack W. Fritz $1,500 $36,500
Thomas A. Melfe $1,500 $36,500
Alexander B. Trowbridge $1,500 $36,500
</TABLE>
________________________
* Each Director also serves as a Director or Trustee of 13 other investment
companies advised by Counsellors.
** Mr. Furth is considered to be an interested person of the Fund and
Counsellors, as defined under Section 2(a)(19) of the 1940 Act,
and, accordingly, receives no compensation from the Fund or any other
investment company managed by Counsellors.
Richard H. King, vice president of the Fund and portfolio manager of
the International Equity Portfolio, earned a B.A. degree from Durham
University in England. Mr. King has been a portfolio manager of the Fund
since its inception on May 2, 1989 and is also portfolio manager of Warburg,
Pincus International Equity Fund and a co-portfolio manager of Warburg, Pincus
Japan OTC Fund and Warburg, Pincus Emerging Markets Fund. From 1968 to 1982,
he worked at W.I. Carr Sons & Company (Overseas), a leading international
brokerage firm. He resided in the Far East as an Investment Analyst from 1970
to 1977, became Director, and later relocated to the U.S. where he became
founder and President of W.I. Carr (America), based in New York. From 1982 to
1984 he was a director in charge of the Far East equity investments at N.M.
Rothschild International Asset Management, a London merchant bank. In 1984
Mr. King became Chief Investment Officer and Director for all international
investment strategy with Fiduciary Trust Company International S.A., in
London. He managed an EAFE mutual fund (FTIT) 1985-1986 which grew from $3
million to over $100 million during this two-year period.
Nicholas P.W. Horsley, associate portfolio manager and research
analyst of the International Equity Portfolio, has been with the International
Equity Portfolio since joining Counsellors in 1993 and is also a co-portfolio
manager of Warburg, Pincus Japan
<PAGE>33
OTC Fund and Warburg, Pincus Emerging Markets Fund and an associate portfolio
manager and research analyst of Warburg, Pincus International Equity Fund.
From 1981 to 1984 he was a Securities Analyst at Barclays Merchant Bank in
London, UK and Johannesburg, RSA. From 1984 to 1986 he was a Senior Analyst
with BZW Investment Management in London. From 1986 to 1993 he was a
Director, portfolio manager and analyst at Barclays deZoete Wedd in New York
City. Mr. Horsley earned B.A. and M.A. degrees with honors from University
College, Oxford.
Harold W. Ehrlich, associate portfolio manager and research analyst
of the International Equity Portfolio, is also an associate portfolio manager
and research analyst of Warburg, Pincus International Equity Fund and Warburg,
Pincus Emerging Markets Fund. Prior to joining Counsellors, Mr. Ehrlich was a
senior vice president, portfolio manager and analyst at Templeton Investment
Counsel Inc. from 1987 to 1995. He was a research analyst and assistant
portfolio manager at Fundamental Management Corporation from 1985 to 1986 and
a research analyst at First Equity Corporation of Florida from 1983 to 1985.
Mr. Ehrlich earned a B.S.B.A. degree from University of Florida and earned his
Chartered Financial Analyst designation in 1990.
Vincent McBride, associate portfolio manager and research analyst of
the International Equity Portfolio, is also an associate portfolio manager and
research analyst of Warburg, Pincus International Equity Fund and Warburg,
Pincus Emerging Markets Fund. Prior to joining Counsellors in 1994, Mr.
McBride was an international equity analyst at Smith Barney Inc. from 1993 to
1994 and at General Electric Investment Corp. from 1992 to 1993. He was also
a portfolio manager/analyst at United Jersey Bank from 1989 to 1992 and a
portfolio manager at First Fidelity Bank from 1987 to 1989. Mr. McBride
earned a B.S. degree from the University of Delaware and an M.B.A. from
Rutgers University.
Dale C. Christensen, vice president of the Fund and portfolio
manager of the Global Fixed Income Portfolio, earned a B.S. in Agriculture
from the University of Alberta and a B.Ed. in Mathematics from the University
of Calgary, both located in Canada. Mr. Christensen directs the Fixed Income
Group at Counsellors, which he joined in 1989, providing portfolio management
for Warburg Pincus Funds and institutional clients around the world. Mr.
