<PAGE>
PROSPECTUS
THE LEGENDS FUND, INC./TM/
200 EAST WILSON BRIDGE ROAD
WORTHINGTON, OHIO 43085
TELEPHONE: 1-800-325-8583
The Legends Fund, Inc. (Fund) is an open-end management investment company with
multiple portfolios available for investment. Shares of the Portfolios are
currently sold only to separate accounts of Integrity Life Insurance Company and
National Integrity Life Insurance Company as an investment medium for variable
annuity certificates and contracts they issue. The Fund's current portfolios
and their investment objectives are:
- MORGAN STANLEY ASIAN GROWTH PORTFOLIO seeks long-term capital appreciation.
It invests primarily in the common stocks of Asian issuers, excluding
Japan.
- MORGAN STANLEY WORLDWIDE HIGH INCOME PORTFOLIO seeks high current income
consistent with relative stability of principal and, secondarily, capital
appreciation. It invests primarily in a portfolio of high yielding fixed
income securities of issuers located throughout the world.
- RENAISSANCE BALANCED PORTFOLIO seeks capital appreciation and income in
rising markets and capital preservation in declining markets. Its assets
are allocated among common stocks, United States Government and high
quality corporate debt issues and high quality cash equivalent issues.
- ZWEIG ASSET ALLOCATION PORTFOLIO seeks long-term capital appreciation. It
invests primarily in stocks which are comparable to Blue Chip Stocks (as
defined in "Investment Objectives and Policies").
- NICHOLAS-APPLEGATE BALANCED PORTFOLIO seeks maximum total return in both
the equity and fixed income portion of its investments. It generally
allocates 60%-65% of assets to equity securities and 35%-40% of assets to
U.S. Government securities and cash equivalent issues.
- HARRIS BRETALL SULLIVAN & SMITH EQUITY GROWTH PORTFOLIO seeks long-term
capital appreciation. It invests primarily in stocks of established
companies with proven records of superior and consistent growth.
- DREMAN VALUE PORTFOLIO seeks primarily long-term capital appreciation with
a secondary objective of current income. It invests primarily in equity
securities considered by the Sub-Adviser to be undervalued.
- ZWEIG EQUITY (SMALL CAP) PORTFOLIO seeks long-term capital appreciation. It
invests primarily in Small Company Stocks (as defined in "Investment
Objectives and Policies").
- PINNACLE FIXED INCOME PORTFOLIO seeks as high a level of current income as
is consistent with the preservation of capital. It invests primarily in
corporate debt securities, U.S. Government securities (including mortgage-
backed securities issued by GNMA, FNMA and FHLMC) and asset-backed
securities. The Pinnacle Fixed Income Portfolio is advised by J.P. Morgan
Investment Management Inc.
- ARM CAPITAL ADVISORS MONEY MARKET PORTFOLIO seeks maximum current income
consistent with liquidity and conservation of capital. It invests in high
grade money market instruments with remaining maturities of 13 months or
less, and repurchase agreements secured by such instruments. While the
Portfolio seeks to maintain a stable net asset value of $1.00 per share,
there is no assurance that it will be able to do so. An investment in the
Portfolio is neither insured nor guaranteed by the U.S. Government.
Morgan Stanley Worldwide High Income Portfolio invests predominantly in lower
rated and unrated bonds, commonly referred to as "junk bonds." Bonds of this
type are considered to be speculative with regard to the payment of interest and
return of principal and are subject to greater risk of loss of principal and
interest. Purchasers should carefully assess the risks associated with an
investment in this Portfolio. See "Description of Various Securities and
Investment Techniques -- Debt Securities."
This Prospectus sets forth information about the Fund that a prospective
investor should know before investing. Please read this Prospectus and retain
it for future reference. A Statement of Additional Information (SAI) dated May
1, 1996 (which is incorporated by reference herein) has been filed with the
Securities and Exchange Commission and is available upon request and without
charge. You can obtain a copy by calling or writing to the Fund at the
telephone number and address shown above.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
Prospectus dated May 1, 1996
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights presented for the two years ended June 30, 1995 and
1994 (the period from June 15, 1994, commencement of operations, to June 30,
1994 for the Morgan Stanley Asian Growth and Morgan Stanley Worldwide High
Income Portfolios) have been audited by Ernst & Young LLP, independent auditors
for the Fund, and the financial statements of the Fund, along with the report of
Ernst & Young LLP thereon, are set forth in the SAI. The financial highlights
presented for the fiscal period from commencement of operations through June
30, 1993 have been audited by other independent auditors. Per share information
is for a share of capital stock outstanding throughout the respective fiscal
period. The information presented below for the six months ended December 31,
1995 is unaudited, and the unaudited financial statements for such period are
set forth in the SAI. Further performance information is contained in the Fund's
annual report which may be obtained without charge by calling or writing to the
Fund at the address listed on the first page of this prospectus.
The financial highlights information pertains to the Portfolios of the Fund and
does not reflect charges related to Integrity Life Insurance Company Separate
Account II or National Integrity Life Insurance Company Separate Account II.
You should refer to the appropriate Separate Account prospectus for additional
information regarding such charges.
<PAGE>
<TABLE>
<CAPTION>
RENAISSANCE BALANCED PORTFOLIO
FINANCIAL HIGHLIGHTS
Six Months December 14, 1992
Ended (commencement
December 31, of operations)
1995 Year Ended Year Ended through
(Unaudited) June 30, 1995 June 30, 1994 June 30, 1993
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of
period $ 11.61 $ 10.40 $ 10.42 $ 10.00
Income from investment operations:
Net investment income 0.18 0.42 0.20 0.13
Net realized and unrealized gain
(loss) on investments 0.98 0.99 (0.11) 0.29
----------- ----------- ----------- ----------
Total from investment operations 1.16 1.41 0.09 0.42
Less distributions:
From net investment income (0.40) (0.17) (0.11) --
From net realized gain -- (0.03) -- --
----------- ----------- ----------- ----------
Total distributions (0.40) (0.20) (0.11) --
----------- ----------- ----------- ----------
Net asset value, end of period $ 12.37 $ 11.61 $ 10.40 $ 10.42
=========== =========== =========== ==========
TOTAL RETURN (A) 10.01% 13.71% 0.73% 7.70%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $28,606,368 $27,032,195 $25,046,394 $7,798,672
Ratio of expenses to average net
assets (C) 0.97% 0.96% 1.06% 1.24%
Ratio of net investment income to
average net assets (C) 2.76% 3.53% 2.72% 2.36%
Portfolio turnover rate 33% 71% 85% 29%
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
(C) The ratios of expenses and net investment income to average net assets
before voluntary expense reimbursement were 2.95% and 0.65%, respectively,
for the period December 14, 1992 (commencement of operations) through June
30, 1993.
<PAGE>
<TABLE>
<CAPTION>
ZWEIG ASSET ALLOCATION PORTFOLIO
FINANCIAL HIGHLIGHTS
Six Months December 14,1992
Ended (commencement
December 31, of operations)
1995 Year Ended Year Ended through
(Unaudited) June 30,1995 June 30, 1994 June 30,1993
------------- ------------- -------------- -----------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of
period $ 13.02 $ 11.44 $ 10.81 $ 10.00
Income from investment operations:
Net investment income 0.11 0.33 0.10 0.08
Net realized and unrealized gain
on investments 0.72 1.33 0.58 0.73
----------- ----------- ----------- ----------
Total from investment operations 0.83 1.66 0.68 0.81
Less distributions:
From net investment income (0.33) (0.08) (0.05) --
----------- ----------- ----------- ----------
Net asset value, end of period $ 13.52 $ 13.02 $ 11.44 $ 10.81
=========== =========== =========== ==========
TOTAL RETURN (A) 6.42% 14.57% 6.27% 14.86%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $39,532,169 $36,736,161 $31,563,173 $3,855,544
Ratio of expenses to average net assets (C) 1.20% 1.20% 1.39% 1.51%
Ratio of net investment income to average
net assets (C) 1.67% 2.73% 1.67% 1.40%
Portfolio turnover rate 32% 45% 101% 12%
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
(C) The ratios of expenses and net investment income to average net assets
before voluntary expense reimbursement were 4.87% and (1.17%) respectively,
for the period December 14, 1992 (commencement of operations) through June
30, 1993.
<PAGE>
NICHOLAS-APPLEGATE BALANCED PORTFOLIO
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months December 3, 1992
Ended (commencement
December 31, of operations)
1995 Year Ended Year Ended through
(Unaudited) June 30, 1995 June 30, 1994 June 30, 1993
------------- -------------- --------------- ----------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of
period $ 13.17 $ 11.27 $ 11.50 $ 10.00
Income from investment operations:
Net investment income 0.15 0.27 0.09 0.11
Net realized and unrealized gain
(loss) on investments 0.60 1.74 (0.29) 1.39
----------- ----------- ----------- ----------
Total from investment operations 0.75 2.01 (0.20) 1.50
Less distributions:
From net investment income (0.27) (0.11) (0.03) -
----------
Net asset value, end of period $ 13.65 $ 13.17 $ 11.27 $ 11.50
=========== =========== =========== ==========
TOTAL RETURN (A) 5.71% 17.92% (1.70%) 26.07%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $48,039,717 $45,780,611 $39,357,996 $5,567,264
Ratio of expenses to average net assets (C) 0.95% 0.94% 1.03% 1.25%
Ratio of net investment income
to average net assets (C) 2.15% 2.20% 1.69% 1.70%
Portfolio turnover rate 63% 108% 56% 21%
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
(C) The ratios of expenses and net investment income to average net assets
before voluntary expense reimbursement were 3.87% and (0.72%),
respectively, for the period December 3, 1992 (commencement of operations)
through June 30, 1993.
<PAGE>
HARRIS BRETALL SULLIVAN & SMITH EQUITY GROWTH PORTFOLIO
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months December 8, 1992
Ended (commencement
December 31, of operations)
1995 Year Ended Year Ended through
(Unaudited) June 30, 1995 June 30, 1994 June 30, 1993
---------------- ------------- ----------------- ------------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of period $ 12.85 $ 9.36 $ 9.71 $ 10.00
Income from investment operations:
Net investment income (loss) (0.00)(E) 0.01 (0.02)(C) --
Net realized and unrealized gain
(loss) on investments 0.92 3.48 (0.33) (0.29)
----------- ----------- ----------- ----------
Total from investment operations 0.92 3.49 (0.35) (0.29)
Less distributions:
From net investment income (0.01) -- -- --
From net realized gain (0.09) -- -- --
----------- ----------- ----------- ----------
Total distributions (0.10) -- -- --
----------- ----------- ----------- ----------
Net asset value, end of period $ 13.67 $ 12.85 $ 9.36 $ 9.71
=========== =========== =========== ==========
TOTAL RETURN (A) 7.17% 37.29% (3.60%) (5.16%)
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $22,647,233 $16,393,276 $10,693,027 5,143,365
Ratio of expenses to average net
assets(D) 1.02% 1.05% 1.29% 1.34%
Ratio of net investment income
(loss) to average net assets(D) (0.01%) 0.13% (0.17%) (0.06%)
Portfolio turnover rate 18% 31% 38% 6%
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
(C) Net investment income (loss) per share has been calculated using the
weighted monthly average number of shares outstanding.
(D) The ratios of expenses and net investment income to average net assets
before voluntary expense reimbursement were 3.52% and (1.94%) respectively,
for the period December 8, 1992 (commencement of operations) through June
30, 1993.
(E) Less than $0.01 per share.
<PAGE>
DREMAN VALUE PORTFOLIO
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months December 14, 1992
Ended (commencement
December 31, of operations)
1995 Year Ended Year Ended through
(Unaudited) June 30, 1995 June 30, 1994 June 30,1993
----------- ------------- ------------- ------------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of
period $ 12.59 $ 10.66 $ 10.45 $ 10.00
Income from investment operations:
Net investment income 0.10 0.26 0.12 0.11
Net realized and unrealized gain
on investments 2.55 1.85 0.17 0.34
---- ---- ---- ----
Total from investment operations 2.65 2.11 0.29 0.45
Less distributions:
From net investment income (0.19) (0.14) (0.08) --
From net realized gain (0.11) (0.04) -- --
----- ----- ----- ----
Total distributions (0.30) (0.18) (0.08) --
----- ----- ----- ----
Net asset value, end of period $ 14.94 $ 12.59 $ 10.66 $ 10.45
=========== =========== ========== ==========
TOTAL RETURN (A) 21.24% 19.98% 2.80% 8.25%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $15,638,902 $10,876,910 $8,952,174 $1,671,220
Ratio of expenses to average net
assets (C) 0.89% 1.13% 1.40% 1.24%
Ratio of net investment income
to average net assets (C) 2.07% 1.98% 1.98% 2.00%
Portfolio turnover rate 8% 29% 9% 5%
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
(C) The ratios of expenses and net investment income to average net assets
before voluntary expense reimbursement were 1.61% and 1.76%, respectively, for
the year ended June 30, 1994 and were 8.43% and (1.49%), respectively, for the
period December 14, 1992 (commencement of operations) through June 30, 1993.
<PAGE>
ZWEIG EQUITY (SMALL CAP) PORTFOLIO
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months
Ended December 14, 1992
December 31, (commencement
1995 Year Ended Year Ended of operations) through
(Unaudited) June 30, 1995 June 30, 1994 June 30, 1993
------------ -------------- -------------- ----------------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of period $ 11.62 $ 10.65 $ 10.11 $ 10.00
Income from investment operations:
Net investment income 0.03 0.17 0.15 0.05
Net realized and unrealized gain on
investments 1.13 0.93 0.50 0.06
----------- ---------- ---------- ----------
Total from investment operations 1.16 1.10 0.65 0.11
Less Distributions:
From net investment income (0.16) (0.06) (0.11) --
From net realized gain -- (0.07) -- --
----------- ---------- ---------- ----------
Total distributions (0.16) (0.13) (0.11) --
----------- ---------- ---------- ----------
Net asset value, end of period $ 12.62 $ 11.62 $ 10.65 $ 10.11
=========== ========== ========== ==========
TOTAL RETURN (A) 10.06% 10.39% 6.53% 2.02%
RATIOS AND SUPPLEMENTAL DATA (B)
Net Assets, end of period $10,344,612 $8,033,792 $7,590,947 $2,115,634
Ratio of expenses to average net assets 1.54% 1.55% 1.72% 1.61%
Ratio of net investment income to
average net assets .75% 1.54% 1.75% 0.84%
Ratio of expenses to average net
assets before voluntary expense
reimbursement 1.54% 1.59% 2.14% 7.29%
Ratio of net investment income
(loss) to average net assets before
voluntary expense reimbursement .75% 1.50% 1.32% (1.80%)
Portfolio turnover rate 29% 7% 249% 15%
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
<PAGE>
PINNACLE FIXED INCOME PORTFOLIO
(FORMERLY THE MITCHELL HUTCHINS FIXED INCOME PORTFOLIO)*
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months January 5, 1993
Ended (commencement
December 31, of operations)
1995 Year Ended Year Ended through
(Unaudited) June 30, 1995 June 30, 1994 June 30, 1993
----------- -------------- --------------- -----------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of
period $ 10.88 $ 10.00 $ 10.43 $ 10.00
Income from investment operations:
Net investment income 0.34 0.56 0.20 0.19
Net realized and unrealized gain
(loss) on investments 0.29 0.53 (0.52) 0.24
---------- ---------- ---------- --------
Total from investment operations 0.63 1.09 (0.32) 0.43
Less distributions:
From net investment income (0.58) (0.21) (0.11) --
---------- ---------- ----------
Net asset value, end of period $ 10.93 $ 10.88 $ 10.00 10.43
========== ========== ========== ========
TOTAL RETURN (A) 5.91% 11.08% (3.06%) 8.67%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $5,023,652 $5,415,497 $4,860,499 $905,836
Ratio of expenses to average net
assets 1.40% 1.40% 1.56% 1.56%
Ratio of net investment income to
average net assets 5.03% 5.41% 3.62% 3.86%
Ratio of expenses to average net assets
before voluntary expense
reimbursement 1.62% 1.59% 2.49% 15.72%
Ratio of net investment income (loss)
to average net assets before voluntary expense 4.81% 5.22% 2.68% (1.64%)
reimbursement
Portfolio turnover rate 167% 432% 527% 103%
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
___________________________
* J.P. Morgan Investment Management Inc. began managing the investment
operations of the Portfolio on April 1, 1996.
<PAGE>
ARM CAPITAL ADVISORS MONEY MARKET PORTFOLIO
(FORMERLY THE MITCHELL HUTCHINS MONEY MARKET PORTFOLIO)*
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months January 12,1993
Ended (commencement
December 31, of operations)
1995 Year Ended Year Ended through
(Unaudited) June 30, 1995 June 30, 1994 June 30, 1993
------------- ------------- ------------- -----------------
<S> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00
Income from investment operations:
Net investment income 0.02 0.04 0.02 0.01
Less distributions:
From net investment income (0.02) (0.04) (0.02) (0.01)
---------- ---------- ---------- --------
Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00
========== ========== ========== ========
TOTAL RETURN (A) 2.34% 4.30% 2.04% 1.66%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $9,122,956 $6,753,095 $5,452,417 $753,585
Ratio of expenses to average net
assets 1.15% 1.15% 1.29% 1.34%
Ratio of net investment income to
average net assets 4.70% 4.31% 2.19% 1.67%
Ratio of expenses to average net
assets before voluntary expense
reimbursement 1.15% 1.27% 2.08% 22.41%
Ratio of net investment income (loss) to
average net assets before voluntary
expense reimbursement 4.70% 4.20% 1.40% (2.05%)
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
____________________________
* ARM Capital Advisors, Inc. began managing the investment operations of the
Portfolio on April 1, 1996.
<PAGE>
MORGAN STANLEY ASIAN GROWTH PORTFOLIO
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months June 15, 1994
Ended (commencement
December 31, of operations)
1995 Year Ended through
(Unaudited) June 30, 1995 June 30, 1994
------------ ------------- --------------
<S> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of
period $ 10.18 $ 10.00 $ 10.00
Income from investment operations:
Net investment income 0.03 0.01 0.00 (C)
Net realized and unrealized gain
on investments 0.06 0.17 --
----------- ----------- ----------
Total from investment operations 0.09 0.18 0.00
Less distributions:
From net investment income (0.04) 0.00(C) --
From net realized gain (0.01) -- --
----------- ----------- ----------
Total distributions (0.05) 0.00 --
-----------
Net asset value, end of period $ 10.22 $ 10.18 $ 10.00
=========== =========== ==========
TOTAL RETURN (A) 0.96% 1.80% 0.52%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $11,932,318 $12,824,663 $1,905,357
Ratio of expenses to average net
assets (D) 1.61% 1.92% 0.75%
Ratio of net investment income to
average net assets (D) (0.05)% 0.76% 0.59%
Portfolio turnover rate 8% 30% --
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
(C) Less than $0.01 per share.
