<PAGE>
THE ANALYTIC SERIES FUND
2222 MARTIN STREET, SUITE 230
IRVINE, CA 92715-1406
(800) 374-2633 -- (714) 833-0294
FAX: (714) 833-8049
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INVESTMENT OBJECTIVE The Analytic Series Fund, a Delaware business trust (the
AND POLICIES "Fund"), is a no-load, open-end diversified investment
company or "mutual fund" presently consisting of 3 separate
Portfolios, each with a distinct investment objective. The
Portfolios are: the Analytic Short-Term Government Portfolio
("SHORT-TERM GOVERNMENT PORTFOLIO"), the Analytic Master
Fixed Income Portfolio ("MASTER FIXED INCOME PORTFOLIO"),
and the Analytic Enhanced Equity Portfolio ("ENHANCED EQUITY
PORTFOLIO").
The investment objective of the SHORT-TERM GOVERNMENT
PORTFOLIO is to provide a high level of income consistent
with both low fluctuations in market value and low credit
risk. At least 80% of the total assets of the Portfolio will
be invested in U.S. government securities and up to 20%, may
be invested in securities of foreign issuers.
The investment objective of the MASTER FIXED INCOME
PORTFOLIO is to provide above-average total returns from a
diversified bond portfolio consisting primarily of domestic
government, corporate, and mortgage-related fixed income
securities. Up to 20% of the total assets of the Portfolio
may be invested in securities of foreign issuers.
The investment objective of the ENHANCED EQUITY PORTFOLIO is
to provide above-average total returns from a diversified
equity portfolio which consists primarily of domestic common
stocks and related investments such as options and futures.
Up to 20% of the total assets of the Portfolio may be
invested in securities of foreign issuers.
OPENING AN ACCOUNT Please complete and return the Account Registration. If you
need assistance in completing this form, please call
Shareholder Services at (800) 374-2633. There is no minimum
investment for tax deferred retirement accounts; otherwise,
the minimum initial investment is $5,000 invested in any
proportion among the Portfolios. Shares may be purchased at
net asset value per share, without a sales charge, next
determined after receipt of a purchase order in good form.
ABOUT THIS PROSPECTUS This Prospectus sets forth concisely the information you
should know about the Fund before you invest. It should be
retained for future reference. A Statement of Additional
Information containing additional information about the Fund
has been filed with the Securities and Exchange Commission.
The Statement is incorporated by reference into this
Prospectus and a copy may be obtained without charge by
writing to the Fund or by calling Shareholder Services at
(800) 374-2633.
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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 COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
THE DATE OF THIS PROSPECTUS AND THE RELATED STATEMENT OF ADDITIONAL INFORMATION
IS MAY 1, 1996
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HIGHLIGHTS
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THREE SEPARATE PORTFOLIOS Investors may choose from any of the three Portfolios of the
Fund. The investment characteristics of each Portfolio are
summarized in the chart below.
PAGE 4
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PORTFOLIO SUMMARY
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<CAPTION>
MAY USE MAY USE
OPTIONS FOREIGN
PORTFOLIO PRIMARY INVESTMENTS AND FUTURES SECURITIES
- --------------------------- ------------------------------------------------------------ ----------- ---------
<S> <C> <C> <C>
Short-Term Government Shorter term U.S. Treasury & U.S. Government agency fixed Yes Yes
income securities, with an average duration of 1 to 3 years
Master Fixed Income Intermediate and longer term U.S. Government, and high grade Yes Yes
corporate and mortgage-related fixed income securities
Enhanced Equity Publicly traded common stocks with average capitalization Yes Yes
typical of medium to large companies
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RISK CHARACTERISTICS The securities in the Portfolios are subject to various
risks, including interest rate risk, credit risk, currency
risk and equity risk. The following chart summarizes the
Adviser's opinion of the exposure of each Portfolio to these
risks and the expected price fluctuations due to these and
other risks, based on the historical financial
characteristics of the various securities.
PAGE 9
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RISK SUMMARY
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<CAPTION>
INTEREST RATE
AND CURRENCY EXPECTED PORTFOLIO
PORTFOLIO CREDIT RISK EQUITY RISK RISK PRICE FLUCTUATIONS
- --------------------------- ---------------- -------------------- --------- ---------------------
<S> <C> <C> <C> <C>
Short-Term Government Low None Low Low to Moderate
Master Fixed Income High Low to Moderate Low Moderate to High
Enhanced Equity Low High Low High to Very High
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1
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INVESTMENT ADVISER Analytic-TSA Global Asset Management, Inc. (the "Adviser"),
2222 Martin Street, Suite 230, Irvine, CA 92715, is the
investment adviser of the Fund. The Adviser is a wholly
owned subsidiary of United Asset Management Corporation, a
holding company described under "Management of the Fund" in
the Statement of Additional Information.
PAGE 25
DIVIDEND POLICY The Short-Term Government and Master Fixed Income Portfolios
declare a dividend each business day based on their
respective net investment incomes. These dividends are paid
on the first business day of each month. The Enhanced Equity
Portfolio declares and pays its net investment income on the
last business day of the calendar quarter. All Portfolios
distribute net realized capital gains, if any, annually.
PAGE 29
TAXES Dividends and capital gains distributions paid by the Fund's
Portfolios are generally subject to federal, state and local
income taxes. However, depending on provisions of your
state's tax law, the portion of a Portfolio's income derived
from "full faith and credit" U.S. Treasury obligations may
be exempt from state and local taxes. A sale of shares,
whether by outright redemption or exchange, is a taxable
event and may result in a capital gain or loss.
PAGE 29
PURCHASING SHARES Shares may be purchased by wire, mail, or exchange from
another Portfolio in the Fund, at net asset value per share,
without a sales charge, next determined after receipt of a
purchase order in good form. There is no minimum initial or
subsequent purchase of Portfolio shares by tax deferred
retirement plans (including IRA, SEP-IRA and profit sharing
and money purchase plans) or Uniform Gifts to Minors Act
accounts. For other investors the minimum is $5,000 for an
initial purchase, in any proportion among the Portfolios,
and there is no minimum for subsequent purchases.
PAGE 33
REDEEMING SHARES Shares are redeemed without charge and redemptions may be
made by telephone, mail, or exchange to another Portfolio in
the Fund.
PAGE 35
SHAREHOLDER SERVICES The Adviser acts as the transfer agent, dividend disbursing
agent, and shareholder relations servicing agent.
Shareholder inquiries should be addressed to Analytic-TSA
Global Asset Management, Inc., Attn: Shareholder Services,
2222 Martin Street, Suite 230, Irvine, CA 92715-1406;
telephone (800) 374-2633; or FAX (714) 833-8049.
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FUND EXPENSES
The following table illustrates the expenses and fees that a shareholder of
the Fund is expected to incur for the Fund's 1996 fiscal year.
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<CAPTION>
SHORT-TERM MASTER FIXED ENHANCED
GOVERNMENT INCOME EQUITY
SHAREHOLDER TRANSACTION EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO
- ------------------------------------------------------ ------------- ------------- -----------
<S> <C> <C> <C>
Sales Load Imposed on Purchases....................... None None None
Sales Load Imposed on Reinvested Dividends............ None None None
Redemption Fees....................................... None None None
Exchange Fees......................................... None None None
<CAPTION>
SHORT-TERM MASTER FIXED ENHANCED
GOVERNMENT INCOME EQUITY
SHAREHOLDER TRANSACTION EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO
- ------------------------------------------------------ ------------- ------------- -----------
<S> <C> <C> <C>
Management Fees....................................... .15% .37% .23%
12b-1 Fees............................................ None None None
Other Expenses........................................ .45 .28 .63
Total Fund Operating Expenses (after expense
reimbursement)....................................... .60% .65% .86%
</TABLE>
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* After reimbursement of expenses. The Adviser has voluntarily agreed to
reimburse expenses of the Fund, including advisory fees (but excluding
interest, taxes, and extraordinary expenses) that exceed 0.60%, 0.80%, and
1.0% of average daily net assets for the Short-Term Government, Master Fixed
Income, and Enhanced Equity Portfolios, respectively, for the year ending
December 31, 1996. Without such reimbursement, management fees for the
Short-Term Government, Master Fixed Income, and Enhanced Equity Portfolio
would be 0.30%, 0.45% and 0.60%, respectively, and total expenses are
expected to be 0.75%, 0.92% and 1.46%, respectively, for the year ending
December 31, 1996. The voluntary expense caps for year ended December 31,
1995 were 0.50%, 0.70% and 0.80%, respectively. The information in the Fund
Expenses table has been restated to reflect the current expense caps.
The Master Fixed Income and Enhanced Equity Portfolios have entered into
agreements whereby certain operating expenses of the Portfolio are reimbursed by
a broker, based upon a percentage of commissions earned by the broker for
execution of portfolio transactions. Gross commission rates for this broker are
consistent with those of other brokers utilized by the Fund. With respect to the
Master Fixed Income Portfolio, for 1995, expenses reimbursed by such broker
represented .01% of average daily net assets and, absent such reimbursement,
expenses would have been 1.03% of average daily net assets. With respect to the
Enhanced Equity Portfolio, for 1995, expenses reimbursed by such broker
represented .28% of average daily net assets and, absent such reimbursement,
expenses would have been 1.61% of average daily net assets.
EXAMPLE
The following example illustrates the expenses you would pay on a $1,000
investment, assuming (1) a 5% annual rate of return and (2) redemption at the
end of each period.
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PORTFOLIO 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- --------------------------------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Short-Term Goverment..................................... $ 6 $ 18 $ 33 $ 75
Master Fixed Income...................................... 7 21 36 81
Enhanced Equity.......................................... 9 27 48 106
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FINANCIAL HIGHLIGHTS
The financial information in the tables below for the years ended December
31, 1995, 1994, 1993, and the one month ended December 31, 1992, has been
derived from audited financial statements of the Fund performed by Deloitte &
Touche LLP, independent auditors. Such financial statements and the report of
Deloitte & Touche LLP thereon are incorporated by reference in the Statement of
Additional Information. Copies of the Fund's 1995 Annual Report to Shareholders
may be obtained, at no charge, by writing or telephoning the Fund at the address
or telephone number appearing on the cover page of this Prospectus.
SHORT TERM GOVERNMENT PORTFOLIO
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<CAPTION>
ONE MONTH
YEAR ENDED YEAR ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1994 1993 1992
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net asset value, beginning of period................... $ 9.55 $ 10.03 $ 10.03 $ 10.00
Income from investment operations
Net investment income................................ 0.56 0.48 0.53 0.05
Net gains or losses on securities (both realized and
unrealized)......................................... 0.43 (0.48) 0.00 0.03
------------- ------------- ------------- ------
Total from investment operations................... 0.99 0.00 0.53 0.08
Less distributions
Dividends (from net investment income)............... 0.56 0.48 0.53 0.05
Distributions (from capital gains)................... 0.00 0.00 0.00 0.00
------------- ------------- ------------- ------
Total distributions................................ 0.56 0.48 0.53 0.05
------------- ------------- ------------- ------
Net asset value, end of period......................... $ 9.98 $ 9.55 $ 10.03 $ 10.03
------------- ------------- ------------- ------
------------- ------------- ------------- ------
Total return....................................... 10.65% 0.00% 5.37% 9.38+
------------- ------------- ------------- ------
------------- ------------- ------------- ------
Ratios/supplemental data
Net assets, end of period (000)........................ $ 27,880 $ 24,481 $ 26,097 $ 7,619
Ratio of expenses to average net assets**.............. 0.50% 0.45% 0.45% 0.45+
Ratio of net investment income to average net assets... 5.76% 5.37% 4.91% 5.45+
Portfolio turnover rate................................ 10.15% 3.21% 85.69% 0.00%
</TABLE>
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** Net of expense reimbursements of .32%, .40%, .30% and .32% of average net
assets, respectively.
+ Annualized.
4
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MASTER FIXED INCOME PORTFOLIO
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<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED ONE MONTH
DECEMBER 31, DECEMBER 31, DECEMBER 31, ENDED DECEMBER
1995 1994 1993 31, 1992
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Net asset value, beginning of period................... $ 9.50 $ 10.26 $ 10.06 $ 10.00
Income from investment operations
Net investment income................................ 0.61 0.64 0.67 0.04
Net gains or losses on securities (both realized and
unrealized)......................................... 0.91 (0.75) 0.41 0.06
------------- ------ ------ ------
Total from investment operations................... 1.52 (0.11) 1.08 0.10
Less distributions
Dividends (from net investment income)............... 0.61 0.64 0.67 0.04
Distributions (from capital gains)................... 0.00 0.01 0.21 0.00
------------- ------ ------ ------
Total distributions................................ 0.61 0.65 0.88 0.04
------------- ------ ------ ------
Net asset value, end of period......................... $ 10.41 $ 9.50 $ 10.26 $ 10.06
------------- ------ ------ ------
------------- ------ ------ ------
Total return....................................... 16.43% (1.04)% 10.94% 13.09%+
------------- ------ ------ ------
------------- ------ ------ ------
Ratios/supplemental data
Net assets, end of period (000)........................ $ 24,868 $ 6,155 $ 8,066 $ 9,219
Ratio of expenses to average net assets**.............. 0.69% 0.60% 0.60% 0.60%+
Ratio of net investment income to average net assets... 5.99% 7.16% 6.39% 5.63%+
Portfolio turnover rate................................ 31.82% 44.30% 105.39% 0.00%
Average commission rate................................ $ 0.0277
</TABLE>
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** Net of expense reimbursements of .34%, .57%, .44% and .45% of average net
assets, respectively.
+ Annualized
5
<PAGE>
ENHANCED EQUITY PORTFOLIO
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<CAPTION>
ONE MONTH
YEAR ENDED YEAR ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1994 1993 1992
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net asset value, beginning of period................... $ 9.83 $ 10.15 $ 10.02 $ 10.00
Income from investment operations
Net investment income................................ 0.23 0.28 0.40 0.01
Net gains or losses on securities (both realized and
unrealized)......................................... 3.22 (0.32) 0.62 0.02
------------- ------ ------ -------------
Total from investment operations................... 3.45 (0.04) 1.02 0.03
Less distributions
Dividends (from net investment income)............... 0.23 0.28 0.40 0.01
Distributions (from capital gains)................... 0.11 0.00 0.37 0.00
Return of capital.................................... 0.00 0.00 0.12 0.00
------------- ------ ------ -------------
Total distributions................................ 0.34 0.28 0.89 0.01
------------- ------ ------ -------------
Net asset value, end of period......................... $ 12.94 $ 9.83 $ 10.15 $ 10.02
------------- ------ ------ -------------
------------- ------ ------ -------------
Total return....................................... 35.36% (0.37)% 10.07% 4.08%+
------------- ------ ------ -------------
------------- ------ ------ -------------
Ratios/supplemental data
Net assets, end of period (000)........................ $ 2,318 $ 1,511 $ 903 $ 12,823
Ratio of expenses to average net assets**.............. 0.50% 0.24% 0.57% 0.70%+
Ratio of net investment income to average net assets... 2.02% 3.24% 2.16% 1.66%+
Portfolio turnover rate................................ 10.15% 24.75% 76.34% 25.20%
Average commission rate................................ $ 0.0431
</TABLE>
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** Net of expense reimbursements of .83%, 1.11%, .47% and .50% of average net
assets, respectively.
+ Annualized
6
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INVESTMENT OBJECTIVES AND The investment objectives and policies of each Portfolio are
POLICIES listed below. The objectives are fundamental and may not be
changed without shareholder approval. However, the
investment policies, practices, and strategies employed in
pursuit of each Portfolio's objective are not fundamental
and may be changed without shareholder approval. Because
there are risks inherent in all securities investments,
there is no assurance that these objectives will be
achieved.
SHORT-TERM GOVERNMENT INVESTMENT OBJECTIVE:
PORTFOLIO The investment objective of the Short-Term Government
Portfolio is to provide a high level of income consistent
with both low fluctuations in market value and low credit
risk.
INVESTMENT POLICIES:
The Short-Term Government Portfolio seeks to achieve its
investment objective by investing primarily in U.S. Treasury
or U.S. Government agency securities to minimize credit
risk. To minimize fluctuations in market value, the
Portfolio is expected, under normal market conditions, to
maintain a dollar weighted average maturity and weighted
average duration between 1 and 3 years. Duration is the
weighted average time to receipt of both principal and
interest payments of a debt security and also a measure of
the sensitivity of fixed income related investments to
interest rate changes.
Under normal market conditions, the Short-Term Government
Portfolio will invest at least 80% of its total assets in
U.S. Government securities. Subject to certain additional
limitations, the remainder of the Portfolio's assets may be
invested in other high grade debt securities, securities of
foreign governments and supranational organizations
considered to be of high grade investment quality,
currency-rate and interest rate-related options and futures,
and cash and cash equivalents. The high grade investment
standard for the Fund includes only those securities with
(i) over 1 year original maturity and rated at the time of
purchase a minimum of A by Moody's Investors Service, Inc.
("Moody's") or Standard & Poor's Corporation ("Standard &
Poor's") , (ii) under 1 year original maturity and rated at
the time of purchase a minimum of Prime 1 by Moody's or A-1
by Standard & Poor's, or (iii) unrated securities determined
by the Adviser at the time of purchase to be equivalent to
these ratings. See the discussion of ratings under
"Implementation of Policies" below.
The Portfolio may also invest in repurchase agreements
collateralized by U.S. Government securities. For temporary
defensive purposes, the Portfolio may reduce the average
duration to less than 1 year. See "Implementation of
Policies" for a description of these investment practices of
the Portfolio and the additional limitations that may apply
to some of the investments described above.
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7
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MASTER FIXED INCOME INVESTMENT OBJECTIVE:
PORTFOLIO The investment objective of the Master Fixed Income
Portfolio is to provide above-average total returns from a
diversified bond portfolio consisting primarily of U.S.
Government, corporate, and mortgage-related fixed income
securities. For this purpose, "above average" total returns
means returns above the average long-term total returns of
other mutual funds with similar investment policies and risk
characteristics.
INVESTMENT POLICIES:
The Master Fixed Income Portfolio seeks to achieve its
objective by investing primarily in U.S. Treasury, U.S.
Government, and U.S. dollar denominated high grade
securities, including mortgage-related securities. The
weighted average duration of the Portfolio's fixed income
investments is generally expected, under normal market
conditions, to range between 3 and 10 years.
Under normal market conditions, the Master Fixed Income
Portfolio will invest at least 65% of its total assets in
U.S. dollar denominated, high grade, fixed income debt
securities. The high grade investment standard for the Fund
includes only those securities with (i) over 1 year original
maturity and rated at the time of purchase a minimum of A by
Moody's or Standard & Poor's, (ii) under 1 year original
maturity and rated at the time of purchase a minimum of
Prime 1 by Moody's or A-1 by Standard & Poor's, or (iii)
unrated securities determined by the Adviser at the time of
purchase to be equivalent to these ratings. See the
discussion of ratings under "Implementation of Policies"
below.
Subject to certain additional limitations, under normal
market conditions, the remainder of the Portfolio's assets
may be invested in floating rate and other types of debt
securities, high grade non-U.S.-dollar denominated debt
securities, below high grade fixed income securities,
convertible securities, "synthetic convertible" positions,
covered call and cash secured put investments, preferred
stock, and the shares of other investment companies which
invest primarily in high grade debt securities. The
Portfolio may also invest in interest and currency
rate-related derivative securities. For temporary defensive
purposes, the Portfolio may retain all or part of its assets
in high grade, U.S. dollar denominated debt securities or
cash and cash equivalents. See "Implementation of Policies"
for a description of these investment practices of the
Portfolio and the additional limitations that may apply to
some of the investments described above.
ENHANCED EQUITY PORTFOLIO INVESTMENT OBJECTIVE:
The investment objective of the Enhanced Equity Portfolio is
to provide above-average total returns from a diversified
equity portfolio which consists primarily of common stocks
and related investments
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8
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such as options and futures. For this purpose, "above
average" total returns means returns above the average
long-term total returns of other mutual funds with similar
investment policies and risk characteristics.
INVESTMENT POLICIES:
The Enhanced Equity Portfolio seeks to achieve its objective
by investing primarily in the publicly traded common stocks
of U.S. domiciled corporations and options and futures that
relate to such stocks. While the Portfolio may invest in
stocks of any market capitalization, it is anticipated that
the average capitalization of the Portfolio's stocks will be
typical of medium to large companies (typically $1 billion
or higher). A company's market capitalization is the total
stock market value of its outstanding shares.
Under normal market conditions, the Enhanced Equity
Portfolio will invest at least 65% of its total assets in
common stocks of U.S. domiciled corporations and equity-type
investments that relate to U.S. domiciled corporations.
Equity-type investments include preferred stock, warrants,
and convertible securities. See "Implementation of Policies"
for a description of certain additional limitations on the
percentage of the Portfolio that may be invested in some of
the equity-type investments.
Subject to certain additional limitations, the remainder of
the Portfolio's assets may be invested in foreign equity and
equity-type securities, equity related options and futures
contracts, debt securities of investment grade or below, the
shares of other investment companies, and cash or cash
equivalents awaiting investment.
For temporary defensive purposes, the Portfolio may retain
all or part of its assets in high grade, U.S. dollar
denominated debt securities or cash and cash equivalents.
See "Implementation of Policies" for a description of these
and other investment practices of the Portfolio and the
additional limitations that may apply to some of the
investments described above.
INVESTMENT RISKS All of the Portfolios are expected to have fluctuations in
their net asset values. However, the Short-Term Government
Portfolio is expected to have the lowest volatility of the
three Portfolios and the Enhanced Equity Portfolio is
expected to have the highest.
CERTAIN INVESTMENT RISKS These fluctuations in value are associated with various
risks to which the securities in the Portfolios are subject.
These risks include, but are not limited to, interest rate
risk, credit risk, currency risk, and equity risk. These
risks are described below. In addition, the trading
practices of the Portfolios (such as their use of
mortgage-related securities,
</TABLE>
9
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foreign securities and options and futures strategies) will
expose them to additional risks, discussed below under
"Implementation of Policies" and in the Statement of
Additional Information.
Each Portfolio that holds fixed income securities is subject
to varying degrees of interest rate risk. Interest rate risk
is the potential for a decline in bond prices due to rising
interest rates. In general, bond prices vary inversely with
interest rates. When interest rates rise, bond prices
generally fall. Conversely, when interest rates fall, bond
prices generally rise. The change in price depends on
several factors, including the bond's maturity date. In
general, bonds with longer maturities are more sensitive to
interest rates than bonds with shorter maturities.
Each Portfolio that holds fixed income securities is also
subject to varying degrees of credit risk. Credit risk is
the possibility that a bond issuer will fail to make timely
payments of interest or principal. The credit risk to which
a Portfolio is subject depends on the quality of its
investments. Reflecting their higher risks, lower-quality
bonds generally offer higher yields than higher-quality
bonds.
Each Portfolio that holds foreign securities is subject to
currency risk. Currency risk is the potential for changes in
value because of changes in the exchange rate between the
currency in which principal and interest on the security are
payable and the U.S. dollar. Currency fluctuations will
affect the value of the Portfolios' shares irrespective of
the performance of its underlying investments.
A Portfolio that holds common stocks and equity-type
investments is subject to equity risk. Equity risk is the
potential for price declines. The magnitude of this risk
associated with any particular investment can vary widely
depending on the business and financial condition of the
issuer, market conditions in general, the type of
investment, and the extent to which the position may be
hedged.
SHORT-TERM GOVERNMENT The Short-Term Government Portfolio should be subject to
PORTFOLIO relatively low interest rate and credit risk, but should
have no equity risk. Because of the short-term average
duration of this Portfolio, it is expected to exhibit low to
moderate price fluctuations as interest rates change. The
Portfolio's average duration and maturity should also
exhibit low to moderate fluctuations. With respect to the
Portfolio's primary investments, credit risk should be
negligible for its U.S. Treasury securities, and only
slightly higher for its U.S. Government agency obligations
(some of which are not explicitly guaranteed by the U.S
Government). Risks associated with the Portfolio's other
investments, in securities of foreign governments,
mortgage-related securities, options and futures contracts,
and repurchase agreements, are discussed under
"Implementation of Policies" below.
</TABLE>
10
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MASTER FIXED INCOME The Master Fixed Income Portfolio will have a higher degree
PORTFOLIO of both interest rate risk and credit risk than the
Short-Term Government Portfolio. With respect to its primary
investments, the Portfolio is expected to exhibit moderate
to high fluctuations as interest rates change, because it
will generally have significant holdings of both
intermediate-term and longer-term bonds. The Portfolio will
also have various credit risks as a result of holding
obligations of high grade securities of non-governmental
issuers. It will also have low to moderate equity risk as a
result of its investment in convertible and synthetic
convertible security positions and covered call and cash
secured put investments. Risks associated with the
Portfolio's other investments, including convertible and
synthetic convertible positions, covered call and cash
secured put investments, non-investment grade fixed income
securities, foreign securities and interest and currency-
related derivative securities, are discussed under
"Implementation of Policies" below. Reflecting these
increased risks, the Portfolio will generally offer higher
yields than the Short-Term Government Portfolio.