Christensen was a Vice President in the International Private Banking division
and the domestic pension fund management division at Citicorp, N.A. from 1985
to 1989. Prior to that, Mr. Christensen was a Fixed Income Portfolio Manager
at CIC Asset Management from 1982 to 1984.
As of January 31, 1995, Directors and officers of the Fund as a
group owned of record 213,234 of the outstanding shares of the International
Equity Portfolio. As of the same date Messrs. Pincus and Furth may be deemed
to have beneficially owned 99.70% and 98.67%, respectively, of the
International Equity Portfolio's shares outstanding, including shares owned by
clients for which Counsellors has investment discretion and, in the case of
Mr. Pincus, including shares owned by companies that EMW may be deemed to
control. Messrs. Pincus and Furth disclaim ownership of these shares and do
not intend to exercise voting rights with respect to these shares.
<PAGE>34
Investment Adviser and Co-Administrators
Counsellors serves as investment adviser to each Portfolio,
Counsellors Funds Service, Inc. ("Counsellors Service") serves as co-
administrator to the Fund, and PFPC serves as a co-administrator to the Fund
pursuant to separate written agreements (the "Advisory Agreement," the
"Counsellors Service Co-Administration Agreement" and the "PFPC Co-
Administration Agreement," respectively). The services provided by, and the
fees payable by each Portfolio to, Counsellors under the Advisory Agreement,
Counsellors Service under the Counsellors Service Co-Administration Agreement
and PFPC under the PFPC Co-Administration Agreement are described in the
Prospectus. Prior to March 1, 1994, PFPC served as administrator to the Fund
and Counsellors Service served as administrative services agent to the Fund
pursuant to separate written agreements.
Counsellors agrees that if, in any fiscal year, the expenses borne
with respect to each Portfolio exceed the applicable expense limitations
imposed by the securities regulations of any state in which shares of the
Portfolio are registered or qualified for sale to the public, it will
reimburse the Fund to the extent required by such regulations. Unless
otherwise required by law, such reimbursement would be accrued and paid on a
monthly basis. At the date of this Statement of Additional Information, the
most restrictive annual expense limitation applicable to the Fund is 2.5% of
the first $30 million of the average net assets of each Portfolio, 2% of the
next $70 million of the average net assets of each Portfolio and 1.5% of the
remaining average net assets of each Portfolio.
The advisory fee payable by each Portfolio is calculated at an
annual rate based on a percentage of the Portfolio's average daily net assets.
See the Prospectus, "Management of the Fund." During the two-month period
beginning September 1, 1992 (commencement of operations) through October 31,
1992, Counsellors voluntarily waived $21,393 of the $23,021 in investment
advisory fees earned. For the years ending October 31, 1993 and October 31,
1994, Counsellors earned $406,466 and $1,736,864, respectively, and waived
$195,081 and $542,549, respectively, in investment advisory fees. PFPC
received $3,453, $60,970 and $259,290, respectively, in fees and voluntarily
waived $3,028, $29,253 and $81,358 of such fees for the fiscal period or years
ending October 31, 1992, October 31, 1993 and October 31, 1994. Counsellors
Service earned $1,775, $24,631 and $188,503 during the fiscal period or years
ending October 31, 1992, October 31, 1993 and October 31, 1994, respectively.
Since the Global Fixed Income Portfolio had not commenced investment
operations as of October 31, 1994, no fees were paid to Counsellors, PFPC or
Counsellors Service with respect to it.
Organization of the Fund
The Fund was incorporated on May 13, 1992 under the laws of the
State of Maryland. The Fund's charter authorizes the Board of Directors to
issue three billion full and fractional shares of separate series of common
stock, $.001 par value per share. Shares of two series have been authorized,
which constitute the interests in the Portfolios. When matters are submitted
for shareholder vote, shareholders of each Portfolio will have one vote
<PAGE>35
for each share owned and proportionate, fractional votes for fractional shares
held. Shareholders generally vote in the aggregate, except with respect to
(a) matters affecting only the shares of a particular Portfolio, in which case
only the shares of the affected Portfolio would be entitled to vote, or (b)
when the 1940 Act requires that shares of the Portfolios be voted separately.