(D) The ratios of expenses and net investment income to average net assets
before voluntary expense reimbursement were 9.79% and (8.44%),
respectively, for the period June 15, 1994 (commencement of operations)
through June 30, 1994.
<PAGE>
MORGAN STANLEY WORLDWIDE HIGH INCOME PORTFOLIO
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Six Months June 15, 1994
Ended (commencement
December 31, of operations)
1995 Year Ended through
(Unaudited) June 30, 1995 June 30, 1994
------------ ------------- --------------
<S> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of
period $ 10.40 $ 10.00 $ 10.00
Income from investment operations:
Net investment income 0.57 0.89 0.00 (C)
Net realized and unrealized gain
(loss) on investments 0.39 (0.49) --
---------- ---------- --------
Total from investment operations 0.96 0.40 0.00
Less distributions:
From net investment income (0.89) 0.00 (C) --
From net realized gain on investments (0.01) -- --
---------- ---------- --------
Total distributions (0.90) -- --
Net asset value, end of period $ 10.46 $ 10.40 $ 10.00
========== ========== ========
TOTAL RETURN (A) 10.20% 4.00% 0.79%
RATIOS AND SUPPLEMENTAL DATA (B)
Net assets, end of period $6,236,743 $6,241,897 $687,484
Ratio of expenses to average net
assets (D) 1.57% 1.61% 0.85%
Ratio of net investment income to
average net assets (D) 10.60% 9.28% 0.80%
Portfolio turnover rate 36% 42% --
</TABLE>
(A) Total returns for periods of less than one year are not annualized.
(B) Data expressed as a percentage are annualized as appropriate.
(C) Less than $0.01 per share.
(D) The ratios of expenses and net investment income to average net assets
before voluntary expense reimbursement were 24.78% and (23.13%),
respectively, for the period June 15, 1994 (commencement of operations)
through June 30, 1994.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
THE FUND..................................................... 1
INVESTMENT OBJECTIVES AND POLICIES........................... 1
Morgan Stanley Asian Growth Portfolio..................... 1
Morgan Stanley Worldwide High Income Portfolio............ 2
Renaissance Balanced Portfolio............................ 7
Zweig Asset Allocation Portfolio.......................... 8
Nicholas-Applegate Balanced Portfolio..................... 8
Harris Bretall Sullivan & Smith Equity Growth Portfolio... 9
Dreman Value Portfolio.................................... 10
Zweig Equity (Small Cap) Portfolio........................ 11
Pinnacle Fixed Income Portfolio........................... 11
ARM Capital Advisors Money Market Portfolio............... 12
DESCRIPTION OF VARIOUS SECURITIES AND INVESTMENT TECHNIQUES.. 13
DIVIDENDS, DISTRIBUTIONS AND FEDERAL INCOME TAXES............ 25
VALUATION OF SHARES.......................................... 26
PURCHASES AND REDEMPTIONS.................................... 26
MANAGEMENT OF THE FUND....................................... 27
Investment Manager, Sub-Advisers and Distributor.......... 27
Expenses.................................................. 31
PORTFOLIO TRANSACTIONS AND BROKERAGE......................... 32
OTHER INFORMATION............................................ 32
Appendix A
DESCRIPTION OF COMMERCIAL PAPER AND BOND RATINGS............. A-1
</TABLE>
<PAGE>
THE FUND
The Legends Fund, Inc. (Fund) was incorporated in Maryland on July 22, 1992
under the name "Integrity Series Fund, Inc." and is an open-end management
investment company registered under the Investment Company Act of 1940, as
amended (the 1940 Act). It is a series-type investment company consisting of
multiple portfolios. The Board of Directors of the Fund may establish additional
Portfolios at any time.
ARM Capital Advisors, Inc. (Manager) serves as investment manager to all the
Portfolios of the Fund and has entered into a sub-advisory agreement with a
professional adviser for each Portfolio except for the ARM Capital Advisors
Money Market Portfolio (also referred to herein as the Money Market Portfolio).
Such advisers are individually called a Sub-Adviser, and collectively, the Sub-
Advisers (which term when applied to the Money Market Portfolio includes the
Manager). The Manager provides the Fund with supervisory and management
services. ARM Financial Group, Inc. (ARM) is the parent of the Manager. See
"Management of the Fund."
Shares of the Portfolios are offered to separate accounts of Integrity Life
Insurance Company (Integrity) and National Integrity Life Insurance Company
(National Integrity) to serve as an investment vehicle for contributions under
certain variable annuity contracts and certificates (certificates) issued by the
companies. See "Purchases and Redemptions."
Shareholders have the right to vote on the election of members of the Board of
Directors of the Fund, on any other matters on which by law they may be entitled
to vote, and on any other business which may properly come before a meeting of
shareholders. On any matters affecting only one Portfolio, only the shareholders
of that Portfolio are entitled to vote. On matters relating to all the
Portfolios, but affecting the Portfolios differently, separate votes by
Portfolio are required. The Fund does not hold annual meetings of shareholders.
Each share of a Portfolio has equal voting, dividend and liquidation rights.
INVESTMENT OBJECTIVES AND POLICIES
Set forth below is a description of the investment objectives and policies of
each Portfolio. The SAI describes specific investment restrictions which govern
each Portfolio's investments. The objectives, and the policies and restrictions
specifically cited as fundamental in this Prospectus and the SAI, are
fundamental and may not be changed with respect to any Portfolio without a
majority vote of shareholders of that Portfolio. Other investment policies and
practices described in this Prospectus and in the SAI are not fundamental, and
the Board of Directors of the Fund may change them without shareholder approval.
Each Portfolio has its own investment objectives and policies. There is no
assurance that a Portfolio will achieve its investment objectives.
MORGAN STANLEY ASIAN GROWTH PORTFOLIO seeks long-term capital appreciation
through investment primarily in common stocks of Asian issuers, excluding Japan.
The production of any current income is incidental to this objective. The
Portfolio seeks to achieve its objective by investing under normal market
conditions at least 65% of the value of its total assets in common stocks which
are traded on recognized stock exchanges of the countries in Asia described
below and in common stocks of companies organized under the laws of an Asian
country whose business is conducted principally in Asia. The Portfolio does not
intend to invest in securities which are traded in markets in Japan or in
companies organized under the laws of Japan. The Portfolio may also invest in
sponsored or unsponsored American Depositary Receipts (ADRs) of Asian issuers
that are traded on stock exchanges in the United States. See "Description of
Various Securities and Investment Techniques." Morgan Stanley Asset Management
Inc. (MSAM) is the Sub-Adviser for the Portfolio. For more information about
MSAM, see "Management of the Fund."
The Portfolio will invest in countries having more established markets in the
region. The Asian countries to be represented in the Portfolio will consist of
three or more of the following countries: Hong Kong, Singapore, Malaysia,
Thailand, the Philippines and Indonesia. The Portfolio may also invest in common
stocks traded on markets in China, Taiwan, South Korea, India, Pakistan, Sri
Lanka and other developing markets that are open to foreign investment. There is
no requirement that the Portfolio, at any given time, invest in any one
particular country or in all of the countries listed above or in any other Asian
countries. The Portfolio has no set policy for allocating investments among the
several Asian countries. Allocation of investments among the various countries
will depend on the relative attractiveness of the stocks of issuers in the
respective countries. Government
<PAGE>
regulation and restrictions in many of the countries of interest may limit the
amount, mode and extent of investment in companies in such countries.
As stated above, at least 65% of the total assets of the Portfolio will be
invested in common stocks of issuers in Asian countries under normal
circumstances. The remaining portion of the Portfolio will be kept in any
combination of debt instruments, bills and bonds of governmental entities in
Asia and the United States, in notes, debentures, and bonds of companies in Asia
and in money market instruments of the United States. Common stocks for this
purpose include common stocks and equivalents, such as securities convertible
into common stocks and securities having common stock characteristics, such as
rights and warrants to purchase common stocks. Debt securities convertible into
common stocks will be investment grade (rated in one of the four highest rating
categories by a nationally recognized statistical rating organization (NRSRO))
or, if unrated, will be of comparable quality as determined by the Sub-Adviser.
See Appendix A.
The Sub-Adviser's approach in selecting investments for the Portfolio is
oriented to individual stock selection and is value driven. In selecting stocks
for the Portfolio, the Sub-Adviser initially identifies those stocks which it
believes to be undervalued in relation to the issuer's assets, cash flow,
earnings and revenues, and then evaluates the future value of such stocks by
running the results of an in-depth study of the issuer through a dividend
discount model. The Sub-Adviser utilizes the research of a number of sources,
including its affiliate in Geneva, Morgan Stanley Capital International, in
identifying attractive securities, and applies a number of proprietary screening
criteria to identify those securities it believes to be undervalued. Portfolio
holdings are regularly reviewed and subjected to fundamental analysis to
determine whether they continue to conform to the Sub-Adviser's value criteria.
Those which no longer conform are sold. The Sub-Adviser will analyze assets,
revenues and earnings of an issuer. In selecting industries and particular
issuers, the Sub-Adviser will evaluate costs of labor and raw materials, access
to technology, export of products and government regulation. Although the
Portfolio seeks to invest in larger companies, it may invest in small- and
medium-sized companies that, in the Sub-Adviser's view, have potential for
growth.
The Portfolio may invest in equity securities of smaller capitalized companies,
which are more vulnerable to financial and other risks than larger companies.
Investment in securities of smaller companies may involve a higher degree of
risk and price volatility than in securities of larger companies. The
Portfolio's investments will include securities of issuers located in developing
countries and traded in emerging markets. These securities pose greater
liquidity risks and other risks than securities of companies located in
developed countries and traded in more established markets. For a description
of special considerations and certain risks associated with investment in
foreign issuers, see "Description of Various Securities and Investment
Techniques."
Although the Portfolio intends to invest primarily in securities listed on stock
exchanges, it will also invest in securities traded in over-the-counter markets
and, to a limited extent, in non-publicly traded securities. Securities traded
in over-the-counter markets and non-publicly traded securities pose liquidity
risks.
Pending investment or settlement, and for liquidity purposes, the Portfolio may
invest in domestic, Eurodollar and foreign short-term money market instruments.
As determined by the Sub-Adviser, the Portfolio may also purchase such
instruments to temporarily reduce the Portfolio's equity holdings for defensive
purposes in response to adverse market conditions.
Because of the lack of hedging facilities in the currency markets of Asia, no
active currency hedging strategy is anticipated currently. Instead, each
investment will be considered on a total currency adjusted basis with the United
States dollar as a base currency. The Portfolio may engage in foreign currency
exchange contracts. See "Description of Various Securities and Investment
Techniques."
MORGAN STANLEY WORLDWIDE HIGH INCOME PORTFOLIO seeks high current income
consistent with relative stability of principal and, secondarily, capital
appreciation, through investing primarily in a portfolio of high yielding fixed
income securities of issuers located throughout the world. The Portfolio seeks
to achieve its investment objective by allocating its assets among any or all of
three investment sectors: U.S. corporate lower rated and unrated debt
securities, emerging country debt securities and global fixed income securities
offering high real yields. The types of securities within each investment
sector in which the Portfolio may invest are described
2
<PAGE>
below. MSAM is the Sub-Adviser for the Portfolio. For more information about
MSAM, see "Management of the Fund."
In selecting U.S. corporate lower rated and unrated debt securities for the
Portfolio, the Sub-Adviser will consider, among other things, the price of the
security, and the financial history, condition, prospects and management of an
issuer. The Sub-Adviser intends to invest a portion of the Portfolio's assets
in emerging country debt securities that provide a high level of current income,
while at the same time holding the potential for capital appreciation if the
perceived creditworthiness of the issuer improves due to improving economic,
financial, political, social or other conditions in the country in which the
issuer is located. In addition, the Sub-Adviser will attempt to invest a
portion of the Portfolio's assets in fixed income securities of issuers in
global fixed income markets displaying high real (inflation adjusted) yields.
Under normal conditions, the Portfolio intends to invest between 80% and 100% of
its total assets in some or all of these three categories of higher yielding
securities, some of which may entail increased credit and market risk. See
"Description of Various Securities and Investment Techniques -- Debt
Securities."
The Sub-Adviser's approach to multicurrency fixed-income management is strategic
and value-based and designed to produce an attractive real rate of return. The
Sub-Adviser's assessment of the bond markets and currencies is based on an
analysis of real interest rates. Current nominal yields of securities are
adjusted for inflation prevailing in each currency sector using an analysis of
past and projected inflation rates. The Portfolio's aim is to invest in bond
markets which offer the most attractive real returns relative to inflation.
A portion of the Portfolio's investments, which may be up to 100% of the
Portfolio's investments, may be considered to have credit quality below
investment grade as determined by internationally recognized credit rating
agency organizations, such as Moody's Investors Service, Inc. (Moody's) and
Standard & Poor's Ratings Group (S&P), or be unrated but determined to be of
comparable quality by the Sub-Adviser. Such lower rated bonds are commonly
referred to as "junk bonds." Securities in the lowest rating categories may
have predominantly speculative characteristics or may be in default. See
Appendix A for a description of Moody's and S&P's corporate bond ratings.
Ratings represent the opinions of rating agencies as to the quality of bonds and
other debt securities they undertake to rate at the time of issuance. However,
ratings are not absolute standards of quality and may not reflect changes in an
issuer's creditworthiness. Accordingly, while the Sub-Adviser will consider
ratings, it will perform its own analysis and will not rely principally on
ratings. Emerging country debt securities in which the Portfolio may invest
will be subject to high risk and will not be required to meet a minimum rating
standard and may not be rated for creditworthiness by any internationally
recognized credit rating organizations. The Portfolio's investments in U.S.
corporate lower rated and unrated debt securities and emerging country debt
securities are expected to be rated in the lower and lowest rating categories of
internationally recognized credit rating organizations or to be unrated
securities of comparable quality. Ratings of a non-U.S. debt instrument, to the
extent that those ratings are undertaken, are related to evaluations of the
country in which the issuer of the instrument is located. Ratings generally
take into account the currency in which a non-U.S. debt instrument is
denominated; instruments issued by a foreign government in other than the local
currency, for example, typically have a lower rating than local currency
instruments due to the existence of an additional risk that the government will
be unable to obtain the required foreign currency to service its foreign
currency-denominated debt. In general, the ratings of debt securities or
obligations issued by a non-U.S. public or private entity will not be higher
than the rating of the currency or the foreign currency debt of the central
government of the country in which the issuer is located, regardless of the
intrinsic creditworthiness of the issuer. To mitigate the risks associated with
investments in such lower rated securities, the Portfolio will diversify its
holdings by market, issuer, industry and credit quality. Investors should
carefully read "Description of Various Securities and Investment Techniques --
Debt Securities."
The Portfolio may invest in or own securities of companies in various stages of
financial restructuring, bankruptcy or reorganization which are not currently
paying interest or dividends, provided that the total value, at time of
purchase, of all such securities will not exceed 10% of the value of the
Portfolio's total assets. The Portfolio may have limited recourse in the event
of default on such debt instruments. The Portfolio may invest in loans,
assignments of loans and participations in loans. The Portfolio may also invest
in depositary receipts issued by U.S. or foreign financial institutions. See
"Description of Various Securities and Investment Techniques."
3
<PAGE>
The Portfolio is not restricted in the portion of its assets which may be
invested in securities denominated in a particular currency and a substantial
portion of the Portfolio's assets may be invested in non-U.S. dollar-denominated
securities. The portion of the Portfolio's assets invested in securities
denominated in currencies other than the U.S. dollar will vary depending on
market conditions. The analysis of currencies is made independent of the
analysis of markets. Value in foreign exchange is determined by relative
purchasing power parity of a given currency. The Portfolio seeks to invest in
currencies currently undervalued based on purchasing power parity. The Sub-
Adviser analyzes current account and capital account performance and real
interest rates to adjust for shorter-term currency flows. Although the Portfolio
is permitted to engage in a wide variety of investment practices designed to
hedge against currency exchange rate risks with respect to its holdings of non-
U.S. dollar-denominated debt securities, the Portfolio may be limited in its
ability to hedge against these risks. The Portfolio may also write (i.e., sell)
covered call options and may enter into futures contracts and options on futures
and sell indexed financial futures contracts. See "Description of Various
Securities and Investment Techniques."
The Portfolio may also invest in zero coupon, pay-in-kind or deferred payment
securities, and in securities that may be collateralized by zero coupon
securities (such as Brady Bonds). Zero coupon securities are securities sold at
a discount to par value and are not entitled to interest payments during the
life of the security. Upon maturity, the holder is entitled to receive the par
value of the security. While interest payments are not made on such securities,
holders of such securities are deemed to receive "phantom income," which the
Portfolio will accrue prior to the receipt of cash payments. Pay-in-kind
securities are securities that have interest payable by delivery of additional
securities. Upon maturity, the holder is entitled to receive the aggregate par
value of the securities. Deferred payment securities are securities that remain
zero coupon securities until a predetermined date, at which time the stated
coupon rate becomes effective and interest becomes payable at regular intervals.
Zero coupon, pay-in-kind and deferred payment securities may be subject to
greater fluctuation in value and lesser liquidity in the event of adverse market
conditions than comparably rated securities paying cash interest at regular
interest payment periods.
The Portfolio is authorized to borrow in an amount up to 33-1/3% of its total
assets (including the amount borrowed), less all liabilities and indebtedness
other than the borrowing, for investment purposes to increase the opportunity
for greater return and for payment of dividends. Such borrowings would
constitute leverage, which is a speculative characteristic. Leveraging will
magnify declines as well as increases in the net asset value of the Portfolio's
shares and in the yield on the Portfolio's investments. See "Description of
Various Securities and Investment Techniques."
The average time to maturity of the Portfolio's securities will vary depending
upon the Sub-Adviser's perception of market conditions. The Sub-Adviser invests
in medium-term securities (i.e., those with a remaining maturity of
approximately five years) in a market neutral environment. When the Sub-Adviser
believes that real yields are high, the Sub-Adviser lengthens the remaining
maturities of securities held by the Portfolio and, conversely, when the Sub-
Adviser believes real yields are low, it shortens the remaining maturities.
Thus, the Portfolio is not subject to any restrictions on the maturities of the
debt securities it holds, and the Sub-Adviser may vary the average maturity of
the securities held by the Portfolio without limit.
The Portfolio may, to a limited extent, invest in non-publicly traded
securities, private placements and restricted securities.
For temporary defensive purposes, the Portfolio may invest part or all of its
total assets in cash or in short-term securities, including certificates of
deposit, commercial paper, notes, obligations issued or guaranteed by the U.S.
Government or any of its agencies or instrumentalities, and repurchase
agreements involving such government securities.