ENHANCED EQUITY PORTFOLIO The Enhanced Equity Portfolio is expected to be subject
primarily to equity risk, and to exhibit high to very high
price fluctuations, as is characteristic of common stocks
and equity funds in general. The price fluctuations of this
Portfolio can generally be expected to be greater than
either of the other Portfolios. The Portfolio's use of
options, futures contracts, foreign and non-investment grade
debt securities will also expose it to certain additional
risks, discussed under "Implementation of Policies" below.
WHO SHOULD INVEST Because of potential fluctuations in the share price of all
of the Portfolios in the Fund, any of the Portfolios may be
inappropriate for short-term investors who require maximum
stability of principal. For example, money market funds
attempt to maintain a stable net asset value and will
provide more stability of principal and less risk than the
Portfolios. You should base your selection of a Portfolio
(or Portfolios) on your own objectives, risk preferences,
and time horizon. Both the SHORT-TERM GOVERNMENT PORTFOLIO
and the MASTER FIXED INCOME PORTFOLIO are suitable for
investors with common stock holdings who are seeking a
complementary fixed income investment to create a more
diversified and balanced investment mix. The ENHANCED EQUITY
PORTFOLIO is suitable for long-term investors seeking the
generally higher average total returns that diversified
stock portfolios have provided historically, and who can
tolerate substantial price fluctuations and possible
significant loss in value of their investment.
The SHORT-TERM GOVERNMENT PORTFOLIO is designed for
investors who are seeking yields that are more durable and
usually higher than those available from money market funds,
and who can tolerate modest fluctuations in the value of
their investment.
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The MASTER FIXED INCOME PORTFOLIO is designed for investors
seeking total returns from a broadly diversified bond market
investment with high grade credit quality, and who can
tolerate relatively larger fluctuations in price. The yields
from this Portfolio are generally expected to be higher and
the income steadier than from a shorter maturity fund.
However, these higher yields and steadier income levels come
with greater fluctuations in total return. BECAUSE OF THESE
RISKS, THE MASTER FIXED INCOME PORTFOLIO IS INTENDED TO BE A
LONG TERM INVESTMENT VEHICLE AND IS NOT DESIGNED TO PROVIDE
INVESTORS WITH A MEANS OF SPECULATING ON SHORT-TERM INTEREST
RATE MOVEMENTS.
The ENHANCED EQUITY PORTFOLIO is designed for investors
seeking the higher AVERAGE total returns that diversified
equity portfolios have provided over LONG TERM time
horizons. The share price of the Portfolio is expected to be
volatile, and investors should be able to tolerate sudden,
sometimes substantial fluctuations in the value of their
investments. Because of the risks inherent in equity
investing and the general wisdom of diversification,
investors should carefully consider what portion of their
investment assets should be prudently allocated to equities.
BECAUSE OF THESE RISKS, THE ENHANCED EQUITY PORTFOLIO IS
INTENDED TO BE A LONG TERM INVESTMENT VEHICLE AND IS NOT
DESIGNED TO PROVIDE INVESTORS WITH A MEANS OF SPECULATING ON
SHORT-TERM STOCK MARKET MOVEMENTS.
IMPLEMENTATION OF POLICIES In addition to the investment policies described above (and
subject to certain restrictions described herein), the
Portfolios may invest in some or all of the following
securities and employ some or all of the following
investment techniques, some of which may present special
risks as described below. A more complete discussion of
these securities and investment techniques and their
associated risks is contained in the Fund's Statement of
Additional Information.
SHORT-TERM INVESTMENTS Each Portfolio may invest in short-term investments in
connection with its options and futures strategies
(discussed below) and during periods when, in the opinion of
the Adviser, attractive equity or longer maturity fixed
income investments are temporarily unavailable or other
circumstances or market conditions warrant such investments.
Under normal market conditions, and excluding such
short-term investments that are made in connection with
options and futures contracts, no more than 20% of the
MASTER FIXED INCOME PORTFOLIO'S and 20% of the ENHANCED
EQUITY PORTFOLIO'S total assets, will be retained in cash
and cash equivalents. As a result of the collateral
requirements associated with options and futures contracts,
the percentage of each such Portfolio's total assets
invested in cash and cash equivalents may be as high as 35%.
Such investments may include U.S. Treasury Bills and other
U.S. Government and Government agency obligations with
remaining maturities less than one year; certificates of
deposit; banker's acceptances; commercial paper rated at the
time of
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purchase A-1 by Standard & Poor's or P-1 by Moody's; shares
of money market mutual funds; and corporate, foreign and
U.S. government, and supranational organization debt
obligations with remaining maturities less than one year and
with debt ratings by Standard & Poor's, Moody's or other
recognized rating agencies that are determined by the
Adviser at the time of purchase to be equivalent to a cash
equivalent rating of A-1/P-1. Such investments may include
securities which offer a variable or floating rate of
interest. In addition, and subject to a 5% limitation, the
Master Fixed Income Portfolio and the Enhanced Equity
Portfolio may also invest in short-term debt securities
rated at the time of purchase A-2/P-2 or equivalent.
GOVERNMENT SECURITIES Each Portfolio may purchase U.S. Government Securities. U.S.
Government Securities include (1) U.S. Treasury bills
(maturity of one year or less), U.S. Treasury notes
(maturities of one to ten years) and U.S. Treasury bonds
(generally maturities of greater than ten years); and (2)
obligations issued or guaranteed by U.S. Government agencies
and instrumentalities which are supported by the full faith
and credit of the U.S. Treasury (such as Government National
Mortgage Association ("GNMA") Certificates), the right of
the issuer to borrow an amount limited to a specific line of
credit from the U.S. Treasury, discretionary authority of
the U.S. Government to purchase certain obligations of the
agency or instrumentality, or the credit of the
instrumentality. Agencies and instrumentalities include:
Federal Land Banks, Farmers Home Administration, Federal
Farm Credit Banks, Federal Home Loan Banks, Federal National
Mortgage Association ("FNMA"), GNMA, Federal Home Loan
Mortgage Corporation ("FHLMC"), Student Loan Marketing
Association, Financing Corporation, Tennessee Valley
Authority, Resolution Funding Corporation, Farm Credit
Financial Assistance Corporation, Private Export Funding
Corporation, and others.
FLOATING RATE AND Each Portfolio may invest in securities which offer a
OTHER DEBT SECURITIES variable or floating rate of interest. Variable rate
securities provide for automatic establishment of a new
interest rate at fixed intervals (e.g., daily, monthly or
semi-annually). Floating rate securities provide for
automatic adjustment of the interest rate whenever some
specified interest rate index changes. The interest rate on
variable or floating-rate securities is ordinarily
determined by reference to or is a percentage of a bank's
prime rate, the 90-day U.S. Treasury bill rate, or some
other objective measure. Such obligations are often secured
by letters of credit or other credit support arrangements
provided by banks. Such obligations frequently are not rated
by credit rating agencies and, if not so rated, the Fund may
invest in them only if the Adviser determines that, at the
time of the investment, the obligations are of comparable
quality to the other obligations in which a particular
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Portfolio may invest. The Adviser will consider on an
ongoing basis the creditworthiness of the issuers of such
instruments in the Fund's Portfolios.
Each Portfolio may also from time to time invest in
zero-coupon, step-coupon and pay-in-kind securities. These
securities are debt securities that do not make regular
interest payments. Zero-coupon and step-coupon securities
are sold at a deep discount to their face value. Pay-in-kind
securities pay interest through the issuance of additional
securities. A Portfolio will not purchase any security in
one of these categories if, as a result of such purchase,
more than 5% of its net assets would be invested in such
category of securities.
REPURCHASE AGREEMENTS Each Portfolio may invest in repurchase agreements for the
purpose of managing its short-term cash. In a repurchase
agreement, the seller (a U.S. commercial bank or recognized
U.S. securities dealer) sells securities to the Portfolio
and agrees to repurchase the securities at the Portfolio's
cost plus interest within a specified period (normally one
to seven days). In these transactions, which are the
economic equivalents of loans by the Portfolio, the
securities purchased by the Portfolio will at all times have
a total value equal to or in excess of the value of the
repurchase obligation.
While repurchase agreements involve certain risks not
associated with direct investments in U.S. Government
securities, the Portfolio will follow procedures designed to
minimize such risks. These procedures include effecting
repurchase transactions only with large, well-capitalized
banks and certain reputable broker-dealers. In addition, the
Portfolio's repurchase agreements will provide that the
value of the collateral underlying the repurchase agreement
will always be at least equal to the repurchase price,
including any accrued interest earned on the repurchase
agreement. In the event of a default or bankruptcy by a
seller, the Portfolio will seek to liquidate such
collateral. However, to liquidate such collateral could
involve certain costs or delays and, to the extent that
proceeds from any sale upon a default of the obligation to
repurchase were less than the repurchase price, the
Portfolio could suffer a loss.
MORTGAGE-RELATED SECURITIES Each Portfolio may invest in mortgage-related securities.
Mortgage-related securities are interests in pools of
mortgage loans made to U.S. residential home buyers,
including mortgage loans made by savings and loan
institutions, mortgage bankers, commercial banks, and
others. Mortgage-related securities not issued or guaranteed
by U.S. government agencies or instrumentalities are not
considered U.S. government securities for purposes of the
80% test for such securities in the Short-Term Government
Portfolio. Pools of mortgage loans are assembled as
securities for sale to investors by various governmental,
government-related and private organizations. The
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interest rates earned on such securities may be fixed, in
the case of pools of fixed-rate mortgages, or variable, in
the case of pools of adjustable-rate mortgages. Each
Portfolio may also invest in debt securities which are
secured with collateral consisting of U.S. mortgage-related
securities, such as collateralized mortgage obligations, and
in other types of mortgage-related securities, limited in
the aggregate to 5% of each Portfolio's net assets.
An example of a mortgage-related security is a GNMA
mortgage-backed certificate. Although the mortgage loans in
the pool underlying the certificate will have maturities of
up to 30 years, the actual average life of a GNMA
certificate will be substantially less because the mortgages
may be prepaid prior to maturity. Prepayment rates vary
widely and may be affected by changes in mortgage interest
rates. In periods of falling interest rates, the rate of
prepayment on higher interest rate mortgages increases,
thereby shortening the average life of the GNMA certificate.
Conversely, when interest rates are rising, the rate of
prepayment decreases, thereby lengthening the actual average
life of the certificate. Reinvestment of prepayments may
occur at higher or lower rates than the original yield on
the certificates. Due to the possibility of prepayment and
the need to reinvest prepayments of principal at current
rates, GNMA certificates can be less effective then typical
non-callable bonds of similar maturities at "locking in"
higher yields during periods of declining rates, although
they may have comparable risks of decline in value during
periods of rising interest rates. See "Investment Objectives
and Policies" in the Statement of Additional Information.
FOREIGN SECURITIES Each Portfolio may invest its assets directly in the
securities of foreign issuers and supranational
organizations ("foreign securities"), or options and futures
related to foreign securities, subject to the following
additional limitations. Foreign securities may be
denominated in U.S. dollars or in a foreign currency.
The SHORT-TERM GOVERNMENT PORTFOLIO will limit its foreign
securities to (i) 20% of Portfolio total assets, and (ii)
high grade debt obligations issued or guaranteed by foreign
governments, agencies, instrumentalities, or their political
subdivisions, or supranational agencies, and judged by the
Adviser to have a credit risk at the time of purchase
comparable to a domestic A or better credit rating.
The MASTER FIXED INCOME PORTFOLIO and the ENHANCED EQUITY
PORTFOLIO will limit their non-U.S. dollar denominated
foreign security investments to 20% of Portfolio total
assets, but have no percentage limitation on the amount
invested in foreign securities which are U.S. dollar
denominated, including investments in foreign securities in
domestic markets through depository receipts. Foreign debt
securities that these two Portfolios purchase will generally
be high grade as the
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MASTER FIXED INCOME PORTFOLIO and the ENHANCED EQUITY
PORTFOLIO have adopted a 5% limitation on non-investment
grade securities (See "Non-Investment Grade Securities").
Foreign debt securities that these two portfolios purchase
will generally be high grade as the MASTER FIXED INCOME
PORTFOLIO and the ENHANCED EQUITY PORTFOLIO have adopted a
5% limitation on below high grade fixed income securities
and a 5% limitation on below high grade convertible
securities (See "Below High Grade Securities"). Foreign
investments involve risks which are in addition to the risks
inherent in domestic investments. In many countries, there
is less publicly available information about issuers,
including governments, than is available in the reports and
ratings published about issuers in the United States. In
addition, foreign companies are not subject to uniform
accounting, auditing, and financial reporting standards. The
value of foreign investments may rise or fall because of
changes in currency exchange rates, and a Portfolio may
incur certain costs in converting securities denominated in
foreign currencies to U.S. dollars. Dividends and interest
on foreign securities may be subject to foreign withholding
taxes, which would reduce a Portfolio's income without
providing a tax credit for Portfolio shareholders. Obtaining
judgments, when necessary, in foreign countries may be more
difficult and more expensive than in the United States.
Although each Portfolio intends to invest in securities of
foreign governments or issuers located in developed nations
which the Adviser considers as having stable and friendly
governments, there is the possibility of expropriation,
confiscatory taxation, nationalization, currency blockage,
or political or social instability which could affect
investments in those nations. These factors are considered
when making foreign security investments and the Adviser
would make such investments when they are expected to
provide higher income or higher total returns to compensate
for such increased risks beyond those of domestic
investments.
OPTIONS AND FUTURES Each Portfolio may utilize various call option, put option,
STRATEGIES and financial futures strategies in pursuit of its
objective. Option contracts, futures contracts, and various
other financial contracts are also known as DERIVATIVE
SECURITIES, because their values depend on the values of a
more basic UNDERLYING SECURITY (or perhaps multiple
underlying securities), which may be a common stock, a fixed
income or other debt security, a foreign currency exchange
rate, a stock index, or some other financial instrument or
index. The SHORT-TERM GOVERNMENT PORTFOLIO will limit its
use of derivative securities to those which are primarily
interest rate or currency exchange rate related.
These techniques will be used to hedge against changes in
securities prices, interest rates, or foreign currency
exchange rates on securities held or intended to be acquired
by the Fund, to reduce the volatility of
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the currency exposure associated with foreign securities, or
as an efficient means of adjusting exposure to stock or bond
markets, and not for speculation.
A call option on securities gives the purchaser of the
option the right (but not the obligation) to buy from the
writer of the option the underlying securities at the
exercise price during the option period. Similarly, a put
option on securities gives the purchaser of the option the
right (but not the obligation) to sell to the writer of the
option the underlying securities at the exercise price
during the option period.
A financial futures contract is a commitment by both the
buyer and the seller of the contract to trade the underlying
financial instrument at a price and time agreed upon when
the contract is executed. The financial instrument may be a
stock index, bond index, interest rate, foreign currency
exchange rate, or other similar instrument. The contract may
include an option held by the seller with regard to the
specific underlying instrument to be delivered from a class
of instruments and the specific day of delivery within a
delivery month. Options on futures contracts are similar to
options on securities, with the futures contract playing the
role of the underlying security.
Options on indexes and currencies, and futures on indexes,
are similar to options and futures on securities, with the
underlying index or currency playing the role of the
underlying security, and with the difference that at the end
of the option or future period there is generally a cash
settlement between buyers and sellers instead of delivery of
the underlying security.
Options may be traded on an exchange (EXCHANGE-TRADED
OPTIONS) or may be customized agreements between the
Portfolio and a counter-party, often a brokerage firm, bank,
or other financial institution. These customized agreements
are also known as "over-the-counter" or OTC OPTIONS. Futures
contracts are normally traded as standardized contracts on
exchanges. When firm commitment type agreements similar to
futures are traded over-the-counter they are usually known
as FORWARD CONTRACTS. Exchange-traded options and futures
have the additional financial backing of an intermediary
known as a clearing corporation, whereas OTC options and
forwards have no such intermediary and are subject to the
credit risk that the counter-party will not fulfill its
obligations under the contract. While each Portfolio, to the
extent that it utilizes derivative securities, intends to
primarily utilize exchange-traded options and futures, it
may also utilize OTC options, currency forward contracts,
and other OTC derivative securities. No Portfolio will
invest, at the time of purchase, more than 5% of its net
assets in the purchase of OTC options or invest more than 5%
of its net assets in the purchase of forward contracts.
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Although options on securities and financial futures by
their terms call for actual delivery and acceptance of
securities, in many cases the contracts are closed out
before the expiration date by selling contracts that are
owned or by buying contracts that have been sold or written.
Like any security transaction, this may produce a realized
gain or loss to the Portfolio. Open positions are valued
whenever a Portfolio's assets are valued and the Portfolio
will have an unrealized gain or loss depending on the
difference between the current value of the position and the
opening value when the position was entered.
WRITING COVERED PUT AND CALL OPTIONS ON SECURITIES OR
INDEXES
The Portfolios will not write UNCOVERED options or utilize
written options to create leverage, but instead will write
only COVERED CALLS and COVERED PUTS.
Writing a covered call option on securities or indexes means
that the Portfolio will own at the time of selling the
option (1) the underlying security (or securities
convertible into the underlying security without additional
consideration), or (2) a call option on the same security or
index with the same or lesser exercise price, or (3) a call
option on the same security or index with a greater exercise
price, with the difference between the exercise prices
maintained as a segregated account containing cash, U.S.
government securities or other liquid high-grade debt
securities, or (4) liquid high-grade segregated debt
securities equal to the fluctuating market value of the
optioned securities which is marked-to-the-market daily, or
(5) in the case of an index, a portfolio of securities which
correlates with the index.
Writing a covered put option on securities or indexes means
that the Portfolio will, at the time of selling the option
(1) enter a short position in the underlying security or
index portfolio, or (2) purchase a put option on the same
security or index with the same or greater exercise price,
or (3) purchase a put option on the same security or index
with a lesser exercise price, with the difference between
the exercise prices maintained as liquid high-grade
segregated debt securities, or (4) maintain the entire
exercise price as liquid high-grade segregated debt
securities. No Portfolio will write put options if as a
result more than 25% of the Portfolio's assets would be
represented by debt securities segregated for such put
options.
The MASTER FIXED INCOME PORTFOLIO will only write an
"in-the-money" covered call option on common stock or an
"out-of-the-money" covered put option on common stock or
stock indexes. An in-the-money covered call option is an
investment in which the Portfolio purchases common stock and
sells a call option with an exercise price that is below the
market price of the stock at the time of the option sale. An
out-of-the-money covered put option is an investment in
which the Portfolio sells a put option on a common stock or
stock index with an
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exercise price that is below the market price of the stock
or index at the time of the option sale and maintains the
exercise price as high-grade segregated debt securities.
PURCHASING PUT AND CALL OPTIONS ON SECURITIES OR INDEXES
Each Portfolio may purchase put and call options on
securities or indexes in pursuit of its objective. The
Portfolio may, at the same time, have a long or COVERED
short position in the underlying security or index, and may
have written covered options on the same security or index.
Hence, the Portfolio's entire position in a particular
security may be complex, consisting of a number of different
option positions, a possible position in the underlying
security, and a possible segregated debt securities holding.
CONVERTIBLE SECURITIES, SYNTHETIC CONVERTIBLE INVESTMENTS,
CERTAIN COVERED CALL AND CASH SECURED PUT INVESTMENTS, AND
WARRANTS
The MASTER FIXED INCOME PORTFOLIO and the ENHANCED EQUITY
PORTFOLIO may invest in securities which may be exchanged
for, converted into, or exercised to acquire a predetermined
number of shares of the issuer's common stock at the option
of the Portfolio during a specified time period (such as
convertible preferred stocks, convertible debentures and
warrants). A convertible security is generally a fixed
income security which is senior to common stock in an
issuer's capital structure, but is usually subordinated to
similar non-convertible securities. No more than 5% of a
Portfolio's total assets will be invested in convertible
securities rated at the time of purchase lower than A or
equivalent. See "Investment Objective and Policies" in the
Statement of Additional Information and "Securities Ratings"
below.
In general, the market value of a convertible security is at
least the higher of its "investment value" (i.e., its value
as a fixed income security) or its "conversion value" (i.e.,
its value upon conversion into its underlying common stock).
As a fixed income security, a convertible security tends to
increase in value when interest rates decline and tends to
decrease in value when interest rates rise. However, the
price of a convertible security is also influenced by the
market value of the security's underlying common stock. The
price of a convertible security tends to increase as the
market value of the underlying stock rises, whereas it tends
to decrease as the market value of the underlying stock
declines. While no securities investment is without some
risk, investments in convertible securities and synthetic
convertible positions generally entail less risk than
investments in the common stock of the same issuer.
Investments in warrants involve certain risks, including the
possible lack of a liquid market for resale of the warrants,
potential price fluctuations as a result of speculation or
other factors, and failure of the price of the underlying
security to reach or have reasonable prospects
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of reaching a level at which the warrant can be prudently
exercised (in which event the warrant may expire without
being exercise, resulting in a loss of the Portfolio's
entire investment therein).
The MASTER FIXED INCOME PORTFOLIO and the ENHANCED EQUITY
PORTFOLIO may each invest up to 35% of their total assets in
convertible securities, synthetic convertible and certain
combinations of covered call and cash secured put
investments. A synthetic convertible investment is a
combination investment in which the Portfolio purchases both
(i) high-grade cash equivalents or a high grade debt
obligation of an issuer or U.S. Government securities and
(ii) call options or warrants on the common stock of the
same or different issuer with some or all of the anticipated
interest income from the associated debt obligation that is
earned over the holding period of the option or warrant. The
Portfolios may also write an "in-the-money" covered call
option on common stock or an "out-of-the-money" covered put
option on common stock or stock indexes. Convertible
securities, synthetic convertible and in-the-money covered
calls and out-of-the-money cash secured puts are not taken
into account when determining whether the Portfolios have
met the requirements that 65% of their total assets be
invested in fixed income and equity securities (see
"Investment Objectives and Policies" above).
While providing a fixed income stream (generally higher in
yield than the income derivable from common stock but lower
than that afforded by a similar non-convertible security), a
convertible security also affords an investor the
opportunity, through its conversion feature, to participate
in the capital appreciation attendant upon a market price
advance in the convertible security's underlying common
stock. A synthetic convertible position has similar
investment characteristics, but may differ with respect to
credit quality, time to maturity, trading characteristics,
and other factors. Because the Portfolio will create
synthetic convertible positions only out of high grade fixed
income securities, the credit rating associated with a
Portfolio's synthetic convertible investments is generally
expected to be higher than that of the average convertible
security, many of which are rated below high grade. However,
because the options used to create synthetic convertible
positions will generally have expirations between one month
and three years of the time of purchase, the maturity of
these positions will generally be shorter than average for
convertible securities. Since the option component of a
convertible security or synthetic convertible position is a
wasting asset (in the sense of losing "time value" as
maturity approaches), a synthetic convertible position may
lose such value more rapidly than a convertible security of
longer maturity; however, the gain in option value due to
appreciation of the underlying stock may exceed such time
value loss, the market price of the option component
generally reflects these differences in maturities,
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and the Adviser takes such differences into account when
evaluating such positions. When a synthetic convertible
position "matures" because of the expiration of the
associated option, the Portfolio may extend the maturity by
investing in a new option with longer maturity on the common
stock of the same or different issuer. If the Portfolio does
not so extend the maturity of a position, it may continue to
hold the associated fixed income security.
Covered call and cash secured put investments are subject to
the risks associated with common stocks and options
described above. While such investments have a combined
volatility similar to that of long-term corporate bonds, the
Adviser believes they provide greater returns than
investment in such bonds.
PURCHASE AND SALE OF FINANCIAL FUTURES, AND OPTIONS ON
FINANCIAL FUTURES
Each Portfolio may purchase or sell financial and other
futures contracts and options on financial and other futures
contracts in pursuit of its objective.
Futures contracts and their related options may be purchased
or sold for various reasons: to hedge portfolio securities
against adverse fluctuations, to adjust the level of market
exposure of a portfolio, to facilitate trading, to reduce
transactions costs, and/or to seek higher investment returns
when a futures or option contract is attractively priced
relative to a typical Portfolio investment in the underlying
security or index or securities highly correlated to the
underlying index. As with all of the investment strategies
that a Portfolio may employ, there can be no assurance that
any such strategy will achieve its objective.
A Portfolio's futures and related options transactions will
be conducted within the following limitations:
(i) When a Portfolio sells a futures contract, the value of
that contract will not exceed the total market value of the
portfolio securities being hedged;
(ii) A Portfolio will write only covered call and put
options on futures;
(iii) When a Portfolio purchases a futures contract it will
maintain the market value of the contract in liquid
high-grade segregated debt securities as described above.
(iv) A Portfolio will not enter into futures and options on
futures contracts which would cause the aggregate sum of the
initial margins for such contracts and related option
premiums to exceed 5% of the Portfolio's net assets;
provided, however, that in the case of an option that is
in-the-money at the time of purchase, the in-the-money
amount may be excluded in computing such 5%.