There will normally be no meeting of shareholders for the purpose of electing
Directors unless and until such time as less than a majority of the Directors
holding office have been elected by shareholders. The Directors will call a
meeting for any purpose upon the written request of shareholders holding at
least 10% of the Fund's outstanding shares.
All shareholders of a Portfolio, upon liquidation, participate
ratably in the Portfolio's net assets. Shares do not have cumulative voting
rights, which means that holders of more than 50% of the shares voting for the
election of Directors can elect all Directors. Shares are transferable but
have no preemptive, conversion or subscription rights.
Custodians and Transfer Agent
Fiduciary Trust Company International ("Fiduciary") is custodian of
each Portfolio's assets pursuant to a custodian agreement (the "Custodian
Agreement"). Under the Custodian Agreement, Fiduciary (a) maintains a
separate account or accounts in the name of each Portfolio, (b) holds and
transfers portfolio securities on account of each Portfolio, (c) makes
receipts and disbursements of money on behalf of each Portfolio, (d) collects
and receives all income and other payments and distributions on account of
each Portfolio's portfolio securities and (e) makes periodic reports to the
Fund's Board of Directors concerning the Fund's operations. Fiduciary is
authorized to select one or more foreign or domestic banks or trust companies
to serve as sub-custodian on behalf of the Fund, provided that Fiduciary
remains responsible for the performance of all its duties under the Custodian
Agreement and holds the Fund harmless from the acts and omissions of any
sub-custodian, in accordance with the Custodian Agreement. The principal
business address of Fiduciary is Two World Trade Center, New York, New York
10048.
PNC Bank, National Association ("PNC") also provides certain
custodial services generally in connection with purchases and sales of each
Portfolios' shares. PNC is an indirect wholly owned subsidiary of PNC Bank
Corp., and its principal business address is Broad and Chestnut Streets,
Philadelphia, Pennsylvania 19101.
State Street Bank and Trust Company ("State Street") has agreed to
serve as the shareholder servicing, transfer and dividend disbursing agent
pursuant to a Transfer Agency and Service Agreement, under which State Street
(a) issues and redeems shares of each Portfolio, (b) addresses and mails all
communications by the Fund to record owners of each Portfolios' shares,
including reports to shareholders, dividend and distribution notices and proxy
material for its meetings of shareholders, (c) maintains shareholder accounts
and, if requested, sub-accounts and (d) makes periodic reports to the Fund's
Board of Directors concerning the transfer agent's operations with respect to
the Fund. The principal business address of State Street is 225 Franklin
Street, Boston, Massachusetts 02110.
<PAGE>36
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The offering price of each Portfolio's shares is equal to its per
share net asset value. Additional information on how to purchase and redeem a
Portfolio's shares and how such shares are priced is included in the
Prospectus under "Net Asset Value."
Under the 1940 Act, a Portfolio may suspend the right of redemption
or postpone the date of payment upon redemption for any period during which
the NYSE is closed, other than customary weekend and holiday closings, or
during which trading on the NYSE is restricted, or during which (as determined
by the SEC) an emergency exists as a result of which disposal or fair
valuation of portfolio securities is not reasonably practicable, or for such
other periods as the SEC may permit. (A Portfolio may also suspend or
postpone the recordation of an exchange of its shares upon the occurrence of
any of the foregoing conditions.)
If the Fund's Board of Directors determines that conditions exist
which make payment of redemption proceeds wholly in cash unwise or
undesirable, a Portfolio may make payment wholly or partly in securities or
other property. If a redemption is paid wholly or partly in securities, a
shareholder would incur transaction costs in disposing of the redemption
proceeds. The Fund intends to comply with Rule 18f-1 promulgated under the
1940 Act with respect to redemptions in kind.
EXCHANGE PRIVILEGE
Shareholders of a Portfolio may exchange all or part of their shares
for shares of the other Portfolio or other portfolios of the Fund organized by
Counsellors in the future on the basis of their relative net asset values per
share at the time of exchange.