U.S. Corporate High Yield Fixed Income Securities. A portion of the Portfolio's
assets will be invested in U.S. corporate high yield fixed income securities,
which offer a yield above that generally available on U.S. corporate debt
securities in the three highest rating categories of NRSROs and which are
commonly referred to as "junk bonds." The Portfolio may buy unrated securities
that the Sub-Adviser believes are comparable to rated securities that are
consistent with the Portfolio's objectives and policies. The Portfolio may
acquire fixed income securities of U.S. issuers, including debt obligations
(e.g., bonds, debentures, notes, equipment lease certificates, equipment
4
<PAGE>
trust certificates, conditional sales contracts and commercial paper and
obligations) and preferred stock. These fixed income securities may have equity
features, such as conversion rights or warrants, and the Portfolio may invest up
to 10% of its total assets in equity securities other than preferred stock
(common stocks, warrants and rights and limited partnership interests). The
Portfolio may not invest more than 5% of its total assets at time of acquisition
in either of (1) equipment lease certificates, equipment trust certificates and
conditional sales contracts or (2) limited partnership interests.
Emerging Country Fixed Income Securities. A portion of the Portfolio's assets
will be invested in emerging country fixed income securities, which are debt
securities of government and government-related issuers located in emerging
countries (including participations in loans between governments and financial
institutions), and of entities organized to restructure outstanding debt of such
issuers, and debt securities of corporate issuers located in or organized under
the laws of emerging countries. As used in this Prospectus, an emerging country
is any country that the International Bank for Reconstruction and Development
(more commonly known as the World Bank) has determined to have a low or middle
income economy. There are currently over 130 countries which are considered to
be emerging countries, approximately 40 of which currently have established
securities markets. These countries generally include every nation in the world
except the United States, Canada, Japan, Australia, New Zealand and most nations
located in Western Europe.
In selecting emerging country debt securities for investment by the Portfolio,
the Sub-Adviser will apply a market risk analysis contemplating assessment of
factors such as liquidity, volatility, tax implications, interest rate
sensitivity, counterparty risks and technical market considerations. Currently,
investing in many emerging country securities is not feasible or may involve
unacceptable political risks. Initially, the Portfolio expects that its
investments in emerging country debt securities will be made primarily in some
or all of the following emerging countries:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Algeria Egypt Nicaragua Slovakia
Argentina Greece Nigeria South Africa
Brazil Hungary Pakistan Thailand
Bulgaria India Panama Trinidad & Tobago
Chile Indonesia Paraguay Tunisia
China Ivory Coast Peru Turkey
Colombia Jamaica Philippines Uruguay
Costa Rica Jordan Poland Venezuela
Czech Republic Malaysia Portugal Zaire
Dominican Republic Mexico Russia
Ecuador Morocco Singapore
</TABLE>
As opportunities to invest in debt securities in emerging countries develop, the
Portfolio expects to expand and further diversify the emerging countries in
which it invests. While the Portfolio generally is not restricted in the portion
of its assets which may be invested in a single country or region, it is
anticipated that, under normal circumstances, the Portfolio's assets will be
invested in at least three countries.
The Portfolio's investments in government and government-related and
restructured debt securities will consist of (i) debt securities or obligations
issued or guaranteed by governments, governmental agencies or instrumentalities
and political subdivisions located in emerging countries (including
participations in loans between governments and financial institutions), (ii)
debt securities or obligations issued by government owned, controlled or
sponsored entities located in emerging countries, and (iii) interests in issuers
organized and operated for the purpose of restructuring the investment
characteristics of instruments issued by any of the entities described above.
Such type of restructuring involves the deposit with or purchase by an entity of
specific instruments and the issuance by that entity of one or more classes of
securities backed by, or representing
5
<PAGE>
interests in, the underlying instruments. Certain issuers of such structured
securities may be deemed to be "investment companies" as defined in the 1940
Act. As a result, the Portfolio's investment in such securities may be limited
by certain investment restrictions contained in the 1940 Act.
The Portfolio's investments in debt securities of corporate issuers in emerging
countries may include debt securities or obligations issued (i) by banks located
in emerging countries or by branches of emerging country banks located outside
the country or (ii) by companies organized under the laws of an emerging
country. Determinations as to eligibility will be made by the Sub-Adviser based
on publicly available information and inquiries made to the issuer. The
Portfolio may also invest in certain debt obligations customarily referred to as
"Brady Bonds," which are created through the exchange of existing commercial
bank loans to foreign entities for new obligations in connection with debt
restructurings under a plan introduced by former U.S. Secretary of the Treasury
Nicholas F. Brady. See "Investment Policies and Limitations -- Brady Bonds" in
the SAI for further information about Brady Bonds. The Portfolio's investments
in government and government-related and restructured debt instruments are
subject to special risks, including the inability or unwillingness to repay
principal and interest, requests to reschedule or restructure outstanding debt
and requests to extend additional loan amounts. See "Description of Various
Securities and Investment Techniques -- Debt Securities" and "-- Foreign
Government Securities."
Emerging country debt securities held by the Portfolio will take the form of
bonds, notes, bills, debentures, convertible securities, warrants, bank debt
obligations, short-term paper, mortgage- and other asset-backed securities, loan
participations, loan assignments and interests issued by entities organized and
operated for the purpose of restructuring the investment characteristics of
instruments issued by emerging country issuers. U.S. dollar-denominated emerging
country debt securities held by the Portfolio will generally be listed but not
traded on a securities exchange, and non-U.S. dollar-denominated securities held
by the Portfolio may or may not be listed or traded on a securities exchange.
The Portfolio may invest in mortgage-backed securities and in other asset-backed
securities issued by non-governmental entities such as banks and other financial
institutions. Mortgage-backed securities include mortgage pass-through
securities and collateralized mortgage obligations (CMOs). Asset-backed
securities are collateralized by such assets as automobile or credit card
receivables and are securitized either in a pass-through structure or in a pay-
through structure similar to a CMO. Investments in emerging country debt
securities entail special investment risks. See "Description of Various
Securities and Investment Techniques -- Foreign Securities and Depositary
Receipts."
Global Fixed Income Securities. The global fixed income securities in which a
portion of the Portfolio's assets may be invested are debt securities
denominated in currencies of countries displaying high real yields. Such
securities include government obligations issued or guaranteed by U.S. or
foreign governments and their political subdivisions, authorities, agencies or
instrumentalities, and by supranational entities (such as the World Bank, The
European Economic Community, The Asian Development Bank and the European Coal
and Steel Community), Eurobonds, and corporate bonds with varying maturities
denominated in various currencies. In this portion of the Portfolio, the Sub-
Adviser seeks to minimize investment risk by investing in a high quality
portfolio of debt securities, the majority of which will be rated in one of the
two highest rating categories by an NRSRO or, if unrated, will be of comparable
quality, as determined by the Sub-Adviser. U.S. Government securities in which
the Portfolio may invest include obligations issued or guaranteed by the U.S.
Government, such as U.S. Treasury securities, as well as those backed by the
full faith and credit of the United States, such as obligations of the
Government National Mortgage Association and the Export-Import Bank. The
Portfolio may also invest in obligations issued or guaranteed by U.S. Government
agencies or instrumentalities where the Portfolio must look principally to the
issuing or guaranteeing agency for ultimate repayment. Investment in foreign
government securities for this portion of the Portfolio will be limited to those
of developed nations which the Sub-Adviser believes pose limited credit risk.
These countries currently include Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Ireland, Italy, Japan, Luxembourg, the Netherlands,
New Zealand, Norway, Portugal, Spain, Sweden, Switzerland and the United
Kingdom. Corporate and supranational obligations in which the Portfolio will
invest for this portion of its portfolio will be limited to those rated "A" or
better by Moody's, S&P or IBCA Ltd. or, if unrated, determined to be of
comparable quality by the Sub-Adviser.
In selecting securities for this portion of the Portfolio, the Sub-Adviser
evaluates the currency, market, and individual features of the securities being
considered for investment. The Sub-Adviser believes that countries
6
<PAGE>
displaying the highest real yields will over time generate a high total return
and, accordingly, the Sub-Adviser's focus for this portion of the Portfolio will
be to analyze the relative rates of real yield of twenty global fixed income
markets. In selecting securities, the Sub-Adviser will first identify the global
markets in which the Portfolio's assets will be invested by ranking such
countries in order of highest real yield. In this portion of the Portfolio, the
Portfolio will invest its assets primarily in fixed income securities
denominated in the currencies of countries within the top quartile of the Sub-
Adviser's ranking.
The Sub-Adviser's assessment of the global fixed income markets is based on an
analysis of real interest rates. The Sub-Adviser calculates real yield for each
global market by adjusting current nominal yields of securities in each such
market for inflation prevailing in each country using an analysis of past and
projected (one-year) inflation rates for that country. The Sub-Adviser expects
to review and update on a regular basis its real yield ranking of countries and
market sectors and alter the allocation of this portion of the Portfolio's
investments among markets as necessary when changes to real yields and inflation
estimates significantly alter the relative rankings of the countries and market
sectors.
RENAISSANCE BALANCED PORTFOLIO seeks income and capital appreciation in rising
markets and the preservation of capital in adverse market environments by
allocating assets among common stocks of issuers with large capitalizations,
United States Government and high quality corporate debt securities, and high
quality cash equivalent issues, such as commercial paper. Renaissance Investment
Management (Renaissance) is the Sub-Adviser for the Portfolio. For more
information about Renaissance, see "Management of the Fund."
The Portfolio is managed by means of an asset allocation process developed by
Renaissance that utilizes the basic asset classes of stocks, bonds and cash
equivalents. The asset allocation process is a quantitative, value-oriented
process that results in periodic asset allocation shifts to reduce risk and/or
increase return. However, under normal market conditions, at least 25% of the
Portfolio will be invested in senior fixed income securities.
The Renaissance Balanced Strategy is based upon the premise that asset classes
within the financial markets periodically become mispriced relative to one
another. The Sub-Adviser systematically measures the potential returns from each
asset class and continually shifts away from overvalued assets and toward
undervalued assets. The attractiveness of each asset class is expressed in terms
of a payback methodology, which continually calculates the holding period
required for a given asset to return to the investor its current price in the
form of future earnings, dividends, and/or interest payments.
The period of time for the cumulative return to equal the initial investment is
called the Capital Return Time (CRT). Logically, investment funds should flow
toward those alternatives (assets) with shorter CRTs and away from assets with
longer CRTs. In the capital markets, this means that the prices of assets with
relatively low CRTs tend to rise, and the prices of assets with relatively high
CRTs tend to fall as equilibrium is restored. Measuring and exploiting the
difference in CRTs among asset classes are the objectives of the Renaissance
Balanced Strategy.
Equity commitments will generally range from 10% to 75% of the total assets of
the Portfolio. The equity portion of the Portfolio will be well-diversified,
with sector and industry weightings similar to those of the Standard & Poor's
500 Index (S&P 500). Selection of individual common stock issues is based upon a
three-part quantitative process which continually evaluates the large
capitalization stocks in the S&P 500. As a result of these selection procedures,
the equity portion of the Portfolio will have a bias toward high quality, liquid
issues. The value characteristics of the equity portion of the Portfolio, such
as price/earnings ratios, price/book value ratios and yield, will generally be
more favorable than the characteristics of the market as a whole. The investment
objective of the equity portion of the Portfolio is to achieve moderately better
performance than the S&P 500 without incurring excessive risk.
The fixed income class will consist of medium to long-term U.S. Treasury and/or
high quality corporate bonds, and the cash equivalents class will consist of
high quality money market instruments, including 90-day U.S. Treasury bills. See
"ARM Capital Advisors Money Market Portfolio" for a description of the type of
money market securities in which the Portfolio may invest. The commercial paper
in which the Portfolio will invest will generally be rated in the highest
category by S&P or Moody's or, if unrated, of comparable quality as determined
7
<PAGE>
by the Sub-Adviser. See Appendix A. The Portfolio may invest up to 10% of its
total assets in foreign government securities. The Portfolio also may invest in
mortgage-backed securities. See "Description of Various Securities and
Investment Techniques."
The Portfolio periodically may invest in listed options and futures contracts
and related options. These transactions would be made for the purpose of hedging
the portfolio against the possibility of a general market decline, or for the
purpose of increasing market exposure at minimal cost. See "Description of
Various Securities and Investment Techniques."
ZWEIG ASSET ALLOCATION PORTFOLIO seeks long-term capital appreciation through
investment primarily in Blue Chip Stocks, consistent with preservation of
capital and the reduction of portfolio exposure to market risk, as determined by
Zweig/Glaser Advisers (Zweig/Glaser), the Sub-Adviser. Blue Chip Stocks are
stocks which the Sub-Adviser considers comparable to the stocks included in the
S&P 500 that have a minimum of $400 million market capitalization, average daily
trading volume of 50,000 shares or $425 million in total assets, and which are
traded on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX),
over-the-counter (OTC) or on foreign exchanges. For more information about
Zweig/Glaser, see "Management of the Fund."
The extent of the Portfolio's investment in Blue Chip Stocks and the selection
of particular securities are determined primarily on the basis of risk
management strategies and stock selection techniques developed by Dr. Martin
Zweig and his staff. In an effort to meet its investment objective, the
Portfolio will use certain specialized techniques. See "Description of Various
Securities and Investment Techniques." The Fund will use stock index futures
and/or options to increase or decrease market exposure, or to entirely eliminate
market exposure, and invest in high quality money market securities and
repurchase agreements in accordance with the Sub-Adviser's risk management
strategies.
The Sub-Adviser uses a computer-driven stock selection model currently employed
by Dr. Zweig and his staff. The model ranks approximately 1,400 of the most
liquid stocks as determined by the Sub-Adviser by various measures such as
earnings momentum, relative valuation, changes in analysts' earnings estimates
and price momentum, and, based on the rankings, selects up to 300 stocks for the
Portfolio. The stock selection model used may evolve or be replaced by other
stock selection techniques intended to achieve the Portfolio's investment
objective. Shareholders will be notified in the event of any material change to
the stock selection model.
The Portfolio may invest in foreign securities publicly traded in the United
States and in ADRs, which are U.S. dollar denominated receipts issued generally
by domestic banks and representing the deposit of a foreign issuer. For a
discussion of limitations on, and certain risks involved in, investments in
foreign securities, see "Description of Various Securities and Investment
Techniques."
NICHOLAS-APPLEGATE BALANCED PORTFOLIO seeks maximum total return in both the
equity and fixed income portions of its investments. Under normal market
conditions, the Portfolio will have 60% to 65% of its assets invested in equity
securities, including common stocks and securities convertible into or
exchangeable for common stocks (such as convertible preferred stocks and
convertible debentures). The remaining 35% to 40% will be invested in U.S.
Government securities or cash equivalent issues. For information about Nicholas-
Applegate Capital Management (Nicholas-Applegate), the Sub-Adviser to the
Portfolio, see "Management of the Fund."
The Sub-Adviser follows a growth investment philosophy for equity securities. It
engages in fundamental analysis of companies which it considers to have strong
possibilities for long-term capital appreciation. Equity securities purchased
will generally have the following characteristics: (1) market capitalization in
excess of $500 million, (2) increasing earnings, (3) sustainable growth, and (4)
positive relative price momentum. The Sub-Adviser uses a computer system that
includes a proprietary research and verification system to analyze and rank more
than 3,500 stocks by these characteristics. It is anticipated that the Portfolio
will maintain an equity portfolio of between 75 and 100 issues.
The equity portion of the Portfolio will be diversified and consist of equity
securities such as common stocks, preferred stocks and convertible preferred
stocks, which the Sub-Adviser believes have above-average earnings
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growth prospects based on a company-by-company analysis (rather than on broader
analyses of specific industries or sectors of the economy). The Sub-Adviser
seeks to identify stocks of companies which it expects to enter into an
accelerating earnings period, to attract increasing institutional sponsorship or
to demonstrate strong price appreciation relative to their industries and to
broad market averages. The companies in which the Portfolio invests do not
necessarily have records of past high growth. Examples of possible investments
include companies with increasing earnings, companies with new and innovative
products or services, companies facing a changed economic, competitive or
regulatory environment, companies with a new or different management approach
and initial public offerings of companies which the Sub-Adviser believes offer
above-average growth potential.
The Sub-Adviser utilizes an internal research system to systematically
integrate, weight and evaluate 3,500 companies based upon earnings acceleration,
earnings sustainability and relative price strength. The result is portfolios of
equity securities which the Sub-Adviser believes have above-average earnings
growth prospects. Investments are closely monitored with a view to the sale of
portfolio securities when the reasons for the initial purchases are no longer
valid.
The Portfolio may invest up to 20% of its total assets in securities of foreign
issuers and ADRs. See "Description of Various Securities and Investment
Techniques."
The fixed income securities in which the Portfolio will invest are U.S.
Government securities. Generally, such securities will have remaining terms to
maturity of approximately 10 years. The Sub-Adviser uses a statistical model
that identifies significant interest rate trends in the bond market. The
Portfolio will react to changes in the trend of interest rates by purchasing or
shifting to longer-term securities when the rates are declining and to shorter-
term securities when the rates are rising. The Sub-Adviser also will consider
such factors as Gross National Product, the inflation rate, fiscal policy and
the currency market in determining maturities to be purchased.
The Portfolio may attempt to reduce the overall risk of its investments (hedge)
by investing in options. See "Description of Various Securities and Investment
Techniques."
HARRIS BRETALL SULLIVAN & SMITH EQUITY GROWTH PORTFOLIO seeks long-term capital
appreciation. The Portfolio primarily invests in stocks of established companies
with proven records of superior and consistent earnings growth. The Portfolio
may invest all or a portion of its assets in cash and cash equivalents if the
Sub-Adviser considers the securities markets to be overvalued. The Portfolio may
invest in U.S. Government securities when this appears desirable in light of the
Portfolio's investment objective or when market conditions warrant. For more
information about Harris Bretall Sullivan & Smith, Inc. (Harris Bretall Sullivan
& Smith), the Sub-Adviser, see "Management of the Fund."
The Sub-Adviser selects growth stocks by ascertaining that the issuing company
has (i) a track record of superior and consistent growth in revenues and
earnings; (ii) management that has successfully brought the company through a
variety of business conditions and business cycles; (iii) product lines,
technologies or franchises that are leaders in their fields; and (iv) a
financial structure that is stronger than average.
The Sub-Adviser applies qualitative and quantitative screens, using several on-
line databases to 5,000 publicly-held companies and develops a select universe
of approximately 300 stocks that meet its criteria. The Sub-Adviser's stock
selection process is centered on a proprietary multi-factor model which looks at
the individual companies in the universe from three points of view. First,
companies are ranked based on their intrinsic present value using the Sub-
Adviser's earnings and growth rate outlook. Second, their recent quarterly
earnings are reviewed and individual companies are ranked. Finally, based on
their relative price performance against the universe and the general market, a
third score is calculated. The strategy committee, composed of the principals
and senior portfolio managers of the Sub-Adviser, provide the security analysis
to input the earnings estimates, growth rates and risk factors into the model.
The stocks in the universe are then ranked to determine the most attractive,
undervalued companies in the universe. The Portfolio will purchase the top 40 to
50 stocks (Quintile 1), which are the most undervalued, and
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will continue to hold them even if their ranking changes. Stocks are sold when
they are ranked in Quintiles 3, 4 and 5 and replaced by an equal number of
Quintile 1 stocks. Stocks are continuously monitored and rotated so the
Portfolio will always be invested in stocks which show the greatest appreciation
potential. Industry sectors expected to be represented in the Portfolio include
technology, capital goods, basic industry, consumer, energy, health care, media,
interest sensitive, utilities and transportation.
