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PaineWebber Strategic Income Fund
Class Y Shares
1285 AVENUE OF THE AMERICAS, NEW YORK, NEW YORK 10019
PROSPECTUS -- JUNE 3, 1996
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PAINEWEBBER STRATEGIC INCOME FUND ('Fund') is a
professionally managed mutual fund seeking a high level of
current income and, secondarily, capital appreciation by
strategically allocating its investment portfolio among
sectors of the U.S. and foreign fixed income securities
markets.
The Fund is a series of PaineWebber Securities Trust
('Trust'). This Prospectus concisely sets forth
information about the Fund a prospective investor should
know before investing. Please retain this Prospectus for
future reference.
THE FUND MAY INVEST PREDOMINANTLY IN LOWER RATED BONDS,
COMMONLY REFERRED TO AS 'JUNK BONDS.' BONDS OF THIS TYPE
ARE CONSIDERED TO BE SPECULATIVE WITH RESPECT TO THE
PAYMENT OF INTEREST AND RETURN OF PRINCIPAL. PURCHASERS
SHOULD CAREFULLY ASSESS THE RISKS ASSOCIATED WITH AN
INVESTMENT IN THIS FUND.
A Statement of Additional Information dated June 3, 1996
(which is incorporated by reference herein), has been
filed with the Securities and Exchange Commission. The
Statement of Additional Information can be obtained
without charge, and further inquiries can be made, by
contacting the Fund, your PaineWebber investment executive
or PaineWebber's correspondent firms or by calling
toll-free 1-800-647-1568.
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An investment in PaineWebber Strategic Income Fund offers
the following advantages:
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<S> <C>
/ / PROFESSIONAL MANAGEMENT / / SUITABLE FOR RETIREMENT PLANS
/ / DIVIDEND AND CAPITAL GAIN
REINVESTMENT
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The Class Y Shares described in this Prospectus are currently offered for sale
primarily to participants in the INSIGHT Investment Advisory Program
('INSIGHT'), when purchased through that program. See 'Purchases'.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS ANY SUCH
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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PaineWebber Strategic Income Fund
TABLE OF CONTENTS
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Page
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Fund Expenses..................................... 3
Investment Objectives and Policies................ 4
Purchases......................................... 14
Redemptions....................................... 15
Dividends and Taxes............................... 16
Valuation of Shares............................... 17
Management........................................ 17
Performance Information........................... 18
General Information............................... 19
Appendix A........................................ 20
Appendix B........................................ 23
Appendix C........................................ 26
</TABLE>
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PaineWebber Strategic Income Fund
FUND EXPENSES
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EXPENSES OF INVESTING IN THE FUND. The following tables are intended to assist
investors in understanding the expenses associated with investing in Class Y
shares of the Fund.
SHAREHOLDER TRANSACTION EXPENSES
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<S> <C>
Sales charge on purchases of shares......................... None
Sales charge on reinvested dividends........................ None
Redemption fee or deferred sales change..................... None
Maximum annual investment advisory fee payable by
shareholders through INSIGHT (as a percentage of average
daily value of shares held)(1)............................ 1.50%
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ANNUAL FUND OPERATING EXPENSES(2)
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
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<S> <C>
Management fees............................................. 0.75%
12b-1 fees.................................................. 0.00%
Other expenses (estimated).................................. 0.74%
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Total operating expenses (estimated)........................ 1.49%
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(1) Participation in INSIGHT is subject to payment of an advisory fee at the
maximum annual rate of 1.50% of assets held through INSIGHT (generally
charged quarterly in advance) which may be charged to the INSIGHT
participant's PaineWebber account.
(2) See 'Management' for additional information. The management fee payable to
Mitchell Hutchins is greater than the management fee paid by most funds.
'Other Expenses' are estimated based on the expenses incurred by the Fund's
Class A shares for the fiscal year ended January 31, 1996. The INSIGHT fee
is not included.
EXAMPLE OF EFFECT OF FUND EXPENSES
An investor would directly or indirectly pay the following expenses on a $1,000
investment in the Fund (including the 1.50% annual INSIGHT fee), assuming a 5%
annual return:
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<CAPTION>
ONE YEAR THREE YEARS
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<S> <C> <C>
Class Y Shares............................... $ 30 $ 92
</TABLE>
This Example assumes that all dividends and other distributions are reinvested
and that the percentage amounts listed under Annual Fund Operating Expenses
remain the same in the years shown. The above tables and the assumption in the
Example of a 5% annual return are required by regulations of the Securities and
Exchange Commission ('SEC') applicable to all mutual funds; the assumed 5%
annual return is not a prediction of, and does not represent, the projected or
actual performance of the Class Y Shares of the Fund.
THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES, AND THE FUND'S ACTUAL EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
The actual expenses attributable to the Fund's Class Y shares will depend upon,
among other things, the level of average net assets and the extent to which the
Fund incurs variable expenses, such as transfer agency costs.
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Prospectus Page 3
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PaineWebber Strategic Income Fund
INVESTMENT OBJECTIVES AND POLICIES
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The Fund's primary investment objective is to achieve a high level of current
income. As a secondary objective, the Fund seeks capital appreciation. Mitchell
Hutchins Asset Management Inc. ('Mitchell Hutchins') is the Fund's investment
adviser and administrator. The Fund seeks to achieve its investment objectives
by investing in a portfolio of fixed income securities (including debt
instruments the payment on which may be fixed, variable or floating and also
zero coupon securities that pay no interest until maturity) that is
strategically allocated among the following investment sectors: (1) U.S.
government and investment grade securities of corporate and other
non-governmental U.S. issuers ('U.S. Government and Investment Grade
Securities'); (2) high yield, high risk securities of U.S. issuers ('U.S. High
Yield Securities'); and (3) government, corporate or other securities of
non-U.S. issuers ('Foreign and Emerging Market Securities'). Each of these
sectors generally reacts differently to interest rate changes and reacts in
different ways or at different times to different economic events. Data from the
Lehman Aggregate Bond Index, the Salomon Brothers High Yield Index, the Merrill
Lynch High Yield Index and the Salomon Brothers World Government Bond Index
indicate that these sectors are not closely correlated. This means that when one
sector underperforms the market as a whole, another sector may perform at
roughly the same level as the market, while the third sector may outperform the
market.
Mitchell Hutchins allocates the Fund's assets among these investment sectors
based on its assessment of relative values, currency and interest rate trends
and economic, credit and political conditions. Mitchell Hutchins believes that
the relative investment opportunities and risks presented by securities in these
sectors will vary so that, over time, securities in one or more of the Fund's
three sectors will become undervalued relative to the risks presented.
Accordingly, the relative investment performance of these investment sectors
will change over time, and the best performing sector frequently will change
from year to year.
Mitchell Hutchins seeks to take advantage of these changes in relative
performance by allocating a greater proportion of the Fund's assets in those
investment sectors that it believes are undervalued. A portion of the Fund's
assets normally is invested in each of these investment sectors, which should
reduce the risks associated with investing only in any one sector. However, the
Fund has the flexibility at any time to invest all or substantially all of its
assets in any one sector. If successful, the Fund's strategic allocation should
enable the Fund to achieve a higher level of investment return over time than if
the Fund invested exclusively in any one investment sector or allocated a fixed
proportion of its assets to each investment sector. The Fund is, however, more
dependent on the ability of Mitchell Hutchins to successfully evaluate the
relative values of the Fund's three investment sectors than is the case with a
fund that does not seek to adjust market sector allocations over time. The Fund
is not intended to be a complete investment program and is designed for
investors willing to assume additional risk in return for the potential for high
current income and, secondarily, capital appreciation.
Allocations among the Fund's three investment sectors and investment decisions
with respect to the assets allocated to each sector are made by an investment
management team comprised of Dennis McCauley, who acts as the Fund's allocation
manager, and the Fund's sector managers, Nirmal Singh, Craig Varrelman, Thomas
J. Libassi and Stuart Waugh. Determinations as to percentage allocations for
each sector are made by Mr. McCauley, based upon advice from each sector manager
as to the market considerations applicable to his respective sector. Decisions
as to investments within each sector are made by the respective sector managers
based on market outlook, investment research, geographic analysis and forecasts
regarding currencies and interest rates.
There can be no assurance that the Fund will achieve its investment objectives.
The Fund's investment objectives and certain investment limitations as described
in the Statement of Additional Information are fundamental policies that may not
be changed without shareholder approval. All other investment policies may be
changed by the Trust's board of trustees without shareholder approval.
U.S. GOVERNMENT AND INVESTMENT GRADE SECURITIES. The U.S. Government and
Investment Grade Securities in which the Fund may invest include
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PaineWebber Strategic Income Fund
(1) U.S. Treasury obligations and mortgage-backed and other securities issued or
guaranteed by the U.S. government or its agencies or instrumentalities ('U.S.
government securities') and (2) mortgage-backed and asset-backed securities,
bonds and other fixed and variable rate income securities that are issued by
corporate and other non-governmental U.S. issuers and that at the time of
purchase are rated BBB or higher by Standard & Poor's, a division of The
McGraw-Hill Companies, Inc. ('S&P') or Baa/baa or higher by Moody's Investors
Service, Inc. ('Moody's'), are comparably rated by another nationally recognized
statistical rating organization ('NRSRO') or, if not rated, are determined by
Mitchell Hutchins to be comparable to such rated securities. In selecting U.S.
Government and Investment Grade Securities for the Fund's portfolio, Mitchell
Hutchins will consider factors such as the general level of interest rates,
changes in the perceived creditworthiness of the issuers, the prepayment outlook
for the mortgage market and changes in general economic conditions and business
conditions affecting the issuers and their respective industries.
The Fund may invest in U.S. government securities that are backed by the full
faith and credit of the U.S. government, such as U.S. Treasury obligations;
securities that are supported primarily or solely by the creditworthiness of the
government-related issuer, such as securities issued by the Resolution Funding
Corporation, the Student Loan Marketing Association, the Federal Home Loan Banks
and the Tennessee Valley Authority; and securities that are supported primarily
or solely by specific pools of assets and the creditworthiness of a U.S.
government-related issuer, such as U.S. government mortgage-backed securities.
Mortgage-backed securities represent direct or indirect participations in, or
are secured by and payable from, mortgage loans secured by real property. They
include single- and multi-class pass-through securities and collateralized
mortgage obligations. Multi-class pass-through securities and collateralized
mortgage obligations are collectively referred to herein as CMOs. For more
information concerning the types of mortgage-backed securities in which the Fund
may invest, see Appendix B.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. However, the underlying assets are not first lien
mortgage loans or interests therein, but include assets such as motor vehicle
installment sales contracts, other installment sale contracts, home equity
loans, leases of various types of real and personal property and receivables
from revolving credit (credit card) agreements. Such assets are securitized
through the use of trusts or special purpose corporations. Payments or
distributions of principal and interest on asset-backed securities may be
guaranteed up to certain amounts and for a certain time period by a letter of
credit or a pool insurance policy issued by a financial institution unaffiliated
with the issuer or other credit enhancements may be present.
The yield characteristics of the mortgage- and asset-backed securities in which
the Fund may invest differ from those of traditional debt securities. Among the
major differences are that interest and principal payments are made more
frequently on mortgage- and asset-backed securities, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other assets generally may be prepaid at any time. See '--Other Investment
Policies and Risk Factors' herein and 'Investment Policies and Restrictions' in
the Statement of Additional Information.
U.S. HIGH YIELD SECURITIES. The U.S. High Yield Securities in which the Fund
may invest include bonds, debentures, notes, mortgage- and asset-backed
securities, convertible debt and preferred stock that are issued by corporate
and other non-governmental U.S. issuers and that at the time of purchase are
rated BB or lower by S&P or Ba/ba or lower by Moody's, are comparably rated by
another NRSRO or, if not rated, are determined by Mitchell Hutchins to be
comparable to such rated securities. Such securities are commonly referred to as
'junk bonds' and involve a high degree of risk. The U.S. High Yield Securities
in which the Fund may invest may be rated as low as D by S&P or C by Moody's or
be comparable, unrated securities. Such obligations are highly speculative and
may be in default in the payment of interest and the repayment of principal. See
'--Other Investment Policies and Risk Factors.' For further information
regarding S&P and Moody's ratings, see Appendix A.