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CERTAIN RISK FACTORS ASSOCIATED WITH HEDGING STRATEGIES
When a Portfolio utilizes futures or options to hedge the
price fluctuations of securities it may own or want to
purchase, the Portfolio is exposed to the risk of imperfect
correlation between the futures or options and the
securities being hedged. That is, the prices of the
securities being hedged may not move in the same amount, or
even in the same direction, as the hedging instrument. The
Adviser will attempt to minimize this risk by investing only
in those contracts whose behavior is expected to resemble
the Portfolio securities being hedged. However, if the
Adviser's judgment about the general direction of interest
rates, market value, volatility, and other economic factors
is incorrect, the Portfolio would have been better off
without the use of such hedging techniques. In addition,
there is the risk of a possible lack of a liquid secondary
market and the resultant inability to close a futures or
option position prior to its maturity or expiration date. If
the Adviser determines that the ability to close such a
position early is important to its investment strategy, it
will only enter such positions on an exchange with a
secondary market that it judges to be appropriately active.
COVERED SHORT SALES To hedge against market risks, each Portfolio may make
covered short sales of securities in pursuit of its
objective. A covered short sale is a sale of borrowed
securities in which the Portfolio will (1) own at the time
of selling the securities, the underlying security (or
securities convertible into the underlying security without
additional consideration), or (2) own a call option on the
same security with the difference between the exercise price
and any margin required to be deposited in connection with
the short sale at the broker maintained as liquid high-grade
segregated debt securities. Total segregated collateral for
short sales will not exceed 10% of a Portfolio's net assets
at any one time.
In order to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code, a Portfolio must
derive less than 30% of its gross income from the sale of
securities it has held for less than three months (the
"three month gain rule"). The three month gain rule may
limit a Portfolio's ability to sell a portfolio security
short, or to terminate its short position, at a time when
the Adviser believes it would be advantageous to do so. A
Portfolio will not enter into a short sale or purchase and
deliver new securities to terminate its short position if
such action would cause it to violate the three month gain
rules, which would result in the taxation of Portfolio
income at the Portfolio level.
BELOW HIGH GRADE SECURITIES The SHORT-TERM GOVERNMENT PORTFOLIO may not purchase
securities rated below A ("high grade" securities) and will
sell securities whose ratings are downgraded to below high
grade. The MASTER FIXED INCOME
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PORTFOLIO and the ENHANCED EQUITY PORTFOLIO may each invest
up to 5% of net assets in fixed income securities and up to
5% of net assets in convertible securities rated lower than
the high grade investment standard employed by the Fund
(i.e., rated BBB or lower). The MASTER FIXED INCOME
PORTFOLIO and the ENHANCED EQUITY PORTFOLIO will not
necessarily sell particular securities whose ratings are
downgraded to below A, but will sell sufficient amounts from
the two classes of (i) below high grade fixed income
securities or (ii) below high grade convertible securities
to bring the total percentage of such securities to 5% or
less in each class. Ratings of securities by rating agencies
such as S & P and Moody's evaluate the safety of principal
and interest payments, not the market value risk associated
with changes in interest rates. Credit rating agencies may
fail to timely change such ratings to reflect subsequent
events. A debt security may be assigned a lower rating or
cease to be rated after its purchase by the Fund. For
additional descriptions of the risks of these investments
and the various rating grades, see the Statement of
Additional Information "Appendix -- Description of Bond
Ratings".
INVESTMENTS IN SECURITIES Each of the Portfolios may purchase the securities of other
OF OTHER INVESTMENT investment companies. The SHORT-TERM GOVERNMENT PORTFOLIO
COMPANIES may invest up to 20% of its total assets in such securities
and the MASTER FIXED INCOME PORTFOLIO and ENHANCED EQUITY
PORTFOLIO may each invest up to 35% of their respective
total assets in such securities. However, no Portfolio may
own voting stock of any one such investment company in an
amount which, when aggregated with such stock owned by all
affiliated persons of the Fund (as defined in the 1940 Act)
exceeds 3% of the total outstanding voting stock of such
investment company.
Such transactions may in some cases raise a Portfolio's
transaction costs relative to a direct investment in the
same securities, but in some cases a Portfolio may benefit
from being able to acquire a diversified investment in one
purchase that could not be made economically in a direct
fashion. As other investment companies pay management fees
to their investment advisers, shareholders of a Portfolio
which purchases such securities will bear the proportionate
share of such fees as well as the management fees paid by
the Portfolio. In addition, the 1940 Act provides that no
investment company in which the Fund invests is obligated to
redeem shares of such company owned by the Fund in an amount
exceeding 1% of such company's outstanding shares during any
period of less than thirty days.
Investments in the securities of other investment companies
by each Portfolio are intended to (i) provide an investment
vehicle for each Portfolio's cash reserves that the
Portfolio does not want to commit to riskier investments,
(ii) facilitate each Portfolio's investment strategies in
which high-grade collateral is required, or (iii) facilitate
each Portfolio's investment strategies by acquiring
investments in portfolios
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of securities more diversified or with specialized
characteristics that could not be efficiently acquired
directly. The SHORT-TERM GOVERNMENT PORTFOLIO will limit its
purchases of the securities of other investment companies to
those that invest primarily in the same securities that the
SHORT-TERM GOVERNMENT PORTFOLIO may invest in directly.
LENDING OF SECURITIES Each Portfolio may lend its investment securities to
qualified institutional investors for the purpose of
realizing income. Loans of securities by the Portfolio will
be collateralized by cash, letters of credit, or securities
issued or guaranteed by the U.S. Government or its agencies.
The collateral will equal at least 100% of the current
market value of the loaned securities at all times during
which the securities are loaned by marking to market daily,
and such loans will not exceed one-third of the total value
of the Portfolio's securities. Such loans involve risks of
delay in receiving additional collateral or in recovering
the securities loaned or even loss of rights in the
collateral should the borrower of the securities fail
financially. However, such securities lending will be made
only when, in the Adviser's judgment, the income to be
earned from the loans justifies the attendant risks. Loans
are subject to termination at the option of the Fund or the
borrower.
DELAYED DELIVERY The Fund may purchase securities on a when-issued or delayed
TRANSACTIONS delivery basis and sell securities on a delayed delivery
basis. These transactions involve a commitment by the Fund
to purchase or sell securities for a predetermined price or
yield, with payment and delivery taking place more than
seven days in the future, or after a period longer than the
customary settlement period for that type of security. When
delayed delivery purchases are outstanding, the Fund will
set aside and maintain until the settlement date cash, U.S.
Government securities or liquid high grade debt obligations
in an amount sufficient to meet the purchase price. When
purchasing a security on a delayed delivery basis, the Fund
assumes the rights and risks of ownership of the security,
including the risk of price and yield fluctuations, and
takes such fluctuations into account when determining its
net asset value, but does not accrue income on the security
until delivery. When the Fund sells a security on a delayed
delivery basis, it does not participate in future gains or
losses with respect to the security. If the other party to a
delayed delivery transaction fails to deliver or pay for the
security, the Fund could miss a favorable price or yield
opportunity or could suffer a loss. A Portfolio will not
invest more than 25% of its total assets in when-issued and
delayed delivery transactions.
PORTFOLIO TURNOVER A Portfolio will not attempt to achieve, nor will it be
limited to, a predetermined rate of portfolio turnover.
Turnover rate is the lesser of purchases or sales of
portfolio securities for a year, excluding all securities
with maturities of one year or less, divided by the monthly
average value of such securities. The turnover rates of the
ENHANCED EQUITY PORTFOLIO and the MASTER FIXED INCOME
PORTFOLIO are not
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expected to exceed 150%. The turnover of the SHORT-TERM
GOVERNMENT PORTFOLIO may be higher due to the short-term
maturities of the securities purchased, but is not expected
to exceed 300%. For the years ended December 31, 1995 and
1994, the portfolio turnover rates were 10.15% and 3.21% for
the SHORT-TERM GOVERNMENT PORTFOLIO, 31.82% and 44.30% for
the MASTER FIXED INCOME PORTFOLIO, and 10.15% and 24.75% for
the ENHANCED EQUITY PORTFOLIO. While higher portfolio
turnover (100% or more) can involve correspondingly greater
brokerage commissions and other transaction costs than lower
turnover, and such commissions and costs must be borne by
the Portfolio and its shareholders, the brokerage
commissions associated with the SHORT-TERM GOVERNMENT
PORTFOLIO are expected to be substantially less than the
other Portfolios as a percentage of assets, as short-term
fixed income securities generally trade on a net basis or
with a relatively small commission as a percentage of the
value of the security. High portfolio turnover may also
result in the realization of substantial net short-term
capital gains, and any distributions resulting from such
gains will be ordinary income for federal income tax
purposes. It is the Adviser's opinion that such turnover is
not expected to affect the SHORT-TERM GOVERNMENT PORTFOLIO'S
status as a regulated investment company for federal tax
purposes. See "Dividends, Distributions and Taxes."
BORROWING Each Portfolio may borrow money from banks up to a limit of
15% of the market value of its assets, but only for
temporary or emergency purposes. The Portfolio would borrow
money only to meet redemption requests prior to the
settlement of securities already sold or in the process of
being sold by the Portfolio. To the extent that a Portfolio
borrows money prior to selling securities, the Portfolio may
be leveraged; at such times, the Portfolio may appreciate or
depreciate in value more rapidly than if it did not borrow.
A Portfolio will repay any money borrowed in excess of 5% of
the market value of its total assets prior to purchasing
securities.
INVESTMENT LIMITATIONS Each of the Portfolios has adopted certain additional
limitations designed to reduce its exposure to specific
situations. These limitations are fundamental policies that
cannot be changed without the approval of the holders of a
majority of the Portfolio's outstanding shares, as defined
in the Investment Company Act of 1940. See "Investment
Limitations" in the Statement of Additional Information.
MANAGEMENT OF THE FUND The Officers of the Fund manage its day to day operations
and are responsible to Fund's Board of Trustees.
INVESTMENT ADVISER Analytic-TSA Global Asset Management, Inc., 2222 Martin
Street, Suite 230, Irvine, CA 92715, is the Adviser of the
Fund. The Adviser is a
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wholly owned subsidiary of United Asset Management
Corporation, a holding company described under "Management
of the Fund" in the Statement of Additional Information.
The Adviser was founded in 1970 as Analytic Investment
Management, Inc. one of the first independent investment
counsel firms specializing in the creation and continuous
management of optioned equity and optioned debt portfolios
for fiduciaries and other long term investors. It is one of
the oldest and largest independent investment management
firms in this specialized area. In January 1996, the Adviser
acquired and merged with TSA Capital Management which
emphasizes U.S. and global tactical asset allocation,
currency management, quantitative equity and fixed income
management, as well as option yield curve strategies. The
Adviser serves, among others, pension and profit-sharing
plans, endowments, foundations, corporate investment
portfolios, mutual savings banks, and insurance companies,
for which it manages in excess of $2,000,000,000. It has
also managed another registered investment company since
1978.
Pursuant to an Investment Advisory Agreement with the Fund,
the Adviser, subject to the control and direction of the
Fund's Officers and Board of Trustees, manages the
Portfolios of the Fund in accordance with each Portfolio's
stated investment objective and policies, makes investment
decisions for the Fund, and administers the operations of
the Fund. Pursuant to separate agreements, the Adviser also
acts as the Fund's transfer agent, dividend disbursing
agent, and shareholder relations servicing agent, and
provides accounting and daily pricing services to the Fund.
John A. Flom is the primary portfolio manager of the
Short-Term Government and Master Fixed Income Portfolios.
Mr. Flom, a Chartered Financial Analyst has been a portfolio
manager of the Adviser since 1986. Charles L. Dobson is the
portfolio manager for the Enhanced Equity Portfolio. Mr.
Dobson is the Executive Vice President of The Analytic
Series Fund and Analytic Optioned Equity Fund has been a
portfolio manager of the Adviser since 1978. Both Mr. Flom
and Mr. Dobson are subject to the supervision of the
Adviser's investment management committee.
MANAGEMENT AND SERVICE FEES As compensation for furnishing investment advisory,
management, and other services, and costs and expenses
assumed, pursuant to the Investment Management Agreement
each Portfolio of the Fund pays the Adviser an annual fee
based on the average daily net assets of that Portfolio.
These annual fee schedules are:
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Short-Term Government...................... 0.30%
Master Fixed Income........................ 0.45%
Enhanced Equity............................ 0.60%
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The Adviser also acts as the Fund's transfer agent, dividend
disbursing agent, and shareholder relations servicing agent
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for which each Portfolio pays fees based on the number of
accounts and net assets. Each Portfolio also pays the
Adviser a fee based on its net assets to calculate its daily
share price and maintain its general accounting records.
EXPENSES In addition to management and service fees, each Portfolio
pays all costs and expenses of its operations, including
fees of Trustees not affiliated with the Adviser, membership
dues of trade associations, custodian, legal and accounting
fees, interest charges, brokerage commissions, federal and
state taxes, prospectuses and shareholder reports, expenses
of shareholder meetings, and costs of registration and
qualification of the shares of the Portfolio under various
federal and state laws and maintaining and updating such
registrations and qualifications on a current basis. Any
shared expense of the Portfolios is generally apportioned to
each Portfolio based on its relative total assets within the
Fund unless some other expense allocation method is
determined by the Board of Trustees to be more appropriate.
The Adviser has voluntarily agreed to reimburse annual
Portfolio expenses including advisory fees (but excluding
interest, taxes, and extraordinary expenses) that exceed
0.60%, 0.80%, and 1.0% of average daily net assets for the
Short-Term Government, Master Fixed Income, and Enhanced
Equity Portfolios respectively until December 31, 1996.
During 1995, the ratios of operating expenses to average net
assets in the Short-Term Government Portfolio, Master Fixed
Income Portfolio, and Enhanced Equity Portfolio, before
expense reimbursements, were 0.82%, 1.03% and 1.61%,
respectively. In calculating Portfolio expenses for purposes
of such reimbursement, any commission reimbursement from
broker-dealers will not be applied. After December 31, 1996,
the Adviser may voluntarily waive all or a portion of its
management fee and/or absorb certain expenses of a
Portfolio. Any such waiver or absorption will have the
effect of lowering the overall expense ratio for a Portfolio
and increasing the overall total return and yield to
investors at the time any such amounts were waived and/or
absorbed.
BROKERAGE Under the terms of the Investment Advisory Agreement, the
Adviser is authorized to employ broker-dealers to execute
orders for the purchase and sale of portfolio securities and
for other portfolio transactions who in its best judgment
can provide "best execution". In determining the abilities
of the broker-dealer to provide execution of a particular
portfolio transaction, the Adviser will consider all
relevant factors including the execution capabilities
required by the transaction or transactions; the ability and
willingness of the broker-dealer to facilitate each
transaction by participation therein for its own account;
the familiarity with sources from or to whom particular
securities might be purchased or sold; the quality and
continuity of service rendered by the broker-dealer with
regard to a Portfolio's other transactions; and
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any other factors relevant to the selection of a
broker-dealer for a particular and related transactions of a
Portfolio. Provided that best execution is obtained, the
Adviser may consider sales of the Portfolios' shares and the
provision of research services to the Adviser as factors in
the selection of broker-dealers to execute portfolio
transactions.
In addition, the Fund may enter into agreements whereby a
portion of the commissions earned by a broker-dealer on the
transactions placed with a broker-dealer will be reimbursed
to the Portfolios by the payment of all or a portion of the
Portfolios' custodian fee or other Portfolio expense. Such
reimbursement, if any, will be in addition to any expense
reimbursement by the Adviser. The Fund has entered into such
agreements and with respect to the Master Fixed Income and
Enhanced Equity Portfolios, payment of expenses aggregated
$979 and $5,240, respectively, for the year ended December
31, 1995.
Fixed income securities are traded primarily in the
over-the-counter market. They are generally traded on a net
basis and do not normally involve either brokerage
commission or transfer taxes. The cost of executing such
portfolio transactions will primarily consist of dealer
spreads and underwriting commissions. The Fund will always
attempt to deal with dealers where better prices and
execution are available. Securities may also be purchased
directly from the issuer.
THE SHARE PRICE OF EACH The share price or "net asset value" per share of each
PORTFOLIO Portfolio is computed once daily at 4:30 P.M. Eastern Time,
after the close of trading of the New York Stock Exchange
and the various option exchanges, or such other time as is
determined by or under the direction of the Board of
Trustees, on each day in which there is a sufficient degree
of trading in the securities that might materially affect
the Portfolio's net asset value. The Portfolios will not be
priced on days when the New York Stock Exchange is closed.
In addition, the Short-Term Government and Master Fixed
Income Portfolios will not be priced on days when the bond
market is closed, such as certain bank holidays, even though
the New York Stock Exchange may be open. The share price is
calculated by dividing the total value of the Portfolio's
assets, less total liabilities, by the total outstanding
shares of the Portfolio. Expenses and interest on portfolio
securities are accrued daily.
Portfolio securities are valued based on market quotations
or, if not readily available, at fair market value as
determined in good faith under procedures established by the
Board of Trustees. Bonds and fixed income securities may be
valued on the basis of prices provided by a pricing service
when such prices are believed by the Board to reflect fair
market value. See "Portfolio Valuation" in the Statement of
Additional Information.
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DIVIDENDS, CAPITAL GAINS
AND TAXES
DISTRIBUTIONS Dividends consisting of net investment income are declared
and payable to shareholders of record daily by both the
Short-Term Government and Master Fixed Income Portfolios.
Such dividends are paid on the first business day of each
month. Dividends consisting of net investment income of the
Enhanced Equity Portfolio are declared and payable to
shareholders of record on the last business day of each
calendar quarter. For the purpose of calculating such
dividends, net investment income consists of income accrued
on portfolio assets, less accrued expenses. In addition, net
realized capital gains of all Portfolios, if any, are
distributed annually.
The Fund's dividend and capital gains distributions may be
reinvested in additional shares or received in cash. See
"Selecting a Distribution Option".
TAX STATUS OF THE FUND Each Portfolio of the Fund intends to qualify for taxation
as a "regulated investment company" under the Internal
Revenue Code so that it will not be liable for federal
income taxes on amounts distributed to shareholders as
dividends and capital gains.
However, the Code contains a number of complex tests
relating to qualification which a Portfolio might not meet
in any particular year. For example, if a Portfolio derives
30% or more of its gross income from the sale of securities
held for less than 3 months, it may fail to qualify. If a
Portfolio did not so qualify, it would be treated for tax
purposes as an ordinary corporation and receive no tax
deduction for payments made to shareholders.
TAXATION OF SHAREHOLDERS Distributions paid by each of the Portfolios from net
investment income are taxable to shareholders as ordinary
income, whether received in cash or reinvested in additional
shares. Long-term capital gains distributions are taxable to
shareholders as long-term capital gains, regardless of how
long such shareholders have held their shares.
Any capital gain distribution paid by the Fund has the
effect of reducing the net asset value per share on the
reinvestment date by the amount of the distribution.
Therefore, a capital gain distribution paid shortly after a
purchase of shares by a shareholder would represent, in
substance, a partial return of capital to the shareholder
(to the extent it is paid on the shares so purchased), even
though it would be subject to income taxes as discussed
above. Accordingly, prior to purchasing shares, a
shareholder should carefully consider the impact of
dividends or capital gains distributions which are expected
to be or have been announced.
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For corporate investors, dividends paid by the Short-Term
Government Portfolio will generally not qualify for the
dividends received deduction, a minimal amount of dividends
paid by the Master Fixed Income Portfolio will qualify for
the deduction, and some fraction of dividends by the
Enhanced Equity Portfolio will qualify for such deduction.
The Fund will notify its shareholders annually of the tax
status of its dividends and capital gain distributions.
The sale of shares of the Fund is a taxable event and may
result in a capital gain or loss. A capital gain or loss may
be realized from an ordinary redemption of shares or an
exchange of shares between Portfolios of the Fund.
Dividend distributions, capital gains distributions, and
capital gains or losses from redemptions and exchanges may
be subject to state and local taxes. However, depending on
provisions of your state's tax law, the portion of a
Portfolio's income derived from "full faith and credit" U.S.
Treasury and agency obligations may be exempt from state and
local taxes. The Fund will indicate each year the portion of
a Portfolio's income, if any, that may qualify for this
exemption.
The Fund is required to withhold 31% of taxable dividends,
capital gains distributions, and redemption proceeds paid to
shareholders who have not complied with IRS taxpayer
identification regulations. Such withholding requirement may
be avoided by certifying on the Account Registration your
proper Social Security or Tax Identification Number and
further certifying that you are not subject to backup
withholding. Dividends, capital gains distributions, and
redemption proceeds paid to foreign shareholders will
generally be subject to withholding at the rate of 30% (or
lower treaty rate). You should consult your own tax adviser
regarding specific questions about federal, state, or local
taxation.
GENERAL INFORMATION The Fund is a Delaware business trust organized on November
18, 1992. The Declaration of Trust permits the Trustees to
issue an unlimited number of shares of beneficial interest.
The Board of Trustees has the power to designate one or more
classes ("Portfolios") of shares of beneficial interest and
to classify or reclassify any unissued shares with respect
to such classes. Presently the Fund is offering shares of
the three Portfolios described above.
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SHARES OF BENEFICIAL The shares of each Portfolio, when issued, are fully paid
INTEREST and non- assessable, are redeemable at the option of the
holder, are fully transferable and have no conversion or
pre-emptive rights. Shares are also redeemable at the option
of the Fund under certain circumstances (see "Redeeming
Shares"). Each share of a Portfolio is equal as to earnings,
expenses and assets of the Portfolio and, in the event of
liquidation of the Portfolio, is entitled to an equal
portion of all of the Portfolio's net assets. Shareholders
of the Fund are entitled to one vote for each full share
held and fractional votes for fractional shares held, and
will vote in the aggregate and not by Portfolio except as
otherwise required by law or when the Board of Trustees
determines that a matter to be voted upon affects only the
interest of the shareholders of a particular Portfolio.
Voting rights are not cumulative, so that the holders of
more than 50% of the shares voting in any election of
Trustees can, if they so choose, elect all of the Trustees.
While the Fund is not required, and does not intend, to hold
annual meetings of shareholders, such meetings may be called
by the Trustees at their discretion, or upon demand by the
holders of 10% or more of the outstanding shares of any
Portfolio for the purpose of electing or removing Trustees.
As of March 31, 1996, Southern New England
Telecommunications Corporation and Trust Company of
Knoxville held of record more than 25% of the Fund's
outstanding shares, and may be deemed controlling persons of
the Fund under the 1940 Act.
SHARE CERTIFICATES All shares (including reinvested dividends and capital gain
distributions) are issued or redeemed in full and fractional
shares rounded to the fourth decimal place. No share
certificates will be issued. Instead, an account will be
established for each shareholder and all shares purchased
will be held in book-entry form by the Fund.
SHAREHOLDER SERVICES Shareholder inquiries should be addressed to Analytic-TSA
Global Asset Management, Inc., Attn: Shareholder Services,
2222 Martin Street, Suite 230, Irvine, CA 92715-1406;
telephone (800) 374-2633; or FAX (714) 833-8049.
CONFIRMATION AND STATEMENTS Whenever a transaction takes place in an account, a
confirmation statement will be sent to the shareholder of
such transaction. This confirmation statement will include
complete details of all transactions for the calendar year
to date. For purposes of confirming dividend and/ or capital
gain distributions, shareholders of the Short-Term
Government and Master Fixed Income Portfolios may expect
statements at least monthly, and shareholders of the
Enhanced Equity Portfolio may expect statements at least
quarterly.
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FINANCIAL STATEMENTS The Fund will send to shareholders of each of the Portfolios
an unaudited semi-annual financial statement. The annual
financial statements of the Fund will be audited by
independent public accountants.
CUSTODIAN The Fund's custodian is The Union Bank of California, N.A.,
475 Sansome Street, San Francisco, California 94111.
ADDITIONAL INFORMATION This Prospectus, including the Statement of Additional
Information which has been incorporated by reference herein,
does not contain all the information set forth in the
Registration Statement filed by the Fund with the Securities
and Exchange Commission under the Securities Act of 1933.
Copies of the Registration Statement may be obtained at a
reasonable charge from the Commission or may be examined,
without charge, at the office of the Commission in
Washington, D.C.
YIELD, TOTAL RETURN, AND From time to time the Fund may advertise the "yield", "total
OTHER CALCULATIONS return", and "average annual total return" of one or more of
the Portfolios. Yield and return calculations are based on
historical results, do not take into account any federal or
state income taxes which may be payable, and are not
intended to indicate future performance.
The "30-day yield" of a Portfolio is calculated by dividing
net investment income per share earned during a thirty-day
period by the net asset value per share on the last day of
the period. Net investment income includes interest and
dividend income earned on the Portfolio's securities after
subtracting all expenses that have been applied to all
shareholder accounts. The yield calculation assumes that net
investment income earned over thirty days is compounded
monthly for six months and then annualized. Methods used to
calculate advertised yields are standardized for all stock
and bond mutual funds.