When the Sub-Adviser believes unusual circumstances warrant a defensive posture,
the Portfolio temporarily may commit all or a portion of its assets to cash,
U.S. Government securities or money market instruments, including repurchase
agreements.
DREMAN VALUE PORTFOLIO seeks primarily long-term capital appreciation with a
secondary objective of current income. The Portfolio will invest principally in
a diversified portfolio of securities believed by Dreman Value Advisors, Inc.
(Dreman), the Sub-Adviser for the Portfolio, to be undervalued. The Sub-
Adviser's philosophy centers on identifying stocks of large, well-known
companies with solid financial strength and generous dividend yields that have
low price-earnings ratios (P/E ratios) and have been generally overlooked by the
market. For more information about Dreman, see "Management of the Fund."
The Sub-Adviser's strategy reflects a contrarian approach, in that the potential
for superior relative performance is highest during down markets when investment
risks are greatest and protecting capital becomes of paramount importance. The
Sub-Adviser seeks to outperform the S&P 500 over a market cycle. There is, of
course, no assurance that this goal will be realized.
The Sub-Adviser's basic strategy is to buy low P/E stocks. In addition, the Sub-
Adviser seeks to identify financially strong companies paying above-average
dividends but which are currently out of favor. The Portfolio will normally be
invested in approximately 35 to 45 stocks divided among 16 to 20 industries. The
Sub-Adviser believes that diversification is essential to the low P/E strategy.
After having refined the portfolio candidate universe to a manageable group of
promising stocks, the Sub-Adviser then applies a proprietary fundamental
analysis. Qualifying stocks must generally satisfy certain requirements,
including: a strong financial position, favorable operating and financial
ratios, accelerating earnings growth, and a high dividend yield which a company
can sustain and probably increase.
The next factor considered by the Sub-Adviser is the price-to-book value
relationship. The Portfolio's investments will be principally in companies whose
market prices are low in relation to book value, as the Sub-Adviser seeks solid
assets and value rather than paying a high price for a concept or fad. Another
characteristic sought by the Sub-Adviser is low or sharply declining
institutional ownership. The Sub-Adviser believes that this is a sign of a stock
that is falling out of favor from Wall Street's point of view and becoming
relatively cheap.
The Sub-Adviser also analyzes debt-to-equity ratios to confirm that there is a
manageable amount of debt on a company's balance sheet, usually no more than
40%. The Sub-Adviser devotes attention to reviewing cash and current ratios to
be certain that the Portfolio's potential investments have strong staying power
and can self-finance should the need arise.
Generally, the Sub-Adviser seeks companies with better than average growth rates
in the last five and ten-year periods for both earnings and dividends. Most
investments will be in securities of domestic companies; however, the Portfolio
may also invest in securities of foreign companies through the acquisition of
ADRs.
In order to conserve assets during periods when the Sub-Adviser believes that
the market for equity securities is unduly speculative or when interest rates
are abnormally high, the Portfolio may invest in U.S. Government securities and
other high-grade, short-term money market instruments, including repurchase
agreements with respect to such instruments. The Portfolio may also purchase and
sell stock index futures contracts and index options. The Portfolio will invest
in stock index futures contracts and index options solely for the purpose of
hedging against changes resulting from market conditions in the values of the
securities held by the Portfolio or securities which it intends to purchase or
sell where such transactions are economically appropriate for the reduction of
risks inherent in the ongoing management of the Portfolio. See "Description of
Various Securities and Investment Techniques."
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ZWEIG EQUITY (SMALL CAP) PORTFOLIO seeks long-term capital appreciation through
investment primarily in Small Company Stocks, consistent with preservation of
capital and reduction of portfolio exposure to market risk, as determined by
Zweig/Glaser, the Sub-Adviser. Current income is not an objective. Small Company
Stocks are the 2,500 stocks positioned immediately after the 500 largest stocks
ranked in terms of market capitalization and/or trading volume, and which are
traded on the NYSE, AMEX or OTC. Currently, the market capitalization of the
2,500 stocks ranges between $7.5 billion and $50 million. Trading volume is
determined by multiplying a stock's average daily shares traded over the last
year by the average price of the stock for that same period. Currently, Small
Company Stocks have an average daily trading volume of approximately $3.0
million. For more information about Zweig/Glaser, see "Management of the Fund."
The extent of the Portfolio's investment in Small Company Stocks and the
selection of particular securities are to be determined primarily on the basis
of risk management strategies and stock selection techniques developed by Dr.
Martin Zweig and his staff. In an effort to meets its investment objective, the
Portfolio will use certain specialized techniques. See "Description of Various
Securities and Investment Techniques." The Portfolio will use stock index
futures and/or options to increase or decrease market exposure, or to entirely
eliminate market exposure, and will invest in high quality money market
securities, repurchase agreements, and U.S. Government securities with remaining
maturities of 5 years or less, in accordance with the Sub-Adviser's risk
management strategies.
The Sub-Adviser will use a computer-driven stock selection model developed by
Dr. Zweig and his staff that evaluates approximately 3,000 stocks for their
attractiveness by various measures such as earnings momentum, relative
valuation, changes in analysts' earnings estimates and price momentum. Small
Company Stocks may present greater opportunities for capital appreciation and
greater risk; and they tend to be more volatile than stocks of larger, more
established companies.
Although the Portfolio will invest primarily in Small Company Stocks, it may
invest up to 35% of its total assets in stocks that rank among the 500 largest
in terms of market capitalization and/or trading volume. The stock selection
model and risk management strategies used by the Sub-Adviser may evolve or be
replaced by other stock selection techniques or risk management strategies
intended to achieve the Portfolio's investment objective. Shareholders will be
notified in advance of any such material change.
Under normal circumstances, the Portfolio will invest between 50% and 65% of its
net assets in Small Company Stocks.
The Portfolio may invest in foreign securities publicly traded in the U.S. and
in ADRs. For a discussion of limitations on, and certain risks involved in,
investments in foreign securities, see "Descriptions of Various Securities and
Investment Techniques."
PINNACLE FIXED INCOME PORTFOLIO seeks as high a level of current income as is
consistent with the preservation of capital. The Portfolio invests primarily in
corporate debt securities; U.S. Government securities (including mortgage-backed
securities issued by the Government National Mortgage Association, the Federal
National Mortgage Association, and the Federal Home Loan Mortgage Corporation);
obligations of other governmental issuers such as the Federal Farm Credit System
and the Federal Home Loan Banks; asset-backed securities; repurchase agreements
with respect to securities in which the Portfolio may invest; and instruments
used in certain hedging and related income strategies. The Portfolio may also
invest in certain private placements and in debt securities of foreign
governments and governmental entities. See "Description of Various Securities
and Investment Techniques." The Portfolio will principally invest in securities
rated at least investment grade, or, if not rated, determined by the Sub-Adviser
to be of comparable quality. However, the Portfolio may invest up to 15% of its
total assets in securities rated below investment grade or of equivalent
quality, if not rated, including defaulted securities. Lower rated securities
involve greater risks than do higher rated securities, in that they are
especially subject to adverse changes in general conditions and in the
industries in which the issuers are engaged, to changes in the financial
condition of the issuers and to price fluctuation in response to changes in
interest rates. For a more in-depth discussion of the risks inherent in
investing in lower quality debt securities, see "Description of Various
Securities and Investment Techniques -- Debt Securities." J.P. Morgan Investment
Management Inc.
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(J.P. Morgan) is the Sub-Adviser to the Portfolio. For more information about
J.P. Morgan, see "Management of the Fund."
The Sub-Adviser may purchase money market instruments as part of its management
of the Portfolio's duration, to invest temporary cash balances or to maintain
liquidity to meet redemptions. However, the Portfolio may also invest in money
market instruments without limitation as a temporary defensive measure taken in
the Sub-Adviser's judgment during, or in anticipation of, adverse market
conditions. These money market investments include obligations of the U.S.
Government and its agencies and instrumentalities, other debt securities,
commercial paper, bank obligations and repurchase agreements.
The Portfolio may engage in certain strategies involving options (both exchange-
traded and OTC) to attempt to enhance income. The Portfolio also may attempt to
reduce the overall risk of its investments (hedge) by using options and futures
contracts. The Portfolio also may use forward currency contracts and foreign
currency options, futures contracts and options thereon to attempt to hedge
against movements in exchange rates. The Portfolio's ability to use these
strategies may be limited by market conditions, regulatory limits and tax
considerations. For more information about these investment techniques and the
special risks related thereto, see "Description of Various Securities and
Investment Techniques."
J.P. Morgan uses a sophisticated, disciplined, collaborative process for
managing all asset classes. For fixed income portfolios, this process focuses on
systematic analysis of real interest rates, sector diversification, and
quantitative and credit analysis.
J.P. Morgan actively manages the Portfolio's duration, the allocation of
securities across market sectors, and the selection of specific securities
within sectors. Based on fundamental, economic and capital markets research,
J.P. Morgan adjusts the duration of the Portfolio in light of market conditions
and J.P. Morgan's interest rate outlook. For example, if interest rates are
expected to fall, the duration may be lengthened to take advantage of the
expected associated increase in bond prices. J.P. Morgan also actively allocates
the Portfolio's assets among the broad sectors of the fixed income market
including, but not limited to, U.S. Government and agency securities, corporate
securities, private placements, asset-backed and mortgage-related securities.
Specific securities which J.P. Morgan believes are undervalued are selected for
purchase within the sectors using advanced quantitative tools, analysis of
credit risk, the expertise of a dedicated trading desk, and the judgment of
fixed income portfolio managers and analysts. Under normal circumstances, J.P.
Morgan intends to keep the Portfolio essentially fully invested with at least
65% of the Portfolio's assets invested in fixed income securities.
Duration is a measure of the weighted average maturity of the bonds held in the
Portfolio and can be used as a measure of the sensitivity of the Portfolio's
market value to changes in interest rates. Generally, the longer the duration of
the Portfolio, the more sensitive its market value will be to changes in
interest rates. Under normal market conditions the Portfolio's duration will
range between one year shorter and one year longer than the duration of the U.S.
investment grade fixed income universe, as represented by Salomon Brothers Broad
Investment-Grade Bond Index. Currently, the index's duration is approximately
4.5 years. The maturities of the individual securities in the Portfolio may vary
widely, however.
J.P. Morgan intends to manage the Portfolio actively in pursuit of the
Portfolio's investment objective. Portfolio transactions are undertaken
principally to accomplish the Portfolio's objective in relation to expected
movements in the general level of interest rates, but the Portfolio may also
engage in short-term trading consistent with its objective. To the extent the
Portfolio engages in short-term trading, it may realize short-term capital gains
or losses and incur increased transaction costs.
ARM CAPITAL ADVISORS MONEY MARKET PORTFOLIO seeks maximum current income
consistent with liquidity and conservation of capital. The Portfolio invests in
high grade money market instruments, with remaining maturities of 13 months or
less, and repurchase agreements secured by such instruments, and maintains a
dollar-weighted average portfolio maturity of 90 days or less. These instruments
include (1) U.S. Government securities (which may or may not be backed by the
full faith and credit of the United States), (2) obligations (including
certificates of deposit, bankers' acceptances and similar obligations) of U.S.
banks, including foreign branches of domestic banks and domestic branches of
foreign banks, having total assets in excess of $1.5 billion at the time of
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purchase, (3) interest-bearing savings deposits in U.S. commercial and savings
banks having total assets of $1.5 billion or less, provided that the principal
amounts at each such bank are fully insured by the Federal Deposit Insurance
Corporation and the aggregate amount of such deposits (plus interest earned)
does not exceed 5% of the Portfolio's asset value, and (4) commercial paper and
other short-term corporate obligations, corporate bonds and notes with remaining
maturities of 13 months or less, variable and floating rate securities and
participation interests (pro rata interests in securities held by others) or
repurchase agreements involving any of the foregoing securities. The Manager is
the sole investment adviser for the Money Market Portfolio. See "Management of
the Fund."
The commercial paper and other short-term corporate obligations purchased by the
Portfolio consist only of obligations that the Sub-Adviser determines, pursuant
to procedures adopted by the Fund's Board of Directors, present minimal credit
risks and are either (1) rated in the highest short-term rating category by at
least two NRSROs, (2) rated in the highest short-term rating category by a
single NRSRO if only that NRSRO has assigned the obligations a short-term rating
or (3) unrated, but determined by the Sub-Adviser to be of comparable quality
(First Tier Securities). The Portfolio generally may invest no more than 5% of
its total assets in the securities of a single issuer (other than securities
issued by the U.S. Government, its agencies or instrumentalities). For a
discussion of U.S. Government securities and repurchase agreements, see
"Description of Various Securities and Investment Techniques."
AN INVESTMENT IN THE ARM CAPITAL ADVISORS MONEY MARKET PORTFOLIO IS NEITHER
INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT, AND THERE CAN BE NO ASSURANCE
THAT THE MONEY MARKET PORTFOLIO WILL BE ABLE TO MAINTAIN A STABLE NET ASSET
VALUE OF $1.00 PER SHARE.
DESCRIPTION OF VARIOUS SECURITIES AND INVESTMENT TECHNIQUES
U.S. GOVERNMENT SECURITIES: Each Portfolio may purchase U.S. Government
securities, which are obligations of, or guaranteed by, the U.S. Government, its
agencies or instrumentalities. These include direct obligations of the U.S.
Treasury (such as Treasury bills, notes and bonds) and obligations issued by
U.S. Government agencies and instrumentalities, including securities that are
supported by the full faith and credit of the United States (such as Government
National Mortgage Association certificates) and securities supported primarily
or solely by the creditworthiness of the issuer (such as securities of the
Federal National Mortgage Association, the Federal Home Loan Mortgage
Corporation and the Tennessee Valley Authority). See "Mortgage-Backed
Securities" below.
MORTGAGE-BACKED SECURITIES: Morgan Stanley Worldwide High Income Portfolio,
Renaissance Balanced Portfolio and Pinnacle Fixed Income Portfolio may invest in
mortgage-backed securities, some of which are also considered to be U.S.
Government securities. Mortgage-backed securities include:
Ginnie Maes -- Ginnie Maes are debt securities issued by a mortgage banker or
other mortgagee and represent an interest in a pool of mortgages insured by the
Federal Housing Administration or the Farmers Home Administration or guaranteed
by the Veterans Administration. The Government National Mortgage Association
(GNMA) guarantees the timely payment of principal and interest. The GNMA
guarantee is backed by the full faith and credit of the U.S. Government.
Fannie Maes -- The Federal National Mortgage Association (FNMA) is a government-
sponsored corporation owned entirely by private stockholders that purchases
residential mortgages from a list of approved seller/servicers. Pass-through
securities issued by FNMA are guaranteed as to timely payment of principal and
interest by FNMA but are not backed by the full faith and credit of the U.S.
Government.
Freddie Macs -- The Federal Home Loan Mortgage Corporation (FHLMC), a corporate
instrumentality of the U.S. Government, issues participation certificates (PCs)
which represent an interest in residential mortgages from FHLMC's National
Portfolio. FHLMC guarantees the timely payment of interest (and, under certain
circumstances, principal) and ultimate collection of principal, but PCs are not
backed by the full faith and credit of the U.S. Government.
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Government Collateralized Mortgage Obligations -- These are securities issued
by a U.S. Government instrumentality or agency which are backed by a
portfolio of mortgages or mortgage-backed securities held under an indenture.
CMOs are described more fully below.
Interest and principal payments (including prepayments) on the mortgages
underlying mortgage-backed securities are passed through to the holders of the
mortgage-backed security. Prepayments occur when the mortgagor on an individual
mortgage prepays all or a portion of the remaining principal before the
mortgage's scheduled maturity date. As a result of the pass-through of
prepayments of principal on the underlying securities, mortgage-backed
securities are often subject to more rapid prepayments of principal than their
stated maturity would indicate. Because the prepayment characteristics of the
underlying mortgages vary, it is not possible to predict accurately the realized
yield or average life of a particular issue of pass-through certificates.
Prepayments are important because of their effect on the yield and price of the
securities. During periods of declining interest rates, such prepayments can be
expected to accelerate and a Portfolio might have to reinvest the proceeds at
the lower interest rates then available. In addition, prepayments of mortgages
which underlie securities purchased at a premium could result in capital losses
because the premium may not have been fully amortized at the time the obligation
is repaid. As a result of these principal payment features, mortgage-backed
securities are generally more volatile investments than other U.S. Government
securities.
A CMO is a security issued by a private corporation or a U.S. Government
instrumentality which is backed by a portfolio of mortgages or mortgage-backed
securities held under an indenture. The issuer's obligation to make interest and
principal payments is secured by the underlying portfolio of mortgages or
mortgage-backed securities. CMOs are issued with a number of classes or series
which have different maturities and which may represent interests in some or all
of the interest or principal on the underlying collateral or a combination
thereof. CMOs of different classes are generally retired in sequence as the
underlying mortgage loans in the mortgage pool are repaid. In the event of
sufficient early prepayments on such mortgages, the class or series of CMO first
to mature generally will be retired prior to its maturity. Thus, the early
retirement of a particular class or series of CMO held by a Portfolio would have
the same effect as the prepayment of mortgages underlying a mortgage-backed
pass-through security. Except as described below, the Portfolios may invest in
only those privately-issued CMOs which are collateralized by mortgage-backed
securities issued by GNMA, FHLMC or FNMA, and in CMOs issued by a U.S.
Government agency or instrumentality.
Certain issuers of CMOs may be deemed to be investment companies under the 1940
Act. The Portfolios intend to conduct their operations in a manner consistent
with this view, and therefore generally may not invest more than 10% of their
respective total assets in such issuers without obtaining appropriate regulatory
relief. In reliance on recent Securities and Exchange Commission (SEC) staff
interpretations, the Portfolios may invest in those CMOs and other mortgage-
backed securities that are not by definition excluded from the provisions of the
1940 Act, but have obtained exemptive orders from the SEC from such provisions.
Morgan Stanley Worldwide High Income Portfolio and Pinnacle Fixed Income
Portfolio may also invest in a type of mortgage-backed security issued by a real
estate mortgage investment conduit (REMIC), which is a private entity formed for
the purpose of holding a fixed pool of mortgages secured by an interest in real
property and of issuing multiple classes of interests therein to investors such
as the Portfolios.
Morgan Stanley Worldwide High Income Portfolio and Pinnacle Fixed Income
Portfolio may also invest in zero coupon U.S. Government securities which have
been stripped of their unmatured interest coupons and receipts or in
certificates representing undivided interests in such stripped U.S. Government
securities and coupons. Pinnacle Fixed Income Portfolio may also invest in
certificates representing rights to receive payments of the interest only or
principal only of mortgage-backed securities (IO/PO Strips). Such securities may
also be referred to as derivatives. These securities tend to be more volatile
than other types of U.S. Government securities. IO Strips involve the additional
risk of loss of the entire value of the investment if the underlying mortgages
are prepaid.