In selecting U.S. High Yield Securities for the Fund's portfolio, Mitchell
Hutchins seeks to identify issuers and industries that Mitchell Hutchins
believes are more likely to experience stable or improving financial conditions.
Many corporations are in the process of strengthening, or have recently
improved, their financial positions through cost-cutting, restructuring or
refinancing with lower cost debt. Mitchell Hutchins expects that, at times when
the U.S. economy is improving, these factors and others may lead many issuers to
experience financial improvement and possible credit upgrades. Mitchell Hutchins
seeks to identify these issuers through detailed credit research. Mitchell
Hutchins' analysis may include consideration of general industry trends, the
issuer's experience and managerial strength, changing financial conditions,
borrowing requirements or debt maturity schedules, the
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PaineWebber Strategic Income Fund
issuer's responsiveness to changes in business conditions and interest rates,
and other terms and conditions. Mitchell Hutchins may also consider relative
values based on anticipated cash flow, interest or dividend coverage, asset
coverage and earnings prospects.
FOREIGN AND EMERGING MARKET SECURITIES. The Foreign and Emerging Market
Securities in which the Fund may invest include (1) Brady Bonds and other debt
securities issued or guaranteed by governments, their agencies,
instrumentalities or political subdivisions located in foreign countries,
including industrialized countries and emerging market countries, or by central
banks located in such countries (collectively, 'Sovereign Debt') and debt
securities issued by multi-national institutions such as the International Bank
for Reconstruction and Development ('World Bank') and the International Monetary
Fund ('IMF'); (2) debt securities and preferred stock issued by corporations,
banks and other business entities located in foreign countries, including
industrialized countries and emerging market countries, or securities
denominated in or indexed to the currencies of foreign countries; and (3)
interests in issuers organized and operated for the purpose of securitizing or
restructuring the investment characteristics of any of the foregoing. The Fund
may invest without limit in securities of issuers located in any country in the
world, including both industrialized and emerging market countries.
Mitchell Hutchins selectively invests the Fund's assets allocated to Foreign and
Emerging Market Securities in securities of issuers in countries where the
combination of income market yields, the price appreciation potential of fixed
income securities and, with respect to non-U.S. dollar-denominated securities,
currency exchange rate movements present opportunities for high current income
and, secondarily, capital appreciation. Determinations as to the foreign markets
in which the Fund invests are based on an evaluation of total debt levels,
currency reserve levels, net exports/imports, overall economic growth, level of
inflation, currency fluctuation, political and social climate and payment
history of the country in which the issuer is located. Particular securities are
selected based upon credit risk analysis of potential issuers, the
characteristics of the security and interest rate sensitivity of the various
issues by a single issuer, analysis of volatility and liquidity of these
particular instruments and the tax implications to the Fund of various
instruments. While the Fund generally is not restricted in the portion of its
assets that may be invested in a single country or region, under normal
conditions, the Fund's assets will be invested in issuers located in at least
three countries. No more than 25% of the Fund's total assets will be invested in
securities issued or guaranteed by any single foreign government.
The Foreign and Emerging Market Securities in which the Fund may invest are not
required to meet any minimum credit rating standard and may not be rated by any
NRSRO. All or a substantial portion of the Fund's investments in Foreign and
Emerging Market Securities may be rated below investment grade or may be unrated
securities with credit characteristics that are comparable to securities that
are rated below investment grade. The Fund may invest without limit in
securities of issuers in emerging market countries and in non-U.S. dollar-
denominated fixed income securities, including securities denominated in the
local currencies of emerging market countries. See '--Other Investment Policies
and Risk Factors' herein and 'Investment Policies and Restrictions' in the
Statement of Additional Information.
OTHER INVESTMENT POLICIES
AND RISK FACTORS
RISKS OF FIXED INCOME SECURITIES. The value of the corporate, government and
other fixed income securities held by the Fund, and thus the net asset value of
the Fund's shares, generally fluctuates with (1) movements in interest rates,
(2) changes in the perceived creditworthiness of the issuers of those securities
and (3) with respect to non-U.S. dollar-denominated securities, changes in the
relative values of the currencies in which the Fund's investments are
denominated with respect to the U.S. dollar. The extent of the fluctuation of
the Fund's net asset value depends on various other factors, such as the average
maturity of the Fund's investments, the extent to which the Fund holds
instruments denominated in foreign currencies and the extent to which the Fund
hedges its interest rate, credit and currency exchange rate risks. There are no
limitations on the maturities of the fixed income securities in which the Fund
may invest or on the average maturity of the Fund's portfolio.
RISKS OF HIGH YIELD, HIGH RISK SECURITIES. The U.S. High Yield Securities and
all or a portion of the Foreign and Emerging Market Securities in which the Fund
invests are high yield, high risk securities that are rated below investment
grade or are comparable, unrated securities. Debt securities rated below
investment grade are deemed by S&P and Moody's to be predominantly speculative
with respect to the issuer's capacity to pay interest and repay principal and
may involve major risk exposures to adverse conditions.
The high yield, high risk securities in which the Fund may invest include
securities having the lowest ratings
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PaineWebber Strategic Income Fund
assigned by S&P or Moody's and, together with comparable unrated securities, may
include securities that are in default or that face the risk of default with
respect to the payment of principal or interest. Such securities are generally
unsecured and are often subordinated to other creditors of the issuer. To the
extent the Fund is required to seek recovery upon a default in the payment of
principal or interest on its portfolio holdings, the Fund may incur additional
expenses and may have limited legal recourse in the event of a default.
Ratings of fixed income securities represent the rating agencies' opinions
regarding their quality, are not a guarantee of quality and may be reduced after
the Fund has acquired the security. Mitchell Hutchins will consider such an
event in determining whether the Fund should continue to hold the security but
is not required to dispose of it. Credit ratings attempt to evaluate the safety
of principal and interest payments and do not reflect an assessment of the
volatility of the security's market value or the liquidity of an investment in
the security. Also, NRSROs may fail to make timely changes in credit ratings in
response to subsequent events, so that an issuer's current financial condition
may be better or worse than the rating indicates.
High yield, high risk securities generally offer a higher current yield than
that available from higher grade issues, but they involve higher risks in that
they are especially subject to adverse changes in general economic conditions
and in the industries in which the issuers are engaged, to changes in the
financial condition of the issuers and to price fluctuations in response to
changes in interest rates. During periods of economic downturn or rising
interest rates, highly leveraged issuers may experience financial stress, which
could adversely affect their ability to make payments of principal and interest
and increase the possibility of default. Certain emerging market governments
that issue high yield, high risk debt securities are among the largest debtors
to commercial banks, foreign governments and supranational organizations such as
the World Bank and may not be able or willing to make principal or interest
payments as they come due.
The market for high yield, high risk securities has expanded rapidly in recent
years, and its growth paralleled a long economic expansion. In the past, the
prices of many high yield, high risk securities declined substantially,
reflecting an expectation that many issuers of such securities might experience
financial difficulties. As a result, the yields on such securities rose
dramatically. Such higher yields did not reflect the value of the income stream
that holders of such securities expected, but rather the risk that holders of
such securities could lose a substantial portion of their value as a result of
the issuers' financial restructuring or default. There can be no assurance that
such declines will not recur. The market for high yield, high risk securities
generally is thinner and less active than that for higher quality securities,
which may limit the Fund's ability to sell such securities at fair value in
response to changes in the economy or the financial markets. Adverse publicity
and investor perceptions, whether or not based on fundamental analysis, may also
decrease the values and liquidity of high yield, high risk securities,
especially in a thinly traded market.
Although Mitchell Hutchins attempts to minimize the speculative risks associated
with investments in high yield, high risk securities through securities
selection, credit analysis and attention to current trends in interest rates and
other factors, investors should consider their ability to assume these
investment risks before making an investment in the Fund.
During its 1996 fiscal year, the Fund had 86.83% of its average annual net
assets in debt securities that received a rating from S&P or Moody's or another
NRSRO and 13.17% of its net assets in debt securities that were not so rated.
The Fund had the following percentages of its net assets invested in rated
securities: AAA/Aaa (including cash items)--36.91%, AA/Aa--0.18%, A/A--0.00%,
BBB/Baa--0.74%, BB/Ba--15.29%, B/B--31.86% and CCC/Caa--1.85%. It should be
noted that this information reflects the average composition of the Fund's
assets during the fiscal year ended January 31, 1996, and is not necessarily
representative of the Fund's assets as of the end of that fiscal year, the
current fiscal year or at any time in the future.
RISKS OF FOREIGN AND EMERGING MARKET SECURITIES. The Foreign and Emerging
Market Securities in which the Fund may invest involve risks relating to
political, social and economic developments abroad, as well as risks resulting
from the differences between the regulations to which U.S. and foreign issuers
and markets are subject. These risks may include nationalization, expropriation,
confiscatory taxation, withholding taxes on dividends and interest, limitations
on the use or transfer of Fund assets and political or social instability or
diplomatic developments, including armed conflict. Such events have occurred in
the past in countries in which the Fund is authorized to invest and could
adversely affect the Fund's assets should these conditions or events recur.
While Mitchell Hutchins intends to manage the Fund's portfolio in a manner that
will reduce the exposure to such risks, there can be no assurance that such
events will not cause the Fund to suffer a loss of interest or principal on any
of its
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PaineWebber Strategic Income Fund
holdings. Investors should consider their ability to assume these investment
risks before making an investment in the Fund.
Individual foreign economies may differ favorably or unfavorably from the U.S.
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position. Securities of many foreign companies may be less liquid and their
prices more volatile than securities of comparable U.S. companies. While the
Fund generally invests only in securities that are traded on recognized
exchanges or in over-the-counter ('OTC') markets, foreign securities may from
time to time be difficult to liquidate rapidly without significantly depressing
the price of such securities. There may be less publicly available information
concerning foreign issuers of securities held by the Fund than is available
concerning U.S. companies. Transactions in foreign securities may be subject to
less efficient settlement practices. Foreign securities trading practices,
including those involving securities settlement where Fund assets may be
released prior to receipt of payment, may expose the Fund to increased risk in
the event of a failed trade or the insolvency of a foreign broker-dealer. Legal
remedies for defaults and disputes may have to be pursued in foreign courts,
whose procedures differ substantially from those of U.S. courts.
The risks of investing in foreign securities may be greater with respect to
securities of issuers in, or denominated in the currencies of, emerging market
countries. The Fund may invest in such securities without limit. The economies
of emerging market countries generally are heavily dependent upon international
trade and, accordingly, have been and may continue to be adversely affected by
trade barriers, exchange controls, managed adjustments in relative currency
values and other protectionist measures imposed or negotiated by the countries
with which they trade. These economies also have been and may continue to be
adversely affected by economic conditions in the countries with which they
trade. Many emerging market countries have experienced substantial, and in some
periods extremely high, rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had and may continue to have very negative
effects on the economies and securities markets of certain emerging market
countries. The securities markets of emerging market countries are substantially
smaller, less developed, less liquid and more volatile than the securities
markets of the United States and other developed countries. Disclosure and
regulatory standards in many respects are less stringent in emerging market
countries than in the United States and other major markets. There also may be a
lower level of monitoring and regulation of emerging markets and the activities
of investors in such markets, and enforcement of existing regulations may be
extremely limited. Investing in local markets, particularly in emerging market
countries, may require the Fund to adopt special procedures, seek local
government approvals or take other actions, each of which may involve additional
costs to the Fund. Certain emerging market countries may also restrict
investment opportunities in issuers in industries deemed important to national
interests.