"Total return" and "average annual total return" are more
comprehensive measures of the Portfolio's historical
performance than the "30-day yield". Total return measures
both net investment income and the effect of realized and
unrealized appreciation or depreciation of the Portfolio on
a hypothetical shareholder, assuming reinvestment of all
distributions into new Portfolio shares. Specifically, the
total return for a stated period is calculated by assuming a
hypothetical investment in a Portfolio at the beginning of a
period; then, assuming reinvestment of all distributions
into new Portfolio shares, the total return is calculated as
the percentage change in the total dollar value of the
investment over the period in question. Average annual total
return expresses this same total return as an annualized
rate which, if compounded annually over the same period,
would result in the same total return.
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These standardized performance measures present historical
returns. In addition, the Fund may present non-standardized
measures which relate to the returns and risk or variability
of the returns of a Portfolio, including "standard deviation
of returns", "beta", "alpha", and "duration". These measures
are not standardized, as they involve choices regarding the
length of historical measurement periods, the frequency of
such measurements, the choice of market benchmarks, and
other factors which are beyond the scope of current SEC
performance standards. Hence, these measures may not be
directly comparable among different funds or different
measurers of the same funds. These risk measurements are
also based on historical results and are not intended to be
an indication of future performance.
The Fund may also include comparative performance
information in advertising or marketing shares.
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SHAREHOLDER GUIDE
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OPENING AN ACCOUNT To open a new account, either by mail or by wire, complete
and return a signed Account Registration. Please indicate
the Portfolio(s) you have chosen and the respective
amount(s) to be invested.
MINIMUM INVESTMENTS There is no minimum initial or subsequent purchase of
Portfolio shares by tax deferred retirement plans (including
IRA, SEP-IRA and profit sharing and money purchase plans) or
Uniform Gifts to Minors Act accounts. For other investors
the initial minimum purchase is $5,000 invested in any
proportion among the Portfolios and there is no minimum for
subsequent purchases.
PURCHASING SHARES Shares of the Portfolios are purchased directly from the
Fund with no sales charge or commission at the net asset
value per share next computed after an order and payment are
received by the Fund. Any order received after 1:00 P.M.
Pacific Time will be processed at the next day's closing net
asset value. Broker-dealers who place orders for the
purchase of shares of any Portfolio on behalf of their
customers may charge the customers for that service.
The Fund reserves the right to reject any purchase order or
to suspend or modify the continuous offering of its shares.
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BY MAIL The simplest way to make initial purchases of Portfolio
FOR INITIAL INVESTMENTS, shares is to mail a completed and signed Account
COMPLETE AND SIGN AN Registration together with a check made payable to THE
ACCOUNT REGISTRATION FORM. ANALYTIC SERIES FUND (REFERENCE PORTFOLIO NAME). For
FOR SUBSEQUENT INVESTMENTS, subsequent purchases, complete the Mail Remittance Form
COMPLETE A MAIL REMITTANCE (located on a statement) and return it with a check made
FORM. payable to THE ANALYTIC SERIES FUND (REFERENCE PORTFOLIO
NAME). Overnight mail service is suggested. Shares will be
purchased at the net asset value per share next determined
after an order and payment are received by the Fund.
BY WIRE Before wiring funds, you must telephone Shareholder Services
TELEPHONE SHAREHOLDER at (800) 374-2633 with the sending bank's name, date and
SERVICES AT (800) 374-2633 amount being wired to insure proper investment. There is no
BEFORE WIRING FUNDS. charge by the Fund for wire purchases.
Federal funds wiring instructions are:
The Union Bank of California, N.A.
ABA #1210-0001-5 for San Francisco Trust Account #011-094166
The Analytic Series Fund - (NAME OF PORTFOLIO)
For further credit to: (THE ACCOUNT REGISTRATION AND ACCOUNT
#)
Please be sure your bank includes the name of the Portfolio
and your account's registration name and, in the case of
subsequent investments, the account number assigned by the
Fund.
NOTE: Federal funds wire purchase orders will be accepted
only when the Fund and Custodian Bank are open for business.
FOR INITIAL PURCHASES ONLY: No purchases will be processed
until a completed and signed Account Registration has been
received.
BY EXCHANGE You may open an account for a new Portfolio or purchase
additional shares in any Portfolio by making an exchange
from an existing Portfolio account or from an existing
account in the Analytic Optioned Equity Fund. You may not
open an account by exchange unless you have completed an
account application.
If you open an account by exchange, the new account will
have identical registration and special instructions (such
as Distribution Option, Telephone Redemption Instructions,
Telephone Exchange Privileges, and duplicate
confirmation/statements) as the existing account.
For further information concerning exchanges, see
"EXCHANGING SHARES".
SELECTING A DISTRIBUTION You must select one of the three distribution options by
OPTION indicating so on the Account Registration:
AUTOMATIC REINVESTMENT OPTION -- Both dividends and capital
gains distributions will be reinvested in additional
Portfolio shares. This option will be selected for you
automatically unless you specify one of the other options.
</TABLE>
34
<PAGE>
<TABLE>
<S> <C>
CASH DIVIDEND OPTION -- Your dividends will be paid in cash
and your capital gains distributions will be reinvested in
additional Portfolio shares.
ALL CASH OPTION -- Dividends and capital gains distributions
will be paid in cash.
To change your option, written instructions with
signature(s) guaranteed must be received by Shareholder
Services 5 business days prior to the effective date of the
change. For further information concerning signature
guarantees, see "SIGNATURE GUARANTEES".
REDEEMING SHARES Shares are redeemed without charge at the net asset value
per share next computed after instructions and required
documents are received in proper form. Any instructions
received after 1:00 P.M. Pacific Time will be processed at
the next day's net asset value. See the discussions below,
under "By Telephone", "By Mail" and "By Exchange" for
information regarding the required documents. To be in
"proper form" the documents must be complete and executed by
all required parties.
Any redemption may be more or less than your cost, depending
on the market value of the securities held by the Portfolio.
Payment will be made as promptly as possible but in no event
later than 3 business days from the day the redemption
request is received. See "Redemption of Shares" in the
Statement of Additional Information for certain restrictions
that may apply.
BY TELEPHONE Provided that Telephone Redemption Privileges have been
established (by completing the "Telephone Redemption
Privileges" portion of the Account Registration or by
subsequent written instructions with signature(s)
guaranteed), a shareholder may redeem all or part of his
shares by calling Shareholder Services at (800) 374-2633.
No request for telephone redemption will be accepted except
where redemption proceeds are to be remitted to a bank
account that has been predesignated in writing. The
redemption proceeds will be wired by the Fund without charge
to the bank designated in the instructions. Any changes to
the telephone redemption instructions must be in writing
with signature(s) guaranteed.
The Fund's transfer agent will employ procedures designed to
provide reasonable assurance that instructions communicated
by telephone are genuine and, if it does not do so, it may
be liable for any losses due to unauthorized or fraudulent
instructions. The procedures employed by the transfer agent
include requiring the following information at the time of
the telephone call:
Account number;
Registration of account; and
Social Security Number or Tax I.D.
</TABLE>
35
<PAGE>
<TABLE>
<S> <C>
NOTE: Neither the Fund nor the transfer agent is responsible
for unauthorized telephone redemptions by a person
reasonably believed to be a shareholder unless the transfer
agent has received written notice canceling the telephone
redemption authorization. The Fund may change or discontinue
the telephone redemption privilege without notice. For your
protection, the Fund and its agents reserve the right to
record all calls.
The Fund reserves the right to refuse a telephone redemption
if it believes it is advisable to do so. Telephone
redemptions may be difficult to implement during periods of
drastic economic or market changes, which may result in an
unusually high volume of telephone calls. If a shareholder
is unable to reach Shareholder Services by telephone, shares
may be redeemed in writing as described below.
BY MAIL A shareholder may redeem all or part of his shares by
written request to Shareholder Services. The written request
must be endorsed by the registered owner(s) exactly as the
account is registered, including any special capacity of the
registered owner(s). Where the owner(s) have not arranged
with the Fund for redemption proceeds to be remitted to a
predesignated bank account, the Fund requires that the
signature(s) be guaranteed. Fiduciaries, corporations, and
other entities may also be required to furnish supporting
documents.
BY EXCHANGE Shares may be redeemed by making an exchange into another
Analytic Series Fund Portfolio or for shares of the Analytic
Optioned Equity Fund. For more information, see 'EXCHANGING
SHARES".
DELAYED PAYMENT In the event that the Fund is requested to redeem shares for
which it has not received good payment (e.g., cash or
cashier's check on a U.S. bank), it may delay the mailing of
a redemption check until such time as it is determined that
good payment has been collected for the purchase of such
shares. In addition, the Fund reserves the right to delay
the mailing of a redemption check where the shares to be
redeemed have been purchased by check within 15 days prior
to the date the redemption request is received, unless the
Fund has been advised that the check used for investment has
been cleared for payment by the shareholder's bank. However,
such delay will not be longer than 15 days after the
purchase date.
The Fund may suspend the redemption right or postpone
payment at times when the New York Stock Exchange is closed
or under certain other circumstances permitted by the
Securities and Exchange Commission.
</TABLE>
36
<PAGE>
<TABLE>
<S> <C>
PAYMENT-IN-KIND The Fund has made an election with the Securities and
Exchange Commission to pay in cash all redemptions requested
by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of the net
assets of the Fund at the beginning of such period. Such
commitment is irrevocable without the prior approval of the
Commission. Redemptions in excess of the above limits may be
paid in whole or in part in readily marketable investment
securities or in cash, as the Trustees may deem advisable.
However, payment will be made wholly in cash unless the
Trustees believe that economic or market conditions exist
which would make such a practice detrimental to the best
interests of the Fund. If redemptions are paid in investment
securities, such securities will be valued as set forth
under "The Share Price of Each Portfolio" and a redeeming
shareholder will normally incur brokerage expenses if the
shareholder converts these securities to cash.
BACKUP WITHHOLDING The Fund is required to withhold 31% of redemptions paid to
shareholders who have not complied with IRS taxpayer
identification regulations. You may avoid this withholding
requirement by certifying on the Account Registration your
proper Social Security or Taxpayer Identification Number and
by further certifying that you are not subject to backup
withholding.
SIGNATURE GUARANTEES To protect the shareholder's account and the Fund from
fraud, signature guarantees are required for certain
redemptions. The purpose of signature guarantees is to
verify the identity of the party who has authorized the
redemption. A guarantor must be a commercial bank or trust
company; a broker or dealer, municipal securities broker or
dealer, or government securities broker or dealer; a credit
union; a national securities exchange, registered securities
association or clearing agency; or a savings association.
Signature guarantees are required for:
any redemption request for an account where the owner(s)
have not arranged with the Fund for redemption proceeds to
be remitted to a predesignated bank account;
transfers or exchanges between accounts which are not
identically registered;
the addition of, or change in the address and wiring
instruction for, financial institutions designated to
receive redemptions sent directly into a shareholder's
account; and
redemptions involving disputed or deceased shareholder
accounts.
The Fund reserves the right to request additional
information from, and make reasonable inquiries of, any
eligible guarantor institution.
</TABLE>
37
<PAGE>
<TABLE>
<S> <C>
MINIMUM ACCOUNT BALANCE With the exception of qualified retirement plan accounts,
REQUIREMENT the Fund may liquidate any shareholder's account whenever,
due to redemptions, the value of the account falls below the
minimum account balance of $1,000 and the shareholder fails
to purchase sufficient shares to bring the value of the
account to $1,000 within 90 days after receiving written
notice sent by the Fund.
EXCHANGING SHARES Should your investment goals change, you may exchange your
shares between the Portfolios in the Fund or for shares of
the Analytic Optioned Equity Fund.
Exchanges are processed at the net asset value per share
next computed after the receipt of instructions in proper
form. Any instruction received after 1:00 P.M. Pacific Time
will be processed at the next day's net asset value.
BY TELEPHONE Provided that Telephone Exchange Privileges have been
established (by completing the "Telephone Exchange
Privileges" portion of the Account Registration or by
subsequent written instructions with signature(s)
guaranteed), a shareholder may exchange all or part of his
shares by calling Shareholder Services at (800) 374-2633.
The Fund's transfer agent will employ procedures designed to
provide reasonable assurance that instructions communicated
by telephone are genuine and, if it does not do so, it may
be liable for any losses due to unauthorized or fraudulent
instructions. The procedures employed by the transfer agent
include requiring the following information at the time of
the telephone call:
Account number;
Registration of account; and
Social Security Number or Tax I.D.
NOTE: Neither the Fund nor the transfer agent is responsible
for unauthorized telephone exchanges by a person reasonably
believed to be a shareholder unless the transfer agent has
received written notice canceling the telephone exchange
authorization. The Fund may change or discontinue the
telephone exchange privilege without notice. For your
protection, the Fund and its agents reserve the right to
record all calls.
The Fund reserves the right to refuse a telephone exchange
if it believes it is advisable to do so. Telephone exchanges
may be difficult to implement during periods of drastic
economic or market changes, which may result in an unusually
high volume of telephone calls. If a shareholder is unable
to reach Shareholder Services by telephone, shares may be
exchanged in writing as described below.
</TABLE>
38
<PAGE>
<TABLE>
<S> <C>
BY MAIL A shareholder may exchange all or part of his shares by
written request to Shareholder Services. The written request
must be endorsed by the owner(s) exactly as the account is
registered, including any special capacity of the registered
owner(s). The Fund requires that the signature(s) be
guaranteed.
IMPORTANT EXCHANGE Before you make an exchange you should consider the
INFORMATION following:
Please read the prospectus of the Fund or of Analytic
Optioned Equity Fund before making an exchange.
An exchange is treated as a redemption and a purchase and
any gain or loss on the transaction is taxable.
Recently purchased shares may not be exchanged until payment
for the purchase has been collected. The Fund reserves the
right to defer honoring exchange requests where shares to be
exchanged have been purchased by check within 15 days prior
to the date of the exchange request, unless the Fund has
been advised that such check has been cleared for payment by
the shareholder's bank.
Exchanges are accepted only if the registrations of the
accounts are identical.
The redemption and purchase price of shares redeemed by
exchange is the net asset value per share of the respective
Portfolios next computed after the Fund receives
instructions in proper form.
No exchange can be made unless the shares to be purchased
have been registered in the state of the purchaser.
EXCHANGE PRIVILEGE The Fund's exchange privilege is not intended to afford
LIMITATIONS shareholders a way to speculate on short-term market
movements. Accordingly, in order to prevent excessive use of
the Exchange Privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund may establish a policy of limiting excessive exchange
activity.
</TABLE>
39
<PAGE>
<TABLE>
<S> <C>
WITHDRAWAL PLAN A shareholder may establish a Withdrawal Plan under which
the shareholder receives a check monthly, quarterly, or
annually in a predetermined amount of not less than $100.
All income dividends and any realized gain distributions
attributable to the account will be reinvested at net asset
value on the payment dates, as with other shareholder
accounts, and shares of the Portfolio(s) will be redeemed
from the account in order to make the required withdrawal
payment. If a date is not specified by the shareholder, then
monthly distributions under the Withdrawal Plan will be
processed on the first business day of the month, quarterly
distributions will be processed on the last business day of
the calendar quarter, and annual distributions will be
processed on the last business day of the calendar year. The
shareholder may change or terminate his Withdrawal Plan
instructions by notifying the Fund in writing at least 5
business days prior to the effective date of the change.
IMPORTANT WITHDRAWAL PLAN Withdrawal payments should not be considered dividends,
INFORMATION yield, or income on an investment, since portions of each
payment may consist of a return of capital. Depending upon
the size and frequency of payments and fluctuations in value
of the Fund's shares redeemed, redemptions for the purpose
of making Withdrawal Plan disbursements may reduce or even
exhaust a shareholder's account.
</TABLE>
40
<PAGE>
- -----------------------------------------------
THE ANALYTIC
SERIES FUND
- -----------------------------------------------
INVESTMENT ADVISER
Analytic-TSA Global Asset Management, Inc.
2222 Martin Street, Suite 230
Irvine, CA 92715-1406
- -----------------------------------------------
TRANSFER AGENT, DIVIDEND DISBURSING AGENT
AND SHAREHOLDER SERVICES AGENT
Analytic-TSA Global Asset Management, Inc.
2222 Martin Street, Suite 230
Irvine, CA 92715-1406
- -----------------------------------------------
CUSTODIAN
The Union Bank of California, N.A.
Mutual Fund Services Dept., Trust Group
475 Sansome Street, 11th Floor
San Francisco, CA 94111
- -----------------------------------------------
COUNSEL
Paul, Hastings, Janofsky & Walker
555 South Flower Street
Los Angeles, CA 90071
- -----------------------------------------------
INDEPENDENT AUDITORS
Deloitte & Touche LLP
695 Town Center Drive, Suite 1200
Costa Mesa, CA 92626-9978
- -----------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE FUND OR THE ADVISER. THIS PROSPECTUS DOES NOT
CONSTITUTE ANY OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION.
- -----------------------------------------------
PROSPECTUS
MAY 1, 1996
- ------------------------------------
THE ANALYTIC
SERIES FUND
2222 MARTIN STREET, SUITE 230
IRVINE, CA 92715-1406
(800) 374-2633 -- (714) 833-0294
FAX: (714) 833-8049
- -----------------------------------------------
A NO-LOAD OPEN-END FUND WITH
NO SALES CHARGE OR REDEMPTION FEE
- -----------------------------------------------
TABLE OF CONTENTS
<TABLE>
<S> <C>
Highlights................................. 1
Fund Expenses.............................. 3
Financial Highlights....................... 4
Investment Objective and Policies.......... 7
Investment Risks........................... 9
Who Should Invest.......................... 11
Implementation of Policies................. 12
Management of Fund......................... 25
Investment Adviser......................... 25
The Share Price of Each Portfolio.......... 28
Dividends, Capital Gains and Taxes......... 29
General Information........................ 30
Yield, Total Return, and Other
Calculations............................... 32
Shareholder Guide.......................... 33
Opening an Account......................... 33
Purchasing Shares.......................... 33
Redeeming Shares........................... 35
Exchanging Shares.......................... 38
Withdrawal Plan............................ 40
</TABLE>
<PAGE>
PART B
THE ANALYTIC SERIES FUND
2222 Martin Street, Suite 230
Irvine, California 92715-1406
(800) 374-2633
FAX 714-833-8049
STATEMENT OF ADDITIONAL INFORMATION
Dated May 1, 1996
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the Fund's current Prospectus dated May 1, 1996. To obtain
this Prospectus without charge, please write or call Shareholder Services at the
address or telephone number above.
<TABLE>
<CAPTION>
TABLE OF CONTENTS PAGE
<S> <C>
The Fund. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Investment Objective and Policies . . . . . . . . . . . . . . . . 2
Investment Limitations. . . . . . . . . . . . . . . . . . . . . . 18
Purchase of Shares. . . . . . . . . . . . . . . . . . . . . . . . 20
Redemption of Shares. . . . . . . . . . . . . . . . . . . . . . . 20
Management of the Fund. . . . . . . . . . . . . . . . . . . . . . 20
Principal Shareholders. . . . . . . . . . . . . . . . . . . . . . 22
Investment Advisory and Other Services. . . . . . . . . . . . . . 23
Portfolio Transactions. . . . . . . . . . . . . . . . . . . . . . 24
Taxation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Yield, Total Return, and Other Performance Statistics . . . . . . 29
Additional Information. . . . . . . . . . . . . . . . . . . . . . 33
Appendix-Description of Bond Ratings. . . . . . . . . . . . . . . 34
</TABLE>
B-1
<PAGE>
THE FUND
INVESTMENT OBJECTIVE AND POLICIES
CERTAIN INVESTMENT RISKS
All of the Portfolios are expected to have fluctuations in their net asset
values. However, the Short-Term Government Portfolio is expected to have the
lowest such volatility and the Enhanced Equity Portfolio is expected to have the
highest volatility of the three Portfolios.
To illustrate the historical volatility associated with i) short-term bonds,
ii) a diversified bond portfolio, and iii) a diversified common stock portfolio,
the following table sets forth the extremes for annualized total returns as well
as the average annual total return for three indexes representing these sectors
of the market:
ONE TO THREE YEAR MATURITY U.S. TREASURY NOTES (1976-1995)
(Merrill Lynch 1 to 3 Year Treasury Index)
<TABLE>
<CAPTION>
One Year Five Years Ten Years
-------- ---------- ---------
<S> <C> <C> <C>
Best. . . . . 21.2% 14.3% 11.4%
Worst . . . . 0.6 6.7 7.7
Average . . . 9.2 9.8 10.1
</TABLE>
U.S. GOVERNMENT AND CORPORATE BONDS (1973-1995)
(Lehman Brothers Government/Corporate Bond Index)
<TABLE>
<CAPTION>
One Year Five Years Ten Years
-------- ---------- ---------
<S> <C> <C> <C>
Best. . . . . 31.1% 18.0% 13.7%
Worst . . . . -3.5 3.3 7.7
Average . . . 9.6 9.9 10.6
</TABLE>
U.S. COMMON STOCKS (1926-1995)
(Standard & Poor's Composite Stock Index)
<TABLE>
<CAPTION>
One Year Five Years Ten Years
-------- ---------- ---------
<S> <C> <C> <C>
Best. . . . . 54.0% 23.9% 20.1%
Worst . . . . -43.3 -12.5 -0.9
Average . . . 12.5 10.3 10.7
</TABLE>
The total returns shown should not be taken as an indication of future
performance of any Portfolio, but merely as an illustration of the variability
associated with different market sectors. The fluctuations in the total returns
of the above indexes are associated with various risks to which the Portfolios
in the Fund are also exposed, although to different degrees. These risks
include but are not limited to: i) interest rate risk, ii) credit risk, and
iii) equity risk.
Interest rate risk is the potential for a decline in bond prices due to rising
interest rates. In general, bond prices vary inversely with interest rates. When
interest rates rise, bond prices generally fall. Conversely, when interest rates
fall, bond prices generally rise. The change in price depends on several
factors, including the bond's maturity date. In general, bonds with longer
maturities are more sensitive to interest rates than bonds with shorter
maturities. Another name for interest rate risk is DURATION RISK.
B-2
<PAGE>
As an illustration of interest rate risk, the table below shows the effect of a
sudden 2% change in interest rates on two bonds of varying maturities:
Percent Change in the Price of a Par Bond Yielding 6%
<TABLE>
<CAPTION>
2% Increase In 2% Decrease In
Stated Maturity Interest Rates Interest Rates
---------------------------- -------------- --------------
<S> <C> <C>
Short-Term (2 years) -4% +4%
Intermediate-Term (10 years) -13% +16%
</TABLE>
The chart is intended to provide you with guidelines for determining the degree
of interest rate risk you may be willing to assume. The yield and price changes
shown should not be taken as representative of a Portfolio's current or future
yield or expected changes in a Portfolio's share price.
In addition to interest rate risk, each Portfolio that holds fixed income
securities is subject to varying degrees of credit risk. Credit risk, also known
as default risk, is the possibility that a bond issuer will fail to make timely
payments of interest or principal to a Portfolio. The credit risk of a Portfolio
depends on the quality of its investments. Reflecting their higher risks,
lower-quality bonds generally offer higher yields (all other factors being
equal).
When a Portfolio holds mortgage-backed securities, it is also subject to
prepayment risk. Prepayment risk is the possibility that, as interest rates
fall, homeowners are more likely to refinance their home mortgages. When these
mortgages are refinanced, the principal on securities backed by these mortgages
is "prepaid" earlier than expected. If the Portfolio has paid a premium for
such securities, it will incur a loss, and the premium will be amortized over a
shorter period than anticipated at the time of purchase, thus reducing the
effective yield on the securities. If the Portfolio that holds these securities
wants to reinvest the unanticipated principal in new fixed income securities,
it will generally be at lower interest rates. This reduces the interest income
of the Portfolio. In addition, when interest rates fall, the market prices of
the mortgage-backed securities will not rise as much as comparable Treasury
securities, as bond market investors anticipate the increase in mortgage
prepayments.
A risk similar to prepayment risk, but generally associated with corporate
obligations, is call risk. Call provisions, common in many corporate bonds that
may be held by the Portfolio, allow bond issuers to redeem bonds prior to
maturity. When interest rates are falling, bond issuers often exercise call
provisions, paying off bonds that carry high stated interest rates and often
issuing new bonds at lower rates. For the Portfolio, the result would be that
bonds with high interest rates are "called", the amortization period for any
purchase premiums would be shorter than expected and the bonds must be replaced
with lower yielding instruments. In these circumstances, the income of the
Portfolio would decline.
Equity risk is the potential for price declines associated generally with common
stocks and equity-type investments. The magnitude of this risk associated with
any particular investment position can vary widely depending on a number of
factors, including the business of the issuer, market conditions in general, the
particular type of security, and the possibility that the position may be HEDGED
with other securities. The portion of equity risk that is particular to the
securities of a given issuer and uncorrelated to common stocks in general is
expected to be reduced by the diversification strategies of a Portfolio.
However, even well diversified common stock portfolios have significant total
equity risk, as illustrated by the table regarding "U.S. Common Stocks" above.