REPURCHASE AGREEMENTS: Each Portfolio may enter into repurchase agreements. When
a Portfolio acquires a security from a bank or securities broker-dealer, it may
simultaneously enter into a repurchase agreement, wherein the seller agrees to
repurchase the security at a mutually agreed-upon time (generally within seven
days)
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and price. The repurchase price is in excess of the purchase price by an amount
which reflects an agreed-upon market rate of return, which is not tied to the
coupon rate on the underlying security. Repurchase agreements will be fully
collateralized. If, however, the seller defaults on its obligation to repurchase
the underlying security, the Portfolio may experience delay or difficulty in
exercising its rights to realize upon the security and might incur a loss if the
value of the security has declined. The Portfolio might also incur disposition
costs in liquidating the security.
LOANS OF PORTFOLIO SECURITIES: Each Portfolio, other than the Money Market
Portfolio, may lend its portfolio securities, provided: (1) such loans are
secured continuously by collateral consisting of U.S. Government securities or
cash or cash equivalents maintained on a daily marked-to-market basis in an
amount at least equal to the current market value of the securities loaned; (2)
the Portfolio may at any time call such loans and obtain the return of the
securities loaned; (3) the Portfolio will receive an amount in cash at least
equal to any interest or dividends paid on the loaned securities; and (4) the
aggregate market value of securities loaned will not at any time exceed 10%
(33-1/3% in the case of Morgan Stanley Asian Growth Portfolio, Morgan Stanley
Worldwide High Income Portfolio, Zweig Asset Allocation Portfolio, Zweig Equity
(Small Cap) Portfolio and Pinnacle Fixed Income Portfolio) of the total assets
of the Portfolio.
BORROWING: Each of the Morgan Stanley Asian Growth Portfolio, Renaissance
Balanced Portfolio, Nicholas-Applegate Balanced Portfolio, Harris Bretall
Sullivan & Smith Equity Growth Portfolio, Dreman Value Portfolio, Pinnacle Fixed
Income Portfolio and the Money Market Portfolio may borrow in an amount up to
10% (33-1/3% in the case of Pinnacle Fixed Income Portfolio) of its respective
total assets from banks for extraordinary or emergency purposes such as meeting
anticipated redemptions, and may pledge assets in connection with such
borrowing. Morgan Stanley Worldwide High Income Portfolio may borrow from banks,
and engage in transactions deemed to be borrowings from other entities, in an
amount up to 33-1/3% of its total assets (including the amount borrowed), less
all liabilities and indebtedness other than the borrowing, for extraordinary or
emergency purposes such as meeting anticipated redemptions, as well as for
investment purposes and to pay dividends, and it is expected that all of such
borrowings will be made on a secured basis. Zweig Asset Allocation Portfolio and
Zweig Equity (Small Cap) Portfolio may borrow money from banks on an unsecured
basis and may pay interest thereon in order to raise additional cash for
investment or to meet redemption requests. These two Portfolios may borrow money
if immediately after such borrowing, the amount of all borrowing is not more
than 20% of the market value of the respective Portfolio's assets (including the
proceeds of the borrowing), less liabilities. Each Portfolio is required to
maintain continuous asset coverage of 300% with respect to such borrowings, and
to sell (within three days) sufficient portfolio holdings to restore such
coverage if it should decline to less than 300% due to market fluctuations or
otherwise, even if disadvantageous from an investment standpoint. Leveraging
will exaggerate the effect of any increase or decrease in the value of portfolio
securities on the Portfolios' net asset value, and money borrowed will be
subject to interest costs (which may include commitment fees and/or the cost of
maintaining balances) which may or may not exceed the interest and option
premiums received from the securities purchased with borrowed funds. This
restriction does not prohibit entry into reverse repurchase agreements by Morgan
Stanley Worldwide High Income Portfolio, Renaissance Balanced Portfolio,
Pinnacle Fixed Income Portfolio and the Money Market Portfolio; provided that
Renaissance Balanced Portfolio, Pinnacle Fixed Income Portfolio and the Money
Market Portfolio may not enter into a reverse repurchase agreement if as a
result its current obligations under such agreements would exceed 5% of the
current market value of the Portfolio's total assets (less its liabilities other
than obligations under such agreements). The borrowing restriction also does not
apply to the entry into interest rate protection transactions by Pinnacle Fixed
Income Portfolio. The borrowing policy is a fundamental policy.
PUT, CALL AND INDEX OPTIONS: Morgan Stanley Worldwide High Income Portfolio,
Renaissance Balanced Portfolio, Zweig Asset Allocation Portfolio, Nicholas-
Applegate Balanced Portfolio, Dreman Value Portfolio, Zweig Equity (Small Cap)
Portfolio and Pinnacle Fixed Income Portfolio may purchase put and call options
listed on a national securities exchange. Put and call options are traded on the
AMEX, Chicago Board Options Exchange, Philadelphia Stock Exchange, Pacific Stock
Exchange and NYSE.
A Portfolio may purchase a call on securities to effect a closing purchase
transaction, which is the purchase of a call covering the same underlying
security and having the same exercise price and expiration date as a call
previously written by the Portfolio on which it wishes to terminate its
obligations. If the Portfolio is unable to
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effect a closing purchase transaction, it will not be able to sell the
underlying security until the call previously written by the Portfolio expires
(or until the call is exercised and the Portfolio delivers the underlying
security).
Morgan Stanley Worldwide High Income Portfolio, Renaissance Balanced Portfolio,
Zweig Asset Allocation Portfolio, Zweig Equity (Small Cap) Portfolio and
Pinnacle Fixed Income Portfolio may write call options if the calls written by
any of the Portfolios are covered throughout the life of the option. A call is
covered if a Portfolio (i) owns the optioned securities, (ii) has an immediate
right to acquire such securities, without additional consideration, upon
conversion or exchange of securities currently held in the Portfolio or (iii) in
the case of options on certain U.S. Government securities or which are settled
in cash, the Portfolio maintains, in a segregated account with the custodian,
cash or U.S. Government securities or other appropriate high-grade debt
obligations with a value sufficient to meet its obligations under the call. When
a Portfolio writes a call on a security, it receives a premium and gives the
purchaser the right to buy the underlying security at any time during the call
period at a fixed exercise price regardless of market price changes during the
call period. If the call is exercised, the Portfolio loses the opportunity for
any gain from an increase in the market price of the underlying security over
the exercise price.
Morgan Stanley Worldwide High Income Portfolio, Renaissance Balanced Portfolio,
Zweig Asset Allocation Portfolio, Zweig Equity (Small Cap) Portfolio and
Pinnacle Fixed Income Portfolio also may write listed put options. A Portfolio
may write puts only if they are secured. Zweig Equity (Small Cap) Portfolio also
may write OTC put options. A put is secured if a Portfolio (i) maintains in a
segregated account with the custodian, cash or U.S. Government securities or
other appropriate high-grade debt obligations with a value equal to the exercise
price or (ii) holds a put on the same underlying security at an equal or greater
exercise price. When a Portfolio writes a put, it receives a premium and gives
the purchaser of the put the right to sell the underlying security to the
Portfolio at the exercise price at any time during the option period. The
Portfolio may purchase a put on the underlying security to effect a closing
purchase transaction, except in those circumstances, which are believed by the
Sub-Adviser to be rare, when it is unable to do so.
A Portfolio will realize a gain (or loss) on a closing purchase transaction with
respect to a call or put previously written by the Portfolio if the premium,
plus commission costs, paid by it to purchase the call or put is less (or
greater) than the premium, less commission costs, received by it on the sale of
a call or put. A gain will be realized if a call or a put which the Portfolio
has written lapses unexercised, because the Portfolio would retain the premium.
Morgan Stanley Worldwide High Income Portfolio, Renaissance Balanced Portfolio,
Zweig Asset Allocation Portfolio, Dreman Value Portfolio, Zweig Equity (Small
Cap) Portfolio and Pinnacle Fixed Income Portfolio may purchase and sell
securities index options. One effect of such transactions is to hedge all or
part of the Portfolio's securities holdings against a general decline in the
securities market or a segment of the securities market. Options on securities
indexes are similar to options on stock except that, rather than the right to
take or make delivery of stock at a specified price, an option on a securities
index gives the holder the right to receive, upon exercise of the option, an
amount of cash if the closing level of the securities index upon which the
option is based is greater than, in the case of a call, or less than, in the
case of a put, the exercise price of the option.
A Portfolio's successful use of options on indexes depends upon its ability to
predict the direction of the market and is subject to various additional risks.
The correlation between movements in the index and the price of the securities
being hedged against is imperfect and the risk from imperfect correlation
increases as the composition of the Portfolio diverges from the composition of
the relevant index. Accordingly, a decrease in the value of the securities being
hedged against may not be wholly offset by a gain on the exercise or sale of a
securities index put option held by the Portfolio. For additional discussion of
risks associated with these transactions, see the Statement of Additional
Information.
Morgan Stanley Worldwide High Income Portfolio, Zweig Equity (Small Cap)
Portfolio and Pinnacle Fixed Income Portfolio may purchase and write options on
the OTC market (OTC options). The staff of the SEC has taken the position that
OTC options that are purchased and the assets used as cover for written OTC
options should generally be treated as illiquid securities. However, if a dealer
recognized by the Federal Reserve Bank as a primary dealer in U.S. Government
securities is the other party to an option contract written by a Portfolio
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and that Portfolio has the absolute right to repurchase the option from the
dealer at a formula price established in a contract with the dealer, the SEC
staff has agreed that the Portfolio needs to treat as illiquid only that amount
of the cover assets equal to the formula price less the amount by which the
market value of the security subject to the option exceeds the exercise price of
the option (the amount by which the option is in-the-money). Although the Sub-
Advisers do not believe that OTC options are generally illiquid, pending
resolution of this issue, the Portfolios will conduct their operations in
conformity with the views of the SEC staff.
New forms of option instruments are continuing to evolve and each of the
Portfolios named above may invest in such new option instruments and variations
of existing option instruments, subject to such Portfolio's investment
restrictions. Each of Morgan Stanley Worldwide High Income Portfolio,
Renaissance Balanced Portfolio, Zweig Asset Allocation Portfolio, Nicholas-
Applegate Balanced Portfolio, Dreman Value Portfolio, Zweig Equity (Small Cap)
Portfolio and Pinnacle Fixed Income Portfolio may purchase a put or call option,
including any straddles or spreads, only if the value of its premium, when
aggregated with the premiums on all other options held by the Portfolio, does
not exceed 5% of the Portfolio's total assets. Zweig Asset Allocation Portfolio
and Zweig Equity (Small Cap) Portfolio will each attempt to limit losses from
all options transactions to 5% of its average net assets per year, or cease
options transactions until in compliance with the 5% limitation, but there can
be no absolute assurance of adherence to these limits. The extent to which each
Portfolio may purchase options may be limited by the requirements for
qualification as a regulated investment company under the Internal Revenue Code
of 1986, as amended (the Code), and the Portfolio's intention to qualify as
such.
The Fund's custodian, or a securities depository acting for it, will act as
escrow agent as to the securities on which a Portfolio has written puts or
calls, or as to other securities acceptable for such escrow, so that no margin
deposit will be required of the Portfolio. Until the underlying securities are
released from escrow, they cannot be sold by the Portfolio.
FUTURES CONTRACTS AND RELATED OPTIONS: Morgan Stanley Worldwide High Income
Portfolio, Renaissance Balanced Portfolio, Zweig Asset Allocation Portfolio,
Dreman Value Portfolio, Zweig Equity (Small Cap) Portfolio and Pinnacle Fixed
Income Portfolio may purchase and sell interest rate futures contracts as a
hedge against changes in interest rates. Morgan Stanley Worldwide High Income
Portfolio, Renaissance Balanced Portfolio, Zweig Asset Allocation Portfolio,
Dreman Value Portfolio, Zweig Equity (Small Cap) Portfolio and Pinnacle Fixed
Income Portfolio may purchase and sell stock index futures contracts and Morgan
Stanley Worldwide High Income Portfolio, Renaissance Balanced Portfolio, Zweig
Asset Allocation Portfolio, Zweig Equity (Small Cap) Portfolio and Pinnacle
Fixed Income Portfolio may purchase options on such contracts solely for the
purpose of hedging against the effect that changes in general market conditions,
interest rates and conditions affecting particular industries may have on the
values of securities held in each such Portfolio's portfolio, or which it
intends to purchase, and not for the purpose of speculation.
Generally, if market interest rates increase, the value of outstanding debt
securities declines (and vice versa). Entering into a futures contract for the
sale of securities has an effect similar to the actual sale of securities,
although sale of the futures contract might be accomplished more easily and
quickly. For example, if a Portfolio holds long-term U.S. Government securities
and the Sub-Adviser anticipates a rise in long-term interest rates, it could, in
lieu of disposing of its portfolio securities, enter into futures contracts for
the sale of similar long-term securities. If rates increased and the value of
the Portfolio's securities declined, the value of the Portfolio's futures
contracts would increase, thereby protecting the Portfolio by preventing the net
asset value from declining as much as it otherwise would have. Similarly,
entering into futures contracts for the purchase of securities has an effect
similar to the actual purchase of the underlying securities, but permits the
continued holding of securities other than the underlying securities. For
example, if the Sub-Adviser expects long-term interest rates to decline, the
Sub-Adviser might enter into futures contracts for the purchase of long-term
securities so that it could gain rapid market exposure that may offset
anticipated increases in the costs of securities it intends to purchase, while
continuing to hold higher-yielding short-term securities or waiting for the
long-term market to stabilize.
A stock index futures contract is an agreement in which one party agrees to
deliver to the other an amount of cash equal to a specific dollar amount
multiplied by the difference between the value of a specific stock index at the
close of the last trading day of the contract and the price at which the
agreement is made. No physical delivery of securities is made. The writing of a
put option on a futures contract is similar to the purchase of the futures
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contract, except that, if the market price declines, the Portfolio would pay
more than the market price for the underlying securities. The net cost to the
Portfolio would be reduced, however, by the premium received on the sale of the
put, less any transaction costs.
There is no assurance that it will be possible, at any particular time, to close
a futures position. In the event that a Portfolio could not close a futures
position and the value of the position declined, the Portfolio would be required
to continue to make daily cash payments of maintenance margin. There can be no
assurance that hedging transactions will be successful, as there may be an
imperfect correlation (or no correlation) between movements in the prices of the
futures contracts and of the securities being hedged, or price distortions due
to conditions in the futures markets because futures markets may have daily
market price movement limits for futures contracts. Where futures contracts are
purchased to hedge against an increase in the price of long-term securities, but
the long-term market declines and a Portfolio does not invest in long-term
securities, the Portfolio would realize a loss on the futures contracts, which
would not be offset by a reduction in the price of securities purchased. Where
futures contracts are sold to hedge against a decline in the price of long-term
securities in a Portfolio, but the long-term market advances, the Portfolio
would lose part or all of the benefit of the advance due to offsetting losses in
its futures positions. Successful use of futures contracts by a Portfolio is
subject to the Sub-Adviser's ability to predict correctly movements in the
direction of interest rates, currency exchange rates, market prices and other
factors affecting markets for debt securities.
A Portfolio may not enter into futures contracts or purchase or write related
options unless it complies with rules and interpretations of the Commodity
Futures Trading Commission (CFTC) which require, among other things, that
futures and related options be used solely for bona fide hedging purposes, as
defined in CFTC regulations or, alternatively, that the Portfolio will not enter
into futures and related options transactions if the sum of the aggregate
initial margin deposits on futures contracts and premiums paid for related
options exceeds 5% of the market value of the Portfolio's total assets
(calculated in accordance with CFTC regulations).
ILLIQUID SECURITIES: Each Portfolio may invest up to 10% (15% in the case of
Morgan Stanley Asian Growth Portfolio, Morgan Stanley Worldwide High Income
Portfolio, Renaissance Balanced Portfolio, Zweig Asset Allocation Portfolio and
Zweig Equity (Small Cap) Portfolio) of its net assets in illiquid securities,
including securities the disposition of which is restricted under Federal
securities laws, securities which are not readily marketable, OTC options,
repurchase agreements which have a maturity of longer than seven days and, in
the case of Morgan Stanley Worldwide High Income Portfolio, certain loan
participations and assignments and structured financings. Securities that are
freely marketable in the countries where they are principally traded, but that
would not be freely marketable in the United States, will not be considered
illiquid. The Portfolios will not include, for purposes of the percentage
restrictions on illiquid investments described above, securities sold pursuant
to Rule 144A under the Securities Act of 1933 (Rule 144A Securities) so long as
such securities meet liquidity guidelines established by the Fund's Board of
Directors.
FOREIGN SECURITIES AND DEPOSITARY RECEIPTS: Morgan Stanley Asian Growth
Portfolio and Morgan Stanley Worldwide High Income Portfolio may each invest
substantially all of their assets in securities of foreign issuers. Zweig Asset
Allocation Portfolio and Zweig Equity (Small Cap) Portfolio may invest up to 15%
of the value of their net assets in securities of foreign issuers. Nicholas-
Applegate Balanced Portfolio may invest up to 20% of its total assets in
securities of foreign issuers. Pinnacle Fixed Income Portfolio may invest up to
10% of its net assets in securities of foreign issuers.
Each Portfolio named above and Dreman Value Portfolio may purchase ADRs, which
are dollar-denominated receipts issued generally by domestic banks and
representing the deposit with the bank of a security of a foreign issuer. ADRs
are not subject to the above percentage limitations. Morgan Stanley Worldwide
High Income Portfolio may also invest in Global Depositary Receipts (GDRs),
European Depositary Receipts (EDRs) and other Depositary Receipts (which,
together with ADRs, GDRs and EDRs, are hereinafter collectively referred to as
Depositary Receipts), to the extent that such Depositary Receipts become
available. GDRs, EDRs and other types of Depositary Receipts (except ADRs) are
typically issued by foreign depositaries, although they may also be issued by
U.S. depositaries, and evidence ownership interests in a security or pool of
securities issued by either a foreign or a U.S. corporation. ADRs are publicly
traded on exchanges or over-the-counter in the United States. ADRs include
American Depositary Shares and New York Shares. Depositary Receipts may be
"sponsored" or
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"unsponsored." Sponsored Depositary Receipts are established jointly by a
depositary and the underlying issuer, whereas unsponsored Depositary Receipts
may be established by a depositary without participation by the underlying
issuer. Holders of unsponsored Depositary Receipts generally bear all the costs
associated with establishing the unsponsored Depositary Receipts. The depositary
of an unsponsored Depositary Receipt is under no obligation to distribute
shareholder communications received from the underlying issuer or to pass
through to the holders of the unsponsored Depositary Receipt voting rights with
respect to the deposited securities or pool of securities. The Portfolios may
invest in sponsored and unsponsored Depositary Receipts. For purposes of Morgan
Stanley Asian Growth and Morgan Stanley Worldwide High Income Portfolios'
investment policies, the Portfolios' investments in Depositary Receipts will be
deemed to be investments in the underlying securities.