Foreign investment in foreign debt securities is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in certain securities and increase the costs and expenses of
the Fund. Certain countries require governmental approval prior to investments
by foreign persons, limit the amount of investment by foreign persons in a
particular issuer, limit the investment by foreign persons only to a specific
class of securities of an issuer that may have less advantageous rights than the
classes available for purchase by domiciliaries of the countries and impose
additional taxes on foreign investors. Foreign countries may require
governmental approval for the repatriation of investment income, capital or the
proceeds of sales of securities by foreign investors. In addition, if a
deterioration occurs in a foreign country's balance of payments, the country
could impose temporary restrictions on foreign capital remittances. The Fund
could be adversely affected by a delay in, or a refusal to grant, any required
governmental approval for repatriation of capital, as well as by the application
to the Fund of any restrictions on investments. Investing in local markets,
particularly in emerging market countries, may require the Fund to adopt special
procedures, seek local government approvals or take other actions, each of which
may involve additional costs to the Fund.
Investments in Sovereign Debt involve special risks. Certain foreign countries,
particularly emerging market countries, have historically experienced, and may
continue to experience, high rates of inflation, high interest rates, exchange
rate fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. The issuer of the debt or the
governmental authorities that control the repayment of the debt may be unable or
unwilling to repay principal or interest when due in accordance with the terms
of such debt, and the Fund may have limited legal recourse in the event of
default.
Sovereign Debt also includes fixed income securities of 'quasi-governmental
agencies' and fixed income
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PaineWebber Strategic Income Fund
securities denominated in multinational currency units of an issuer (including
supranational issuers). An example of a multinational currency unit is the
European Currency Unit, which represents specified amounts of the currencies of
certain member states of the European Union. Fixed income securities of
quasi-governmental agencies are issued by entities owned by either a national,
state or equivalent government or are obligations of a political unit that is
not backed by the national government's full faith and credit and general taxing
powers.
The Fund may invest without limit in non-U.S. dollar-denominated securities.
Accordingly, changes in foreign currency exchange rates will affect the Fund's
net asset value, the value of dividends and interest earned, gains and losses
realized on the sale of securities and net investment income to be distributed
to shareholders by the Fund. If the value of a foreign currency rises against
the U.S. dollar, the value of Fund assets denominated in that currency will
increase; correspondingly, if the value of a foreign currency declines against
the U.S. dollar, the value of Fund assets denominated in that currency will
decrease. The exchange rates between the U.S. dollar and other currencies are
determined by factors such as supply and demand in the currency exchange
markets, international balances of payments, speculation and other economic and
political conditions. In addition, some foreign currency values may be volatile
and there is the possibility of governmental controls on currency exchange or
governmental intervention in currency markets. Any of these factors could
adversely affect the Fund.
RISKS OF MORTGAGE- AND ASSET-BACKED SECURITIES. The yield characteristics of
the mortgage-backed and asset-backed securities in which the Fund may invest
differ from those of traditional debt securities. Among the major differences
are that interest and principal payments are made more frequently on mortgage-
and asset-backed securities, usually monthly, and that principal may be prepaid
at any time because the underlying mortgage loans or other assets generally may
be prepaid at any time. As a result, if the Fund purchases these securities at a
premium, a prepayment rate that is faster than expected will reduce yield to
maturity, while a prepayment rate that is slower than expected will have the
opposite effect of increasing the yield to maturity. Conversely, if the Fund
purchases these securities at a discount, faster than expected prepayments will
increase, while slower than expected prepayments will reduce, yield to maturity.
Amounts available for reinvestment by the Fund are likely to be greater during a
period of declining interest rates and, as a result, are likely to be reinvested
at lower interest rates than during a period of rising interest rates. The
market for privately issued mortgage- and asset-backed securities is smaller and
less liquid than the market for U.S. government mortgage-backed securities. CMO
classes may be specially structured in a manner that provides any of a wide
variety of investment characteristics, such as yield, effective maturity and
interest rate sensitivity. As market conditions change, however, and
particularly during periods of rapid or unanticipated changes in market interest
rates, the attractiveness of the CMO classes and the ability of the structure to
provide the anticipated investment characteristics may be significantly reduced.
These changes can result in volatility in the market value, and in some
instances reduced liquidity, of the CMO class.
Certain classes of CMOs and other mortgage-backed securities are structured in a
manner that makes them extremely sensitive to changes in prepayment rates.
Interest-only ('IO') and principal-only ('PO') classes are examples of this. IOs
are entitled to receive all or a portion of the interest, but none (or only a
nominal amount) of the principal payments, from the underlying mortgage assets.
If the mortgage assets underlying an IO experience greater than anticipated
principal prepayments, then the total amount of interest payments allocable to
the IO class, and therefore the yield to investors, generally will be reduced.
In some instances, an investor in an IO may fail to recoup all of his or her
initial investment, even if the security is government issued or guaranteed or
is rated AAA or the equivalent. Conversely, PO classes are entitled to receive
all or a portion of the principal payments, but none of the interest, from the
underlying mortgage assets. PO classes are purchased at substantial discounts
from par, and the yield to investors will be reduced if principal payments are
slower than expected. Some IOs and POs, as well as other CMO classes, are
structured to have special protections against the effects of prepayments. These
structural protections, however, normally are effective only within certain
ranges of prepayment rates and thus will not protect investors in all
circumstances.
Some CMO classes are structured to pay interest at rates that are adjusted in
accordance with a formula, such as a multiple or fraction of the change in a
specified interest rate index, so as to pay at a rate that will be attractive in
certain interest rate environments but not in others. For example, an inverse
floating rate CMO class pays interest at a rate that increases as a specified
interest rate index decreases but decreases as that index increases. For other
CMO classes, the yield may move in the same direction as market interest
rates--i.e., the yield may increase as rates increase and decrease as rates
decrease-but may do so more rapidly or to a greater degree. The market value
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of such securities generally is more volatile than that of a fixed rate
obligation. Such interest rate formulas may be combined with other CMO
characteristics. For example, a CMO class may be an 'inverse IO,' on which the
holders are entitled to receive no payments of principal and are entitled to
receive interest at a rate that will vary inversely with a specified index or a
multiple thereof.
During 1994, the value and liquidity of many mortgage-backed securities declined
sharply due primarily to increases in interest rates. There can be no assurance
that such declines will not recur. The market value of certain mortgage-backed
securities in which the Fund may invest, including IO and PO classes of
mortgage-backed securities and inverse floating rate securities, can be
extremely volatile and these securities may become illiquid. Mitchell Hutchins
seeks to manage the Fund so that the volatility of the Fund's portfolio, taken
as a whole, is consistent with the Fund's investment objectives. If market
interest rates or other factors that affect the volatility of securities held by
the Fund change in ways that Mitchell Hutchins does not anticipate, the Fund's
ability to meet its investment objectives may be reduced.
See Appendix B to this Prospectus for more information concerning the types of
mortgage-backed securities in which the Fund may invest.
ILLIQUID SECURITIES. The Fund may invest up to 15% of its net assets in
illiquid securities. The term 'illiquid securities' for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the price at which the Fund has valued the
securities. Under current guidelines of the staff of the SEC, IOs and POs are
considered illiquid. However, IO and PO classes of fixed-rate mortgage-backed
securities issued by the U.S. government or one of its agencies or
instrumentalities will not be considered illiquid if Mitchell Hutchins has
determined that they are liquid pursuant to guidelines established by the
Trust's board of trustees. Illiquid securities are also considered to include,
among other things, written OTC options, repurchase agreements with maturities
in excess of seven days and securities whose disposition is restricted under the
federal securities laws (other than 'Rule 144A' securities that Mitchell
Hutchins has determined to be liquid under procedures approved by the Trust's
board of trustees).
Rule 144A establishes a 'safe harbor' from the requirements of the Securities
Act of 1933 ('1933 Act'). Institutional markets for restricted securities have
developed as a result of Rule 144A, providing both readily ascertainable values
for restricted securities and the ability to liquidate an investment to satisfy
share redemption orders. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held by
the Fund, however, could affect adversely the marketability of such portfolio
securities and the Fund might be unable to dispose of such securities promptly
or at favorable prices.
The Fund may not be able to sell illiquid securities when Mitchell Hutchins
considers it desirable to do so or may have to sell such securities at a price
lower than could be obtained if they were more liquid. Also, the sale of
illiquid securities may require more time and may result in higher dealer
discounts and other selling expenses than does the sale of securities that are
liquid. Illiquid securities may be more difficult to value due to the
unavailability of reliable market quotations for such securities.
HEDGING AND RELATED INCOME STRATEGIES. The Fund may use options (both
exchange-traded and OTC) and futures contracts to attempt to enhance income and
may use these instruments and forward currency contracts to reduce the overall
risk of its investments (hedge). Hedging strategies may be used in an attempt to
manage the Fund's average duration, foreign currency exposure and other risks of
the Fund's investments, which can affect fluctuations in the Fund's net asset
value. The Fund's ability to use these strategies may be limited by market
conditions, regulatory limits and tax considerations. The use of options and
futures solely to enhance income may be considered a form of speculation.
Appendix C to this Prospectus describes these instruments and the Statement of
Additional Information contains further information on these strategies.
The Fund may purchase and sell call and put options on securities indices and on
individual securities for hedging purposes or to enhance income. The Fund also
may purchase and sell interest rate and currency futures contracts and options
thereon and may purchase and sell covered straddles on securities, bond indices
or currencies or options on such futures contracts. The Fund may enter into
options, futures contracts and forward currency contracts under which up to 100%
of the Fund's portfolio is at risk.
The Fund may enter into forward currency contracts for the purchase or sale of a
specified currency at a specified future date, either with respect to specific
transactions or with respect to its portfolio positions. For example, when
Mitchell Hutchins anticipates making a currency exchange transaction in
connection with the purchase or sale of a security, the Fund may enter into a
forward contract in order to set the exchange rate at which the transaction will
be made. The Fund also may enter into
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a forward contract to sell an amount of a foreign currency approximating the
value of some or all of the Fund's securities positions denominated in such
currency. The Fund may use forward contracts in one currency or a basket of
currencies to hedge against fluctuations in the value of another currency when
Mitchell Hutchins anticipates there will be a correlation between the two and
may use forward currency contracts to shift the Fund's exposure to foreign
currency fluctuations from one country to another. The purpose of entering into
these contracts is to minimize the risk to the Fund from adverse changes in the
relationship between the U.S. and foreign currencies. The Fund may also purchase
and sell foreign currency futures contracts, options thereon and options on
foreign currencies to hedge against the risk of fluctuations in market value of
foreign securities the Fund holds in its portfolio, or that it intends to
purchase, resulting from changes in foreign exchange rates. In addition, the
Fund may purchase and sell options on foreign currencies to enhance income.
The Fund may enter into interest rate protection transactions, including
interest rate swaps, caps, collars and floors, to preserve a return or spread on
a particular investment or portion of its portfolio or to protect against any
increase in the price of securities the Fund anticipates purchasing at a later
date. The Fund will enter into interest rate protection transactions only with
banks and recognized securities dealers believed by Mitchell Hutchins to present
minimal credit risks in accordance with guidelines established by the Trust's
board of trustees.
The Fund might not employ any of the strategies described above, and no
assurance can be given that any strategy used will succeed. If Mitchell Hutchins
incorrectly forecasts interest or currency exchange rates, market values or
other economic factors in utilizing a strategy for the Fund, the Fund would be
in a better position if it had not entered into the transaction. The use of
these strategies involves certain special risks, including (1) the fact that
skills needed to use hedging instruments are different from those needed to
select the Fund's securities, (2) possible imperfect correlation, or even no
correlation, between price movements of hedging instruments and price movements
of the investments being hedged, (3) the fact that, while hedging strategies can
reduce the risk of loss, they can also reduce the opportunity for gain, or even
result in losses, by offsetting favorable priced movements in hedged investments
and (4) the possible inability of the Fund to purchase or sell a portfolio
security at a time that otherwise would be favorable for it to do so, or the
possible need for the Fund to sell a portfolio security at a disadvantageous
time, due to the need for the Fund to maintain 'cover' or to segregate
securities in connection with hedging transactions and the possible inability of
the Fund to close out or to liquidate its hedged position. Only a limited
market, if any, currently exists for hedging instruments relating to securities
or currencies in most emerging market countries. Accordingly, under present
circumstances, the Fund does not anticipate that it will be able to effectively
hedge its currency exposure or investment in such markets.