B-3
<PAGE>
Interest rate risk and credit risk for the SHORT-TERM GOVERNMENT PORTFOLIO
should be modest. Because of the short-term average weighted duration of this
Portfolio, it is expected to exhibit low to moderate price fluctuations as
interest rates change. Credit risk should be negligible for the Portfolio's
holding of US. Treasury securities. In relative terms, credit risk will be
slightly higher for the Portfolio's holding of US. Government agency
obligations. Even though they carry top (AAA) credit ratings from S & P or
Moody's, some agency obligations are not explicitly guaranteed by the U.S.
Government and so are perceived as somewhat riskier than comparable Treasury
securities. The Portfolio may also, to a limited extent, invest in the
securities of foreign governments. The Portfolio expects that these investments
will generally carry AAA and AA ratings from S & P or Moody's at the time of
purchase, although they may also be rated A or, if unrated, be determined by the
Adviser to be equivalent to such ratings. Accordingly, the Portfolio's holdings
of foreign securities exposes the Portfolio to more credit risk than if it
exclusively invested in U.S. Government securities. The Portfolio may also hold
mortgage-backed securities such as GNMA securities, which are backed by the full
faith and credit of the U.S. Government, but which expose the Portfolio to
prepayment risk.
The MASTER FIXED INCOME PORTFOLIO has a higher degree of both interest rate risk
and credit risk than the SHORT-TERM GOVERNMENT PORTFOLIO. This Portfolio is
expected to exhibit moderate to high price fluctuations as interest rates
change, because the Portfolio will generally have significant holdings of both
intermediate-term and longer term bonds. The Portfolio will have various credit
risks through its holding of high grade (A or higher) obligations. When the
Portfolio makes a purchase of a debt security with a given quality rating, there
is the risk that the rating will be subsequently downgraded to either a lower
investment grade or a rating below high grade. Such a down-grading or its
anticipation is almost always accompanied by a drop in the market price of the
bond. In addition, even though a particular debt security may have a relatively
high quality rating from a rating agency, the issuer may still default on its
obligations to the Portfolio. This Portfolio is expected to normally have
significant holdings in mortgage-backed securities, which exposes it to
prepayment risk. It also is subject to call risk.
Reflecting these increased interest rate, credit, prepayment, and call risks,
the MASTER FIXED INCOME PORTFOLIO will generally offer higher yields than the
SHORT-TERM GOVERNMENT PORTFOLIO. However, it is sometimes the case in the bond
market that shorter maturity bonds offer higher yields than longer maturity
bonds. This is known as an INVERTED YIELD CURVE environment. In such an
environment, it is possible that the Short-Term Government Portfolio may have,
for example, a higher 30-day yield than the Master Fixed Income Portfolio. No
matter what the yield curve environment, yields are not a comprehensive measure
of a Portfolio's performance nor a guide to expected future performance. More
comprehensive measures of a Portfolio's historical performance are its average
annual total return and its variability of total return.
The SHORT-TERM GOVERNMENT PORTFOLIO should have no equity risk, as the Portfolio
does not intend to acquire any investments with equity-type characteristics. The
MASTER FIXED INCOME PORTFOLIO is expected to have low to moderate equity risk
through its use of convertible and synthetic convertible security positions and
its use of covered call and cash secured put investments. Convertible bonds are
hybrid securities that generally pay a fixed rate of interest but also may be
converted into a fixed amount of the common stock of the issuer; this
"conversion value" gives the security some equity risk. A synthetic convertible
investment is a combination investment in which the Portfolio purchases both (i)
high-grade cash equivalents, high grade debt obligations of an issuer or U.S.
Government securities and (ii) call options or warrants on the common stock of
the same or different issuer with some or all of the anticipated interest income
from the debt obligation that will be earned over the holding period of the
option or warrant. Since convertible securities often have credit ratings that
are below high grade, the Portfolio's use of synthetic convertible positions may
enable the Portfolio to receive both interest income and some equity exposure
without the typical credit risk of many convertible bonds or notes. See
"Convertible Securities, Synthetic Convertible Positions and Warrants". In
pursuit of its investment objective, the Portfolio may also invest in covered
call and cash secured put investments. Covered call and cash secured put
investments are equity positions hedged with options which are expected, on
average, to have similar average volatility over time to longer maturity
corporate or convertible bonds. The Portfolio will make such investments when it
expects to receive a higher total return than generally available from longer
term corporate bonds. Similarly to convertible bonds, these positions have both
equity and fixed income characteristics and expose the Portfolio to equity risk.
However, the Portfolio considers such risks when making such investments and
evaluates them in relation to their expected return and the objectives of the
Portfolio.
B-4
<PAGE>
The ENHANCED EQUITY PORTFOLIO is expected to be subject primarily to equity risk
and exhibit HIGH TO VERY HIGH price fluctuations as is characteristic of common
stocks and equity funds in general. The price fluctuations of this Portfolio can
generally be expected to be greater than either the Short-Term Government
Portfolio or the Master Fixed Income Portfolio. The Portfolio's use of options,
futures, and foreign securities may also expose the Portfolio to certain risks
in addition to those normally associated with a domestic common stock portfolio.
DURATION
The discussion in the Prospectus of the investment policies of the Short-Term
Government and Master Fixed Income Portfolios refer to the Portfolios' duration.
Duration is the weighted average life of a Portfolio's debt instruments measured
on a present value basis; it is generally superior to average weighted maturity
as a measure of a Portfolio's potential volatility due to changes in interest
rates.
Unlike a Portfolio's average weighted maturity, which takes into account only
the stated maturity date of the Portfolio's debt instruments, duration
represents a weighted average of both interest and principal payments,
discounted by the current yield-to-maturity of the securities. For example, a
four-year, zero-coupon bond, which pays interest only upon maturity (along with
principal), has both a maturity and duration of 4 years. However, a four-year
bond priced at par with an 8% coupon has a maturity of 4 years but a duration of
3.6 years (at an 8% yield), reflecting the bond's earlier payment of interest.
In general, a bond with a longer duration will fluctuate more in price than a
bond with a shorter duration. Also, for small changes in interest rates,
duration serves to approximate the resulting change in a bond's price. For
example, a sudden 1% change in interest rates will cause roughly a 4% move in
the price of a zero-coupon bond with a 4 year duration, whereas an 8% coupon
bond (with a 3.6 year duration) will change by approximately 3.6%.
MORTGAGE-RELATED SECURITIES
Mortgage-related securities are interest in pools of mortgage loans made to U.S.
residential home buyers, including mortgage loans made by savings and loan
institutions, mortgage bankers, commercial banks and others. Pools of mortgage
loans are assembled as securities for sale to investors by various governmental,
government-related and private organizations. The Fund may also invest in debt
securities which are secured with collateral consisting of U.S. mortgage-related
securities, and in other types of mortgage-related securities.
U.S. MORTGAGE PASS-THROUGH SECURITIES. Interests in pools of mortgage-related
securities differ from other forms of debt securities, which normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. Instead, these securities provide a monthly
payment which consists of both interest and principal payments. In effect,
these payments are a "pass-through" of the monthly payments made by the
individual borrowers on their residential mortgage loans, net of any fees paid
to the issuer or guarantor of such securities. Additional payments are caused
by repayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-related securities (such as securities issued by the
GNMA) are described as "modified pass-through." These securities entitle the
holder to receive all interest and principal payments owed on the mortgage pool,
net of certain fees, at the scheduled payment dates regardless of whether or not
the mortgagor actually makes the payment.
The principal governmental guarantor of U.S. mortgage-related securities is the
Government National Mortgage Association. GNMA is a wholly owned United State
Government corporation within the department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the United
States Government, the timely payment of principal and interest on securities
issued by institutions approved by GNMA (such as savings and loan institutions,
commercial banks and mortgage bankers) and backed by pools of mortgages insured
by the Federal Housing Agency or guaranteed by the Veterans Administration.
Government-related guarantors include the FNMA and the FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders and
subject to general regulation by the Secretary of Housing
B-5
<PAGE>
and Urban Development. FNMA purchases conventional residential mortgages not
insured or guaranteed by any government agency from a list of approved
seller/servicers which include state and federally chartered savings and loan
associations, mutual savings banks, commercial banks and credit unions and
mortgage bankers. FHLMC is a government-sponsored corporation created to
increase availability of mortgage credit for residential housing and owned
entirely by private stockholders. FHLMC issues participation certificates
which represent interests in conventional mortgages from FHLMC's national
portfolio. Pass-through securities issued by FNMA and participation
certificates issued by FHLMC are guaranteed as to timely payment of principal
and interest by FNMA and FHLMC, respectively, but are not backed by the full
faith and credit of the U.S. Government.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create pass-
through pools of conventional residential mortgage loans. Such issuers may, in
addition, be the originators or servicers of the underlying mortgage loans as
well as the guarantors of the mortgage-related securities. Pools created by
such non-governmental issuers generally offer a higher rate of interest than
government and government-related pools because they lack direct or indirect
government or agency guarantees of payment. However, timely payment of interest
and principal of these pools may be supported by various forms of insurance or
guarantees, including individual loan, pool insurance and letters of credit,
issued by governmental entities, private insurers, and mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers thereof will be
considered in determining whether a mortgage-related security meets the Fund's
high grade investment quality standards. However, there can be no assurance
that private insurers or guarantors will meet their obligations. In addition,
the Fund may buy mortgage-related securities without insurance or guarantees if
through an examination of the loan experience and practices of the
originator/servicers and poolers the Adviser determines that the securities meet
the Fund's quality standards.
Although the underlying mortgage loans in a pool may have maturities of up to 30
years, the actual average life of the pool certificates typically will be
substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Prepayment rates vary widely
and may be affected by changes in market interest rates. In periods of falling
interest rates, the rate of prepayment tends to increase, thereby shortening the
actual average life of the pool certificates. Conversely, when interest rates
are rising, the rate of prepayments tends to decrease, thereby lengthening the
actual average life of the certificates. Accordingly, it is not possible to
predict accurately the average life of a particular pool.
Although the market for mortgage pass-through securities is becoming
increasingly liquid, securities issued by certain private organizations may not
be readily marketable. The Fund will not purchase mortgage-related securities
or any other assets which are illiquid if, as a result, the Fund would exceed
its policy limitation on illiquid securities. (See "Investment Limitations".)
FOREIGN MORTGAGE-RELATED SECURITIES. Foreign mortgage-related securities are
interests in pools of mortgage loans made to residential home buyers domiciled
in a foreign country. These include mortgage loans made by trust and mortgage
loan companies, credit unions, chartered banks, and others. Pools of mortgage
loans are assembled as securities for sale to investors by various governmental,
government-related, and private organizations (e.g., Canada Mortgage and Housing
Corporation and First Australian National Mortgage Acceptance Corporation
Limited). The mechanics of these mortgage-related securities are generally the
same as those issued in the United States. However, foreign mortgage markets
may differ materially from the U.S. mortgage market with respect to matters such
as the sizes of loan pools, prepayment experience, and maturities of loans. In
addition, foreign mortgage-related securities are subject to special currency
and other risks (see "Foreign Securities"). A Portfolio will not purchase any
foreign mortgage-related securities if as a result of such purchase more than 5%
of its net assets would be invested in such category of securities.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS'). A domestic or foreign CMO is a
hybrid between a mortgage-backed bond and a mortgage pass-through security.
Like a bond, interest and prepaid principal is paid, in most cases, semi-
annually. CMOs may be collateralized by whole mortgage loans, but are more
typically collateralized by portfolios of mortgage pass-through securities
guaranteed by GNMA, FHLMC, FNMA or equivalent foreign entities.
B-6
<PAGE>
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding
the longer maturity classes receive principal only after the first class has
been retired. A Portfolio will not purchase any CMOs if as a result of such
purchase more than 5% of its net assets would be invested in such category of
securities.
OTHER MORTGAGE-RELATED SECURITIES. Other mortgage-related securities include
securities of U.S. or foreign issuers that directly or indirectly represent a
participation in, or are secured by and payable from, mortgage loans on a real
property. These other mortgage-related securities may be equity or debt
securities issued by governmental agencies or instrumentalities or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, home builders, mortgage banks, commercial banks, investment banks,
partnerships, trusts and special purpose entities. A Portfolio will not
purchase any other mortgage-related securities if as a result of such purchase
more than 5% of its net assets would be invested in such category of securities.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
Each Portfolio may from time to time invest in zero-coupon, step-coupon, and
pay-in-kind securities. These securities are debt securities that do not make
regular interest payments. Because such securities do not pay current income,
the price of these securities can be volatile when interest rates fluctuate (see
the discussion on "Duration" above). While these securities do not pay current
cash income, federal income tax law requires the holders of taxable zero-coupon,
step-coupon, and certain pay-in-kind securities to report as interest each year
the portion of the original discount (or deemed discount) on such securities
accruing that year. In order to qualify as a "regulated investment company"
under the Code, a Portfolio may be required to distribute a portion of such
discount, which would then become part of a shareholder's taxable income. A
Portfolio will not purchase any zero-coupon, step-coupon, or pay-in-kind
securities if as a result of such purchase more than 5% of its net assets would
be invested in such category of securities.
SECURITIES OF SUPRANATIONAL ORGANIZATIONS
Each Portfolio may invest in the debt obligations of supranational institutions,
which may be either U.S. dollar denominated or denominated in a foreign
currency. There are currently 14 supranational organizations, which may be
divided into two groups: (i) 12 multilateral lending institutions ("MLIs"), and
(ii) two other supranationals -- the European Coal and Steel Community and the
European Economic Community. The 14 supranationals are the largest group of
borrowers in the world. All supranationals are currently rated at least AA or
equivalent by at least one recognized rating agency, with most rated AAA. The
MLIs consist of five development finance institutions, six European multilateral
financing organizations, and Intelsat supported satellite system operations. The
MLIs are not the direct obligations of any one country, but are sovereign-
supported financial institutions whose creditworthiness depend upon the member
countries' willingness and ability to support their obligations and their own
financial strength and expertise. Continued support of a supranational
organization by its government members is subject to a variety of political,
economic and other factors. The voting power of each member country within a
particular supranational closely follows the financial obligations of that
country. MLIs include the African Development Bank, Asian Development Bank,
Council of Europe Resettlement Fund, European Bank for Reconstruction and
Development, European Investment Bank, Eurofima, Eutelsat, Intelsat, Inter-
American Development Bank, International Finance Corporation, Nordic Investment
Bank, and The World Bank.
B-7
<PAGE>
OPTIONS AND FUTURES CONTRACTS
The Fund may purchase and sell ("write") both put options and call options on
securities, securities indices and foreign currencies, enter into interest rate,
foreign currency and index futures contracts, and purchase and sell options on
such futures contracts ("futures options") for various reasons: to hedge
portfolio securities against adverse fluctuations, to adjust the level of market
exposure of a portfolio, to facilitate trading, to reduce transactions costs,
and/or to seek higher investment returns when a futures or option contract is
attractively priced relative to a typical Portfolio investment in the underlying
security or index or securities highly correlated to the underlying index, and
not for speculation. The Fund may purchase and sell foreign currency options
for purposes of increasing exposure to a foreign currency or to shift exposure
to foreign currency fluctuations from one country to another. If other types of
options, futures contracts, or futures options are traded in the future, the
Fund may also use those instruments, provided the Board of Trustees determines
that their use is consistent with the Fund's investment objectives, and their
use is consistent with restrictions applicable to options and futures contracts
currently eligible for use by the Fund.
OPTIONS ON SECURITIES OR INDICES. The Fund may purchase and write options on
securities and indices. An index is a statistical measure designed to reflect
specified facets of a particular financial or securities market, a specific
group of financial instruments or securities, or certain economic indicators
such as the Merrill Lynch 1 to 3 Year Global Government Bond Index, the JP
Morgan Global Government Bond Index, and the Lehman Brothers
Government/Corporate Index.
An option on a security (or an index) is a contract that gives the holder of the
option, in return for a premium, the right to buy from (in the case of a call)
or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option (in the case of "American Style"
options) or at the expiration of the option (in the case of the "European Style"
options). The writer of a call or put option on a security is obligated upon
exercise of the option to deliver the underlying security upon payment of the
exercise price or to pay the exercise price upon delivery of the underlying
security, as the case may be. The writer of an option on an index is obligated
upon exercise of the option to pay the difference between the cash value of the
index and the exercise price multiplied by a specified multiplier for the index
option, such difference always being positive.
The Fund will write call options and put options only if they are "covered" as
defined in the Prospectus. If an option written by the Fund expires
unexercised, the Fund realizes a capital gain equal to the premium received at
the time the option was written. If an option purchased by the Fund expires
unexercised, the Fund generally realizes a capital loss equal to the premium
paid, with the exception that certain losses on put options purchased may be
deferred for tax accounting purposes. See "Taxation - Hedging Transactions".
Prior to the earlier of exercise or expiration, an option may be closed out by
an offsetting purchase or sale of an option of the same series (i.e., of the
same type, with respect to the same underlying security or index, and with the
same exercise price and expiration date). The Fund will realize a capital gain
from a closing purchase transaction if the cost of the closing option is less
than the premium received from writing the option; if it is more, the Fund will
realize a capital loss. If the premium received from a closing sale transaction
is more than the premium paid to purchase the option, the Fund will realize a
capital gain; if it is less, the Fund will realize a capital loss. The
principal factors affecting the market value of a put or a call option include
supply and demand, interest rates, the current market price of the underlying
security or index in relation to the exercise price of the option, the
volatility of the underlying security or index, and the time remaining until the
expiration date.
The market value of a put or call option purchased by the Fund is an asset of
the Fund. The premium received for an option written by the Fund is recorded as
an asset and the associated liability is subsequently marked to market daily.
The value of an option purchased or written is marked to market daily and is
valued at the closing price on the exchange on which it is traded or, if not
traded on an exchange or no closing price is available, at the mean between the
last bid and asked prices.
B-8
<PAGE>
RISKS ASSOCIATED WITH OPTIONS ON SECURITIES AND INDICES. Several risks are
associated with transactions in options on securities and indices. For example,
significant differences between the securities and options markets could result
in an imperfect correlation between those markets, causing a given transaction
not to achieve its objectives. A decision as to whether, when and how to use
options involves the exercise of skill and judgment, and even a well-conceived
transaction may be unsuccessful to some degree because of market behavior or
unexpected events.
There can be no assurance that a liquid market will exist when the Fund seeks to
close out an option position. If the Fund were unable to close out an option
that it had purchased on a security, it would have to exercise the option in
order to realize any profit. If the Fund were unable to close out a covered
call option that it had written on a security, it would not be able to sell the
underlying security unless the option expired without exercise. As the writer
of a covered call option, the Fund foregoes, during the option's life, the
opportunity to profit from increases in the market value of the security
covering the call option above the sum of the premium and the exercise price of
the call.
If trading were suspended in an option purchased by the Fund, the Fund would not
be able to close out the option. If restrictions on exercise were imposed, the
Fund might be unable to exercise an option it has purchased. Except to the
extent that a call option on an index written by the Fund is covered by an
option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN CURRENCY OPTIONS. The Fund may buy or sell put and call options on
foreign currencies. A put or call option on a foreign currency gives the
purchaser of the option the right to sell or purchase a foreign currency at the
exercise price until the option expires. The Fund will use foreign currency
options separately or in combination to control currency volatility. Among the
strategies employed to control currency volatility is an option collar. An
option collar involves the purchase of a put option and the simultaneous sale of
a call option on the same currency with the same expiration date but with
different exercise (or "strike") prices. Generally, the put option will have an
out-of-the-money strike price, while the call option will have either an at-the-
money strike price or an in-the-money strike price. Currency options traded on
U.S. or other exchanges may be subject to position limits which may limit the
ability of the Fund to reduce foreign currency risk using such options.
COMBINATIONS OF OPTIONS. The Fund may employ certain combinations of put and
call options. A "straddle" involves the purchase of a put and call option on
the same security with the same exercise prices and expiration dates. A
"strangle" involves the purchase of a put option and a call option on the same
security with the same expiration dates but different exercise prices. A
"collar" involves the purchase of a put option and the sale of a call option on
the same security with the same expiration dates but different exercise prices.
A "spread" involves the sale of an option and the purchase of the same type of
option (put or call) on the same security with the same or different expiration
dates and different exercise prices. The Fund may, at the same time it employs
certain combination of options, also have a position in the underlying security,
and a holding of segregated collateral as part of its "coverage" of short
options. Hence, the Fund's entire position related to a particular security,
index, foreign currency, or future may be complex; however, the Fund will always
be in a covered position with respect to options sold by the Fund.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Fund may use interest
rate, foreign currency or index futures contracts. An interest rate or foreign
currency contract provides for the future sale by one party and purchase by
another party of a specified quantity of a financial instrument or foreign
currency at a specified price and time. A futures contract on an index is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of a certain specified securities, no physical delivery of
these securities is made.
B-9
<PAGE>
A public market exists in futures contracts covering several indices as well as
a number of financial instruments and foreign currencies, including U.S.
Treasury bonds, U.S. Treasury notes, GNMA Certificates, three-month U.S.
Treasury bills, 90-day commercial paper, bank certificates of deposit,
Eurodollar certificates of deposit, the Australian dollar, the Canadian dollar,
the British pound, the German mark, the Japanese yen, the Swiss franc, and
certain multinational currencies such as the European Currency Unit ("ECU").
Other futures contracts are likely to be developed and traded in the future.
The Fund intends to enter primarily into futures contracts which are
standardized and traded on a U.S. or foreign exchange, board of trade, or
similar entity, or quoted on an automated quotation system. However, the Fund
may also enter into currency forward contracts, which are not exchange-traded
(see "Foreign Currency Transactions").
The Fund may also purchase and write call and put options on futures contracts.
Futures options possess many of the same characteristics as options on
securities and indices. A futures option gives the holder the right, in return
for the premium paid, to assume a long position (call) or short position (put)
in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a
long position in the futures contract and the writer is assigned the opposite
short position. In the case of a put option, the opposite is true.
As long as required by regulatory authorities, the Fund will use futures
contracts and futures options for hedging purposes and not for speculation. For
example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's securities or the price of the securities which the Fund intends to
purchase. The Fund's hedging activities may include sales of futures contracts
as an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
the Fund's exposure to interest rate fluctuations, the Fund may be able to hedge
its exposure more effectively and at a lower cost by using futures contracts and
futures options.
When a purchase or sale of a futures contract is made by the Fund, the Fund is
required to deposit with its Custodian (or futures commission merchant, if
legally permitted) a specified amount of cash or U.S. Government securities
("initial margin"). The margin required for a futures contract is set by the
exchange on which the contract is traded and may be modified during the term of
the contract. The initial margin is in the nature of a performance bond or good
faith deposit on the futures contract which is returned to the Fund upon
termination of the contract, assuming all contractual obligations have been
satisfied. The Fund expects to earn interest income on its initial margin
deposits. A futures contract held by the Fund is valued daily at the official
settlement price of the exchange on which it is traded. Each day the fund pays
or receives cash, called "variation margin", equal to the daily change in value
of the futures contract. This process is known as "marking to market."
Variation margin does not represent a borrowing or loan by a Fund but is instead
a settlement between the Fund and the futures commission merchant of the amount
one would owe the other if the futures contract expired. In computing daily net
asset value, the Fund will mark to market its open futures positions.
The Fund is also required to deposit and maintain margin with respect to put and
call options on futures contracts written by it. Such margin deposits will vary
depending on the nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the option, and other
futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts
(contracts traded on the same exchange, on the same underlying security or
index, and with the same delivery month). If an offsetting purchase price is
less than the original sale price, the Fund realizes a capital gain; if it is
more, the Fund realizes a capital loss. Conversely, if an offsetting sale price
is more than the original purchase price, the Fund realizes a capital gain; if
it is less, the Fund realizes a capital loss. The transaction costs must also
be included in these calculations.
B-10
<PAGE>
LIMITATIONS ON USE OF FUTURES AND FUTURES OPTIONS. The Fund will not enter into
a futures contract or futures option contract if, immediately thereafter, the
aggregate initial margin deposits relating to such positions plus premiums paid
by it for open futures option positions, less the amount by which any such
options are "in-the-money", would exceed 5% of the Fund's total assets. A call
option is "in-the-money" if the value of the futures contract that is the
subject of the option exceeds the exercise price. A put option is "in-the-
money" if the exercise price exceeds the value of the futures contract that is
the subject of the option.
When purchasing a futures contract, the Fund will maintain with its Custodian
(and mark to market on a daily basis) cash, U.S. Government securities, or other
highly liquid debt securities that, when added to the amounts deposited with a
futures commission merchant as margin, are equal to the market value of the
futures contract. Alternatively, the Fund may "cover" its position by
purchasing a put option on the same futures contract with a strike price as high
or higher than the price of the contract held by the Fund.
When selling a futures contract, the Fund will maintain with its Custodian (and
mark to market on a daily basis) liquid assets, that, when added to the amount
deposited with a futures commission merchant as margin, are equal to the market
value of the instruments underlying the contract. Alternatively, the Fund may
"cover" its position by owning the instruments underlying the contract (or, in
the case of an index futures contract, a portfolio with characteristics
substantially similar to that of the index on which the futures contract is
based), or by holding a call option permitting the fund to purchase the same
futures contract at a price no higher than the price of the contract written by
the Fund (or at a higher price if the difference is maintained in liquid assets
with the Fund's Custodian).