Investing in the securities of foreign companies, foreign branches of domestic
banks and foreign governments (see "Foreign Government Securities" and "Foreign
Bank and Foreign Branch Instruments" below) involves special risks and
considerations not typically associated with investing in the United States.
These include differences in accounting, auditing and financial reporting
standards, limited publicly available information with respect to foreign
issuers, generally higher commission rates on foreign portfolio transactions,
the possibility of expropriation or confiscatory taxation, adverse changes in
investment or exchange control regulations, political instability which could
affect U.S. investments in foreign countries, and potential restrictions on the
flow of international capital. There may also be less government supervision and
regulation of foreign securities exchanges, brokers and listed companies than in
the United States. Additionally, dividends payable on foreign securities may be
subject to foreign taxes withheld prior to distribution. Foreign securities
often trade with less frequency and volume than domestic securities and
therefore may exhibit greater price volatility. Changes in foreign exchange
rates will affect the value of those securities which are denominated or quoted
in currencies other than the U.S. dollar.
Investing in securities of issuers in emerging countries, including certain
Asian countries, involves certain considerations not typically associated with
investing in securities of U.S. companies, including (1) restrictions on foreign
investment and on repatriation of capital, (2) currency fluctuations, (3) the
cost of converting foreign currency into U.S. dollars, (4) potential price
volatility and lesser liquidity of shares traded on emerging country securities
markets and (5) political and economic risks, including the risk of
nationalization or expropriation of assets and the risk of war. In addition,
accounting, auditing, financial and other reporting standards in emerging
countries may not be equivalent to U.S. standards, and therefore disclosure of
certain material information may not be made and less information may be
available to investors investing in emerging countries than in the United
States. There is also generally less governmental regulation of the securities
industry in emerging countries than in the United States. Many of these
countries may have less stable political environments than western democracies.
Moreover, it may be more difficult to obtain a judgment in a court outside the
United States. For further information concerning emerging country securities,
see "Foreign Government Securities" and "Asian and Emerging Country Debt
Securities" below and "Investment Policies and Limitations -- Brady Bonds" in
the SAI.
FOREIGN GOVERNMENT SECURITIES. Morgan Stanley Asian Growth Portfolio and Morgan
Stanley Worldwide High Income Portfolio may each invest without limit, and
Renaissance Balanced Portfolio and Pinnacle Fixed Income Portfolio may invest up
to 10% of their respective total assets, in obligations supported by national,
state or provincial governments or similar political subdivisions. Foreign
government securities also include debt obligations of supranational entities,
which include international organizations designated or supported by
governmental entities to promote economic reconstruction or development,
international banking institutions and related government agencies. Examples
include the World Bank, the European Coal and Steel Community, the Asian
Development Bank and the InterAmerican Development Bank.
Foreign government securities also include debt securities of quasi-governmental
agencies and debt securities denominated in multinational currency units of an
issuer (including supranational issuers). An example of a multinational currency
unit is the European Currency Unit. A European Currency Unit represents
specified amounts of the currencies of certain member states of the European
Economic Community. Debt securities of quasi-governmental agencies are issued by
entities owned by either a national, state or equivalent government or are
obligations of a political unit that is not backed by the national government's
full faith and credit and general taxing powers. Foreign government securities
also include mortgage-related securities issued or
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guaranteed by national, state or equivalent governmental instrumentalities,
including quasi-governmental agencies.
Investments in emerging country government debt securities involve special
risks. Certain emerging countries have historically experienced, and may
continue to experience, high rates of inflation, high interest rates, exchange
rate fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. The issuer or governmental
authority that controls the repayment of an emerging country's debt may not be
able or willing to repay the principal and/or interest when due in accordance
with the terms of such debt. As a result of the foregoing, a government obligor
may default on its obligations. If such an event occurs, the Portfolio may have
limited legal recourse against the issuer and/or guarantor. Remedies must, in
some cases, be pursued in the courts of the defaulting party itself, and the
ability of the holder of foreign government debt securities to obtain recourse
may be subject to the political climate in the relevant country. In addition, no
assurance can be given that the holders of commercial bank debt will not contest
payments to the holders of other foreign government debt obligations in the
event of default under their commercial bank loan agreements.
See "Foreign Securities and Depositary Receipts" above for a discussion of
additional risks of investing in foreign government securities.
FOREIGN BANK AND FOREIGN BRANCH INSTRUMENTS. Morgan Stanley Asian Growth
Portfolio, Morgan Stanley Worldwide High Income Portfolio and the Money Market
Portfolio may invest in obligations of domestic branches of foreign banks and
foreign branches of domestic banks. Such investments may involve risks that are
different from investments in obligations of U.S. branches of domestic banks.
These risks may include future unfavorable political and economic developments,
possible withholding taxes, seizure of foreign deposits, currency controls,
interest limitations or other governmental restrictions that might affect the
payment of principal or interest on the securities held by the Portfolio.
Additionally, there may be less publicly available information about foreign
banks and foreign branches of U.S. banks, as these institutions may not be
subject to the same regulatory requirements as domestic banks.
FOREIGN CURRENCY TRANSACTIONS: Morgan Stanley Asian Growth Portfolio may enter
into foreign currency forward contracts. Morgan Stanley Worldwide High Income
Portfolio and Pinnacle Fixed Income Portfolio may enter into foreign currency
forward contracts, foreign currency futures contracts and foreign currency
options (as described in additional detail below). These contracts are used to
minimize the risk to the Portfolio from unfavorable changes in the relationship
between the U.S. dollar and foreign currencies.
The Portfolios may engage in foreign currency exchange transactions in
connection with the purchase and sale of portfolio securities (transaction
hedging), and to protect the value of specific portfolio positions (position
hedging). They also may engage in cross-hedging by using forward contracts in
one currency to hedge against fluctuations in the value of securities
denominated in a different currency if the Sub-Adviser anticipates that there
will be a correlation between the two currencies.
If conditions warrant, all of the Portfolios named above may enter into
contracts to purchase or sell foreign currencies at a future date (forward
contracts) and Morgan Stanley Worldwide High Income Portfolio and Pinnacle Fixed
Income Portfolio may purchase and sell foreign currency futures contracts as a
hedge against changes in foreign currency exchange rates between the trade and
settlement dates on particular transactions and not for speculation. A foreign
currency forward contract is a negotiated agreement to exchange currency at a
future time at a rate or rates that may be higher or lower than the spot (i.e.
cash) rate. Foreign currency futures contracts are standardized exchange-traded
contracts and have margin requirements.
For hedging purposes, Morgan Stanley Worldwide High Income Portfolio and
Pinnacle Fixed Income Portfolio may also purchase exchange-listed and OTC call
and put options on foreign currency futures contracts and on foreign currencies.
A put option on a foreign currency futures contract gives the Portfolio the
right to assume a short position in the futures contract until expiration of the
option. A put option on currency gives the Portfolio the right to sell a
currency at an exercise price until the expiration of the option. A call option
on a foreign currency futures contract gives the Portfolio the right to assume a
long position in the futures contract until the
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expiration of the option. A call option on a currency gives the Portfolio the
right to purchase a currency at the exercise price until the expiration of the
option.
There can be no assurance that any of these strategies, including cross-hedging
techniques, if used by a Portfolio, will be successful. The strategies entail
special risks, including that (1) the skills needed by the Sub-Adviser to employ
hedging instruments are different from those needed to select the Portfolio's
securities, (2) there may not be any correlation, or an imperfect one, between
price movements of hedging instruments and price movements of the securities
being hedged, (3) while hedging strategies may reduce the risk of loss, they
offset favorable price movements in hedged investments, thereby reducing the
opportunity for gain or even resulting in losses, and (4) the Portfolio may be
unable to sell a security at an opportune time, or may be required to sell a
security at a disadvantageous time, due to the need for the Portfolio to
maintain cover or to segregate securities for hedging transactions or to the
inability of the Portfolio to close out its hedged position.
FIRM COMMITMENT AGREEMENTS AND WHEN-ISSUED PURCHASES: Morgan Stanley Asian
Growth Portfolio, Morgan Stanley Worldwide High Income Portfolio, Renaissance
Balanced Portfolio and Pinnacle Fixed Income Portfolio may purchase securities
under a firm commitment agreement or on a when-issued basis. Firm commitment
agreements and when-issued purchases call for the purchase of securities at an
agreed-upon price on a specified future date, and would be used, for example,
when a decline in the yield of securities of a given issuer is anticipated. The
Portfolio as purchaser assumes the risk of any decline in value of the security
beginning on the date of the agreement or purchase. A Portfolio will not enter
into such transactions for the purpose of leveraging, and accordingly will
segregate U.S. Government securities, cash or cash equivalents with its
custodian equal (on a daily marked-to-market basis) to the amount of its
commitment to purchase the when-issued securities and securities subject to the
firm commitment agreement.
DEBT SECURITIES: Renaissance Balanced Portfolio, Nicholas-Applegate Balanced
Portfolio and Pinnacle Fixed Income Portfolio may invest a substantial portion
of their assets in investment grade debt securities, which are debt securities
rated in one of the four highest grades assigned by S&P or Moody's or, if
unrated, determined by the Sub-Adviser to be of comparable quality to securities
having such a rating. Debt securities rated BBB or higher by S&P or Baa or
higher by Moody's are investment grade, although Moody's considers debt
securities rated Baa to have speculative characteristics. Changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
for issuers of securities rated BBB or Baa to make principal and interest
payments than issuers of higher rated securities. See Appendix A for a
description of ratings assigned by S&P and Moody's.
Morgan Stanley Worldwide High Income Portfolio may invest without limit, and
Pinnacle Fixed Income Portfolio may invest up to 15% of its total assets, in
securities rated below investment grade, including securities rated in the
lowest grades of S&P (D) or Moody's (C) or in unrated securities of comparable
quality. Securities rated BB or Ba or lower (and comparable unrated securities)
are commonly referred to as junk bonds. Securities rated D by S&P are in
default.
Debt securities rated below investment grade are considered by the rating
agencies to be predominantly speculative regarding the issuer's ability to pay
interest and repay principal and may also be subject to price volatility due to
such factors as interest rate sensitivity, market perception of the
creditworthiness of the issuer and general market liquidity (market risk).
Ratings of debt securities represent the rating agency's opinion regarding
quality of the securities, but are not a guarantee of quality and may be reduced
after a Portfolio has acquired the security. The Sub-Adviser will consider such
an event in determining whether the Portfolio should continue to hold the
security. Also, rating agencies may fail to make timely changes in response to
subsequent events, so that an issuer's financial condition may be better or
worse than the rating indicates. Lower rated debt securities generally offer a
higher current yield than that available from higher grade issues. However,
lower rated securities involve higher risks, in that they are especially subject
to adverse changes in general conditions and in the industries in which the
issuers are engaged, to changes in the financial condition of the issuers and to
price fluctuation in response to changes in interest rates. During periods of
economic downturn or rising interest rates, highly leveraged issuers may
experience financial stress which could adversely affect their ability to make
payments of principal and interest and increase the possibility of default. In
addition, the market for lower rated securities has expanded rapidly in recent
years, and its growth paralleled a long economic expansion. Recently,
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the prices of many lower rated debt securities declined substantially,
reflecting an expectation that many issuers of such securities might experience
financial difficulties. As a result, the yields on lower rated debt securities
rose dramatically, but such higher yields did not reflect the value of the
income stream that holders of such securities expected, but rather the risk that
holders of such securities could lose a substantial portion of their value as a
result of the issuers' financial restructuring or default. There can be no
assurance that such declines will not recur. The market for lower rated debt
securities may be thinner and less active than that for higher quality
securities, which may limit a Portfolio's ability to sell such securities at
fair value in response to changes in the economy or the financial markets.
Adverse publicity and investor perceptions, whether or not based on fundamental
analysis, may also decrease the values and liquidity of lower rated securities,
especially in a thinly traded market. In addition, the prices for lower rated
debt securities may be affected by legislative and regulatory developments.
ASIAN AND EMERGING COUNTRY SECURITIES: Morgan Stanley Asian Growth Portfolio and
Morgan Stanley Worldwide High Income Portfolio define Asian securities and
emerging country securities, respectively, to include securities of companies
that may have characteristics and business relationships common to companies in
a country or countries other than an Asian or emerging country. As a result, the
value of the securities of such companies may reflect economic and market forces
applicable to other countries, as well as to an Asian or emerging country. Each
Portfolio may invest in companies organized and located in countries other than
an Asian or emerging country, respectively, including companies having their
entire production facilities outside of an Asian or emerging country when
securities of such companies meet one or more elements of the Portfolio's
definition of an Asian or emerging country security and so long as the Sub-
Adviser believes at the time of investment that the value of the company's
securities will reflect principally conditions in such Asian or emerging
country.
SHORT SALES: Morgan Stanley Worldwide High Income Portfolio, Renaissance
Balanced Portfolio, Zweig Asset Allocation Portfolio, Nicholas-Applegate
Balanced Portfolio and Zweig Equity (Small Cap) Portfolio may engage in short
sales. When a Portfolio makes a short sale, it sells a security it does not own
in anticipation of a decline in market price. The proceeds from the sale are
retained by the broker until the Portfolio replaces the borrowed security. To
deliver the security to the buyer, the Portfolio must arrange through a broker
to borrow the security and, in so doing, the Portfolio will become obligated to
replace the security borrowed at its market price at the time of replacement,
whatever that price may be. The Portfolio may have to pay a premium to borrow
the security. The Portfolio may, but will not necessarily, receive interest on
such proceeds. The Portfolio must pay to the broker any dividends or interest
payable on the security until it replaces the security.
The Portfolio's obligation to replace the security borrowed will be secured by
collateral deposited with the broker, consisting of cash or U.S. Government
securities or other securities acceptable to the broker. In addition, the
Portfolio will be required to deposit cash or U.S. Government securities as
collateral in a segregated account with its custodian in an amount such that the
value of both collateral deposits is at all times equal to at least 100% of the
current market value of the securities sold short. The Portfolio will receive
the interest accruing on any U.S. Government securities held as collateral in
the segregated account with the custodian. The deposits do not necessarily limit
the Portfolio's potential loss on a short sale, which may exceed the entire
amount of the collateral deposits.
If the price of a security sold short increases between the time of the short
sale and the time the Portfolio replaces the borrowed security, the Portfolio
will incur a loss, and if the price declines during this period, the Portfolio
will realize a capital gain. Any realized capital gain will be decreased, and
any incurred loss increased, by the amount of transaction costs and any premium,
dividend, or interest which the Portfolio may have to pay in connection with
such short sale.
The Portfolios may enter into short sales against the box. A short sale is
against the box when, at all times during which a short position is open, the
Portfolio owns an equal amount of such securities, or owns securities giving it
the right, without payment of future consideration, to obtain an equal amount of
securities sold short.
WARRANTS: Morgan Stanley Asian Growth Portfolio, Morgan Stanley Worldwide High
Income Portfolio, Renaissance Balanced Portfolio, Zweig Asset Allocation
Portfolio, Nicholas-Applegate Balanced Portfolio and Zweig Equity (Small Cap)
Portfolio may invest in warrants, which are basically an option to purchase
securities
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at a specific price valid for a specific period of time. Warrants have no voting
rights, pay no dividends, and have no rights with respect to the assets of the
corporation issuing them. It should also be noted that the prices of warrants do
not necessarily move parallel to the prices of the underlying securities. A
Portfolio may not invest more than 5% of its net assets (at the time of
investment) in warrants (other than those attached to other securities). It
should be noted that if the market price of the underlying security never
exceeds the exercise price, the Portfolio will lose the entire investment in the
warrant. Moreover, if a warrant is not exercised within the specified time
period, it will become worthless and the Portfolio will lose the purchase price
and the right to purchase the underlying security.
REVERSE REPURCHASE AGREEMENTS: Morgan Stanley Worldwide High Income Portfolio,
Renaissance Balanced Portfolio, Pinnacle Fixed Income Portfolio and the Money
Market Portfolio may enter into reverse repurchase agreements. A reverse
repurchase agreement involves the sale of a money market instrument by the
Portfolio, coupled with its agreement to repurchase the instrument at a
specified time and price. The Portfolio will maintain a segregated account with
its custodian consisting of U.S. Government securities or cash or cash
equivalents equal (on a daily marked-to-market basis) to its obligations under
reverse repurchase agreements with broker-dealers (but not banks). The Portfolio
will invest the proceeds in other money market instruments or repurchase
agreements maturing simultaneously with or prior to the expiration of the
reverse repurchase agreement or which are held under an agreement to resell
maturing as of that time. However, reverse repurchase agreements involve the
risk that the market value of securities retained by the Portfolio may decline
below the repurchase price of the securities sold by the Portfolio which it is
obligated to repurchase. Under the 1940 Act, reverse repurchase agreements may
be considered to be borrowings by the seller. Renaissance Balanced Portfolio,
Pinnacle Fixed Income Portfolio and the Money Market Portfolio may not enter
into a reverse repurchase agreement if as a result its current obligations under
such agreements would exceed 5% of the current market value of the Portfolio's
total assets (less its liabilities other than obligations under such
agreements).
CONVERTIBLE SECURITIES: Morgan Stanley Asian Growth Portfolio, Morgan Stanley
Worldwide High Income Portfolio, Renaissance Balanced Portfolio and Pinnacle
Fixed Income Portfolio may invest in convertible securities. These securities
normally provide a higher yield than the underlying stock but lower than a
fixed-income security without the convertibility feature. Also, the price of the
convertible security will normally vary to some degree with changes in the price
of the underlying stock although the higher yield tends to make the convertible
security less volatile than the underlying common stock. In addition, the price
of the convertible security will also vary to some degree inversely with
interest rates. Convertible securities that are rated below BBB by S&P or Baa by
Moody's or comparable unrated securities as determined by the Sub-Adviser may
share some or all of the risks of debt securities rated below investment grade.
For a description of these risks, see "Debt Securities" above.
INTEREST RATE PROTECTION TRANSACTIONS: Pinnacle Fixed Income Portfolio may enter
into interest rate protection transactions, including interest rate swaps and
interest rate caps, collars and floors. Interest rate swap transactions involve
an agreement between two parties to exchange payments that are based,
respectively, on variable and fixed rates of interest and that are calculated on
the basis of a specified amount of principal (the notional principal amount) for
a specified period of time. Interest rate cap and floor transactions involve an
agreement between two parties in which the first party agrees to make payments
to the counterparty when a designated market interest rate goes above (in the
case of a cap) or below (in the case of a floor) a designated level on
predetermined dates or during a specified time period. Interest rate collar
transactions involve an agreement between two parties in which the first party
makes payments to the counterparty when a designated market interest rate goes
above a designated level of predetermined dates or during a specified time
period, and the counterparty makes payments to the first party when a designated
market interest rate goes below a designated level on predetermined dates or
during a specified time period.