REPURCHASE AGREEMENTS. The Fund may use repurchase agreements. Repurchase
agreements are transactions in which the Fund purchases securities from a bank
or recognized securities dealer and simultaneously commits to resell the
securities to the bank or dealer at an agreed-upon date and price reflecting a
market rate of interest unrelated to the coupon rate or maturity of the
purchased securities. Repurchase agreements carry certain risks not associated
with direct investments in securities, including possible decline in the market
value of the underlying securities and delays and costs to the Fund if the other
party to the repurchase agreement becomes insolvent. The Fund intends to enter
into repurchase agreements only with banks and dealers in transactions believed
by Mitchell Hutchins to present minimum credit risks in accordance with
guidelines established by the Trust's board of trustees.
ARBITRAGED DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS. The Fund may enter
into dollar rolls, in which the Fund sells mortgage-backed or other securities
for delivery in the current month and simultaneously contracts to purchase
substantially similar securities on a specified future date. In the case of
dollar rolls involving mortgage-backed securities, the mortgage-backed
securities that are purchased will be of the same type and will have the same
interest rate and maturity as those sold, but will be supported by different
pools of mortgages. The Fund forgoes principal and interest paid during the roll
period on the securities sold, but the Fund is compensated by the difference
between the current sales price and the lower price for the future purchase as
well as by any interest earned on the proceeds of the securities sold. The Fund
also could be compensated through the receipt of fee income equivalent to a
lower forward price.
The Fund may also enter into reverse repurchase agreements in which the Fund
sells securities to a bank or dealer and agrees to repurchase them at a mutually
agreed-upon date and price. The market value of securities sold under reverse
repurchase agreements typically is greater than the proceeds of the sale, and,
accordingly, the market value of the securities sold is likely to be greater
than the value of the securities in
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which the Fund invests those proceeds. Thus, reverse repurchase agreements
involve the risk that the buyer of the securities sold by the Fund might be
unable to deliver them when the Fund seeks to repurchase. In the event the buyer
of securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, such buyer or its trustee or receiver may receive an
extension of time to determine whether to enforce the Fund's obligation to
repurchase the securities, and the Fund's use of the proceeds of the reverse
repurchase agreement may effectively be restricted pending such decision.
The dollar rolls and reverse repurchase agreements entered into by the Fund
normally will be arbitrage transactions in which the Fund will maintain an
offsetting position in U.S. Government and Investment Grade Securities or
repurchase agreements involving U.S. Government and Investment Grade Securities
that mature on or before the settlement date of the related dollar roll or
reverse repurchase agreement. Since the Fund will receive interest on the
securities or repurchase agreements in which it invests the transaction
proceeds, such transactions may involve leverage. However, because such U.S.
Government and Investment Grade Securities or repurchase agreements will mature
on or before the settlement date of the dollar roll or reverse repurchase
agreement, Mitchell Hutchins believes that such arbitrage transactions do not
present the risks to the Fund that are associated with other types of leverage.
Dollar rolls and reverse repurchase agreements will be considered to be
borrowings and, accordingly, will be subject to the Fund's limitations on
borrowings, which will restrict the aggregate of such transactions (and other
borrowings) to 33 1/3% of the Fund's total assets. The Fund will not enter into
dollar rolls or reverse repurchase agreements, other than in arbitrage
transactions as described above, in an aggregate amount in excess of 5% of the
Fund's total assets. The Fund has no present intention to enter into dollar
rolls other than in such arbitrage transactions, and it has no present intention
to enter into reverse repurchase agreements other than in such arbitrage
transactions or for temporary or emergency purposes. The Fund may borrow money
for temporary purposes, but not in excess of 10% of its total assets.
ZERO COUPON, OTHER ORIGINAL ISSUE DISCOUNT AND PAYMENT-IN-KIND SECURITIES. The
Fund may invest up to 35% of its total assets in zero coupon securities. It also
may invest without limit in other securities that are issued with original issue
discount ('OID') and in payment-in-kind ('PIK') securities. Zero coupon
securities usually trade at a substantial discount from their face or par value;
PIK securities often trade at a substantial discount from their face or par
value. Both zero coupon and PIK securities are subject to greater fluctuations
of market value in response to changing interest rates than debt obligations of
comparable maturities that make current distributions of interest in cash.
Federal tax law requires that a holder of a security with OID accrue a portion
of the OID on the security as income each year, even though the holder may
receive no interest payment on the security during the year. Accordingly,
although the Fund will receive no payments on its zero coupon securities prior
to their maturity or disposition, it will have income attributable to such
securities. Similarly, while PIK securities may pay interest in the form of
additional securities rather than cash, that interest must be included in the
Fund's annual income.
Federal tax law requires that companies such as the Fund, which seek to qualify
for pass-through federal income tax treatment as regulated investment companies,
distribute substantially all of their net investment income each year, including
non-cash income. Accordingly, the Fund will be required, in order to maintain
the desired tax treatment, to include in its dividends an amount equal to the
income attributable to its zero coupon, other OID and PIK securities. See
'Taxes' in the Statement of Additional Information. Those dividends will be paid
from the cash assets of the Fund or by liquidation of portfolio securities, if
necessary, at a time when the Fund otherwise would not have done so.
LOAN PARTICIPATIONS AND ASSIGNMENTS. The Fund may invest in fixed and floating
rate loans ('Loans') arranged through private negotiations between a U.S. or
foreign borrower and one or more financial institutions ('Lenders'). The Fund's
investments in Loans are expected in most instances to be in the form of
participations in Loans ('Participations') and assignments of all or a portion
of Loans ('Assignments') from third parties. Participations typically will
result in the Fund's having a contractual relationship only with the Lender, not
with the borrower. The Fund will have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In connection with purchasing Participations, the Fund
generally has no direct right to enforce compliance by the borrower with the
terms of the loan agreement relating to the Loan ('Loan Agreement'), nor any
rights of set-off against the borrower, and the Fund may not directly benefit
from any collateral supporting the Loan in which it has purchased the
Participation. As a result, the Fund will assume the credit risk of both the
borrower and the Lender that is selling the Participation. In the event of
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the insolvency of the Lender selling a Participation, the Fund may be treated as
a general creditor of the Lender and may not benefit from any set-off between
the Lender and the borrower. The Fund will acquire Participations only if the
Lender interpositioned between the Fund and the borrower is determined by
Mitchell Hutchins to be creditworthy. When the Fund purchases Assignments from
Lenders, the Fund will acquire direct rights against the borrower on the Loan.
However, since Assignments are arranged through private negotiations between
potential assignees and assignors, the rights and obligations acquired by the
Fund as the purchaser of an Assignment may differ from, and be more limited
than, those held by the assigning Lender.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Fund may purchase securities
on a 'when-issued' basis or may purchase or sell securities on a 'delayed
delivery' basis, i.e., for issuance or delivery to the Fund later than the
normal settlement date for such securities at a stated price and yield. The Fund
generally would not pay for such securities or start earning interest on them
until they are received. However, when the Fund undertakes a when-issued or
delayed delivery obligation, it immediately assumes the risks of ownership,
including the risk of price fluctuation. Failure of the issuer to deliver a
security purchased by the Fund on a when-issued or delayed delivery basis may
result in the Fund's incurring a loss or missing an opportunity to make an
alternative investment. Depending on market conditions, the Fund's when-issued
and delayed delivery purchase commitments could cause its net asset value per
share to be more volatile, because such securities may increase the amount by
which the Fund's total assets, including the value of when-issued and delayed
delivery securities held by the Fund, exceed its net assets.
CONVERTIBLE SECURITIES. The Fund may invest in convertible securities, which
are bonds, debentures, notes, preferred stocks or other securities that may be
converted into or exchanged for a specified amount of common stock of the same
or a different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest normally
paid or accrued on debt or the dividend paid on preferred stock until the
convertible security matures or is redeemed, converted or exchanged. Convertible
securities have unique investment characteristics in that they generally (1)
have higher yields than common stocks, but lower yields than comparable
non-convertible securities, (2) are less subject to fluctuation in value than
the underlying stock since they have fixed income characteristics, and (3)
provide the potential for capital appreciation if the market price of the
underlying common stock increases. Most convertible securities currently are
issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
DERIVATIVES. The Fund may invest in instruments or securities that commonly are
referred to as 'derivatives' because their value depends on (or 'derives' from)
the value of an underlying asset, reference rate or index. Derivative
instruments include options, futures contracts, interest rate protection
contracts and similar instruments that may be used by the Fund in hedging and
related income strategies. There is only limited consensus as to what
constitutes a 'derivative' security. However, in Mitchell Hutchins' view, the
derivative securities in which the Fund may invest include 'stripped'
securities, such as CATS and TIGRs, specially structured types of mortgage- and
asset-backed securities, such as IOs, POs and inverse floaters, and securities
denominated in one currency whose value is linked to another currency. The
market value of derivative instruments and securities sometimes is more volatile
than that of other investments, and each type of derivative may pose its own
special risks. Mitchell Hutchins takes these risks into account in its
management of the Fund.
OTHER SECURITIES. The Fund may invest up to 10% of its total assets in
preferred stock of U.S. and foreign companies. Preferred stock generally has a
preference as to dividends and upon liquidation over an issuer's common stock
but ranks junior to debt securities in an issuer's capital structure. Preferred
stock generally pays dividends in cash (or other shares of preferred stock) at a
defined rate but, unlike interest payments on debt securities, preferred stock
dividends are payable only if declared by the issuer's board of directors.
Dividends on preferred stock may be cumulative, meaning that, in the event the
issuer fails to make one or more dividend payments on the preferred stock, no
dividends may be paid on the issuer's common stock until all unpaid preferred
stock dividends have been paid. Preferred stock also may provide that, in the
event the issuer fails to make a specified number of dividend payments, the
holders of the preferred stock will have the right to elect a specified number
of directors to the issuer's board. Preferred stock also may be subject to
optional or mandatory redemption provisions.
The Fund may invest in debt securities issued by banks and other business
entities that are indexed to specific foreign currency exchange rates. The terms
of such securities provide that their principal amount is adjusted upwards or
downwards (but not below zero) at maturity to reflect changes in the exchange
rate between two
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currencies while the obligations are outstanding. While such securities offer
the potential for an attractive rate of return, they also entail the risk of
loss of principal. New forms of such securities continue to be developed. The
Fund may invest in such securities to the extent consistent with its investment
objectives. The Fund may acquire equity securities (including common stocks and
rights and warrants for equity securities, debt securities and commodities) when
attached to fixed income securities or as part of a unit including fixed income
securities, or in connection with a conversion or exchange of fixed income
securities. The Fund also may invest in certificates of deposit issued by banks
and savings associations and in banker's acceptances. Under normal
circumstances, the Fund invests at least 65% of its total assets in income
producing securities, including zero coupon and PIK securities.
LENDING OF PORTFOLIO SECURITIES. The Fund is authorized to lend up to 33 1/3%
of the total value of its portfolio securities to broker-dealers or
institutional investors that Mitchell Hutchins deems qualified. Lending
securities enables the Fund to earn additional income, but could result in a
loss or delay in recovering the securities.
OTHER INFORMATION. The Fund may implement various temporary defensive
strategies at times when Mitchell Hutchins determines that conditions in the
markets make pursuing the Fund's basic investment strategy inconsistent with the
best interests of its shareholders. The Fund may commit all or any portion of
its assets to cash, denominated in U.S. dollars or foreign currencies, or money
market instruments of U.S. or foreign issuers, including repurchase agreements,
for such temporary, defensive purposes or for liquidity purposes, such as
clearance of portfolio transactions, the payment of dividends and expenses and
redemptions. The Fund also may engage in short sales of securities 'against the
box' to defer realization of gains or losses for tax purposes.