The exchange privilege enables shareholders to acquire shares in a
portfolio with a different investment objective when they believe that a shift
between portfolios is an appropriate investment decision. This privilege is
available to shareholders residing in any state in which the portfolios'
shares being acquired may legally be sold.
Upon receipt of proper instructions and all necessary supporting
documents, shares submitted for exchange are redeemed at the then-current net
asset value of the portfolio and the proceeds are invested on the same day at
a price as described above, in shares of the portfolio being acquired.
Counsellors reserves the right to reject more than three exchange requests by
a shareholder in any 30-day period. The exchange privilege may be modified or
terminated at any time.
<PAGE>37
ADDITIONAL INFORMATION CONCERNING TAXES
The discussion set out below of tax considerations generally
affecting the Fund and its shareholders is intended to be only a summary and
is not intended as a substitute for careful tax planning by prospective
shareholders. Shareholders are advised to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in a
Portfolio.
Each Portfolio of the Fund has qualified and intends to continue to
qualify separately as a "regulated investment company" under Subchapter M of
the Code. If it qualifies as a regulated investment company, a Portfolio will
pay no federal income taxes on its taxable net investment income (that is,
taxable income other than net realized capital gains) and its net realized
capital gains that are distributed to shareholders. To qualify under
Subchapter M, a Portfolio must, among other things: (1) distribute to its
shareholders at least 90% of its taxable net investment income (for this
purpose consisting of taxable net investment income and net realized
short-term capital gains); (2) derive at least 90% of its gross income from
dividends, interest, payments with respect to loans of securities, gains from
the sale or other disposition of securities, or other income (including, but
not limited to, gains from options, futures, and forward contracts) derived
with respect to its business of investing in securities; (3) derive less than
30% of its annual gross income from the sale or other disposition of
securities, options, futures or forward contracts held for less than three
months; and (4) diversify its holdings so that, at the end of each fiscal
quarter of the Portfolio (a) at least 50% of the market value of the
Portfolio's assets is represented by cash, U.S. government securities and
other securities, with those other securities limited, with respect to any one
issuer, to an amount no greater in value than 5% of the Portfolio's total
assets and to not more than 10% of the outstanding voting securities of the
issuer, and (b) not more than 25% of the market value of the Portfolio's
assets is invested in the securities of any one issuer (other than U.S.
government securities or securities of other regulated investment companies)
or of two or more issuers that the Portfolio controls and that are determined
to be in the same or similar trades or businesses or related trades or
businesses. In meeting these requirements, a Portfolio may be restricted in
the selling of securities held by the Portfolio for less than three months and
in the utilization of certain of the investment techniques described above and
in the Portfolio's prospectus. As a regulated investment company, a Portfolio
will be subject to a 4% non-deductible excise tax measured with respect to
certain undistributed amounts of ordinary income and capital gain required to
be but not distributed under a prescribed formula. The formula requires
payment to shareholders during a calendar year of distributions representing
at least 98% of the Portfolio's taxable ordinary income for the calendar year
and at least 98% of the excess of its capital gains over capital losses
realized during the one-year period ending October 31 during such year,
together with any undistributed, untaxed amounts of ordinary income and
capital gains from the previous calendar year. The Portfolios expect to pay
the dividends and make the distributions necessary to avoid the application of
this excise tax.