When selling a call option on a futures contract, the Fund will maintain with
its Custodian (and mark to market on a daily basis) cash, U.S. Government
securities, or other highly liquid debt securities that, when added to the
amounts deposited with a futures commission merchant as margin, equal the total
market value of the futures contract underlying the call option. Alternatively,
the Fund may cover its position by entering into a long position in the same
futures contract at a price no higher than the strike price of the call option,
by owning the instruments underlying the futures contract (or, in the case of an
index futures contract, a portfolio with characteristics substantially similar
to that of the index on which the futures contract is based), or by holding a
separate call option permitting the fund to purchase the same futures contract
at a price not higher than the strike price of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain with its
Custodian (and mark to market on a daily basis) cash, U.S. Government
securities, or other highly liquid debt securities that equal the purchase price
of the futures contract, less any margin on deposit. Alternatively, the Fund
may cover the position either by entering into a short position in the same
futures contract, or by owning a separate put option permitting it to sell the
same futures contract so long as the strike price of the purchased put option is
the same or higher than the strike price of the put option sold by the Fund.
In order to comply with currently applicable regulations of the Commodity
Futures Trading Commission ("CFTC") for exemption from the definition of a
"commodity pool", the Fund is limited in its futures trading activities to (i)
positions which constitute "bona fide hedging" positions within the meaning and
intent of applicable CFTC rules, and (ii) other positions for the establishment
of which the aggregate initial margin and premiums (less the amount by which any
such options are "in-the-money") do not exceed 5% of the investment company's
net assets.
B-11
<PAGE>
The requirements for qualification as a regulated investment company also may
limit the extent to which the Fund may enter into futures, futures options or
forward contracts. See "Taxation".
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS. There are several risks
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no
guarantee that there will be a correlation between price movements in the
hedging vehicle and in the Fund securities being hedged. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation, depending on circumstances such as
variations in speculative market demand for futures and futures options relative
to the demand for securities, technical influences in futures trading and
futures options, and differences between the financial instruments being hedged
and the instruments underlying the standard contracts available for trading in
such respects as interest rate levels, maturities, and creditworthiness of
issuers. A decision as to whether, when and how to hedge involves the exercise
of skill and judgment, and even a well-conceived hedge may be unsuccessful to
some degree because of market behavior or unexpected interest rate trends.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of the
current trading session. Once the daily limit has been reached in a futures
contract subject to the limit, no more trades may be made on that day at a price
beyond that limit. The daily limit governs only price movements during
particular trading days and therefore does not limit potential losses, because
the limit may work to prevent the liquidation of unfavorable positions. For
example, futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
There can be no assurance that a liquid market will exist at a time when the
Fund seeks to close out a futures contract or a futures option position, in
which event the Fund would remain obligated to meet margin requirements until
the position is closed. In addition, many of the contracts discussed above are
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist.
OTC OR DEALER OPTIONS. The Fund may engage in transactions involving OTC options
on securities, currencies, or indices as well as exchange-traded options.
Certain risks are specific to OTC options. While the Fund would look to a
clearing corporation to exercise exchange-traded options, if the Fund were to
purchase an OTC option it would rely on the counter-party (typically a broker,
bank, or other financial institution) from whom it purchased the option to
perform if the option were exercised. Failure by the counter-party to do so
would result in the loss of the premium paid by the Fund as well as loss of the
expected benefit of the transaction.
B-12
<PAGE>
Exchange-traded options generally have a continuous liquid market while OTC
options may not. Consequently, the Fund may generally be able to realize the
value of a OTC option it has purchased only by exercising or reselling the
option to the counter-party who issued it. Similarly, when the Fund writes a
OTC option, the Fund may generally be able to close out the option prior to its
expiration only by entering into a closing purchase transaction with the
counter-party to whom the Fund originally wrote the option. While the Fund will
seek to enter into OTC options only with counter-parties who will agree to and
are expected to be capable of entering into closing transactions with the Fund,
there can be no assurance that the Fund will be able to liquidate a OTC option
at a favorable price at any time prior to expiration. Unless the Fund, as a
covered OTC call option writer, is able to effect a closing purchase
transaction, it will not be able to liquidate securities (or other assets) used
as cover until the option expires or is exercised. In the event of insolvency
of the counter-party, the Fund may be unable to liquidate a OTC option. With
respect to options written by the Fund, the inability to enter into a closing
transaction may result in material losses to the Fund. For example, since the
Fund must maintain a secured position with respect to any call option on a
security it writes, the Fund may not sell the assets which it has segregated to
secure the position while it is obligated under the option. This requirement
may impair the Fund's ability to sell portfolio securities at a time when such
sale might be advantageous.
The Staff of the SEC has taken the position that purchased OTC options and the
assets used to secure written OTC options are illiquid securities. The Fund may
treat the cover used for written OTC options as liquid if the counter-party
agrees that the Fund may repurchase the OTC option it has written for a maximum
price to be calculated by a predetermined formula. In such cases, the OTC
option would be considered illiquid only to the extent the maximum purchase
price under the formula exceeds the intrinsic value of the option. Accordingly,
the Fund will treat OTC options as subject to the Fund's limitation on
unmarketable securities. If the SEC changes its position on the liquidity of
OTC options, the Fund will change its treatment of such instruments accordingly.
FOREIGN CURRENCY TRANSACTIONS
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to attempt to minimize the risk to the Fund from adverse changes in
the relationship between the U.S. dollar and foreign currencies. A forward
contract is an obligation to purchase or sell a specific currency for an agreed
price at a future date which is individually negotiated and privately traded by
currency traders and their customers. The Fund may sell a forward contract, for
example, when it purchases a foreign security denominated in a foreign currency,
in an attempt to remove the effect of exchange rate changes on the value of the
position. Such exchange rate changes, had their effect not been removed, may
have been either favorable or unfavorable to the Fund. Removing or partially
removing the effect of such currency rate changes does not remove other sources
of price variation in a security, due to the type of security and its exposure
to various risks.
Precise matching of the amount of forward currency contracts and the value of
the Fund's securities denominated in such currencies will not generally be
possible, since the future value of such securities in foreign currencies will
change as a consequence of market movements in the value of those securities
between the date the forward contract is entered into and the date it matures.
Prediction of short-term currency market movements is extremely difficult, and
the successful execution of a short-term hedging strategy is highly uncertain.
The Fund will not enter into such forward contracts or maintain a net exposure
to such contracts where the consummation of the contracts would obligate the
Fund to deliver an amount of foreign currency in excess of the value of the
Fund's portfolio securities or other assets denominated in that currency. Under
normal circumstances, consideration of the prospect for currency parities will
be incorporated into the longer term investment decision made with regard to
overall diversification strategies. However, the Adviser believes that it is
important to have the flexibility to enter into such forward contracts when it
determined that the best interests of the Fund will be served by doing so.
At the maturity of a forward contract, the Fund may either sell the portfolio
security and make delivery of the foreign currency, or it may retain the
security and terminate its contractual obligation to deliver the foreign
currency by purchasing an "offsetting" contract obligating it to purchase, on
the same maturity date, the same amount of the foreign currency.
B-13
<PAGE>
It may be necessary for the Fund to purchase additional foreign currency on the
spot market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of the foreign currency the Fund is
obligated to deliver.
If the Fund retains a portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
foreign currency. Should forward prices decline during the period between the
date the Fund enters into a forward contract for the sale of a foreign currency
and the date it enters into an offsetting contract for the purchase of the
foreign currency, the Fund will realize a gain to the extent the price of the
currency it has agreed to sell exceeds the price of the currency it has agreed
to purchase. Should forward prices increase, the Fund will suffer a loss to the
extent the price of the currency it has agreed to purchase exceeds the price of
the currency it has agreed to sell.
The Fund's dealings in forward foreign currency exchange contracts will be
limited to the transactions described above. Use of forward currency contracts
to hedge against a decline in the value of a currency does not eliminate
fluctuations in the underlying prices of the securities. Additionally, although
such contracts tend to minimize the risk of loss due to a decline in the value
of the hedged currency, they also tend to limit any potential gain which might
results from an increase in the value of that currency.
Although the Fund values its assets daily in terms of U.S. dollars, it does not
intend to convert its holdings of foreign currencies into U.S. dollars on a
daily basis. Foreign exchange dealers do not charge a fee for conversion, but
they do realize a profit based on the difference (the "spread") between the
prices at which they are buying and selling various currencies. Thus, a dealer
may offer to sell a foreign currency to the Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to resell that currency to the
dealer.
COVERED SHORT SALES
As discussed in the Prospectus, the Fund may make covered short sales of
securities to hedge against market risks. Generally, the Fund expects to make
such sales in connection with the Fund's option and futures strategies. For
example, the Fund may engage in option spreads in which it is both the purchaser
and the covered writer of the same type of option (puts or calls) on the same
underlying security with the options having different exercise prices and/or
expiration dates. When the Fund enters into such a spread involving two put
options, it is sometimes advantageous to enter into a "synthetic put" position
instead of purchasing the put option which is the long side of the spread. A
synthetic put position is created by a short sale of the underlying security
which is hedged or covered by long position in a call option with the same terms
as the put option being synthesized.
The Fund may also make short sales which are covered or hedged by securities
convertible or exchangeable into an equal number of shares of the securities
sold short or by holdings of the same security (known as "short sales against
the box"). Short sales against the box may be made for the purpose of receiving
a portion of the interest earned by the executing broker from the proceeds of
such a sale and/or to defer the realization of gain or loss for Federal income
tax purposes. The Fund will segregate in a special account with its Custodian or
broker an equal amount of the securities sold short or securities convertible
into or exchangeable for such securities. The extent to which the Fund may make
such short sales may be limited by the Code's requirements for qualification as
a regulated investment company. (See "Taxation").
B-14
<PAGE>
CONVERTIBLE SECURITIES, SYNTHETIC CONVERTIBLE POSITIONS, AND WARRANTS
The Master Fixed Income Portfolio and the Enhanced Equity Portfolio may invest
in securities which may be exchanged for, converted into or exercised to acquire
a predetermined number of shares of common stock of the same or a different
issuer at the option of the Portfolio during a specified time period. Such
securities include convertible securities (i.e., convertible preferred stock and
convertible debentures) and warrants. A convertible security is generally a
fixed income security which is senior to common stock in an issuer's capital
structure, but is usually subordinated to similar non-convertible securities.
In addition, the Portfolio may create a synthetic convertible position in which
the Portfolio purchases both (i) high-grade cash equivalents or a high grade
non-convertible fixed income security of an issuer (or U.S. Government
securities) and (ii) call options or warrants on the common stock of the same or
different issuer with some or all of the anticipated interest from the debt
obligation that will be earned over the holding period of the option or warrant.
In general, the market value of a convertible security is at least the higher of
its "investment value" (i.e., its value as a fixed income security) or its
"conversion value" (i.e., its value upon conversion into its underlying common
stock). As a fixed income security, a convertible security tends to increase in
value when interest rates decline and tends to decrease in value when interest
rates rise. However, the price of a convertible security tends to increase as
the market value of the underlying stock rises, whereas it tends to decrease as
the market value of the underlying stock declines. While no securities
investment is without some risk, investments in convertible securities and
synthetic convertible positions generally entail less risk than investments in
common stock of the same issuer.
Investments in warrants involve certain risks, including the possible lack of a
liquid market for resale of the warrants, potential price fluctuations as a
result of speculation or other factors, and failure of the price of the
underlying security to reach or have reasonable prospects of reaching a level at
which the warrant can be prudently exercised (in which event the warrant may
expire without being exercise, resulting in a loss of the Portfolio's entire
investment therein).
ILLIQUID SECURITIES
Under the Fund's investment restrictions, the Fund may not invest more than 15%
of the value of its net assets in securities that at the time of purchase have
legal or contractual restrictions on resale or are otherwise illiquid. See
"Investment Limitations". The Investment Adviser will monitor the amount of
illiquid securities in each Portfolio to ensure compliance with the Fund's
investment limitations. In the absence of a readily available market for such
securities, the restrictions on resale may cause such securities to be
considered illiquid.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
having a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Mutual funds do not typically hold a significant amount of
these restricted or other illiquid securities because of the potential for
delays on resale and uncertainty in valuation. Limitations on resale may have
an adverse effect on the marketability of portfolio securities and a mutual fund
might be unable to dispose of restricted or other illiquid securities promptly
or at reasonable prices and might thereby experience difficulty satisfying
redemptions within seven days. A mutual fund might also have to register such
restricted securities in order to dispose of them, resulting in additional
expense and delay. Adverse market conditions could impede such a public
offering of securities.
B-15
<PAGE>
In recent years, however, a large institutional market has developed for certain
securities that are not registered under the Securities Act, including
repurchase agreements, commercial paper, foreign securities, municipal
securities, and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments. If such securities are subject to purchase by institutional buyers
in accordance with Rule 144A promulgated by the Securities and Exchange
Commission (the "Commission") under the Securities Act, the Company's Board of
Trustees may determine that such securities are not illiquid securities,
notwithstanding their legal or contractual restrictions on resale. In all other
cases, however, securities subject to restrictions on resale will be deemed
illiquid.
INVESTMENT GRADE BONDS
See the Appendix for a description of securities ratings. The "high grade"
investment standard which the Fund uses only includes the highest three
categories for debt over one year maturity (A or better) and A-1 or equivalent
for short term maturities. The rating agencies themselves generally define
investment grade to include the top four categories for debt over one year
maturity. Subsequent to its purchase by a Portfolio, a security may be assigned
a lower rating or cease to be rated. In addition to considering ratings
assigned by the rating services in connection with its selection of investments
for the Portfolios, the Adviser will consider, among other things, information
concerning the financial history and conditions of the issuer and its revenue
and expense prospects.
Debt obligations in the BBB or equivalent category have speculative
characteristics, and changes in economic conditions or other circumstances
are more likely to lead to a weakened capacity to make principal and interest
payments than is the case with respect to higher grade bonds.
Debt obligations that are below investment grade are likely to be subject to
greater market fluctuation and to greater risk of loss of income and principal
due to default than investments of higher rated fixed income securities. Such
high-yielding securities generally tend to reflect short-term corporate and
market developments to a greater extent than higher rated securities, which
react more to fluctuations in the general level of interest rates. The Adviser
seeks to reduce risk to the investor by diversification, credit analysis and
attention to current developments in trends of both the economy and financial
market. However, while diversification reduces the effect on the Portfolios of
any single investment, it does not reduce the overall risk of investing in lower
rated securities. In no event will the Portfolios invest in any security rated
below CCC or equivalent at the time of purchase.
LENDING OF PORTFOLIOS SECURITIES
For the purpose or realizing income, each Portfolio may lend securities with a
value of up to 30% of its total assets to broker-dealers, institutional
investors or other persons. The Fund will have the right to call each loan and
obtain the securities on five business days' notice or, in connection with
securities trading on foreign markets, within a longer period of time which
coincides with the normal settlement period for purchases and sales of such
securities in such foreign markets. Loans will only be made to persons deemed
by the Adviser to be of good standing in accordance with standards approved by
the Board of Trustees and will not be made unless, in the judgment of the
Adviser, the consideration to be earned from such loans would justify the risk.
B-16
<PAGE>
BORROWING
The Fund may borrow for temporary, extraordinary or emergency purposes, or for
the clearance of transactions. The Investment Company Act of 1940 (the "1940
Act") requires the Fund to maintain continuous asset coverage (that is, total
assets including borrowings, less liabilities exclusive of borrowings) of 300%
of the amount borrowed. If the 300% asset coverage should decline as a result
of market fluctuations or other reasons, the Fund may be required to sell some
of its portfolio holdings within three days to reduce the debt and restore the
300% asset coverage, even though it may be disadvantageous from an investment
standpoint to sell securities at that time. As a matter of operating policy,
the Fund will not borrow in excess of 15% of its total assets (see "Investment
Limitations"). To avoid the potential leveraging effects of the Fund's
borrowings, investments will not be made while borrowings are in excess of 5% of
the Fund's total assets. Money borrowed will be subject to interest costs which
may or may not be recovered by appreciation of the securities purchased. The
Fund also may be required to maintain minimum average balances in connection
with any such borrowing or to pay a commitment or other fee to maintain a line
of credit, either of which would increase the cost of borrowing over the stated
interest rate.
FOREIGN SECURITIES
There are special risks in investing in foreign securities in addition to those
relating to investments in U.S. securities.
POLITICAL AND ECONOMIC FACTORS. Individual foreign economies of certain
countries may differ favorably or unfavorably from the United States' economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency, diversification and balance of payments
position. The internal politics of certain foreign countries may not be as
stable as those of the United States.
Governments in certain foreign countries continue to participate to a
significant degree, through ownership interest or regulation, in their
respective economies. Action by these governments could include restrictions on
foreign investment, nationalization, expropriation of goods or imposition of
taxes, and could have a significant effect on market prices of securities and
payment of interest. The economies of many foreign countries are heavily
dependent upon international trade and are accordingly affected by the trade
policies and economic conditions of their trading partners. Enactment of these
trading partners of protectionist trade legislation could have a significant
adverse effect upon the securities markets of such countries.
CURRENCY FLUCTUATIONS. The Fund will invest in securities denominated in foreign
currencies. Accordingly, a change in the value of any such currency against the
U.S. dollar will result in a corresponding change in the U.S. dollar value of
the Fund's assets denominated in that currency. Such changes will also affect
the Fund's income. The value of the Fund's assets may also be affected
significantly by currency restrictions and exchange control regulations enacted
from time to time.
MARKET CHARACTERISTICS. The Fund may invest in foreign bonds, stocks or other
debt or equity- related securities. While the foreign stocks or equity-related
securities may be exchange traded, the Fund expects that most foreign debt
securities in which the Fund invests will be purchased in over-the-counter
markets or on bond exchanges located in the countries in which the principal
offices of the issuers of the various securities are located, if that is the
best available market. Foreign stock or bond markets may be more volatile than
those in the United States. While growing in volume, they usually have
substantially less volume than U.S. markets, and the Fund's portfolio securities
may be less liquid and more volatile than U.S. securities. Moreover, settlement
practices for transactions in foreign markets may differ from those in United
States markets, and may include delays beyond periods customary in the United
States.
B-17
<PAGE>
Transactions in options on securities, futures contracts, futures options,
currency contracts and options on currencies may not be regulated as effectively
on foreign exchanges as similar transaction in the United States, and may not
involve clearing mechanisms and related guarantees. The value of such positions
also could be adversely affected by the imposition of different exercise terms
and procedures and margin requirements than in the United States.
The value of the Fund's portfolio positions may also be adversely impacted by
delays in the Fund's ability to act upon economic events occurring in foreign
markets during non-business hours in the United States.
LEGAL AND REGULATORY MATTERS. Certain foreign countries may have less
supervision of securities markets, brokers and issuers of securities, and less
financial information available to issuers, than is available in the United
States.
TAXES. The interest payable on certain of the Fund's foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to the Fund's shareholders. A
shareholder otherwise subject to United States federal income taxes may, subject
to certain limitations, be entitled to claim a credit or deduction for U.S.
federal income tax purposes for his proportionate share of such foreign taxes
paid by the Fund. (See "Other Taxation").
INVESTMENT LIMITATIONS
The Fund has adopted the investment restrictions described below. Fundamental
policies of the Fund may not be changed without the approval of the lesser of
(1) 67% of the Portfolio's shares present at a meeting of shareholders if the
holders of more than 50% of the outstanding shares are present in person or by
proxy or (2) more than 50% of the Portfolio's outstanding shares. Operating
policies are subject to change by the Board of Trustees without shareholder
approval. Any investment restriction which involves a maximum percentage of
securities or assets will not be considered to be violated unless an excess
occurs immediately after, and is caused by, an acquisition of securities of
assets of, or borrowings by, the Fund.
FUNDAMENTAL POLICIES
As a matter of fundamental policy, a Portfolio may not:
(1) INDUSTRY CONCENTRATION. Purchase securities of issuers conducting their
principal business activities in the same industry if, immediately after the
purchase and as a result thereof, the value of the Portfolio's investments in
that industry would constitute 25% or more of its total assets, provided that:
(i) this limitation does not apply to obligations issued or guaranteed by the
U.S. Government or its agencies or instrumentalities; (ii) utility companies
will be divided according to their services (for example, gas, gas transmission,
electric, electric and gas, and telephone will each be considered a separate
industry); and (iii) financial service companies will be classified according to
the end users of their services (for example, automobile finance, bank finance,
and diversified finance will be considered as separate industries). For
purposes of this policy, the Adviser classifies companies into approximately
forty industries based on their primary business and financial characteristics.
(2) OIL, GAS, REAL ESTATE. Invest directly in real estate, oil, gas, or other
mineral exploration or development programs; however, this limitation will not
prevent the purchase of securities of companies engaged in such activities or
secured by interests in such activities.
(3) LOANS. Make loans, except that the Portfolio may (i) purchase money market
securities and enter into repurchase agreements, (ii) acquire bonds, debentures,
notes and other debt securities, and (iii) lend portfolio securities in an
amount not to exceed 30% of its total assets.
(4) MARGIN. Purchase securities on margin, except that the Portfolio may (i)
use short-term credit necessary for clearance of purchases of portfolio
securities, and (ii) make margin deposits in connection with futures contracts
and options on futures contracts.
B-18
<PAGE>
(5) SINGLE ISSUER DIVERSIFICATION. With respect to 75% of its total assets,
purchase securities of issuer (except securities issued or guaranteed by the
U.S. Government, its agencies or instrumentalities) if, as a result, more than
5% of the value of its assets would be invested in the securities of any single
issuer or it would own more than 10% of the voting securities of any issuer.
(6) UNDERWRITING. Underwrite securities issued by other persons, except to the
extent that the Portfolio may be deemed to be an underwriter within the meaning
of the Securities Act in connection with the purchase and sale of its portfolio
securities in the ordinary course of pursuing its investment program.
(7) BORROWING. Borrow money, except as a temporary measure for extraordinary or
emergency purposes or for the clearance of transactions, and then only in
amounts not exceeding 15% of its total assets valued at market (for this
purpose, delayed delivery transactions covered by segregated accounts are not
considered to be borrowings).
OPERATING POLICIES
As a matter of operating policy, a Portfolio may not:
(1) COMMODITIES. Purchase or sell commodities or commodity contracts, except
that a Portfolio may (i) enter into financial and currency futures contracts
and options on such futures contracts, (ii) enter into forward foreign
currency exchange contracts (the Fund does not consider such contracts to be
commodities), and (iii) invest in instruments which have the characteristics
of both futures contracts and securities.
(2) ILLIQUID SECURITIES. Purchase a security if, as a result of such purchase,
more than 15% of the value of the Portfolio's net assets would be invested in
illiquid securities or other securities that are not readily marketable,
including repurchase agreements which do not provide for payment within seven
days.
(3) INVESTMENT COMPANIES. Purchase securities of open-end or closed-end
investment companies except in compliance with the 1940 Act.
(4) OWNERSHIP OF PORTFOLIO SECURITIES BY OFFICERS AND DIRECTORS. Purchase or
retain the securities of any issuer if, to the knowledge of the Trust's
management, any officers and Trustees of the Trust and of the Adviser who own
beneficially more than 0.5% of the outstanding securities of such issuer,
together own beneficially more than 5% of such securities.
(5) UNSEASONED ISSUERS. Purchase securities (other than obligations issued or
guaranteed by the U.S. Government or any foreign government, their agencies or
instrumentalities) if, as a result, more than 5% of the value of the Portfolio's
net assets would be invested in the securities of issuers which at the time of
purchase had been in operation for less than three years (for this purpose, the
period of operation of any issuer will include the period of operation of any
predecessor or unconditional guarantor of such issuer).
STATE UNDERTAKINGS
In order to permit the sale of shares of the Fund in certain states, the Board
of Trustees may adopt investment policies more restrictive than those described
above. Should the trustees determine that any such more restrictive policy is
no longer in the best interests of the Fund or its shareholders, the Trustees
may revoke such policy and the Fund may cease offering shares of the Fund in the
state involved. Moreover, if the state involved no longer requires any such
restrictive policy, the trustees may revoke it.
The Fund has undertaken to the Texas State Securities Board and the Arizona
Corporation Commission that it will limit its investments in warrants to no more
than 5% of a Portfolio's net assets and, of this 5%, no more than 2% will be
invested in warrants which are not listed on the New York Stock Exchange or the
American Stock Exchange; provided, however, that for the purposes of this
limitation, warrants acquired in units or attached to other securities will be
deemed to be without value. The Fund intends to comply with this undertaking
for so long as the shares of the Fund are registered for sale in the States of
Texas or Arizona.
B-19
<PAGE>
PURCHASE OF SHARES
Each Portfolio reserves the right in its sole discretion (i) to suspend the
offering of its shares, and (ii) to reduce or waive the minimum for initial and
subsequent investments where certain economies can be achieved in sales of the
Portfolio's shares. In addition to cash, the Fund may accept securities as
payment for shares in any Portfolio at the applicable net asset value per share.