New types of mortgage- and asset-backed securities, derivative securities,
hedging instruments and risk management techniques are developed and marketed
from time to time. The Fund may invest in these securities and instruments and
use these techniques to the extent consistent with its investment objectives and
limitations and with regulatory and tax considerations.
The Fund is 'non-diversified,' as defined in the Investment Company Act of 1940
('1940 Act') but intends to continue to qualify as a regulated investment
company for federal income tax purposes. See 'Taxes' in the Statement of
Additional Information. This means, in general, that more than 5% of the Fund's
total assets may be invested in securities of one issuer but only if, at the
close of each quarter of the Fund's taxable year, the aggregate amount of such
holdings does not exceed 50% of the value of its total assets and no more than
25% of the value of its total assets is invested in the securities of a single
issuer. To the extent that the Fund's portfolio at times may include the
securities of a smaller number of issuers than if it were 'diversified' (as
defined in the 1940 Act), the Fund will at such times be subject to greater risk
with respect to its portfolio securities than an investment company that invests
in a broader range of securities, because changes in the financial condition or
market assessment of a single issuer may cause greater fluctuations in the net
asset value of the Fund's shares.
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PURCHASES
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Class Y shares are sold to eligible investors at the net asset value next
determined (see 'Valuation of Shares') after the purchase order is received at
PaineWebber's New York City offices. No initial or contingent deferred sales
charge is imposed, nor are Class Y shares subject to Rule 12b-1 distribution or
service fees. Mitchell Hutchins is the distributor of the Fund's shares and has
appointed PaineWebber Incorporated ('PaineWebber') as the exclusive dealer for
the sale of those shares. The Fund and Mitchell Hutchins reserve the right to
reject any purchase order and to suspend the offering of the Class Y shares for
a period of time.
PURCHASES BY INSIGHT PARTICIPANTS. An investor who purchases $50,000 or more of
shares of mutual funds that are available to INSIGHT participants (which include
the PaineWebber mutual funds in the Flexible Pricing System(Service Mark) and
certain specified other mutual funds) may take part in INSIGHT, a total
portfolio asset allocation program sponsored by PaineWebber, and thus become
eligible to purchase Class Y shares. INSIGHT offers comprehensive investment
services, including a
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personalized asset allocation investment strategy using an appropriate
combination of funds, monitoring of investment performance and comprehensive
quarterly reports that cover market trends, portfolio summaries and personalized
account information. Participation in INSIGHT is subject to payment of an
advisory fee to PaineWebber at the maximum annual rate of 1.50% of assets held
through the program (generally charged quarterly in advance), which covers all
INSIGHT investment advisory services and program administration fees. Employees
of PaineWebber and its affiliates are entitled to a 50% reduction in the fee
otherwise payable for participation in INSIGHT. INSIGHT clients may elect to
have their INSIGHT fees charged to their PaineWebber accounts (by the automatic
redemption of money market fund shares) or, if a qualified plan, invoiced.
Please contact your PaineWebber investment executive or PaineWebber
correspondent firm or call 1-800-647-1568 for more information concerning mutual
funds that are available to INSIGHT participants or for other INSIGHT
information.
ACQUISITION OF CLASS Y SHARES BY OTHERS. The Fund is authorized to offer Class
Y shares to employee benefit and retirement plans of Paine Webber Group Inc. and
its affiliates and certain other investment programs that are sponsored by
PaineWebber and that may invest in PaineWebber mutual funds. At present,
however, INSIGHT participants are the only purchasers in these two categories.
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REDEMPTIONS
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Class Y shares may be redeemed at their net asset value, and redemption proceeds
will be paid after receipt of a redemption request, as described below.
REDEMPTIONS THROUGH PAINEWEBBER OR CORRESPONDENT FIRMS. INSIGHT participants
who are Class Y shareholders may submit redemption requests to their investment
executives or correspondent firms in person or by telephone, mail or wire. As
the Fund's agent, PaineWebber may honor a redemption request by repurchasing
Class Y shares from a redeeming shareholder at the shares' net asset value next
determined after receipt of the request by PaineWebber's New York City offices.
Within three Business Days after receipt of the request, repurchase proceeds
will be paid by check or credited to the shareholder's brokerage account at the
election of the shareholder. PaineWebber investment executives and correspondent
firms are responsible for promptly forwarding redemption requests to
PaineWebber's New York City offices. A 'Business Day' is any day, Monday through
Friday, on which the New York Stock Exchange, Inc. ('NYSE') is open for
business.
PaineWebber reserves the right not to honor any redemption request, in which
case PaineWebber promptly will forward the request to the Transfer Agent for
treatment as described below.
REDEMPTION THROUGH THE TRANSFER AGENT. Shareholders also may redeem Class Y
shares through the Fund's Transfer Agent, PFPC Inc. ('Transfer Agent').
Shareholders should mail redemption requests directly to the Transfer Agent:
PFPC Inc., Attn: PaineWebber Mutual Funds, P.O. Box 8950, Wilmington, Delaware
19899. A redemption request will be executed at the net asset value next
computed after it is received in 'good order,' and redemption proceeds will be
paid within seven days of the receipt of the request. 'Good order' means that
the request must be accompanied by the following: (1) a letter of instruction or
a stock assignment specifying the number of shares or amount of investment to be
redeemed (or that all shares credited to the Fund account be redeemed), signed
by all registered owners of the shares in the exact names in which they are
registered, (2) a guarantee of the signature of each registered owner by an
eligible institution acceptable to the Transfer Agent and in accordance with SEC
rules, such as a commercial bank, trust company or member of a recognized stock
exchange and (3) other supporting legal documents for estates, trusts,
guardianships, custodianships, partnerships and corporations. Shareholders are
responsible for ensuring that a request for redemption is received in 'good
order.'
ADDITIONAL INFORMATION ON REDEMPTIONS. A shareholder may have redemption
proceeds of $1 million or more wired to the shareholder's PaineWebber brokerage
account or a commercial bank account designated by the shareholder. Questions
about this option, or redemption requirements generally, should be referred to
the shareholder's PaineWebber investment executive or correspondent firm. If a
shareholder requests redemption of shares which were purchased recently, a Fund
may delay payment until it is assured that good
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payment has been received. In the case of purchases by check, this can take up
to 15 days.
Because the Fund incurs certain fixed costs in maintaining shareholder accounts,
it reserves the right to redeem all Fund shares in any shareholder account
having a net asset value below the lesser of $500 or the current minimum for
initial purchases. If the Fund elects to do so, it will notify the shareholder
and provide the shareholder the opportunity to increase the amount invested to
the minimum required level or more within 60 days of the notice. The Fund will
not redeem accounts that fall below the minimum required level solely as a
result of a reduction in net asset value per share.
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DIVIDENDS AND TAXES
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DIVIDENDS. Dividends from the Fund's net investment income are declared and
paid monthly. In addition, the Fund may (but is not required to) distribute with
its monthly dividends all or a portion of any net realized gains from foreign
currency transactions and net short-term capital gain, if any. The Fund
distributes annually substantially all of its net capital gain (the excess of
net long-term capital gain over net short-term capital loss) and any
undistributed net realized gains from foreign currency transactions and net
short-term capital gains. The Fund may make additional distributions if
necessary to avoid a 4% excise tax on certain undistributed income and capital
gain.
The Fund anticipates that a monthly dividend may, from time to time, represent
more or less than the amount of net investment income earned by the Fund in the
period to which the dividend relates. Any undistributed net investment income,
net short-term capital gain and net realized gains from foreign currency
transactions ('undistributed income') would be available to supplement future
dividends, which might otherwise have been reduced by reason of a decrease in
the Fund's monthly net income. Undistributed income will be reflected in the
Fund's net asset value, and, correspondingly, distributions from undistributed
income will reduce the Fund's net asset value. The dividend rate on Fund shares
will be adjusted from time to time and will vary as a result of the performance
of the Fund.
If the Fund's dividends exceed its taxable income in any year, which may result
from currency-related losses, all or a portion of those dividends may be treated
as a return of capital to shareholders for tax purposes.
Dividends and other distributions are paid in additional Class Y shares at net
asset value unless the shareholder has requested cash payments. Shareholders who
wish to receive dividends and/or other distributions in cash, either mailed to
the shareholder by check or credited to the shareholder's PaineWebber account,
should contact their PaineWebber investment executives or correspondent firms or
complete the appropriate section of the application form.
TAXES. The Fund intends to continue to qualify for treatment as a regulated
investment company under the Internal Revenue Code so that it will be relieved
of federal income tax on that part of its investment company taxable income
(consisting generally of net investment income, net short-term capital gain and
net gains from certain foreign currency transactions) and net capital gain that
is distributed to its shareholders.
Dividends from the Fund's investment company taxable income (whether paid in
cash or in additional shares) generally are taxable to its shareholders as
ordinary income. Distributions of the Fund's net capital gain (whether paid in
cash or in additional shares) are taxable to its shareholders as long-term
capital gain, regardless of how long they have held their Fund shares.
Shareholders not subject to tax on their income generally will not be required
to pay tax on amounts distributed to them.
The Fund notifies its shareholders following the end of each calendar year of
the amounts of dividends and capital gain distributions paid (or deemed paid)
that year.
The Fund is required to withhold 31% of all dividends, capital gain
distributions and redemption proceeds payable to any individuals and certain
other noncorporate shareholders who do not provide the Fund with a correct
taxpayer identification number. Withholding at that rate also is required from
dividends and capital gain distributions payable to such shareholders who
otherwise are subject to backup withholding.
A redemption of Fund shares may result in taxable gain or loss to the redeeming
shareholder, depending upon whether the redemption proceeds payable to the
shareholder are more or less than the shareholder's adjusted basis for the
redeemed shares. In addition, if shares of the Fund are purchased within 30 days
before
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PaineWebber Strategic Income Fund
or after redeeming other Fund shares at a loss, that loss will not be deductible
to the extent the redemption proceeds are reinvested and instead will increase
the basis of the newly purchased shares.
The foregoing is only a summary of some of the important federal tax
considerations generally affecting the Fund and its shareholders; see the
Statement of Additional Information for a further discussion. There may be other
federal, state or local tax considerations applicable to a particular investor.
Prospective shareholders are therefore urged to consult their tax advisers.
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VALUATION OF SHARES
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The net asset value of the Fund's shares fluctuates and is determined as of the
close of regular trading on the NYSE (currently 4:00 p.m., Eastern time) each
Business Day. The Fund's net asset value per share is determined by dividing the
value of the securities held by the Fund plus any cash or other assets minus all
liabilities by the total number of Fund shares outstanding.
The Fund values its assets based on their current market value when market
quotations are readily available. If such value cannot be established, assets
are valued at fair value as determined in good faith by or under the direction
of the Trust's board of trustees. The amortized cost method of valuation
generally is used to value debt obligations with 60 days or less remaining to
maturity, unless the board of trustees determines that this does not represent
fair value. All investments denominated in foreign currencies are valued daily
in U.S. dollars based on the then-prevailing exchange rate. It should be
recognized that judgment plays a greater role in valuing foreign or high yield,
high risk securities because there is less reliable, objective data available.
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MANAGEMENT
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The Trust's board of trustees, as part of its overall management responsibility,
oversees various organizations responsible for the Fund's day-to-day management.
Mitchell Hutchins, investment adviser and administrator of the Fund, makes and
implements all investment decisions and supervises all aspects of the Fund's
operations. Mitchell Hutchins receives a monthly fee for these services at the
annual rate of 0.75% of the average daily net assets of the Fund. The Fund's
advisory fee is higher than those paid by most funds, but Mitchell Hutchins and
the board believe the fee is justified by the global nature of the Fund's
investment activities. Brokerage transactions for the Fund may be conducted
through PaineWebber in accordance with procedures adopted by the Trust's board
of trustees.