A Portfolio's transactions, if any, in foreign currencies, forward
contracts, options and futures contracts (including options and forward
contracts on foreign currencies)
<PAGE>38
will be subject to special provisions of the Code that, among other things,
may affect the character of gains and losses recognized by the Portfolio
(i.e., may affect whether gains or losses are ordinary or capital), accelerate
recognition of income to the Portfolio, defer Portfolio losses and cause the
Portfolio to be subject to hyperinflationary currency rules. These rules
could therefore affect the character, amount and timing of distributions to
shareholders. These provisions also (1) will require a Portfolio to
mark-to-market certain types of its positions (i.e., treat them as if they
were closed out) and (2) may cause the Portfolio to recognize income without
receiving cash with which to pay dividends or make distributions in amounts
necessary to satisfy the distribution requirements for avoiding income and
excise taxes. The Portfolio will monitor its transactions, will make the
appropriate tax elections and will make the appropriate entries in its books
and records when it acquires any foreign currency, forward contract, option,
futures contract or hedged investment so that (a) neither the Portfolio nor
its shareholders will be treated as receiving a materially greater amount of
capital gains or distributions than actually realized or received, (b) the
Portfolio will be able to use substantially all of its losses for the fiscal
years in which the losses actually occur and (c) the Portfolio will continue
to qualify as a regulated investment company.
A shareholder of a Portfolio receiving dividends or distributions in
additional shares should be treated for federal income tax purposes as
receiving a distribution in an amount equal to the amount of money that a
shareholder receiving cash dividends or distributions receives, and should
have a cost basis in the shares received equal to that amount. Investors
considering buying shares just prior to a dividend or capital gain
distribution should be aware that, although the price of shares purchased at
that time may reflect the amount of the forthcoming distribution, those who
purchase just prior to a distribution will receive a distribution that will
nevertheless be taxable to them.
Any loss realized on a sale or exchange of a shareholder's shares
will be disallowed to the extent the shares disposed of are replaced,
including replacement through the reinvestment of dividends and capital gains
distributions in a Portfolio, within a period of 61 days beginning 30 days
before and ending 30 days after the disposition of the shares. In such a
case, the basis of the shares acquired will be increased to reflect the
disallowed loss.
Each shareholder will receive an annual statement as to the federal
income tax status of his dividends and distributions from the relevant
Portfolio for the prior calendar year. Furthermore, shareholders will also
receive, if appropriate, various written notices after the close of the
Portfolio's taxable year regarding the federal income tax status of certain
dividends and distributions that were paid (or that are treated as having been
paid) by the Portfolio to its shareholders during the preceding year.
If a shareholder fails to furnish a correct taxpayer identification
number, fails to report fully dividend or interest income, or fails to certify
that he has provided a correct taxpayer identification number and that he is
not subject to "backup withholding," the shareholder may be subject to a 31%
"backup withholding" tax with respect to (1) taxable dividends and
distributions and (2) the proceeds of any sales or repurchases of shares of
the
<PAGE>39
Portfolio. An individual's taxpayer identification number is his social
security number. Corporate shareholders and other shareholders specified in
the Code are or may be exempt from backup withholding. The backup withholding
tax is not an additional tax and may be credited against a taxpayer's federal
income tax liability. Dividends and distributions also may be subject to
state and local taxes depending on each shareholder's particular situation.
Investment in Passive Foreign Investment Companies
If a Portfolio purchases shares in certain foreign entities
classified under the Code as "passive foreign investment companies" ("PFICs"),
the Portfolio may be subject to federal income tax on a portion of an "excess
distribution" or gain from the disposition of the shares, even though the
income may have to be distributed as a taxable dividend by the Portfolio to
its shareholders. In addition, gain on the disposition of shares in a PFIC
generally is treated as ordinary income even though the shares are capital
assets in the hands of the Portfolio. Certain interest charges may be imposed
on either the Portfolio or its shareholders with respect to any taxes arising
from excess distributions or gains on the disposition of shares in a PFIC.
A Portfolio may be eligible to elect to include in its gross income
its share of earnings of a PFIC on a current basis. Generally, the election
would eliminate the interest charge and the ordinary income treatment on the
disposition of stock, but such an election may have the effect of accelerating
the recognition of income and gains by the Portfolio compared to a fund that
did not make the election. In addition, information required to make such an
election may not be available to the Portfolio.