The Fund will only consider accepting securities which: (1) meet the investment
objective and policies of the Portfolio accepting the securities; (2) will be
acquired for investment and not for resale; (3) are liquid securities and not
restricted as to transfer either by law or market liquidity; and (4) have a
readily ascertainable value.
REDEMPTION OF SHARES
Each Portfolio may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Commission, (ii) during any
period when an emergency exists as defined by the rules of the Commission as a
result of which it is not reasonably practicable for a Portfolio to dispose of
securities owned by it, or fairly to determine the value of its assets, and
(iii) for such other periods as the Commission may permit.
MANAGEMENT OF THE FUND
The officers of the Fund manage its day to day operations and are responsible to
the Fund's Board of Trustees. The following is a list of Trustees and officers
of the Fund and their principal occupations during the past five years. The
mailing address of the Trustees and officers of the Fund is 2222 Martin Street,
Suite 230, Irvine, CA 92715-1406. (* indicates a director who is an interested
person of the Fund, as defined under the Investment Company Act of 1940.)
MICHAEL F. KOEHN* CHAIRMAN OF THE BOARD OF TRUSTEES.
Co- Chairman and Executive Director of the Adviser, Director of Analytic
Optioned Equity Fund and President of Analysis Group, Inc., a consulting firm
providing economic and financial consulting services. He earned a Ph.D. in
Finance at the Wharton School, University of Pennsylvania.
MICHAEL D. BUTLER TRUSTEE.
Director of Analytic Optioned Equity Fund. Professor emeritus of Social
Sciences, former Dean of Undergraduate Studies at the University of California
at Irvine and former member of the Society of Fellows, Harvard University.
DR. ROBERT E. VILLAGRANA TRUSTEE.
Director of Analytic Optioned Equity Fund, Inc.; and President of Scientific
Failure Analysis. He earned his Met. Eng. (Metallurgical Engineer) from
Colorado School of Mines and his M.S. and Ph.D. in material science from the
University of California at Berkeley.
ROBERTSON WHITTEMORE TRUSTEE.
Director of Analytic Optioned Equity Fund, Inc.; and Partner, Encore of La
Jolla, retail clothing store. Former real estate broker; attorney, President of
La Jolla Town Council, trustee of Combined Arts and Education Council of San
Diego, and Executive Director of the San Diego Community Foundation. He earned
his B.A. from Yale University, and his J.D. and M.B.A. from the University of
California at Berkeley.
DR. ALAN L. LEWIS PRESIDENT.
Co- Chief Investment Officer of the Adviser and President of Analytic Optioned
Equity Fund, Inc.;. He holds a B.S. from the California Institute of Technology
and a Ph.D. in Physics from the University of California, Berkeley. He is the
author of various articles concerning portfolio optimization, options and other
financial topics.
CHARLES L. DOBSON EXECUTIVE VICE PRESIDENT AND SECRETARY.
Director, Secretary and Portfolio Manager of the Adviser and Executive Vice
President and Secretary of Analytic Optioned Equity Fund, Inc.. He holds a B.A.
in Economics and M.S. in Administration from the University of California,
Irvine.
B-20
<PAGE>
ALAN R. ADELMAN TREASURER.
Co-Chairman, President, Chief Executive Officer and Treasurer of the Adviser and
Treasurer of Analytic Optioned Equity Fund since 1994. Formerly, Chief
Investment Officer, Senior Vice President and Manager of Investment Management
Services of First Interstate Bank of California.
DEBORAH D. BOEDICKER SENIOR VICE PRESIDENT.
Director of Business Development of the Adviser and Senior Vice President of
Analytic Optioned Equity Fund, Inc. She holds a B.S. from California State
University, Long Beach and earned an M.B.A. in Management Information Science
from the University of California, Irvine. She is co-author of a book
concerning expert systems and artificial intelligence.
RICARDO PORRAS VICE PRESIDENT AND PRINCIPAL ACCOUNTING OFFICER.
Controller of the Adviser and Vice President and Principal Accounting Officer of
Analytic Optioned Equity Fund, Inc. He holds a B.A. in Finance from California
State University, Fullerton.
DEBORAH C. SHEFLIN VICE PRESIDENT. Director of Adminstration and Operations of
the Adviser and Vice President of Analytic Optioned Equity Fund, Inc.
Officers and directors of the Fund who are affiliates of the Adviser receive no
fee or salary from the Fund. Each director who is not an affiliate of the
Adviser receives an annual fee of $2,000 plus $1,000 per meeting attended and
reimbursement for expenses. For the fiscal year ended December 31, 1995, total
compensation received by the three directors who are not affiliates of the
Adviser is as follows:
<TABLE>
<CAPTION>
Aggregate Pension/Retirement Total Compensation
Compensation from Benefits Accrued as Estimated From Analytic Optioned
The Analytic Series Part of Fund Annual Benefits Equity Fund and The
Name Fund Expenses from Retirement Analytic Series Fund
- --------------------- ------------------- ------------------- --------------- ----------------------
<S> <C> <C> <C> <C>
Michael D. Butler $5,000 None None $10,000
Sheen T. Kassouf** $5,000 None None $10,000
Dr. Robert E. Villagrana $5,060 None None $10,120
Robertson Whittemore $5,060 None None $10,120
</TABLE>
**Deemed unaffiliated commencing in January 1995.
B-21
<PAGE>
PRINCIPAL SHAREHOLDERS
The following tables show, as of March 31, 1996 the beneficial ownership of each
Portfolio's common stock by all officers and Trustees of the Fund (as a group)
and the record ownership of shares by each person known to the Fund to be a
record owner of more than 5% of the issued and outstanding common stock of a
Portfolio. Except for shares held by officers and Trustees, the Fund has no
information regarding beneficial ownership of such shares.
SHORT-TERM GOVERNMENT PORTFOLIO (TOTAL SHARES OUTSTANDING 2,839,543)
<TABLE>
<CAPTION>
Name and Address Number of Shares Percentage
- ---------------- ---------------- ----------
<S> <C> <C>
Southern New England Telecommunications 2,619,780 92.26%
227 Church Street
New Haven, CT 06510
All Officers and Trustees of the Fund as a group 18,994 0.67%
</TABLE>
MASTER FIXED INCOME PORTFOLIO (TOTAL SHARES OUTSTANDING 2,461,428)
<TABLE>
<CAPTION>
Name and Address Number of Shares Percentage
- ---------------- ---------------- ----------
<S> <C> <C>
Trust Company of Knoxville 1,869,496 75.95%
Memphis City School Retirement Trust 356,393 14.48%
2597 Avery Avenue
Memphis, TN 38112
All Officers and Trustees of the Fund as a group 25,709 1.04%
</TABLE>
ENHANCED EQUITY PORTFOLIO (TOTAL SHARES OUTSTANDING 191,646)
<TABLE>
<CAPTION>
Name and Address Number of Shares Percentage
- ---------------- ---------------- ----------
<S> <C> <C>
The Kassouf Charitable Trust 26,295 13.72%
Ned E. Kasssouf, Trustee
c/o 2222 Martin Street, Suite 230
Irvine, CA 92715-1454
Gregory M. McMurran 20,882 10.90%
c/o 2222 Martin Street, Suite 230
Irvine, CA 92715-1454
The Kassouf Foundation 12,179 6.35%
c/o 2222 Martin Street, Suite 230
Irvine, CA 92715-1454
All Officers and Trustees of the Fund as a group 86,451 45.11%
</TABLE>
B-22
<PAGE>
INVESTMENT ADVISORY AND OTHER SERVICES
THE INVESTMENT ADVISER
Analytic Investment Management, Inc. acquired and merged with TSA Capital
Management Corporation January 31, 1996, and became Analytic-TSA Global Asset
Management, Inc. Analytic-TSA Global Asset Management, Inc. (the "Adviser") is
the investment adviser of the Fund pursuant to an Investment Advisory Agreement
between the Fund and the Adviser, dated November 23, 1992 (the "Advisory
Agreement"). The Advisory Agreement was approved by the Board of Trustees,
including the unanimous vote of the Fund's Trustees who are not parties to the
agreement or "interested persons" of the Fund on March 21, 1996 at a meeting
called for the purpose of voting on such approval.
The Adviser is a wholly owned subsidiary of United Asset Management Corporation
("UAMC"). UAMC was organized in 1980 by its President and principal
stockholder, Norton H. Reamer, for the purpose of acquiring firms engaged in the
institutional investment management business and currently owns 42 such firms.
Mr. Reamer is a member of the Board of Directors of the Adviser and may be
deemed to be a controlling person of the Adviser.
The officers and directors of the Advisor are:
<TABLE>
<S> <C>
Alan R. Adelman Co-Chairman, President, Chief Executive Officer and
Treasurer
Michael F. Koehn Co- Chairman and Executive Director
Alan L. Lewis Co- Chief Investment Officer
Roger G. Clarke Co-Chief Investment Officer
Robert Bannon Director - Research
Harindra de Silva Director - Research
Charles L. Dobson Director and Portfolio Manager
Gregory M. McMurran Director and Portfolio Manager
Deborah Boedicker Director - Business Development
Marie Nastasi Arlt Director - Business Development
Ann Townsend Director - Marketing
Ricardo Porras Controller
Deborah Sheflin Director - Adminstration
</TABLE>
THE INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an Investment Management Agreement with the Fund, the Adviser,
subject to the control and direction of the Fund's Officers and Board of
Trustees, manages the Portfolios of the Fund in accordance with each Portfolio's
stated investment objective and policies, and makes investment decisions for the
Fund. Pursuant to separate agreements, the Adviser also acts as the Fund's
transfer agent, dividend disbursing agent, and shareholder relations servicing
agent, and provides accounting and daily pricing services to the Fund. At its
expense, the Adviser provides the office space and all necessary office
facilities, equipment, and personnel for providing these services to the Fund.
As compensation for furnishing investment advisory, management and other
services, and expenses assumed, pursuant to the Investment Management Agreement,
the Short-Term Government, Master Fixed Income, and Enhanced Equity Portfolios
pay the Adviser an annual fee equal to 0.30%, 0.45% and 0.60% of average daily
net assets, respectively. For the year ended December 31, 1995 the Adviser
voluntarily agreed to reimburse expenses that exceeded 0.50%, 0.70%, and 0.80%
of average daily net assets for the Short-Term Government, Master Fixed Income,
and Enhanced Equity Portfolios, respectively. For the year ended December 31,
1994, the Adviser voluntarily agreed to reimburse expenses that exceeded 0.45%,
0.60%, and 0.70% of average daily net assets for the Short-Term Government,
Master Fixed Income, and Enhanced Equity Portfolios, respectively. After such
reimbursements, the Master Fixed Income Portfolio paid $9,100 advisory fees for
1995 and none for the year ended December 31, 1994. The Short-Term Government
and Enhanced Equity Portfolios paid no advisory fees for the years ended
December 31, 1995 and 1994.
B-23
<PAGE>
The Adviser has agreed that if in any fiscal year the expenses borne by the Fund
exceed the applicable expense limitations imposed by the securities regulations
of any state in which shares of such Fund are registered or qualified for sale
to the public, it will reimburse the Fund for any excess to the extent required
by such regulations. Unless otherwise required by law such reimbursement would
be accrued and paid on the same basis that the advisory fees are accrued and
paid by the Fund. To the Trust's knowledge, the only state expense limitation
in effect on the date of this Statement of Additional information is that of
California, which requires the Adviser to reimburse the Fund for advisory fees
to the extent that certain expenses exceed 2-1/2% of average annual net assets
up to $30,000,000, 2% of the next $70 million of average net assets, and 1-1/2%
of average net assets in excess of $100,000,000.
Under the Management Agreement, any liability of the Adviser to the Fund and its
shareholders is limited to situations involving its own willful misfeasance, bad
faith, gross negligence or reckless disregard of its duties and obligations
under the Advisory Agreement.
The Management Agreement may not be assigned by the Adviser and will terminate
automatically upon assignment. It may be terminated without penalty with
respect to any Portfolio upon 60-days' written notice by either party or by a
vote of a majority of the Portfolio's outstanding voting securities (as defined
in the 1940 Act). The Management Agreement may be amended with respect to any
Portfolio by a vote of a majority of the Trustees of the Fund, including a
majority of the disinterested trustees, cast in person at a meeting called for
that purpose, subject to approval by the vote of a majority of the Portfolio's
outstanding voting securities.
Pursuant to a Fund Accounting Agreement with the Fund, the Adviser maintains
certain books and records for the Portfolios, provides pricing information with
respect to Portfolio investments, calculates daily net asset value per share for
the Portfolios, and performs certain other accounting services. As compensation
for such services, the Adviser receives an annual fee equal to 0.05% of each
Portfolio's average daily net assets, plus reimbursement of reasonable out-of-
pocket expenses.
Pursuant to a Transfer Agency Agreement with the Fund, the Adviser provides
transfer agency services for the Portfolios, including processing of purchase
and redemption orders and confirmations, maintenance of shareholder account
information, and preparation and filing of reports to the Internal Revenue
Service, Commission and state securities authorities. As compensation for such
services, the Adviser receives an annual base fee equal to 0.16% of each
Portfolio's average daily net assets up to $100 million, 0.14% of average daily
net assets in excess of $100 million up to $200 million, and 0.12% of average
daily net assets in excess of $200 million. The Adviser also receives a fee of
$1.50 per shareholder account per month, plus reimbursement of reasonable out-
of-pocket expenses.
Each such Agreement is terminable by either party with respect to any Portfolio
upon 60 days notice. Under each such Agreement, any liability of the Adviser to
the Fund and its shareholders is limited to situations involving its own willful
misfeasance, bad faith, gross negligence or reckless disregard of its duties and
obligations under the Agreement.
PORTFOLIO TRANSACTIONS
Provided that best execution is obtained, the Adviser may consider sales of the
Portfolios' shares and the provision of research services to the Adviser as
factors in the selection of broker-dealers to execute portfolio transactions,
and may enter into agreements whereby a portion of the commissions earned by a
broker-dealer on the transactions placed with a broker-dealer will be reimbursed
to the Portfolios by the payment of all or a portion of the Portfolios'
expenses, including custodian fees. Research services furnished by brokers
through which a Portfolio affects portfolio transactions may be used by the
adviser servicing all of its accounts. Similarly, research services furnished
by brokers through which the adviser's other accounts affect portfolio
transactions may be used in servicing a Portfolio. During the years ended
December 31, 1995 and 1994, the aggregate commissions paid were $0 by the Short-
Term Government Portfolio, $8,587 and $9,309 by the Master Fixed Income
Portfolio and $ 2,360 and $3,750 by the Enhanced Equity Portfolio. None of
these amounts were directed to brokers because of research services provided to
the Adviser.
B-24
<PAGE>
If a Portfolio effects a closing transaction with respect to an option purchased
or written by it, normally such transaction will be executed by the same broker-
dealer who executed the opening purchase or sale of the option, except where the
Portfolio utilizes a clearing agent. Likewise, if an option written or
purchased by a Portfolio is exercised, normally the sale or purchase of the
underlying securities will be executed by the same broker-dealer or clearing
agent who executed the opening purchase or sale of the option.
The Adviser currently manages separate accounts aggregating in excess of
$2,000,000,000 which employ investment strategies similar to those used by the
Portfolios. At times, investment decisions may be made to purchase or sell the
same investment security for a Portfolio and one or more of the other clients
advised by the Adviser. When two or more of such clients are simultaneously
engaged in the purchase or sale of the same security or option, the transactions
will be allocated as to amount and price in a manner considered equitable to
each and so that each receives, to the extent practicable, the average price or
premium for such transaction. There may be circumstances in which such
simultaneous transactions would be disadvantageous to a Portfolio with respect
to price and availability of securities. In other cases, however, it is
believed that transactions would be advantageous to a Portfolio.
PORTFOLIO VALUATION
Each Portfolio's share price or net asset value per share is calculated by
dividing the total value of the Portfolio's assets, less total liabilities, by
the total outstanding shares of the Portfolio. Portfolio securities which are
traded on a national securities exchange are valued at the last sale price or if
there is no recent last sale, at the mean between the current bid and asked
prices. All other securities not so traded are valued at the mean between the
last current bid and asked prices if market quotations are available. Futures
contracts are valued daily at the official settlement price of the exchange on
which they are traded. Other securities and assets are valued at fair value in
accordance with methods determined in good faith by the Fund's Board of
Trustees.
TAXATION
Each Portfolio has elected to be treated and intends to qualify annually as a
regulated investment company under the Internal Revenue Code of 1986, as
amended (the "Code"), and will be treated as a corporate entity for such
purposes. To qualify as a regulated investment company, a Portfolio must,
among other things, (a) derive in each taxable year at least 90% of its gross
income from dividends, interest, payments with respect to securities loans,
and gains from the sale or other disposition of stock, securities or foreign
currencies, or other income (including gains from options, futures and
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies ("Qualifying Income Test"); (b) derive in
each taxable year less than 30% of its gross income from the sale or other
disposition of certain assets held less than three months, namely (1) stocks
or securities, (2) options, futures, or forward contracts (other than those
on foreign currencies), and (3) foreign currencies (or options, futures, and
forward contracts on foreign currencies) not directly related to its business
of investing in stocks or securities; (c) diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Portfolio's assets is represented by cash, U.S. Government
securities, the securities of other regulated investment companies and other
securities, with such other securities of any one issuer limited for the
purposes of this calculation to an amount not greater than 5% of the value of
the Portfolio's total assets and 10% of the outstanding voting securities of
such issuer, and (ii) not more than 25% of the value of its total assets is
invested in the securities of any one issuer (other than U.S. Government
securities or the securities of other regulated investment companies (the
"Diversification Test")); and (d) distribute at least 90% of its investment
company taxable income (which includes dividends, interest and net short-term
capital gains in excess of any net long-term capital losses) each taxable
year. The Treasury Department is authorized to promulgate regulations under
which gains from foreign currencies (and options, futures, and forward
contracts on foreign currency) would constitute qualifying income for
purposes of the Qualifying Income Test only if such gains are directly
relating to investing in stocks or securities. To date, such regulations have
not been issued.
B-25
<PAGE>
As a regulated investment company, a Portfolio will not be subject to U.S.
federal income tax on its investment company taxable income and net capital
gains (any net long-term capital gains in excess of the sum of net short-term
capital losses and any capital loss carryovers from prior years) designated
by the Fund as capital gain dividends, if any, that it distributes to
shareholders. The Short Term Government Portfolio and the Master Fixed Income
Portfolio intend to distribute to their shareholders substantially all of
their investment company taxable income monthly and any net capital gains
annually. The Enhanced Equity Portfolio intends to distribute to its
shareholders substantially all of its investment company taxable income
quarterly and any net capital gains annually. In addition, amounts not
distributed by a Portfolio on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax.
To avoid the tax, a Portfolio must distribute during each calendar year an
amount equal to the sum of (1) at least 98% of its ordinary income and net
capital gain (not taking into account any capital gains or losses as an
exception) for the calendar year, (2) at least 98% of its capital gains in
excess of its capital losses (and adjusted for certain ordinary losses) for
the twelve month period ending on December 31 of the calendar year, and (3)
all ordinary income and capital gains for previous years that were not
distributed during such years. A distribution will be treated as paid on
December 31 of the calendar year if it is declared by a Portfolio in December
of that year to shareholders of record on a date in such a month and paid by
a Portfolio during January of the following year. Such distributions will be
taxable to shareholders (other than those not subject to federal income tax)
in the calendar year in which the distributions are declared, rather than the
calendar year in which the distributions are received. To avoid application
of the excise tax, the Portfolios intend to make their distributions in
accordance with the calendar year distribution requirement.
DISTRIBUTIONS
Dividends paid out of a Portfolio's investment company taxable income will be
taxable to a U.S. shareholder as ordinary income. Distributions received by
tax-exempt shareholders will not be subject to federal income tax to the extent
permitted under the applicable tax exemption.
For corporate investors, dividends paid by the Short Term Government Portfolio
will generally not qualify for the dividends received deduction, a minimal
amount of dividends paid by the Master Fixed Income Portfolio will qualify for
the deduction, and some fraction of dividends by the Enhanced Equity Portfolio
will qualify for such deduction. Distributions of net capital gains, if any,
are taxable as long-term capital gains, regardless of how long the shareholder
has held a Portfolio's shares and are not eligible for the dividends received
deduction. The tax treatment of dividends and distributions will be the same
whether a shareholder reinvests them in additional shares or elects to receive
them in cash.
HEDGING TRANSACTIONS
Many of the options, futures contracts and forward contracts used by the
Portfolios are "Section 1256 contracts". Any gains or losses on Section 1256
contracts are generally considered 60% long-term and 40% short-term capital
gains or losses ("60/40") although certain foreign currency gains and losses
from such contracts may be treated as ordinary in character. Also, Section 1256
contracts held by a Portfolio at the end of each taxable year (and, for purposes
of the 4% excise tax, on certain other dates as prescribed under the Code) are
"marked to market" with the results that unrealized gains or losses are treated
as though they were realized and the resulting gain or loss is treated as
ordinary or 60/40 gain or loss, depending on the circumstances.
Generally, the hedging transactions and certain other transactions in options,
futures and forward contracts undertaken by the Portfolios, may result in
"straddles" for U.S. federal income tax purposes. The straddle rules may affect
the character of gains (or losses) realized by a Portfolio. In addition, losses
realized by a Portfolio on position that are part of a straddle may be deferred
under the straddle rules, rather than being taken into account in calculating
the taxable income for the taxable year in which such losses are realized.
Because only a few regulations implementing the straddle rules have been
promulgated, the tax consequences of transactions in options, futures and
forward contracts to the Portfolios are not entirely clear. The transactions
may increase the amount of short-term capital gain realized by a Portfolio which
is taxed as ordinary income when distributed to shareholders.
B-26
<PAGE>
A Portfolio may make one or more of the elections available under the Code which
are applicable to straddles. If a Portfolio makes any of the elections, the
amount, character and timing of the recognition of gains or losses from the
affected straddle positions will be determined under rules that vary according
to the elections made. The rules applicable under certain of the elections
operate to accelerate the recognition of gains or losses from the affected
straddle positions.
Because application of the straddle rules may affect the character of gains or
losses, defer losses and/or accelerate the recognition of gains or losses from
the affected straddle positions, the amount which must be distributed to
shareholders, and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as compared
to a fund that did not engage in such hedging transactions.
The 30% limit on gains from the disposition of certain options, futures, and
forward contracts held less than three months and the qualifying income and
diversification requirements applicable to a Portfolio's assets may limit the
extent to which a Portfolio will be able to engage in transaction in options,
futures contracts or forward contracts.
SALES OF SHARES
Upon disposition of shares of the Fund (whether by redemption, sale or
exchange), a shareholder will realize a gain or loss. Such gain or loss will be
capital gain or loss if the shares are capital assets in the shareholder's
hands, and will be long-term or short-term generally depending upon the
shareholder's holding period for the shares. Any loss realized on a disposition
will be disallowed to the extent the shares disposed of are replaced within a
period of 61 days beginning 30 days before and ending 30 days after the shares
are disposed of. In such a case, the basis of the shares acquired will be
adjusted to reflect the disallowed loss. Any loss realized by a shareholder on
a disposition of shares held by the shareholder for six months or less will be
treated as a long-term capital loss to the extent of any distributions of
capital gain dividends received by the shareholder with respect to such shares.
BACKUP WITHHOLDING
The Fund may be required to withhold for U.S. federal income taxes 31% of all
taxable distributions payable to shareholders who fail to provide the Fund with
their correct taxpayer identification number or to make required certifications,
or who have been notified by the Internal revenue Service that they are subject
to backup withholding. Corporate shareholders and certain other shareholders
specified in the Code generally are exempt from such backup withholding. Backup
withholding is not an additional tax. Any amounts withheld may be credited
against the shareholder's U.S. federal tax liability.
OTHER TAXATION
Under the Code, gains or losses attributable to fluctuations in exchange rates
which occur between the time a Portfolio accrues interest or other receivables
or accrues expenses or other liabilities denominated in a foreign currency and
the time the Portfolio actually collects such receivables or pays such
liabilities generally are treated as ordinary income or loss. Similarly, on
disposition of debt securities denominated in a foreign currency and on
disposition of certain futures contracts, forward contracts and options, gains
or losses attributable to fluctuations in the value of the foreign currency
between the date of acquisition of the security or contract and the date of
disposition also are treated as ordinary gain or loss. These gains and losses,
referred to under the Code as "Section 988" gains or losses, may increase or
decrease the amount of a Portfolio's investment company taxable income to be
distributed to its shareholders as ordinary income.