The Fund also pays PaineWebber an annual fee of $4.00 per active shareholder
account held at PaineWebber for certain services not provided by the Transfer
Agent. The Fund also incurs other expenses, such as custody and transfer agency
fees, brokerage commissions, professional fees, expenses of board and
shareholder meetings, fees and expenses relating to registration of its shares,
taxes and governmental fees, fees and expenses of the trustees, costs of
obtaining insurance, expenses of printing and distributing shareholder
materials, and extraordinary expenses, including costs or losses in any
litigation. Mitchell Hutchins is located at 1285 Avenue of the Americas, New
York, New York 10019. It is a wholly owned subsidiary of PaineWebber, which is
in turn wholly owned by Paine Webber Group Inc., a publicly owned financial
services holding company. As of April 30, 1996, Mitchell Hutchins was adviser or
sub-adviser of 31 investment companies with 65 separate portfolios and aggregate
assets of over $30.1 billion.
Dennis McCauley, a managing director and chief investment officer of fixed
income of Mitchell Hutchins, has been the Fund's allocation manager since March
1995. Mr. McCauley has been employed by Mitchell Hutchins since December 1994
and is responsible for overseeing all active fixed income investments,
including
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PaineWebber Strategic Income Fund
domestic and global taxable and tax-exempt mutual funds. Prior to joining
Mitchell Hutchins, Mr. McCauley worked for IBM Corporation, where he was
director of fixed income investments responsible for developing and managing
investment strategy for all fixed income and cash management investments of
IBM's pension fund and self-insured medical funds. Mr. McCauley also served as
vice president of IBM Credit Corporation's mutual funds and as a member of the
Retirement Fund Investment Committee.
Nirmal Singh, and Craig M. Varrelman, CFA, have been responsible for the
day-to-day management of the U.S. Government and Investment Grade Securities
sector of the Fund since December 1994. Mr. Singh and Mr. Varrelman are both
first vice presidents of Mitchell Hutchins. Prior to joining Mitchell Hutchins
in September 1993, Mr. Singh was with Merrill Lynch Asset Management, Inc.,
where he was a member of the portfolio management team. From 1990 to 1993, Mr.
Singh was a senior portfolio manager at Nomura Mortgage Fund Management
Corporation. Mr. Varrelman has been with Mitchell Hutchins as a portfolio
manager since 1988.
Thomas J. Libassi, a senior vice president of Mitchell Hutchins, is the sector
manager responsible for the day-to-day management of the Fund's U.S. High Yield
Securities. Mr. Libassi has been employed by Mitchell Hutchins since May 1994.
Prior to May 1994, Mr. Libassi was a vice president and portfolio manager of
Keystone Custodian Funds Inc., with portfolio management responsibility for
approximately $900 million in assets primarily invested in high yield debt
securities.
Stuart Waugh, a managing director of Mitchell Hutchins responsible for global
fixed income and currency trading, is the sector manager responsible for the
day-to-day management of the Fund's Foreign and Emerging Market Securities. Mr.
Waugh has been employed by Mitchell Hutchins since 1984.
Mitchell Hutchins investment personnel may engage in securities transactions for
their own accounts pursuant to a code of ethics that establishes procedures for
personal investing and restricts certain transactions.
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PERFORMANCE INFORMATION
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The Fund performs a standardized computation of annualized total return and may
show this return in advertisements or promotional materials. Standardized return
shows the change in value of an investment in the Fund as a steady compound
annual rate of return. Actual year-by-year returns fluctuate and may be higher
or lower than standardized return. One-, five- and ten-year periods will be
shown, unless the Class has been in existence for a shorter period. Total return
calculations assume reinvestment of dividends and other distributions.
The Fund may use other total return presentations in conjunction with
standardized return. These may cover the same or different periods as those used
for standardized return and may include cumulative returns, average annual
rates, actual year-by-year rates or any combination thereof. Non-standardized
return does not reflect initial or contingent deferred sales charges and would
be lower if such charges were included.
The Fund also may advertise its yield. Yield reflects investment income net of
expenses over a 30-day (or one-month) period on a Class Y share, expressed as an
annualized percentage of the net asset value per share at the end of the period.
Yield computations differ from other accounting methods and therefore may differ
from dividends actually paid or reported net income.
Total return information reflects past performance and does not necessarily
indicate future results. Investment return and principal values will fluctuate,
and proceeds upon redemption may be more or less than a shareholder's cost.
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PaineWebber Strategic Income Fund
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GENERAL INFORMATION
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ORGANIZATION. PaineWebber Securities Trust is a Massachusetts business trust
that is registered with the SEC as an open-end management investment company.
The Trust was organized under a Declaration of Trust dated December 3, 1992. The
trustees have authority to issue an unlimited number of shares of beneficial
interest of separate series, par value $.001 per share, of the Trust. In
addition to the Fund, shares of one other series have been authorized.
The shares of beneficial interest of the Fund are divided into four Classes,
designated Class A shares, Class B shares, Class C shares and Class Y shares.
Each Class represents interests in the same assets of the Fund. The Classes
differ as follows: (1) each Class of shares has exclusive voting rights on
matters pertaining to its plan of distribution, (2) Class A shares are subject
to an initial sales charge, (3) Class B shares bear ongoing distribution fees,
are subject to a contingent deferred sales charge upon most redemptions and will
automatically convert to Class A shares approximately six years after issuance,
(4) Class C shares are not subject to an initial sales charge but are subject to
a contingent deferred sales charge if redeemed within one year of purchase, bear
ongoing distribution fees and do not convert into another Class and (5) each
Class may bear differing amounts of certain Class-specific expenses. Class Y
shares, which may be offered only to limited classes of investors, are subject
to neither an initial or contingent deferred sales charge nor ongoing service or
distribution fees.
The different sales charges and other expenses applicable to the different
classes of Fund shares may affect the performance of those classes. More
information concerning the other classes of the Fund may be obtained from a
PaineWebber investment executive or correspondent firm or by calling
1-800-647-1568.
The Trust does not hold annual shareholder meetings. There normally will be no
meetings of shareholders to elect trustees unless fewer than a majority of the
trustees of the Trust holding office have been elected by shareholders.
Shareholders of record holding at least two-thirds of the outstanding shares of
the Trust may remove a trustee by votes cast in person or by proxy at a meeting
called for that purpose. The trustees are required to call a meeting of
shareholders for the purpose of voting upon the question of removal of any
trustee when so requested in writing by shareholders of record holding at least
10% of the Trust's outstanding shares. Each share of the Fund has equal voting
rights, except as noted above. Each share of the Fund is entitled to participate
equally in dividends and other distributions and the proceeds of any
liquidation, except that, due to the differing expenses borne by the four
Classes, such dividends and liquidation proceeds are likely to be lower on every
other Class of shares than for Class Y shares. The shares of each series of the
Trust will be voted separately except when an aggregate vote of all series is
required by the 1940 Act.
To avoid additional operating costs and for investor convenience, the Fund does
not issue share certificates. Ownership of shares of the Fund is recorded on a
stock register by the Transfer Agent and shareholders have the same rights of
ownership with respect to such shares as if certificates had been issued.
CUSTODIAN AND TRANSFER AGENT. State Street Bank and Trust Company, One Heritage
Drive, North Quincy, Massachusetts 02171 is custodian for the Fund. PFPC, Inc.,
a subsidiary of PNC Bank, National Association, whose business address is 400
Bellevue Parkway, Wilmington, Delaware 19809, is the Fund's transfer and
dividend disbursing agent.
CONFIRMATIONS AND STATEMENTS. Shareholders receive confirmations of purchases
and redemptions of shares of the Fund. PaineWebber clients receive statements at
least quarterly that report their Fund activity and consolidated year-end
statements that show all Fund transactions for that year. Shareholders who are
not PaineWebber clients receive quarterly statements from the Transfer Agent.
Shareholders also receive audited annual and unaudited semi-annual financial
statements of the Fund.
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PaineWebber Strategic Income Fund
APPENDIX A
RATINGS
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DESCRIPTION OF MOODY'S RATINGS FOR CORPORATE AND CONVERTIBLE BONDS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as 'gilt
edged.' Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa. Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than in Aaa securities.
A. Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa. Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba. Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B. Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa. Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca. Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C. Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS
AAA. An issue which is rated aaa is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks; AA. An issue which
is rated aa is considered a high-grade preferred stock. This rating indicates
that there is reasonable assurance that earnings and asset protection will
remain relatively well-maintained in the foreseeable future; A. An issue which
is rated a is considered to be an upper-medium grade preferred stock. While
risks are judged to be somewhat greater than in the aaa and aa classifications,
earnings and asset protection are, nevertheless, expected to be maintained at
adequate levels; BAA. An issue which is rated baa is considered to be medium
grade, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time; BA. An issue which is rated ba is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes
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PaineWebber Strategic Income Fund
preferred stocks in this class; B. An issue which is rated b generally lacks the
characteristics of a desirable investment. Assurance of dividend payments and
maintenance of other terms of the issue over any long period of time may be
small; CAA. An issue which is rated caa is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the future status
of payment; CA. An issue which is rated ca is speculative in a high degree and
is likely to be in arrears on dividends with little likelihood of eventual
payments; C. This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's may apply numerical modifiers, l, 2 and 3 in each generic rating
classification from Aa/aa to B/b. The modifier l indicates that the company
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates that the company ranks in the
lower end of its generic rating category.
DESCRIPTION OF S&P RATINGS FOR CORPORATE AND CONVERTIBLE DEBT SECURITIES
AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB. Debt rated BBB is regarded as having adequate capacity to pay interest and
repay principal. Whereas it normally exhibits adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay interest and repay principal for debt in this
category than in higher rated categories.
BB, B, CCC, CC, C. Debt rated BB, B, CCC, CC and C is 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
lowest 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.
BB. Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B. Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB or BB-
rating.
CCC. Debt rated CCC has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial, or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC. The rating CC is typically applied to debt subordinated to senior debt that
is assigned an actual or implied CCC rating.
C. The rating C is typically applied to debt subordinated to senior debt which
is assigned an actual or implied CCC-debt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed, but debt service
payments are continued.
CI. The rating CI is reserved for income bonds on which no interest is being
paid.
D. Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
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PaineWebber Strategic Income Fund
DESCRIPTION OF S&P PREFERRED STOCK RATINGS
AAA. This is the highest rating that may be assigned by S&P to a preferred
stock issue and indicates an extremely strong capacity to pay the preferred
stock obligations; AA. A preferred stock issue rated AA also qualifies as a
high-quality fixed income security. The capacity to pay preferred stock
obligations is very strong, although not as overwhelming as for issues rated
AAA; A. An issue rated A is backed by a sound capacity to pay the preferred
stock obligations, although it is somewhat more susceptible to the adverse
effect of changes in circumstances and economic conditions; BBB. An issue rated
BBB is regarded as backed by an adequate capacity to pay the preferred stock
obligations. Whereas it normally exhibits adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to make payments for a preferred stock in this category than
for issues in the A category; BBB, B, CCC. Preferred stocks rated BB, B, and CCC
are regarded, on balance, as predominantly speculative with respect to the
issuer's capacity to pay preferred stock obligations. BB indicates the lowest
degree of speculation and CCC the highest degree of speculation. While such
issues will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions;
CC. The rating CC is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments but that is currently paying; C. A preferred
stock rated C is a non-paying issue; D. A preferred stock rated D is a
non-paying issue with issuer in default on debt instruments.