On April 1, 1992 proposed regulations of the Internal Revenue
Service (the "IRS") were published providing a mark-to-market election for
regulated investment companies. The IRS subsequently issued a notice
indicating that final regulations will provide that regulated investment
companies may elect the mark-to-market election for tax years ending after
March 31, 1992 and before April 1, 1993. Whether and to what extent the
notice will apply to taxable years of a Portfolio is unclear. If the
Portfolio is not able to make the foregoing election, it may be able to avoid
the interest charge (but not the ordinary income treatment) on disposition of
the stock by electing, under proposed regulations, each year to mark-to-market
the stock (that is, treat it as if it were sold for fair market value). Such
an election could also result in acceleration of income to the Portfolio.
DETERMINATION OF PERFORMANCE
From time to time, a Portfolio may quote its total return and, in
the case of the Global Fixed Income Portfolio, yield in advertisements or in
reports and other communications to shareholders. The average total return of
the International Equity Portfolio for the fiscal year ended October 31, 1994
was 22.70% (21.56% without waivers).
<PAGE>40
The average annual total return of the International Equity Portfolio for the
period beginning September 1, 1992 (inception) to October 31, 1994 was 26.75%
(26.02% without waivers). A Portfolio's average annualized total return is
calculated by finding the average annual compounded rates of return for the
one-, five- and ten-(or such shorter period as the Portfolio has been in
existence) year periods that would equate the initial amount invested to the
ending redeemable value according to the following formula: P (1 + T)[*OMITTED
GRAPHIC-SEE FOOTNOTE] = ERV. For purposes of this formula, "P" is a
hypothetical investment of $1,000; "T" is average annual total return; "n"
is number of years; and "ERV" is the ending redeemable value of a
hypothetical $1,000 payment made at the beginning of the one-, five- or
ten-year periods (or fractional portion thereof). Total
return or "T" is computed by finding the average annual change in the value of
an initial $1,000 investment over the period and assumes that all dividends
and distributions are reinvested during the period.
A Portfolio may advertise, from time to time, comparisons of its
performance with that of one or more other mutual funds with similar
investment objectives. A Portfolio may advertise its average annual
calendar-year-to-date and calendar quarter returns, which are calculated
according to the formula set forth in the preceding paragraph except that the
relevant measuring period would be the number of months that have elapsed in
the current calendar year or most recent three months, as the case may be.
The actual total return of the International Equity Portfolio for the calendar
year and for the three-month period ended December 31, 1994 was .86% and -
7.20%, respectively (.63% and -7.28%, respectively, without waivers).
Investors should note that this performance may not be representative of the
Portfolio's total return in longer market cycles.
Yield is calculated by annualizing the net investment income
generated by the Portfolio over a specified thirty-day period according to the
following formula:
YIELD = 2[( a-b +1)[**OMITTED GRAPHIC-SEE FOOTNOTE] -1]
cd
For purposes of this formula: "a" is dividends and interest earned during the
period; "b" is expenses accrued for the period (net of reimbursements); "c" is
the average daily number of shares outstanding during the period that were
entitled to receive dividends; and "d" is the maximum offering price per share
on the last day of the period.
A Portfolio's performance will vary from time to time depending upon
market conditions, the composition of the Portfolio's portfolio and operating
expenses allocable to it. As described above, total return and yield are
based on historical earnings and is not intended to indicate future
performance. Consequently, any given performance quotation should not be
considered as representative of the Portfolio's performance for any specified
period in the future. Performance information may be useful as a basis for
comparison with other investment alternatives. However, a Portfolio's
performance will fluctuate, unlike certain bank deposits or other investments
which pay a fixed yield for a stated period of time.
- -----------------------
* - The expression (1+T) is being raised to the nth power.
** - The expression (a-b+1) is being raised to the sixth power.
cd
<PAGE>41
AUDITORS AND COUNSEL
Coopers & Lybrand L.L.P. ("Coopers & Lybrand"), independent
auditors, with principal offices at 2400 Eleven Penn Center, Philadelphia,
Pennsylvania 19103, serves as independent auditors for the Fund. The
financial statements for the Portfolios that appear in this Statement of
Additional Information have been audited by Coopers & Lybrand, whose reports
thereon appears elsewhere herein, and have been included herein in reliance
upon the report of such firm of independent auditors given upon their
authority as experts in accounting and auditing.