The Portfolio expects to enter into interest rate protection transactions to
preserve a return or spread on a particular investment or portion of its
portfolio or to protect against any increase in the price of securities the
Portfolio anticipates purchasing at a later date. The Portfolio intends to use
these transactions as a hedge and not as a speculative investment. There can be
no assurance that the objective of these strategies and techniques will be
achieved.
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The Portfolio may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest rate
swaps on a net basis, i.e., the two payment streams are netted out, with the
Portfolio receiving or paying, as the case may be, only the net amount of the
two payments. Inasmuch as these interest rate protection transactions are
entered into for good faith hedging purposes, and inasmuch as segregated
accounts will be established with respect to such transactions, the Sub-Adviser
and the Portfolio believe such obligations do not constitute senior securities
and accordingly, will not treat them as being subject to its borrowing
restrictions. The net amount of the excess, if any, of the Portfolio's
obligations over its entitlements with respect to each interest rate swap will
be accrued on a daily basis and an amount of cash, U.S. Government securities or
other liquid high grade debt obligations having an aggregate net asset value at
least equal to the accrued excess will be maintained in a segregated account by
a custodian that satisfies the requirements of the 1940 Act. The Portfolio also
will establish and maintain such segregated accounts with respect to its total
obligations under any interest rate swaps that are not entered into on a net
basis and with respect to any interest rate caps, collars and floors that are
written by the Portfolio.
The Portfolio will enter into interest rate protection transactions only with
banks and recognized securities dealers believed by the Sub-Adviser to present
minimal credit risks in accordance with guidelines established by the Fund's
Board of Directors. If there is a default by the other party to such a
transaction, the Portfolio will have to rely on its contractual remedies (which
may be limited by bankruptcy, insolvency or similar laws) pursuant to the
agreements related to the transaction. There can be no assurance that the
objective of these strategies and techniques will be achieved.
The swap market has grown substantially in recent years with a large number of
banks and investment banking firms acting both as principals and as agent
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
ASSET-BACKED SECURITIES: Morgan Stanley Worldwide High Income Portfolio and
Pinnacle Fixed Income Portfolio may invest in asset-backed securities (unrelated
to first mortgage loans) which represent fractional interests in pools of
leases, retail installment loans or revolving credit receivables, both secured
(such as Certificates for Automobile Receivables or CARS) and unsecured (such as
Credit Card Receivable Securities or CARDS). These assets are generally held by
a trust and payments of principal and interest or interest only are passed
through monthly or quarterly to certificate holders and may be guaranteed up to
certain amounts by letters of credit issued by a financial institution
affiliated or unaffiliated with the trustee or originator of the trust.
Like mortgages underlying mortgage-backed securities (see "Mortgage-Backed
Securities" above), underlying automobile sales contracts or credit card
receivables are subject to the risk of prepayment, which may reduce the overall
return to certificate holders. Nevertheless, principal repayment rates tend not
to vary much with interest rates and the short-term nature of the underlying car
loans or other receivables tends to dampen the impact of any change in the
prepayment level. Certificate holders may also experience delays in payment on
the certificates if the full amounts due on underlying sales contracts or
receivables are not realized by the trust because of unanticipated legal or
administrative costs of enforcing the contracts or because of depreciation or
damage to the collateral (usually automobiles) securing certain contracts, or
other factors.
If consistent with their investment objective and policies, the Portfolios
indicated above may invest in other asset-backed securities that may be
developed in the future.
Certain asset-backed securities may be deemed to constitute investment companies
under the 1940 Act. Pinnacle Fixed Income Portfolio intends to conduct its
operations in a manner consistent with this view, and therefore the Portfolio
generally may not invest more than 10% of its total assets in such securities
without obtaining appropriate regulatory relief.
LOAN PARTICIPATIONS AND ASSIGNMENTS: Morgan Stanley Worldwide High Income
Portfolio may invest in fixed and floating rate loans (Loans) arranged through
private negotiations between an issuer of sovereign or corporate debt
obligations and one or more financial institutions (Lenders). The Portfolio's
investments in Loans are expected in most instances to be in the form of
participations in Loans (Participations) and assignments of all
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or a portion of Loans (Assignments) from third parties. In the case of
Participations, the Portfolio will have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In the event of the insolvency of the Lender selling a
Participation, the Portfolio may be treated as a general creditor of the Lender
and may not benefit from any set-off between the Lender and the borrower. The
Portfolio will acquire Participations only if the Lender interpositioned between
the Portfolio and the borrower is determined by the Sub-Adviser to be
creditworthy. When the Portfolio purchases Assignments from Lenders it will
acquire direct rights against the borrower on the Loan. Because Assignments are
arranged through private negotiations between potential assignees and potential
assignors, however, the rights and obligations acquired by the Portfolio as the
purchaser of an Assignment may differ from, and be more limited than, those held
by the assigning Lender. The lack of a liquid secondary market may have an
adverse impact on the value of such securities and the Portfolio's ability to
dispose of particular Assignments or Participations when necessary to meet the
Portfolio's liquidity needs or in response to a specific economic event such as
a deterioration in the creditworthiness of the borrower. The lack of a liquid
secondary market for Assignments and Participations also may make it more
difficult for the Portfolio to assign a value to these securities for purposes
of valuing the Portfolio and calculating its net asset value.
STRUCTURED INVESTMENTS: Morgan Stanley Worldwide High Income Portfolio may
invest a portion of its assets in entities organized and operated solely for the
purpose of restructuring the investment characteristics of sovereign debt
obligations. This type of restructuring involves the deposit with or purchase by
an entity, such as a corporation or trust, of specified instruments (such as
commercial bank loans or Brady Bonds) and the issuance by that entity of one or
more classes of securities (Structured Securities) backed by, or representing
interests in, the underlying instruments. The cash flow on the underlying
instruments may be apportioned among the newly issued Structured Securities to
create securities with different investment characteristics such as varying
maturities, payment priorities and interest rate provisions, and the extent of
the payments made with respect to Structured Securities is dependent on the
extent of the cash flow on the underlying instruments. Because Structured
Securities of the type in which the Portfolio anticipates it will invest
typically involve no credit enhancement, their credit risk generally will be
equivalent to that of the underlying instruments. The Portfolio is permitted to
invest in a class of Structured Securities that is either subordinated or
unsubordinated to the right of payment of another class. Subordinated Structured
Securities typically have higher yields and present greater risks than
unsubordinated Structured Securities. Structured Securities are typically sold
in private placement transactions, and there currently is no active trading
market for Structured Securities.
DIVIDENDS, DISTRIBUTIONS AND FEDERAL INCOME TAXES
Net investment income from interest and dividends and substantially all of any
net realized capital gains (which are not offset or eliminated for Federal
income tax purposes) will be declared and paid annually by each Portfolio, other
than the Money Market Portfolio, when results for the fiscal year are known. Net
realized short-term capital gains may be paid annually or more frequently.
The Money Market Portfolio declares as dividends on each Business Day on which
the NYSE is open for business all of its net investment income. Such dividends
are payable to shareholders of record as of the close of regular trading on the
NYSE on the preceding Business Day and are paid monthly. A Business Day is any
weekday on which the NYSE is open for business. Net investment income of the
Portfolio is accrued interest and earned discount, inclusive of both original
issue and market discounts, minus amortization of market premium and applicable
expenses. Net investment income is determined and dividends declared immediately
before the calculation of net asset value per share. The Portfolio normally will
distribute annually any net short-term capital gain when results from the
previous fiscal year are known, but it may make more frequent distributions of
such gain to maintain its net asset value per share at $1.00 or to avoid income
or excise taxes. The Portfolio does not expect to realize any long-term capital
gain.
Dividends from net investment income and net realized capital gains will be
distributed in additional shares of the Portfolio making the distribution.
Dividends or distributions by a Portfolio other than the Money Market Portfolio
(which attempts to maintain a constant $1.00 per share net asset value) reduce
the per share net asset value by the per share amount so paid.
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Each Portfolio intends to qualify as a regulated investment company under
Subchapter M of the Code. In order to qualify as a regulated investment company,
each Portfolio must, among other things, meet certain source of income and
diversification of asset tests. In any fiscal year in which a Portfolio so
qualifies and distributes at least 90% of its investment company taxable income
(which includes, among other items, dividends, interest and net short-term
capital gain in excess of net long-term capital losses), the Portfolio generally
will be relieved of Federal income tax on amounts distributed to shareholders.
See the Statement of Additional Information for more information about this tax
and its applicability to each Portfolio. The tax implications of an investment
in a certificate are described in the prospectus for the certificates.
VALUATION OF SHARES
The net asset value for the shares of each Portfolio will be determined on each
day the NYSE is open for trading. The net assets of each Portfolio are valued as
of the close of business on the NYSE, which currently is 4:00 P.M., Eastern
Standard Time. Each Portfolio's net asset value per share is calculated
separately.
For all Portfolios other than the Money Market Portfolio, the net asset value
per share is computed by dividing the value of the securities held by the
Portfolio plus any cash or other assets, less its liabilities, by the number of
outstanding shares of the Portfolio. Securities holdings which are traded on a
U.S. or foreign securities exchange are valued at the last sale price on the
exchange where they are primarily traded or, if there has been no sale since the
previous valuation, at the mean between the current bid and asked prices. OTC
securities for which market quotations are readily available are valued at the
mean between the current bid and asked prices. Any securities or other assets
for which market quotations are not readily available are valued at fair market
value under the direction of the Board of Directors. Notwithstanding the above,
bonds and other fixed-income securities are valued using market quotations
provided by dealers, including the Sub-Advisers and their affiliates, and also
may be valued on the basis of prices provided by a pricing service when the
Board of Directors believes that such prices reflect the fair market value of
such securities. Money market instruments are valued at market value, except
that instruments maturing in sixty days or less are valued using the amortized
cost method of valuation described below with respect to the Money Market
Portfolio.
For the Money Market Portfolio, net asset value is computed by dividing the
value of the investments and other assets minus liabilities by the number of
shares outstanding. Securities are valued using the amortized cost method of
valuation, which approximates market value. Under this method of valuation, the
difference between the acquisition cost and value at maturity is amortized by
assuming a constant (straight-line) accretion of a discount or amortization of a
premium to maturity. Cash, receivables and current payables are generally
carried at their face value. See the Statement of Additional Information for a
description of certain conditions and procedures followed by the Portfolio in
connection with amortized cost valuation.
When a Portfolio writes a put or call option, the amount of the premium is
included in the Portfolio's assets and an equal amount is included in its
liabilities. The liability thereafter is adjusted to the current market value of
the option. The premium paid for an option purchased by a Portfolio is recorded
as an asset and subsequently adjusted to market value.
PURCHASES AND REDEMPTIONS
Shares of Portfolios of the Fund are offered to separate accounts of Integrity
and National Integrity in connection with certain certificates they issue. Some
Portfolios may not be available in certain states due to applicable state
insurance law and regulations, and not all Portfolios may be available for all
certificates issued by Integrity and National Integrity.
The separate accounts purchase shares of the Portfolios without a sales charge
at the net asset value per share next determined after receipt of the complete
purchase order. Shares of each Portfolio are redeemed at net asset value without
any redemption charge. Payment upon redemption of Fund shares is normally made
within seven days of receipt of such request (unless redemption is suspended or
payment is delayed as permitted in accordance with SEC regulations).
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MANAGEMENT OF THE FUND
THE MANAGER, SUB-ADVISERS AND DISTRIBUTOR
Under Maryland law and the Fund's Articles of Incorporation and By-Laws, the
business and affairs of the Fund are managed under the direction of the Fund's
Board of Directors.
ARM CAPITAL ADVISORS, INC., 200 Park Avenue, 20th Floor, New York, New York
10166, serves as investment manager to all the Portfolios of the Fund. ARM, the
parent of the Manager, is a financial services company providing retail and
institutional products and services to the long-term savings and retirement
market. The Morgan Stanley Leveraged Equity Fund II, L.P., Morgan Stanley
Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P. and MSCP III
892 Investors, L.P., investment funds sponsored by Morgan Stanley Group, Inc.
(Morgan Stanley), own approximately 91% of the outstanding shares of voting
stock of ARM. The address of ARM is 239 S. Fifth Street, Louisville, Kentucky
40202. The address of each of Morgan Stanley and the investment funds sponsored
by it is 1221 Avenue of the Americas, New York, New York 10020.
The Manager assumed the duties and responsibilities of Integrity as investment
manager to the Fund on February 1, 1996, following an internal reorganization.
Both the Manager and Integrity are wholly-owned subsidiaries of ARM. The
transaction involving the transfer of duties and responsibilities to the Manager
did not result in a change in the actual management or control of the investment
manager of the Fund; there was no change in the management or personnel actually
providing advisory services to the Fund; and there was no change in the terms of
the Fund's management agreement, including no change in the compensation
received by the investment manager. The Manager commenced investment advisory
operations on January 5, 1995, on which date it acquired the domestic fixed
income unit of Kleinwort Benson Investment Management Americas Inc. The Manager
is also the investment adviser to the mutual funds comprising the State Bond
Group.
On August 25, 1994, Integrity purchased for its own account approximately
450,000 shares of the Morgan Stanley Worldwide High Income Portfolio, at net
asset value, for an aggregate purchase price of $4.5 million. Integrity has
indicated that it will vote all of the shares that it owns for its own account
in the Portfolio on any matter requiring the vote of shareholders in the same
proportion as votes are cast by certificate holders relating to the Portfolio.
Integrity has also indicated that it intends to redeem its shares on a dollar-
for-dollar basis to the extent, and at the same time as, the Portfolio has sales
in respect of certificate holders. As of March 29, 1996, approximately 105,683
shares, having a fair value of approximately $1.1 million and constituting
approximately 19.9% of the outstanding shares of the Portfolio, were held by
Integrity for its own account.
On April 1, 1996, Integrity purchased for its own account 478,905 shares of the
Pinnacle Fixed Income Portfolio, at net asset value, for an aggregate purchase
price of $5.1 million. As Integrity owned approximately 49.7% of the shares of
the Portfolio as of that date, Integrity may be deemed to control the Portfolio
within the meaning of the 1940 Act. Integrity has indicated that it will vote
all of the shares that it owns for its own account in the Portfolio on any
matter requiring the vote of shareholders in the same proportion as votes are
cast by certificate holders relating to the Portfolio. Integrity has also
indicated that it intends to redeem its shares on a dollar-for-dollar basis to
the extent, and at the same time as, the Portfolio has sales in respect of
certificate holders.
MORGAN STANLEY ASSET MANAGEMENT INC., 1221 Avenue of the Americas, New York, New
York 10020, serves as the Sub-Adviser to Morgan Stanley Asian Growth Portfolio
and Morgan Stanley Worldwide High Income Portfolio. MSAM, a wholly-owned
subsidiary of Morgan Stanley Group, Inc., conducts a worldwide portfolio
management business. It provides a broad range of portfolio management services
to customers in the United States and abroad. At June 30, 1995, MSAM had
investments totaling approximately $52.2 billion under management and fiduciary
advisory control.
James Cheng, Ean Wah Chin and Seah Kiat Seng have primary responsibility for the
Morgan Stanley Asian Growth Portfolio. James Cheng joined MSAM in 1988 as a
portfolio manager for Asian markets and is a Vice President of MSAM, currently
responsible for investments in Hong Kong, China, Taiwan, and South Korea. Mr.
Cheng is also a Principal of Morgan Stanley & Co. Incorporated. Prior to joining
Morgan Stanley, he was affiliated with American Express and with Arthur
Andersen, where he spent three years as an auditor/consultant.
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Mr. Cheng holds an M.B.A. from the University of Michigan, Ann Arbor. Ean Wah
Chin is a Managing Director of Morgan Stanley & Co. Incorporated, and is
responsible for MSAM's regional Asia ex-Japan operations based in Singapore.
Prior to joining Morgan Stanley in 1986, Ms. Chin spent eight years with the
Monetary Authority of Singapore and the Government of Singapore Investment
Corporation, where she was a portfolio manager of one of the largest portfolios
in Asia. Ms. Chin was an ASEAN scholar educated at the University of Singapore.
Seah Kiat Seng joined MSAM's Singapore office in 1990 as a portfolio
manager/analyst specializing in the Southeast Asian markets. He is currently a
Vice President, responsible for investments in Thailand. Previously, Mr. Seng
worked at Barclays de Zoete Wedd (BZW), where he was a senior investment analyst
who helped pioneer BZW's research effort in Singapore. Mr. Seng is a Chartered
Financial Analyst and a qualified real estate valuer who has worked for the
Singapore Ministry of Finance. He was a Colombo Plan Scholar educated in New
Zealand.
Robert Angevine and Paul Ghaffari have primary responsibility for the Morgan
Stanley Worldwide High Income Portfolio. Robert Angevine is a Principal of
Morgan Stanley & Co. Incorporated and the portfolio manager for high yield
investments. Prior to joining Morgan Stanley in October 1988, he spent over
eight years at Prudential Insurance, where he was responsible for the largest
open-end high yield mutual fund in the country. Mr. Angevine also manages high
yield assets for one of the largest corporate pension funds in the country. His
other experience includes international treasury operations at a major
pharmaceutical company and commercial banking. Mr. Angevine received an M.B.A.
from Fairleigh Dickinson University and a B.A. in Economics from Lafayette
College. He served two years as a Lieutenant in the U.S. Army. Paul Ghaffari is
a Principal of Morgan Stanley & Co. Incorporated and portfolio manager for
Morgan Stanley Emerging Markets Debt Fund (a closed-end investment company).
Prior to joining MSAM, he was a Vice President in the Fixed Income Division of
the Emerging Markets Sales and Trading Department at Morgan Stanley. From 1983
to 1992, Mr. Ghaffari worked in the LDC Sales and Trading Department and the
Mortgage-Backed Securities Department at J.P. Morgan & Co., Inc. and worked in
the Treasury department at the Morgan Guaranty Trust Co. He holds a B.A. in
International Relations from Pomona College and a M.S. in Foreign Service from
Georgetown University.
RENAISSANCE INVESTMENT MANAGEMENT, 1700 Young Street, Cincinnati, Ohio 45210,
serves as the Sub-Adviser to the Renaissance Balanced Portfolio. Renaissance is
a recognized leader in providing quantitatively-based investment management
strategies to individual and institutional clients of all types, including
corporate, endowment, religious, foundation, public and Taft-Hartley funds. As
of June 30, 1995, the firm managed in excess of $1.5 billion in assets.
Michael E. Schroer, Managing Director, is responsible for the day-to-day
management of the Renaissance Balanced Portfolio and has been since the
Portfolio's inception. Mr. Schroer has served as Director of Research and as a
portfolio manager at Renaissance since January 1984.
Affiliated Managers Group, Inc. (AMG), a Delaware corporation, is the Managing
General Partner of Renaissance and may be deemed the parent of Renaissance. AMG
was established in December 1993 to obtain investment interests in high quality
investment management firms. AMG may be deemed to be controlled by Advent VII,
L.P., a Delaware limited partnership which is the largest single stockholder of
AMG. The sole general partner of Advent VII, L.P. is TA Associates VII, L.P., a
Delaware limited partnership, and the sole general partner of TA Associates VII,
L.P. is TA Associates, Inc., a Delaware corporation which, together with its
predecessors, has directly or indirectly invested in more than 200 enterprises
prior to its investment in AMG.