NR. NR indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
PLUS (+) OR MINUS (--). The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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PaineWebber Strategic Income Fund
APPENDIX B
MORTGAGE-BACKED SECURITIES
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The U.S. government securities in which the Fund may invest include
mortgage-backed securities issued or guaranteed as to payment of principal and
interest (but not as to market value) by the Government National Mortgage
Association ('Ginnie Mae'), the Federal National Mortgage Association ('Fannie
Mae'), or the Federal Home Loan Mortgage Corporation ('Freddie Mac'). Other
mortgage-backed securities in which the Fund may invest are issued by private
issuers, generally originators of and investors in mortgage loans, including
savings associations, mortgage bankers, commercial banks, investment bankers and
special purpose entities (collectively, 'Private Mortgage Lenders'). Payments of
principal and interest (but not the market value) of such private
mortgage-backed securities may be supported by pools of mortgage loans or other
mortgage-backed securities that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or they may be
issued without any government guarantee of the underlying mortgage assets but
with some form of non-government credit enhancement. New types of
mortgage-backed securities are developed and marketed from time to time and,
consistent with its investment limitations, the Fund expects to invest in those
new types of mortgage-backed securities that Mitchell Hutchins believes may
assist the Fund in achieving its investment objectives. Similarly, the Fund may
invest in mortgage-backed securities issued by new or existing governmental or
private issuers other than those identified herein.
GINNIE MAE CERTIFICATES
Ginnie Mae guarantees certain mortgage pass-through certificates ('Ginnie Mae
certificates') that are issued by Private Mortgage Lenders and that represent
ownership interests in individual pools of residential mortgage loans. These
securities are designed to provide monthly payments of interest and principal to
the investor. Timely payment of interest and principal is backed by the full
faith and credit of the U.S. government. Each mortgagor's monthly payments to
his lending institution on his residential mortgage are 'passed through' to
certificate holders such as the Fund. Mortgage pools consist of whole mortgage
loans or participations in loans. The terms and characteristics of the mortgage
instruments are generally uniform within a pool but may vary among pools.
Lending institutions that originate mortgages for the pools are subject to
certain standards, including credit and other underwriting criteria for
individual mortgages included in the pools.
FANNIE MAE CERTIFICATES
Fannie Mae facilitates a national secondary market in residential mortgage loans
insured or guaranteed by U.S. government agencies and in privately insured or
uninsured residential mortgage loans (sometimes referred to as 'conventional
mortgage loans' or 'conventional loans') through its mortgage purchase and
mortgage-backed securities sales activities. Fannie Mae issues guaranteed
mortgage pass-through certificates ('Fannie Mae certificates'), which represent
pro rata shares of all interest and principal payments made and owed on the
underlying pools. Fannie Mae guarantees timely payment of interest and principal
on Fannie Mae certificates. The Fannie Mae guarantee is not backed by the full
faith and credit of the U.S. government.
FREDDIE MAC CERTIFICATES
Freddie Mac also facilitates a national secondary market for conventional
residential and U.S. government-insured mortgage loans through its mortgage
purchase and mortgage-backed securities sales activities. Freddie Mac issues two
types of mortgage pass-through securities: mortgage participation certificates
('PCs') and guaranteed mortgage certificates ('GMCs'). Each PC represents a pro
rata share of all interest and principal payments made and owed on the
underlying pool. Freddie Mac generally guarantees timely monthly payment of
interest on PCs and the ultimate payment of principal, but it also has a PC
program under which it guarantees timely payment of both principal and interest.
GMCs also represent a pro rata interest in a pool of mortgages. These
instruments, however, pay interest semi-annually and return
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principal once a year in guaranteed minimum payments. The Freddie Mac guarantee
is not backed by the full faith and credit of the U.S. government.
PRIVATE, RTC AND SIMILAR MORTGAGE-BACKED SECURITIES
Mortgage-backed securities issued by Private Mortgage Lenders are structured
similarly to the pass-through certificates and collateralized mortgage
obligations ('CMOs') issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie
Mac. Such mortgage-backed securities may be supported by pools of U.S.
government or agency insured or guaranteed mortgage loans or by other
mortgage-backed securities issued by a government agency or instrumentality, but
they generally are supported by pools of conventional (i.e., non-government
guaranteed or insured) mortgage loans. Since such mortgage-backed securities
normally are not guaranteed by an entity having the credit standing of Ginnie
Mae, Fannie Mae or Freddie Mac, they normally are structured with one or more
types of credit enhancement. See '--Types of Credit Enhancement.'
The Resolution Trust Corporation ('RTC'), which was organized by the U.S.
government in connection with the savings and loan crisis, held assets of failed
savings associations as either a conservator or receiver for such associations,
or it acquired such assets in its corporate capacity. These assets included
among other things, single family and multifamily mortgage loans, as well as
commercial mortgage loans. In order to dispose of such assets in an orderly
manner, RTC established a vehicle registered with the SEC through which it sold
mortgage-backed securities. RTC mortgage-backed securities represent pro rata
interests in pools of mortgage loans that RTC held or had acquired, as described
above, and are supported by one or more of the types of private credit
enhancements used by Private Mortgage Lenders.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE PASS-THROUGHS
CMOs are debt obligations that are collateralized either by mortgage loans or
mortgage pass-through securities (such collateral collectively being called
'Mortgage Assets'). CMOs may be issued by Private Mortgage Lenders or by
government entities such as Fannie Mae or Freddie Mac. Multi-class mortgage
pass-through securities are interests in trusts that are comprised of Mortgage
Assets and that have multiple classes similar to those in CMOs. Unless the
context indicates otherwise, references herein to CMOs include multi-class
mortgage pass-through securities. Payments of principal and interest on the
Mortgage Assets (and, in the case of CMOs, any reinvestment income thereon)
provide the funds to pay debt service on the CMOs or to make scheduled
distributions on the multi-class mortgage pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes. Each
class of CMO, also referred to as a 'tranche,' is issued at a specific fixed or
floating coupon rate and has a stated maturity or final distribution date.
Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrues on all classes of a CMO (other than any principal
only ('PO') class) on a monthly, quarterly or semiannual basis. The principal
and interest on the Mortgage Assets may be allocated among the several classes
of a CMO in many ways. In one structure, payments of principal, including any
principal prepayments, on the Mortgage Assets are applied to the classes of a
CMO in the order of their respective stated maturities or final distribution
dates so that no payment of principal will be made on any class of the CMO until
all other classes having an earlier stated maturity or final distribution date
have been paid in full. In some CMO structures, all or a portion of the interest
attributable to one or more of the CMO classes may be added to the principal
amounts attributable to such classes, rather than passed through to
certificateholders on a current basis, until other classes of the CMO are paid
in full.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken into
account in calculating the stated maturity date or final distribution date of
each class, which, as with other CMO structures, must be retired by its stated
maturity date or final distribution date but may be retired earlier.
ARM AND FLOATING RATE MORTGAGE-BACKED SECURITIES
ARM mortgage-backed securities are mortgage-backed securities that represent a
right to receive interest payments at a rate that is adjusted to reflect the
interest earned on a pool of mortgage loans bearing variable or adjustable rates
of interest (such mortgage loans are referred to as 'ARMs'). Floating rate
mortgage-backed securities are classes of mortgage-backed securities that have
been structured to represent the right to receive interest payments at rates
that fluctuate in accordance with an index but that generally are supported by
pools comprised of fixed-rate mortgage loans. Because the interest rates
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Prospectus Page 24
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PaineWebber Strategic Income Fund
on ARM and floating rate mortgage-backed securities are reset in response to
changes in a specified market index, the values of such securities tend to be
less sensitive to interest rate fluctuations than the values of fixed-rate
securities.
TYPES OF CREDIT ENHANCEMENT
To lessen the effect of failures by obligors on Mortgage Assets to make
payments, mortgage-backed securities may contain elements of credit enhancement.
Such credit enhancement falls into two categories; (l) liquidity protection and
(2) protection against losses resulting after default by an obligor on the
underlying assets and collection of all amounts recoverable directly from the
obligor and through liquidation of the collateral. Liquidity protection refers
to the provision of advances, generally by the entity administering the pool of
assets (usually the bank, savings association or mortgage banker that
transferred the underlying loans to the issuer of the security), to ensure that
the receipt of payments on the underlying pool occurs in a timely fashion.
Protection against losses resulting after default and liquidation ensures
ultimate payment of the obligations on at least a portion of the assets in the
pool. Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor, from third parties, through
various means of structuring the transaction or through a combination of such
approaches. The Fund will not pay any additional fees for such credit
enhancement, although the existence of credit enhancement may increase the price
of a security. Credit enhancements do not provide protection against changes in
the market value of the security.
Examples of credit enhancement arising out of the structure of the transaction
include 'senior-subordinated securities' (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal thereof
and interest thereon, with the result that defaults on the underlying assets are
borne first by the holders of the subordinated class), creation of 'spread
accounts' or 'reserve funds' (where cash or investments, sometimes funded from a
portion of the payments on the underlying assets, are held in reserve against
future losses) and 'over-collateralization' (where the scheduled payments on, or
the principal amount of, the underlying assets exceed that required to make
payment of the securities and pay any servicing or other fees). The degree of
credit enhancement provided for each issue generally is based on historical
information regarding the level of credit risk associated with the underlying
assets. Delinquency or loss in excess of that anticipated could adversely affect
the return on an investment in such a security.
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Prospectus Page 25
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PaineWebber Strategic Income Fund
APPENDIX C
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The Fund may use the following Hedging Instruments:
OPTIONS ON DEBT SECURITIES AND CURRENCIES--A call option is a contract pursuant
to which the purchaser of the option, in return for a premium, has the right to
buy the security or currency underlying the option at a specified price at any
time during the term, or upon the expiration, of the option. The writer of a
call option, who receives the premium, has the obligation, upon exercise of the
option, to deliver the underlying security or currency against payment of the
exercise price. A put option is a similar contract that gives its purchaser, in
return for a premium, the right to sell the underlying security or currency at a
specified price during the option term or upon expiration. The writer of a put
option, who receives the premium, has the obligation, upon exercise, to buy the
underlying security or currency at the exercise price.
OPTIONS ON INDICES OF DEBT SECURITIES--An index assigns relative values to the
securities included in the index and fluctuates with changes in the market
values of such securities. Index options operate in the same way as more
traditional options except that exercises of index options are effected with
cash payment and do not involve delivery of securities. Thus, upon exercise of
an index option, the purchaser will realize, and the writer will pay, an amount
based on the difference between the exercise price and the closing price of the
index.
DEBT AND EQUITY SECURITY INDEX FUTURES CONTRACTS--An index futures contract is a
bilateral agreement pursuant to which one party agrees to accept and the other
party agrees to make delivery of an amount of cash equal to a specified dollar
amount times the difference between the index value at the close of trading of
the contract and the price at which the futures contract is originally struck.
No physical delivery of the securities comprising the index is made; generally,
contracts are closed out prior to the expiration date of the contract.
DEBT SECURITY AND CURRENCY FUTURES CONTRACTS--A debt security or currency
futures contract is a bilateral agreement pursuant to which one party agrees to
accept and the other party agrees to make delivery of the specific type of debt
security or currency called for in the contract at a specified future time and
at a specified price.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities or currency, except that an option on a futures contract
gives the purchaser the right, in return for the premium, to assume a position
in a futures contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell a security or
currency, at a specified price at any time during the option term. Upon exercise
of the option, the delivery of the futures position to the holder of the option
will be accomplished by delivery of the accumulated balance that represents the
amount by which the market price of the futures contract exceeds, in the case of
a call, or is less than, in the case of a put, the exercise price of the option
on the future. The writer of an option, upon exercise, will assume a short
position in the case of a call and a long position in the case of a put.
FORWARD CURRENCY CONTRACTS--A forward currency contract involves an obligation
to purchase or sell a specific currency at a specified future date, which may be
any fixed number of days from the contract date agreed upon by the parties, at a
price set at the time the contract is entered into.
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Prospectus Page 26
<PAGE>
(Copyright)1996 PaineWebber Incorporated
PaineWebber
Strategic Income
Fund
- -
Class Y Shares
- ---
- -
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE
OFFERING MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
FUND OR ITS DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY
THE FUND OR ITS DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY
NOT LAWFULLY BE MADE.