The financial statements for the periods beginning with commencement
of the Fund through October 31, 1992 have been audited by Ernst & Young LLP
("Ernst & Young"), independent auditors, as set forth in their report, and
have been included in reliance on such report and upon the authority of such
firm as experts in accounting and auditing. Ernst & Young's address is 787
7th Avenue, New York, New York 10019.
Willkie Farr & Gallagher serves as counsel for the Fund as well as
counsel to Counsellors, Counsellors Service and Counsellors Securities.
MISCELLANEOUS
As of January 31, 1995, the name, address and percentage of
ownership of each person (other than Messrs. Pincus and Furth, see "Management
of the Fund") that owned of record 5% or more of the outstanding shares of the
International Equity Portfolio were as follows: University of Iowa Foundation
IIEF Account, c/o Mr. Larry Bruse, Treasurer, 500 Alumni Center, P.O. Box
4550, Iowa City, IA 52244-4550 -- 7.34% and North Carolina Trust Company, NC
Trust Co., Attn: Trust Accounting, P.O. Box 1108, 301 North Elm Street,
Greensboro, NC 27401-2111 -- 5.04%.
FINANCIAL STATEMENTS
The Fund's financial statements for the fiscal year ended October
31, 1994, in the case of the International Equity Portfolio, and the financial
statement as of February 14, 1995 in the case of the Global Fixed Income
Portfolio follow the Reports of Independent Auditors.
<PAGE>42
APPENDIX
DESCRIPTION OF RATINGS
Commercial Paper Ratings
Commercial paper rated A-1 by Standard and Poor's Ratings Group
("S&P") indicates that the degree of safety regarding timely payment is
strong. Those issues determined to possess extremely strong safety
characteristics are denoted a plus sign designation. Capacity for timely
payment on commercial paper rated A-2 is satisfactory, but the relative degree
of safety is not as high as for issues designated A-1.
The rating Prime-1 is the highest commercial paper rating assigned
by Moody's Investors Services, Inc. ("Moody's"). Issuers rated Prime-1 (or
related supporting institutions) are considered to have a superior capacity
for repayment of short-term promissory obligations. Issuers rated Prime-2 (or
related supporting institutions) are considered to have a strong capacity for
repayment of short-term promissory obligations. This will normally be
evidenced by many of the characteristics of issuers rated Prime-1 but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternative
liquidity is maintained.
Corporate Bond Ratings
The following summarizes the ratings used by S&P for corporate
bonds:
AAA - This is the highest rating assigned by S&P to a debt
obligation and indicates an extremely strong capacity to pay interest and
repay principal.
AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from AAA issues only in small degree.
A - Debt rated A has a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB - This is the lowest investment grade. Debt rated BBB has an
adequate capacity to pay interest and repay principal. Although they normally
exhibit adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for bonds in this category than for bonds in
higher rated categories.
BB - Bonds rated BB have less near-term vulnerability to default
than other speculative issues. However, they face major ongoing uncertainties
or exposure to adverse business, financial, or economic conditions, which
could lead to inadequate capacity to meet
<PAGE>43
timely interest and principal payments. The BB rating category is also used
for debt subordinated to senior debt that is assigned an actual or implied BBB
rating.
B - Bonds rated B have a greater vulnerability to default but
currently have the capacity to meet interest payments and principal
repayments. Adverse business, financial, or economic conditions will likely
impair capacity or willingness to pay interest and repay principal. The B
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BB or BBB rating.
To provide more detailed indications of credit quality, the ratings
from "AA" to "B" may be modified by the addition of a plus or minus sign to
show relative standing within this major rating category.
The following summarizes the ratings used by Moody's for corporate
bonds:
Aaa - Bonds that are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or
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 that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium-grade obligations.
Factors giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment sometime
in the future.
Baa - Bonds which are rated Baa are considered as medium-grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba - Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
<PAGE>44
B - Bonds which are rated B generally lack characteristics of the
desirable investments. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers (1, 2 and 3) with respect to the
bonds rated "Aa" through "B". The modifier 1 indicates that the bond being
rated ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the bond
ranks in the lower end of its generic rating category.