B-27
<PAGE>
Income received by a Portfolio from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Tax
conventions between certain countries and the U.S. may reduce or eliminate such
taxes. In addition, the Adviser intends to manage the Fund with the intention
of minimizing foreign taxation in cases where it is deemed prudent to do so. If
more than 50% of the value of a Portfolio's total assets at the close of its
taxable year consists of securities of foreign corporation, a Portfolio will be
eligible to elect to "pass-through" to the Portfolio's shareholders the amount
of foreign income and similar taxes paid by the Portfolio. If this election is
made, a shareholder generally subject to tax will be required to include in
gross income (in addition to taxable dividends actually received) his pro rata
share of the foreign income taxes paid by the Portfolio, and may be entitled
either to deduct (as an itemized deduction) his or her pro rate share of foreign
taxes in computing his taxable income or to use it (subject to limitations) as a
foreign tax credit against his or her U.S. federal income tax liability. No
deduction for foreign taxes may be claimed by a shareholder who does not itemize
deductions. Each shareholder will be notified within 60 days after the close of
the Fund's taxable year whether the foreign taxes paid by the Portfolio will
"pass-through" for that year. The Fund does not currently expect to be eligible
for such "pass-through" election under current operating policies and
limitations on holdings of foreign securities.
Generally, a credit for foreign taxes is subject to the limitation that it may
not exceed the shareholder's U.S. tax attributable to his or her total foreign
source taxable income. For this purpose, if the pass-through election is made,
the source of the Fund's income will flow through to shareholders of the Fund.
With respect to such election, gains from the sale of securities will be treated
as derived from U.S. sources and certain currency fluctuation gains, including
fluctuation gains from foreign currency denominated debt securities, receivables
and payable will be treated as ordinary income derived from U.S. sources. The
limitation on the foreign tax credit is applied separately to foreign source
passive income, and to certain other types of income. Shareholders may be
unable to claim a credit for the full amount of their proportionate share of the
foreign taxes paid by the Fund. The foreign tax credit is modified for purposes
of the Federal alternate minimum tax and can be used to offset only 90% of the
alternative minimum tax imposed on corporations and individuals and foreign
taxes generally are not deductible in computing alternative minimum taxable
income.
Some of the debt securities (with a fixed maturity date of more than one year
from the date of issuance) that may be acquired by a Portfolio may be treated as
debt securities that are issued originally at a discount. Generally, the amount
of the original issue discount ("OID") is treated as interest income and is
included in income over the term of the debt security, even though payment of
that amount is not received until a later time, usually when the debt security
matures. A portion of the OID includible in income with respect to certain
high-yield corporate debt securities may be treated as a dividend for Federal
income tax purposes.
Some of the debt securities (with a fixed maturity date of more than one year
form the date of issuance) that may be acquired by a Portfolio in the secondary
market may be treated as having market discount. Generally, any gain recognized
on the disposition of, and any partial payment of principal on, a debt security
having market discount issued after July 18, 1984 is treated as ordinary income
to the extent the gain, or principal payment, does not exceed the "accrued
market discount" on such debt security. Market discount generally accrues in
equal daily installments. The Fund may make one or more of the elections
applicable to debt securities having market discount, which could affect the
character and timing of recognition of income.
Some of the debt securities (with a fixed maturity date of one year or less from
the date of issuance) that may be acquired by a Portfolio may be treated as
having an acquisition discount, or OID in the case of certain types of debt
securities. Generally, a Portfolio will be required to include the acquisition
discount, or OID, in income over the term of the debt security, even though
payment of that amount is not received until a later time, usually when the debt
security matures. A Portfolio may make one or more of the elections applicable
to debt securities having acquisition discount, or OID, which could affect the
character and timing of recognition of income.
The Fund generally will be required to distribute dividends to shareholders
representing discount on debt securities that is currently includible in income,
even though cash representing such income may not have been received by the
Fund. Cash to pay such dividends may be obtained from sales proceeds of
securities held by the Fund.
B-28
<PAGE>
Distributions also may be subject to additional state, local and foreign taxes,
depending on each shareholder's particular situation. Under the laws of various
states, distributions of investment company taxable income generally are taxable
to shareholders even though all or a substantial portion of such distributions
may be derived from interest on certain Federal obligations which, if the
interest were received directly by a resident of such state, would be exempt
form such state's income tax ("qualifying Federal obligations"). However, some
states may exempt all or a portion of such distributions from income tax to the
extent the shareholder is able to establish that the distribution is derived
from qualifying Federal obligations. Moreover, for state income tax purposes,
interest on some Federal obligations generally is not exempt from taxation,
whether received directly by a shareholder or through distributions of
investment company taxable income (for example, interest on FNMA Certificates
and GNMA Certificates). The Fund will provide information annually to
shareholders indicating the amount and percentage of the Fund's dividend
distribution which is attributable to interest on Federal obligations, and will
indicate to the extent possible from what types of Federal obligations such
dividends are derived. Shareholders are advised to consult their own tax
advisers with respect to the particular tax consequences to them of an
investment in the Fund.
YIELD, TOTAL RETURN, AND OTHER PERFORMANCE STATISTICS
PERFORMANCE
As noted in each Prospectus, each Portfolio may from time to time quote
various standardized performance figures to illustrate the Portfolios' past
performance. They may occasionally cite statistics to reflect volatility or
risk.
Performance quotations by investment companies are subject to rules adopted
by the Securities and Exchange Commission ("SEC"). These rules require the
use of standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the Portfolios be
accompanied by certain standardized performance information computed as
required by the SEC. Current yield and average annual compounded total return
quotations used by the Portfolios are based on the new standardized methods
of computing performance mandated by the SEC. An explanation of those and
other methods used by the Portfolios to compute or express performance
follows.
TOTAL RETURN
The average annual total return is determined by finding the average annual
compounded rates of return over 1, 5, and 10-year periods (to the extent
applicable) that would equate an initial hypothetical $1,000 investment to
its ending redeemable value. The calculation assumes all income dividends and
capital gains are reinvested at net asset value. The quotation assumes the
account was completely redeemed at the end of each 1, 5, and 10-year period
and the deduction of all applicable charges and fees.
The average annual total return is calculated according to the Securities and
Exchange Commission formula:
P(1+T)n = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the 1, 5, or 10-year periods at the end of the 1, 5,
or 10-year periods (or fractional portion thereof)
The Portfolios may quote total rates of return in addition to their average
annual total returns. Such quotations are computed in the same manner as each
Portfolio's average annual compounded rate, except that such quotations will be
based on each Fund's actual return for a specified period as opposed to its
average return over 1, 5, and 10-year periods (or fractional portion thereof).
B-29
<PAGE>
The total returns for each Portfolio for the various periods have been:
<TABLE>
<CAPTION>
Short Term Government Master Fixed Income
Portfolio Portfolio Enhanced Equity Portfolio
<S> <C> <C> <C>
1 year
1/1/95 - 12/31/95 10.54% 16.43% 35.36%
From public inception
7/1/93 - 12/31/95 4.91% 7.35% 14.71%
</TABLE>
YIELD
Current yield reflects the income per share earned by a Portfolio's portfolio
investments.
Current yield is determined by dividing the net investment income per share
earned during a 30-day base period by the share price on the last day of the
period and annualizing the result. Expenses accrued for the period include any
fees charged to all shareholders of a Portfolio during the base period. Yield
is calculated according to the formula:
a - b
Yield = 2[(----- +1)6-1]
cd
where
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period
that were entitled to receive income distributions
d = the share price on the last day of the period
The 30-day yield for the Short-Term Government and Master Fixed Income
Portfolios at March 31, 1996 is 5.08% and 5.18%, respectively.
CURRENT DISTRIBUTION RATE
Yield which is calculated according to a formula prescribed by the SEC is not
indicative of the amounts which were or will be paid to a Portfolio's
shareholders. Amounts paid to shareholders are reflected in the quoted
"current distribution rate." The current distribution rate is computed by
dividing the total amount of dividends per share paid by a portfolio during
the past twelve months by a current maximum offering price. Under certain
circumstances, such as when there has been a change in the amount of dividend
payout, or a fundamental change in investment policies, it might be
appropriate to annualize the dividends paid over the period such policies
were in effect, rather than using the dividends during the past twelve
months. The current distribution rate differs from the current yield
computation because it may include distributions to shareholders from sources
other than portfolio security dividends and interest, such as short-term
capital gains and is calculated over a different period of time.
VOLATILITY
Occasionally statistics may be used to specify a Portfolio's volatility or
risk. Measures of volatility or risk are generally used to compare a
Portfolio's net asset value or performance relative to a market index. One
measure of volatility is beta. Beta is the volatility of a Portfolio relative
to the total market as represented by the Standard & Poor's 500 Stock Index.
A beta of more than 1.00 indicates volatility greater than the market, and a
beta of less than 1.00 indicates volatility less than the market. Sometimes
beta may be calculated relative to a different market index. Another measure
of volatility or risk is standard deviation. Standard deviation is used to
measure variability of net asset value or total return around an average,
over a specified period of time. The premise is that greater volatility
connotes greater risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS
B-30
<PAGE>
One measure of performance that adjusts for risk is alpha. Alpha is a measure
of the difference between a Portfolio's performance and a market index
portfolio with the same beta.
Sales literature referring to the use of a Portfolio as a potential investment
for Individual Retirement Accounts (IRAs), Business Retirement Plans, and other
tax-advantaged retirement plans may quote a total return based upon compounding
of dividends on which is it presumed no federal income tax applies.
Regardless of the method used, past performance is not necessarily indicative of
future results, but is an indication of the return to shareholders only for the
limited historical period used.
COMPARISONS
To help investors better evaluate how an investment in the Portfolios might
satisfy their investment objective, advertisements and other materials regarding
the Portfolios may discuss various measures of a Portfolio's performance as
reported by various financial publications. Materials may also compare
performance (as calculated above) to performance as reported by other
investments, indices, and averages. The following publications, indices, and
averages, among others, may be used:
a) The Dow Jones Composite Average or its component averages - an unmanaged
index composed of 30 blue-chip industrial corporation stocks (Dow Jones
Industrial Average), 15 utilities company stocks (Dow Jones Utilities Average),
and 20 transportation company stocks. Comparisons of performance assume
reinvestment of dividends.
b) Standard and Poor's 500 Stock Index or its component indices - an unmanaged
index composed of 400 industrial stocks, 40 financial stocks, 40 utilities
stocks, and 20 transportation stocks. Comparisons of performance assume
reinvestment of dividends.
c) The New York Stock Exchange composite or component indices - unmanaged
indices of all industrial, utilities, transportation, and finance stocks listed
on the New York Stock Exchange.
d) Wilshire 5000 Equity Index - represents the return on the market value of
all common equity securities for which daily pricing is available. Comparisons
of performance assume reinvestment of dividends.
e) Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry, and rank individual mutual fund performance over specified
time periods, assuming reinvestment of all distributions, exclusive of any
applicable sales charges.
f) CDA Mutual Fund Report, published by CDA Investment Technologies, Inc. -
analyzes price, current yield, risk, total return, and average rate of return
(average annual compounded growth rate) over specified time periods for the
mutual fund industry.
g) Financial publications: The Wall Street Journal and Business Week,
Changing Times, Financial World, Forbes, Fortune, and Money magazines - provide
performance statistics over specified time periods.
h) Consumer Price Index (or Cost of Living Index), published by the U.S.
Bureau of Labor Statistics - a statistical measure of change, over time, in the
price of goods and services, in major expenditure groups.
i) Stocks, Bonds Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
j) Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
k) Historical data supplied by the research departments of First Boston
Corporation, The J.P. Morgan companies, Salomon Brothers, Merrill Lynch, Lehman
Brothers, Smith Barney Shearson and Bloomberg L.P.
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<PAGE>
l) Standard & Poor's 100 Stock Index - an unmanaged index based on the prices
of 100 blue-chip stocks, including 92 industrials, one utility, two
transportation companies, and five financial institutions. The S & P 100 Stock
Index is a smaller more flexible index for options trading.
In assessing such comparisons of performance an investor should keep in mind
that the composition of the investments in the reported indices and averages is
not identical to a Portfolio, that the averages are generally unmanaged. In
addition there can be no assurance that a Portfolio will continue this
performance as compared to such other averages.
B-32
<PAGE>
ADDITIONAL INFORMATION
THE CUSTODIAN
The Fund's Custodian is The Union Bank of California, N.A., Trust Department,
475 Sansome Street, 11th Floor, San Francisco, California 94111. Pursuant to the
terms of the Custodian Agreement, the Fund will forward to the Custodian the
proceeds of each purchase of Portfolio shares. The Custodian will hold such
proceeds and make disbursements therefrom in accordance with the terms of the
Custodian Agreement. It will retain possession of the securities purchased with
such proceeds and maintain appropriate records with respect to receipt and
disbursements of money, receipt and release of securities, and all other
transactions of the Custodian with respect to the securities and other assets of
each Portfolio.
TRANSFER, DIVIDEND DISBURSING AND SHAREHOLDER SERVICING AGENT
The Fund's Transfer, Dividend Disbursing and Shareholder Servicing Agent is
Analytic-TSA Global Asset Management, Inc. (see "Investment Advisory and Other
Services").
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 695 Town Center Drive, Costa Mesa, California 92626,
serves as independent auditors to the Fund. The services provided by the firm
include the audit of the financial statements of the Fund and services related
to other filings made with the Securities and Exchange Commission.
LEGAL COUNSEL
The Fund's legal counsel is Paul, Hastings, Janofsky & Walker, 555 South Flower
Street, Los Angeles, California 90071.
FINANCIAL STATEMENTS
The financial statements in the Fund's 1995 Annual Report to Shareholders are
incorporated in this Statement of Additional Information by reference. Such
financial statements have been audited by the Fund's independent auditors,
Deloitte & Touche LLP, whose report thereon also appears in such Annual Report
and is incorporated herein by reference. Such financial statements have been
incorporated hereby in reliance upon such reports given upon their authority as
experts in accounting and auditing. Copies of the Fund's 1995 Annual Report to
Shareholders may be obtained at no charge by writing or telephoning the Fund at
the address or number on the front page of this Statement of Additional
Information.
B-33
<PAGE>
APPENDIX - DESCRIPTION OF BOND RATINGS
STANDARD & POOR'S BOND RATINGS
A Standard & Poor's corporate rating is a current assessment of the credit
worthiness of an obligor with respect to a specific obligation. This assessment
may take into consideration obligors such as guarantors, insurers or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or obtained
by Standard & Poor's from other sources it considers reliable. Standard &
Poor's does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in, or unavailability of, such
information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations.
1. Likelihood of default -- capacity and willingness of the obligor
as to the timely payment of interest and repayment of principal in
accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of, the obligation in
the event of bankruptcy, reorganization, or other arrangement under
the laws of bankruptcy and other laws affecting creditors' rights.
AAA Bonds have the highest rating assigned by Standard & Poor's. Capacity to
pay interest and repay principal is extremely strong.
AA Bonds have a very strong capacity to pay interest and repay principal and
differs from the highest rated issues only in small degree.
A Bonds have 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 Bonds are regarded as having an adequate capacity to pay interest and repay
principal. Whereas they normally exhibit adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay interest and repay principal for bonds in this
category than in higher rated categories.
BB, B, CCC, CC and C Bonds are regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the least degree of
speculation and C the highest degree of speculation. While such debt will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions. A C rating
is typically applied to debt subordinated to senior debt which is assigned an
actual or implied CCC rating. It may also be used to cover a situation where a
bankruptcy petition has been filed, but debt service payments are continued.
B-34
<PAGE>
MOODY'S BOND RATINGS
Aaa Bonds are judged to be of the best quality. They carry the smallest degree
of investment risk and are generally referred to as "gilt edged". Interest
payments are protected by a large or by an exceptionally stable margin and
principal as secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa Bonds are judged to be of high quality by all standards. Together with the
Aaa group they comprise what are generally known as high grade bonds. They are
rated lower than the best bonds because margins of protection may not be as
large as in Aaa securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which make the long-
term risks appear somewhat larger than in Aaa securities.
A Bonds 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 are considered as medium-grade obligations (i.e., they are neither
highly protected nor poorly secured). Interest payments and principal security
appear adequate for the present but certain protective elements may be lacking
or may be characteristically unreliable over any great length of time. Such
Bonds lack outstanding investment characteristics and in fact have speculative
characteristics as well.
Ba Bonds 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 generally lack characteristics of 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 are of poor standing. Such issues may be in default or there may be
present elements of danger with respect to principal or interest.
FITCH INVESTORS SERVICE, INC. BOND RATINGS
The Fitch Bond Rating provides a guide to investors in determining the
investment risk associated with a particular security. The rating represents
its assessment of the issuer's ability the obligations of a specific debt issue.
Fitch bond ratings are not recommendations to buy, sell or hold securities since
they incorporate no information on market price or yield relative to other debt
instruments.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the record of the issuer and of
any guarantor, as well as the political and economic environment that might
affect the future financial strength and credit quality of the issuer.
Bonds which have the same rating are of similar but not necessarily identical
high grade investment quality since the limited number of rating categories
cannot fully reflect small differences in the degree of risk. Moreover, the
character of the risk factor varies from industry to industry and between
corporate, health care and municipal obligations.
In assessing credit risk, Fitch Investors Service relies on current information
furnished by the issuer and/or guarantor and other sources which it considers
reliable. Fitch does not perform an audit of the financial statements used in
assigning a rating.
B-35
<PAGE>
Ratings may be changed, withdrawn, or suspended at any time to reflect changes
in the financial condition of the issuer, the status of the issue relative to
other debt of the issuer, or any other circumstance that Fitch considers to have
a material effect on the credit of the obligor.
AAA rated bonds are considered to be investment grade and of
the highest credit quality. The obligor has an extraordinary
ability to pay interest and repay principal, which is unlikely
to be affected by reasonably foreseeable events.
AA rated bonds are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay
principal, while very strong, is somewhat less than for AAA rated
securities or more subject to possible change over the term of
the issue.
A rated bonds are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay
principal is considered to be strong, but may be more vulnerable
to adverse changes in economic conditions and circumstances than
bonds with higher ratings.
BBB rated bonds are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest
and repay principal is considered to be adequate. Adverse changes
in economic conditions and circumstances, however, are more likely
to weaken this ability than bonds with higher ratings.
BB rated bonds are considered speculative and of low investment
grade. The obligor's ability to pay interest and repay principal
is not strong and is considered likely to be affected over time by
adverse economic changes.
B rated bonds are considered highly speculative. Bonds in this class
are lightly protected as to the obligor's ability to pay interest
over the life of the issue and repay principal when due.
CCC rated bonds may have certain identifiable characteristics which,
if not remedied, could lead to the possibility of default in
either principal or interest payments.
DUFF & PHELPS, INC. LONG-TERM RATINGS
These ratings represent a summary opinion of the issuer's long-term fundamental
quality. Rating determination is based on qualitative and quantitative factors
which may vary according to the basic economic and financial characteristics of
each industry and each issuer. Important considerations are vulnerability to
economic cycles as well as risks related to such factors as competition,
government action, regulation, technological obsolescence, demand shifts, cost
structure, and management depth and expertise. The projected viability of the
obligor at the trough of the cycle is a critical determination.
Each rating also takes into account the legal form of the security, (e.g., first
mortgage bonds, subordinated debt, preferred stock, etc.). The extent of rating
dispersion among the various classes of securities is determined by several
factors including relative weightings of the different security classes in the
capital structure, the overall credit strength of the issuer, and the nature of
covenant protection. Review of indenture restrictions is important to the
analysis of a company's operating and financial constraints.
B-36
<PAGE>
The Credit Rating Committee formally reviews all ratings once per quarter (more
frequently, if necessary).
Rating
Scale Definition
- --------------------------------------------------------------------------------
AAA Highest credit quality. The risk factors are negligible, being
only slightly more than for risk-free U.S. Treasury debt.
- --------------------------------------------------------------------------------
AA+ High credit quality. Protection factors are strong. Risk modest,
AA but may vary slightly from time to time because of economic
AA- conditions.
- --------------------------------------------------------------------------------
A+ Protection factors are average but adequate. However, risk factors
A are more variable and greater in periods of economic stress.
A-
- --------------------------------------------------------------------------------
BBB+ Below average protection factors but still considered sufficient for
BBB prudent investment. Considerable variability in risk during economic
BBB- cycles.
- --------------------------------------------------------------------------------
BB+ Below investment grade but deemed likely to meet obligations when due.
BB Present or prospective financial factors fluctuate according to
BB- industry conditions or company fortunes. Overall quality may move up
or down frequently within this category.
- --------------------------------------------------------------------------------
B+ Below investment grade and possessing risk that obligations will not
B be met when due. Financial protection factors will fluctuate widely
B- according to economic cycles, industry conditions and/or company
fortunes. Potential exists for frequent changes in the rating within
this category or into a higher or lower rating grade.
- --------------------------------------------------------------------------------
CCC Well below investment grade securities. Considerable uncertainty
exists as to timely payment of principal, interest or preferred
dividends. Protection factors are narrow and risk can be substantial
with unfavorable economic/industry conditions, and/or with unfavorable
company developments.
B-37
<PAGE>
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. The categories are as follows:
A Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues within this category are delineated with
the numbers 1, 2 and 3 to indicate the relative degree of safety.
A-1 Designation indicates that the degree of safety regarding timely payment is
either overwhelming or very strong. Those issues determined to possess
overwhelming safety characteristics are designated A-1+.
A-2 Designation indicates that the capacity for timely payment is strong.
However, the relative degree of safety is not as high as for issues designated
A-1.
A-3 Designation indicates a satisfactory capacity for timely payment. Issues
with this designation, however, are somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the higher
designations.
B Issues are regarded as having only 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.
C Issues have a doubtful capacity for payment.
MOODY'S COMMERCIAL PAPER RATINGS
Moody's rates commercial paper as either Prime, which contains three categories,
or Not Prime. The commercial paper ratings are as follows:
P-1 Issuers (or related supporting institutions) have a superior capacity for
repayment of short-term promissory obligations, normally evidenced by the
following characteristics: (i) leading market positions in well established
industries, (ii) high rates of return on funds employed, (iii) conservative
capitalization structures with moderate reliance on debt and ample asset
protection, (iv) broad margins in earnings coverage of fixed financial charges
and high internal cash generation, and (v) well established access to a range
of financial markets and assured sources of alternate liquidity.
P-2 Issuers (or related supporting institutions) have a strong capacity for
repayment of short-term promissory obligations, normally evidenced by many of
the characteristics of a P-1 rating, but to a lesser degree. Earnings trends
and coverage ratios, while sound, will be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
P-3 Issuers (or related supporting institutions) have an acceptable capacity for
repayment of short-term promissory obligations. The effect of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and the requirement for relatively high financial leverage.
Adequate alternate liquidity is maintained.
Not Prime Issuers (or related supporting institutions) do not fall within any of
the Prime rating categories.
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<PAGE>
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of up to three years, including commercial paper,
certificates of deposit, medium-term notes, and investment notes. Although the
credit analysis is similar to Fitch's bond rating analysis, the short-term
rating places greater emphasis on the existence of liquidity necessary to meet
the issuer's obligations in a timely manner. Fitch's short-term ratings are as
follows:
Fitch-1+ (Exceptionally Strong Credit Quality) Issues assigned
this rating are regarded as having the strongest degree
of assurance for timely payment.
Fitch-1 (Very Strong Credit Quality) Issues assigned this rating
reflect an assurance of timely payment only slightly less
in degree than issues rated Fitch-1+.
Fitch-2 (Good Credit Quality) Issues carrying this rating have a
satisfactory degree of assurance for timely payment but
the margin of safety is not as great as the two higher
categories.
Fitch-3 (Fair Credit Quality) Issues carrying his rating have
characteristics suggesting that the degree of assurance
for timely payment is adequate, however, near-term
adverse change is likely to cause these securities to be
rated below investment grade.
Fitch-S (Weak Credit Quality) Issues carrying this rating have
characteristics suggesting a minimal degree of assurance
for timely payment and are vulnerable to near term
adverse changes in financial and economic conditions.
DUFF & PHELPS, INC. SHORT-TERM RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
utilized by money market participants. The ratings apply to all obligations
with maturities of under one year, including commercial paper, the uninsured
portion of certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds, including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligors reliance on short-term funds on an ongoing basis.
A. Category 1: High Grade
Duff 1+ Highest certainty of timely payment. Short-term
liquidity, including internal operating factors
and/or access to alternative sources of funds,
is outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations.
Duff 1 Very high certainty of timely payment.
Liquidity factors are excellent and supported
by good fundamental protection factors. Risk
factors are minor.
Duff 1- High certainty of timely payment. Liquidity
factors are strong and supported by good
fundamental protection factors. Risk factors
are very small.
B. Category 2: Good Grade
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<PAGE>
Duff 2 Good certainty of timely payment. Liquidity
factors and company fundamentals are sound.
Although ongoing funding needs may enlarge
total financing requirements, access to capital
markets is good. Risk factors are small.
C. Category 3: Satisfactory Grade
Duff 3 Satisfactory liquidity and other protection
factors qualify issue as investment grade.
Risk factors are larger and subject to more
variation. Nevertheless, timely payment is
expected.
D. Category 4: Non-investment Grade
Duff 4 Speculative investment characteristics.
Liquidity is not sufficient to insure
against disruption in debt service.
Operating factors and market access may
be subject to a high degree of variation.
B-40