ZWEIG/GLASER ADVISERS, 5 Hanover Square, New York, New York 10004, serves as the
Sub-Adviser for the Zweig Asset Allocation Portfolio and Zweig Equity (Small
Cap) Portfolio. Glaser Corp., a Delaware corporation formed by Eugene J. Glaser,
and Zweig Management Corp., a Delaware corporation controlled by Dr. Martin E.
Zweig, are the general partners of Zweig/Glaser. Dr. Zweig is also Chairman of
Zweig/Glaser. He has provided investment advisory and portfolio management
services for 24 years and is currently affiliated with investment advisers,
which, as of June 30, 1995 managed over $9.5 billion in assets, including Avatar
Associates, manager of over $2.3 billion of institutional and pension accounts,
of which Dr. Zweig is Director of Research. Dr. Zweig is also President and
Director of The Zweig Fund, Inc. and the Zweig Total Return Fund, Inc., closed-
end funds traded on the NYSE with combined assets of over $1.1 billion. He is
also author of various investment advisory newsletters, including The Zweig
Forecast, a regular panelist on PBS' television program Wall Street Week with
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Louis Rukeyser for 20 years, and an author of three books: Winning on Wall
Street, The ABC's of Market Forecasting, and Winning with New IRAs. Zweig/Glaser
also manages Zweig Series Trust, an open-end investment company with aggregate
assets as of June 30, 1995 of $2.3 billion (consisting of Zweig Strategy Fund,
Zweig Appreciation Fund, Zweig Managed Assets, Priority Selection List Series,
Government Securities Series and Zweig Cash Fund, Inc.).
Dr. Zweig, who determines the asset allocation strategy for each Portfolio, and
David Katzen, who serves as portfolio manager for each Portfolio, are primarily
responsible for the day-to-day management of the Zweig Asset Allocation
Portfolio and Zweig Equity (Small Cap) Portfolio. Dr. Zweig and Mr. Katzen have
managed the Portfolios since inception. Mr. Katzen is First Vice President of
Zweig/Glaser Advisers and has held various positions with the Zweig organization
during the past six years.
NICHOLAS-APPLEGATE CAPITAL MANAGEMENT, 600 West Broadway, 30th Floor, San Diego,
California 92101, serves as Sub-Adviser to the Nicholas-Applegate Balanced
Portfolio. Founded in 1984, Nicholas-Applegate is a California limited
partnership. The general partner of Nicholas-Applegate is Nicholas-Applegate
Capital Management Holdings, L.P., a California limited partnership controlled
by Arthur E. Nicholas. Nicholas-Applegate provides investment management
services to institutional and individual clients. It serves as sub-adviser for
Nicholas-Applegate Growth Equity Fund and Harbor Growth Fund and as adviser of
Nicholas-Applegate Mutual Funds, open-end investment companies. At June 30,
1995, Nicholas-Applegate had assets under management of $26.1 billion.
The Nicholas-Applegate Balanced Portfolio is managed primarily by John Wylie,
Partner, and Nicholas-Applegate's systems-driven management team. Mr. Wylie
joined Nicholas-Applegate as head of institutional marketing activities in 1987
and has managed fixed income and convertible securities since 1989. He has been
responsible for the management of the fixed income portion of the Portfolio
since its inception. The systems-driven investment management team which manages
the equity portion of the Portfolio has been under the supervision of Lawrence
S. Speidell since March 1994. In overseeing the activities of the entire
Global/Systematic team, Mr. Speidell is responsible for portfolio management and
the development, enhancement and application of the firm's quantitative
disciplines. He also guides the firm's international, domestic and global
research efforts. Prior to joining Nicholas-Applegate in 1994, Mr. Speidell
spent ten years with Batterymarch Financial Management, where his wide-ranging
responsibilities for portfolio management included development of domestic and
international portfolio strategies, portfolio optimization, trading techniques
and client relationships. Mr. Speidell was also Senior Vice President and
Portfolio Manager at Putnam Management Company from 1971 to 1983, and served as
a member of that firm's Investment Policy Committee. He is a past president of
the Boston Securities Analysts Society and a past director of the Investor
Responsibility Research Center in Washington, D.C. Mr. Speidell earned his B.E.
in Mechanical Engineering from Yale University and his M.B.A. from Harvard
University.
HARRIS BRETALL SULLIVAN & SMITH, INC., One Sansone Street, Suite 3300, San
Francisco, California 94104, serves as the Sub-Adviser to the Harris Bretall
Sullivan & Smith Equity Growth Portfolio. Harris Bretall Sullivan & Smith was
founded in 1971 and is owned equally by W. Graeme Bretall, President, John J.
Sullivan, Treasurer, and Henry B. Dunlap Smith. The firm provides investment
management services to institutions and individuals, and at June 30, 1995, had
assets under management of approximately $2.6 billion.
W. Graeme Bretall, CFA, a Principal of Harris Bretall Sullivan & Smith, is the
Partner in charge of the Portfolio. Joseph Calderazzo, Vice President, Portfolio
Manager and Co-Chair of the Investment Committee, is the portfolio manager who
is primarily responsible for the day-to-day management of the assets in the
Harris Bretall Sullivan & Smith Equity Growth Portfolio, and has served in this
function since 1994. During the past five year period, Mr. Bretall has served as
President of Harris Bretall Sullivan & Smith. Mr. Calderazzo joined Harris
Bretall Sullivan & Smith as a Portfolio Manager in 1990, and also serves as the
firm's analyst for Political and Governmental Affairs. While Mr. Calderazzo will
make the final investment buy and sell decisions for the Portfolio, there are
never any deviations from the firm's strategic guidelines. A team approach is
utilized at Harris Bretall Sullivan & Smith so that the consensus decisions made
in the firm's weekly Investment Committee meeting are simultaneously implemented
in all tax-exempt and fully discretionary portfolios.
29
<PAGE>
DREMAN VALUE ADVISORS, INC., 10 Exchange Place, 20th Floor, Jersey City, New
Jersey 07302, serves as the Sub-Adviser to the Dreman Value Portfolio. As of
June 30, 1995, Dreman managed over $1.5 billion. Clients include public funds,
corporate benefit funds, college endowments and foundations, Taft-Hartley funds,
and other institutional accounts. In addition, Dreman serves as investment
adviser to the Kemper-Dreman Mutual Group, Inc., which consists of three
portfolios, Kemper-Dreman Contrarian Fund, Kemper-Dreman High Return Fund, and
Kemper-Dreman Small Cap Fund.
All investment decisions by Dreman for the Dreman Value Portfolio are made by an
investment committee, which includes a group of senior investment professionals.
Dreman, a Delaware corporation, an indirect wholly owned subsidiary of Zurich
Insurance Company (Zurich), was formed in August, 1995 in order to purchase
substantially all of the assets of Dreman Value Management, L.P., Dreman's
predecessor organization. Founded in 1872, Zurich is a multinational, public
corporation organized under the laws of Switzerland. Zurich's primary business
is as an insurer. Together with its predecessor organizations, Dreman has been
in the investment management business since 1977.
J.P. MORGAN INVESTMENT MANAGEMENT INC., 522 Fifth Avenue, New York, New York
10036, serves as the Sub-Adviser for the Pinnacle Fixed Income Portfolio. J.P.
Morgan is a wholly owned subsidiary of J.P. Morgan & Co. Incorporated, a bank
holding company organized under the laws of Delaware. J.P. Morgan offers a wide
range of investment management services and acts as investment adviser to
corporate and institutional clients. As of December 31, 1995, J.P. Morgan had
assets under management of over $139 billion.
The following persons are primarily responsible for the day-to-day management
and implementation of J.P. Morgan's process for Pinnacle Fixed Income Portfolio
(their business experience for the past five years is indicated
parenthetically): Ronald Arons, Vice President (employed by J.P. Morgan since
September 1994, previously a portfolio manager with MetLife Investment
Management Corp.) and Arun Lyng, Vice President (employed by J.P. Morgan since
March 1992, previously a portfolio manager with Aetna Capital Markets).
Prior to April 1, 1996, Pinnacle Fixed Income Portfolio (formerly called
Mitchell Hutchins Fixed Income Portfolio) had as its Sub-Adviser Mitchell
Hutchins Institutional Investors, Inc.
Each Portfolio pays the Manager a fee based on an annual percentage of the
average daily net assets of such Portfolio. The management fees are deducted
from the assets of each Portfolio and paid monthly, but are accrued daily for
purposes of determining the value of a share of each Portfolio on each day the
NYSE is open for trading. (See "Valuation of Shares".) For the services provided
to each of the Portfolios, the Manager (and not the Fund) pays each Sub-Adviser
a monthly fee based on an annual percentage of the average daily net assets of
the respective Portfolio. The annual percentage of average daily net assets
payable by each Portfolio to the Manger
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<PAGE>
and by the Manager to each Sub-Adviser is set forth below. The fees paid by
certain of the Portfolios may be higher than those paid by other investment
companies.
<TABLE>
<CAPTION>
Annual Percentage
Annual Percentage of of Average Net
Average Net Assets Paid Assets Paid By
By Portfolio to the the Manager to
Manager Sub-Adviser
------------------------ ------------------
<S> <C> <C>
Morgan Stanley Asian Growth Portfolio 1.00% .85%
Morgan Stanley Worldwide High Income
Portfolio .85% .70%
Renaissance Balanced Portfolio .65% .50%
Zweig Asset Allocation Portfolio .90% .75%
Nicholas-Applegate Balanced Portfolio .65% .50%
Harris Bretall Sullivan & Smith Equity
Growth Portfolio .65% .50%
Dreman Value Portfolio .65% .50%
Zweig Equity (Small Cap) Portfolio 1.05% .90%
Pinnacle Fixed Income Portfolio .70% .50%
ARM Capital Advisors Money
Market Portfolio .50% N/A
</TABLE>
SBM Financial Services, Inc. (SBMFS), a wholly-owned subsidiary of ARM, acts as
Distributor of the Portfolios' shares without remuneration from the Fund or the
Portfolios. SBMFS is registered with the SEC as a broker-dealer and is a member
of the National Association of Securities Dealers, Inc. SBMFS's address is 100
North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-0069.
EXPENSES
The Fund bears all expenses of its operations other than those borne by the
Manager or SBMFS as distributor. In particular, the Fund pays (and allocates
among the respective Portfolios): investment management fees; transaction costs,
including brokerage commissions; record keeping agent fees; custodian fees;
legal fees; audit fees; shareholder reports expenses; registration fees; proxy
and shareholder meeting expenses; and the fees and expenses of Directors who are
not interested persons of the Fund, within the meaning of the 1940 Act. In
addition, a portion of the expenses of organizing the Fund and of the initial
registration of its shares under federal securities laws will be charged to the
Fund's operations, as an expense, over a period not exceeding five years.
The Manager has agreed to reimburse the respective Portfolios on a pro rata
basis up to the amount of their respective fees to the extent that the total
expenses of a Portfolio in a given year (excluding interest, taxes, brokerage
commissions, and extraordinary expenses) exceed any applicable state expense
limitations.
The Manager voluntarily limits the expenses of each Portfolio, other than for
brokerage commissions and the management fee, to .50% of average net assets on
an annualized basis, except that the Manager voluntarily limits the expenses of
Morgan Stanley Asian Growth Portfolio and Morgan Stanley Worldwide High Income
Portfolio, other than for brokerage commissions and the management fee, to 1.00%
of average net assets on an annualized basis. The Manager's reimbursement of
Portfolio expenses results in an increase to each Portfolio's yield or total
return. The Manager has reserved the right to withdraw or modify its policy of
expense reimbursement for the Portfolios.
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<PAGE>
PORTFOLIO TRANSACTIONS AND BROKERAGE
As a general matter, each Sub-Adviser arranges for the purchase and sale of the
respective Portfolio's securities and selects broker-dealers which, in its best
judgment, provide prompt and reliable execution at favorable security prices and
reasonable commission rates. The Sub-Advisers may select broker-dealers which
provide them with research services and may cause a Portfolio to pay such
broker-dealers commissions which exceed those other broker-dealers may have
charged if, in their view, the commissions are reasonable in relation to the
value of the brokerage and/or research services provided by the broker-dealer.
Brokerage arrangements may take into account the distribution of certificates by
broker-dealers, subject to best price and execution.
Brokerage arrangements with affiliates of the Manager or the Sub-Advisers, if
any, will be in accordance with the 1940 Act and the rules and regulations
promulgated thereunder. No transactions may be effected by a Portfolio with an
affiliate of the Manager or a Sub-Adviser acting as principal for its own
account, except to the extent permitted by law.
Transactions in money market securities, other government securities and most
other fixed income securities are principal transactions, on which no brokerage
commission is paid. These transactions are normally effected with major dealers
in money market instruments, government securities or such fixed income
securities. Purchases from or sales to dealers serving as market-makers include
the spread between the bid and asked prices. OTC purchases and sales are
normally made with principal market-makers, except where, in the opinion of the
Sub-Adviser, the best executions are available elsewhere.
The Portfolios described in "Description of Various Securities and Investment
Techniques--Futures Contracts and Related Options" may incur transaction costs
in connection with the acquisition of futures contracts and options thereon.
For reporting purposes, a Portfolio's portfolio turnover rate is calculated by
dividing the lesser of purchases or sales of portfolio securities for the fiscal
year by the monthly average of the value of the portfolio securities owned by
the Portfolio during the fiscal year. In determining such portfolio turnover,
securities whose maturities at the time of acquisition were one year or less are
excluded. Each Sub-Adviser will adjust the Portfolio's assets as it deems
advisable in view of current or anticipated market conditions, and portfolio
turnover will not be a limiting factor should the Sub-Adviser deem it advisable
for a Portfolio to purchase or sell securities. Options activities may increase
the turnover rate for a Portfolio, because the exercise of calls written by the
Portfolio and puts owned by the Portfolio would cause the Portfolio to sell the
underlying securities. Increased portfolio turnover may result in greater
brokerage commissions. See "Financial Highlights" for information as to the
Portfolios' portfolio turnover rates for the periods from commencement of
operations through June 30, 1993 and the fiscal years ended June 30, 1994 and
1995.
OTHER INFORMATION
CUSTODIAN: Investors Fiduciary Trust Company, 127 West 10th Street, Kansas City,
Missouri 64105, acts as custodian of the assets of all of the Portfolios and may
employ sub-custodians approved by the Board of Directors of the Fund in
accordance with the regulations of the Securities and Exchange Commission.
TRANSFER AGENT, DIVIDEND AGENT AND RECORDKEEPING AGENT: Investors Fiduciary
Trust Company also acts as transfer agent, dividend disbursing agent and
recordkeeping agent.
PERFORMANCE INFORMATION: The Fund may, from time to time, calculate the yield
and effective yield of the Money Market Portfolio, the yield of other Portfolios
or total return of all Portfolios and may include such information in reports to
shareholders. Performance information should be considered in light of the
Portfolio's investment objectives and policies, characteristics and quality of
the portfolios, and the market conditions during the given time period, and
should not be considered as a representation of what may be achieved in the
future.
Performance information for the Portfolios is contained in the Fund's annual
reports to shareholders, which may be obtained without charge.
32
<PAGE>
Current yield for the Money Market Portfolio will be based on income received by
a hypothetical investment over a given 7-day period (less expenses accrued
during the period), and then annualized (i.e., assuming that the 7-day yield
would be received for 52 weeks, stated in terms of an annual percentage return
on the investment). Effective yield for the Money Market Portfolio is calculated
in a manner similar to that used to calculate yield, but reflects the
compounding effect of earnings on reinvested dividends. For the remaining
Portfolios, any quotations of yield will be based on all investment income per
share earned during a given 30-day period (including dividends and interest),
less expenses accrued during the period (net investment income), and will be
computed by dividing net investment income by the maximum public offering price
per share on the last day of the period. Quotations of average annual total
return for a Portfolio will be expressed in terms of the average annual
compounded rate of return on a hypothetical investment in the Portfolio over
certain periods that will include periods of 1, 5, and 10 years (up to the life
of the Portfolio), will reflect the deduction of a proportional share of
Portfolio expenses (on an annual basis), and will assume that all dividends and
distributions are reinvested when paid.
For a description of the methods used to determine yield and total return for
the Portfolios, see the Statement of Additional Information.
33
<PAGE>
APPENDIX A
DESCRIPTION OF COMMERCIAL PAPER AND BOND RATINGS
COMMERCIAL PAPER
Description of relevant commercial paper ratings of Standard & Poor's Ratings
Group ("S&P") are as follows:
A-1: This highest category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus (+) sign designation.
A-2: Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
A-3: Issues carrying this designation have an adequate capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the higher
designations.
Description of the relevant commercial paper ratings of Moody's Investors
Service, Inc. ("Moody's") are as follows:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics:
-- Leading market positions in well-established industries.
-- High rates of return on funds employed.
-- Conservative capitalization structure with moderate reliance on
debt and ample asset protection.
-- Broad margins in earnings coverage of fixed financial charges and
high internal cash generation.
-- Well-established access to a range of financial markets and
assured sources of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will
normally be evidenced by many of the characteristics cited above but
to a lesser degree. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample
alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of
industry characteristics and market compositions may be more
pronounced. Variability in earnings and profitability may result in
changes in the level of debt protection measurement and may require
relatively high financial leverage. Adequate alternate liquidity is
maintained.
A-1
<PAGE>
CORPORATE BONDS
Descriptions of the bond ratings of S&P are:
AAA -- Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA -- Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A -- Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher
rated categories.
BBB -- Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in
higher rated categories.
BB, B, CCC, CC or C--Debt rated BB, B, CCC, CC or C is regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse debt
conditions.
C1 -- The rating C1 is reserved for income bonds on which no interest is being
paid.
D -- Debt rated D is in default and payment of interest and/or repayment of
principal is in arrears.
The ratings from AA to CC may be modified by the addition of a plus (+) or minus
(-) sign to show relative standing within the major rating categories.
Descriptions of the bond ratings of Moody's are as follows:
Aaa -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin, and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are more unlikely to impair the fundamentally strong position
of such issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risks
appear somewhat greater than the Aaa securities.
A -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment some time in
the future.
Baa -- Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present, but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
A-2
<PAGE>
Ba -- Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not
well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time
may be small.
Caa -- Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca -- Bonds which are rated Ca represent obligations which are speculative to
a high degree. Such issues are often in default or have other marked
shortcomings.
C -- Bonds which are rated C are the lowest class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies modifiers to each rating classification from Aa through B to
indicate relative ranking within its rating categories. The modifier "1"
indicates that a security ranks in the higher end of its rating category; the
modifier "2" indicates a mid-range ranking; and the modifier "3" indicates that
the issue ranks in the lower end of its rating category.
A-3