PROSPECTUS
June 3, 1996
<PAGE>
PaineWebber Strategic Income Fund
Class Y Shares
1285 Avenue of the Americas
New York, New York 10019
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber Strategic Income Fund ('Fund') is a non-diversified series of
PaineWebber Securities Trust ('Trust'), a professionally managed, open-end
investment company organized as a Massachusetts business trust. The Fund's
primary investment objective is to achieve a high level of current income and,
secondarily, capital appreciation. The Fund seeks to achieve its investment
objectives by investing in a portfolio of fixed income securities (including
debt instruments the payment on which may be fixed, variable or floating and
also zero coupon securities that pay no interest until maturity) that is
strategically allocated among U.S. Government and Investment Grade Securities,
U.S. High Yield Securities and Foreign and Emerging Market Securities. The
Fund's investment adviser, administrator and distributor is Mitchell Hutchins
Asset Management Inc. ('Mitchell Hutchins'), a wholly owned subsidiary of
PaineWebber Incorporated ('PaineWebber'). As distributor for the Fund, Mitchell
Hutchins has appointed PaineWebber to serve as the exclusive dealer for the sale
of Fund shares. This Statement of Additional Information is not a prospectus and
should be read only in conjunction with the Fund's current Prospectus, dated
June 3, 1996. All capitalized terms not otherwise defined herein have the same
meanings as in the Prospectus. A copy of the Prospectus may be obtained by
calling any PaineWebber investment executive or correspondent firm or by calling
toll-free 1-800-647-1568. This Statement of Additional Information is dated June
3, 1996.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Fund's investment policies and limitations.
SPECIAL CHARACTERISTICS OF MORTGAGE- AND ASSET-BACKED SECURITIES
The yield characteristics of mortgage- and asset-backed securities differ
from those of traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other obligations generally may be prepaid at any time. Prepayments on a pool
of mortgage loans are influenced by a variety of economic, geographic, social,
and other factors, including changes in mortgagors' housing needs, job
transfers, unemployment, mortgagors' net equity in the mortgaged properties and
servicing decisions. Generally, however, prepayments on fixed-rate mortgage
loans will increase during a period of falling interest rates and decrease
during a period of rising interest rates. Similar factors apply to prepayments
on asset-backed securities, but the receivables underlying asset-backed
securities generally are of a shorter maturity and thus are less likely to
experience substantial prepayments. Such securities, however, often provide that
for a specified time period the issuers will replace receivables in the pool
that are repaid with comparable obligations. If the issuer is unable to do so,
repayment of principal on the asset-backed securities may commence at an earlier
date. Mortgage- and asset-backed securities may decrease in value as a result of
increases in interest rates and may benefit less than other fixed-income
securities from declining interest rates because of the risk of prepayment.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to the
annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificateholders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the
<PAGE>
holder may vary from the coupon rate, even if adjustable, if the mortgage-backed
securities are purchased or traded in the secondary market at a premium or
discount. In addition, there is normally some delay between the time the issuer
receives mortgage payments from the servicer and the time the issuer makes the
payments on the mortgage-backed securities, and this delay reduces the effective
yield to the holder of such securities.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages as well as changes in interest rates. Because prepayment rates of
individual pools vary widely, it is not possible to predict accurately the
average life of a particular pool. In the past, a common industry practice has
been to assume that prepayments on pools of fixed rate 30-year mortgages would
result in a 12-year average life for the pool. At present, mortgage pools,
particularly those with loans with other maturities or different
characteristics, are priced on an assumption of average life determined for each
pool. In periods of declining interest rates, the rate of prepayment tends to
increase, thereby shortening the actual average life of a pool of
mortgage-related securities. Conversely, in periods of rising interest rates,
the rate of prepayment tends to decrease, thereby lengthening the actual average
life of the pool. However, these effects may not be present, or may differ in
degree, if the mortgage loans in the pools have adjustable interest rates or
other special payment terms, such as a prepayment charge. Actual prepayment
experience may cause the yield of mortgage-backed securities to differ from the
assumed average life yield. Reinvestment of prepayments may occur at lower
interest rates than the original investment, thus adversely affecting the yield
of the Fund.
The Fund may invest in adjustable rate mortgage ('ARM') and floating rate
mortgage-backed securities. Because the interest rates on ARM and floating rate
mortgage-backed securities are reset in response to changes in a specified
market index, the values of such securities tend to be less sensitive to
interest rate fluctuations than the values of fixed-rate securities. As a
result, during periods of rising interest rates, ARMs generally do not decrease
in value as much as fixed rate securities. Conversely, during periods of
declining rates, ARMs generally do not increase in value as much as fixed rate
securities. ARM mortgage-backed securities represent a right to receive interest
payments at a rate that is adjusted to reflect the interest earned on a pool of
ARMs. ARMs generally provide that the borrower's mortgage interest rate may not
be adjusted above a specified lifetime maximum rate or, in some cases, below a
minimum lifetime rate. In addition, certain ARMs provide for limitations on the
maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. ARMs also may provide for limitations on changes in the
maximum amount by which the borrower's monthly payment may adjust for any single
adjustment period. In the event that a monthly payment is not sufficient to pay
the interest accruing on the ARM, any such excess interest is added to the
mortgage loan ('negative amortization'), which is repaid through future
payments. If the monthly payment exceeds the sum of the interest accrued at the
applicable mortgage interest rate and the principal payment that would have been
necessary to amortize the outstanding principal balance over the remaining term
of the loan, the excess reduces the principal balance of the ARM. Borrowers
under ARMs experiencing negative amortization may take longer to build up their
equity in the underlying property and may be more likely to default.
The rates of interest payable on certain ARMs, and therefore on certain ARM
mortgage-backed securities, are based on indices, such as the one-year constant
maturity Treasury rate, that reflect changes in market interest rates. Others
are based on indices, such as the 11th District Federal Home Loan Bank Cost of
Funds index ('COFI'), that tend to lag behind changes in market interest rates.
The values of ARM mortgage-backed securities supported by ARMs that adjust based
on lagging indices tend to be somewhat more sensitive to interest rate
fluctuations than those reflecting current interest rate levels, although the
values of such ARM mortgage-backed securities still tend to be less sensitive to
interest rate fluctuations than fixed-rate securities.
2
<PAGE>
Floating rate mortgage-backed securities are classes of mortgage-backed
securities that have been structured to represent the right to receive interest
payments at rates that fluctuate in accordance with an index but that generally
are supported by pools comprised of fixed-rate mortgage loans. As with ARM
mortgage-backed securities, interest rate adjustments on floating rate
mortgage-backed securities may be based on indices that lag behind market
interest rates. Interest rates on floating rate mortgage-backed securities
generally are adjusted monthly. Floating rate mortgage-backed securities are
subject to lifetime interest rate caps, but they generally are not subject to
limitations on monthly or other periodic changes in interest rates or monthly
payments.
ARMs also may be subject to a greater rate of prepayments in a declining
interest rate environment. For example, during a period of declining interest
rates, prepayments on ARMs could increase because the availability of fixed
mortgage loans at competitive interest rates may encourage mortgagors to
'lock-in' at a lower interest rate. Conversely, during a period of rising
interest rates, prepayments on ARMs might decrease. The rate of prepayments with
respect to ARMs has fluctuated in recent years.
SPECIAL CHARACTERISTICS OF FOREIGN AND EMERGING MARKET SECURITIES
EMERGING MARKET SECURITIES. Many of the Foreign and Emerging Market
Securities held by the Fund will not be registered with the SEC, nor will the
issuers thereof be subject to SEC reporting requirements. Accordingly, there may
be less publicly available information concerning foreign issuers of securities
held by the Fund than is available concerning U.S. companies. Disclosure and
regulatory standards in many respects are less stringent in emerging market
countries than in the U.S. and other major markets. There also may be a lower
level of monitoring and regulation of emerging markets and the activities of
investors in such markets, and enforcement of existing regulations may be
extremely limited. Foreign companies, and in particular, companies in smaller
and emerging capital markets are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory requirements
comparable to those applicable to U.S. companies. The Fund's net investment
income and capital gains from its foreign investment activities may be subject
to non-U.S. withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing. Costs
associated with the exchange of currencies also make foreign investing more
expensive than domestic investing. Investment income on certain foreign
securities in which the Fund may invest may be subject to foreign withholding or
other government taxes that could reduce the return of these securities. Tax
treaties between the United States and foreign countries, however, may reduce or
eliminate the amount of foreign tax to which the Fund would be subject.
Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have failed to
keep pace with the volume of securities transactions, making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of the Fund are uninvested and no return is earned thereon.
The inability of the Fund to make intended security purchases due to settlement
problems could cause the Fund to miss attractive investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
SOVEREIGN DEBT. Sovereign Debt differs from debt obligations issued by
private entities in that, generally, remedies for defaults must be pursued in
the courts of the defaulting party. Legal recourse is therefore limited.
Political conditions, especially a sovereign entity's willingness to meet the
terms of its debt obligations, are of
3
<PAGE>
considerable significance. Also, there can be no assurance that the holders of
commercial bank loans to the same sovereign entity may not contest payments to
the holders of Sovereign Debt in the event of default under commercial bank loan
agreements.
A sovereign debtor's willingness or ability to pay interest and repay
principal in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's policy
toward principal international lenders and the political constraints to which a
sovereign debtor may be subject. A country whose exports are concentrated in a
few commodities could be vulnerable to a decline in the international price of
such commodities. Increased protectionism on the part of a country's trading
partners, or political changes in those countries, could also adversely affect
its exports. Such events could diminish a country's trade account surplus, if
any, or the credit standing of a particular local government or agency. Another
factor bearing on the ability of a country to repay Sovereign Debt is the level
of the country's international reserves. Fluctuations in the level of these
reserves can affect the amount of foreign exchange readily available for
external debt payments and, thus, could have a bearing on the capacity of the
country to make payments on its Sovereign Debt.
To the extent that a country has a current account deficit (generally when
exports of merchandise and services are less than the country's imports of
merchandise and services plus net transfers (e.g., gifts of currency and goods)
to foreigners), it will need to depend on loans from foreign governments,
multilateral organizations or private commercial banks, aid payments from
foreign governments and inflows of foreign investment. The access of a country
to these forms of external funding may not be certain, and a withdrawal of
external funding could adversely affect the capacity of a government to make
payments on its obligations. In addition, the cost of servicing debt obligations
can be affected by a change in international interest rates since the majority
of these obligations carry interest rates that are adjusted periodically based
upon international rates.
With respect to Sovereign Debt of emerging market issuers, investors should
be aware that certain emerging market countries are among the largest debtors to
commercial banks and foreign governments. At times certain emerging market
countries have declared moratoria on the payment of principal and interest on
external debt; such moratoria are currently in effect in certain Latin American
countries.
Certain emerging market countries have experienced difficulty in servicing
their Sovereign Debt on a timely basis which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements
or converting outstanding principal and unpaid interest to Brady Bonds
(discussed below), and obtaining new credit to finance interest payments.
Holders of Sovereign Debt, including the Fund, may be requested to participate
in the rescheduling of such debt and to extend further loans to sovereign
debtors. The interests of holders of Sovereign Debt could be adversely affected
in the course of restructuring arrangements or by certain other factors referred
to below. Furthermore, some of the participants in the secondary market for
Sovereign Debt may also be directly involved in negotiating the terms of these
arrangements and may therefore have access to information not available to other
market participants. Obligations arising from past restructuring agreements may
affect the economic performance and political and social stability of certain
issuers of Sovereign Debt. There is no bankruptcy proceeding by which Sovereign
Debt on which a sovereign has defaulted may be collected in whole or in part.
Foreign investment in certain Sovereign Debt is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in such Sovereign Debt and increase the costs and expenses of
the Fund. Certain countries in which the Fund will invest require governmental
approval prior to investments by foreign persons, limit the amount of investment
by foreign persons in a particular issuer, limit the investment by
4
<PAGE>
foreign persons only to a specific class of securities of an issuer that may
have less advantageous rights than the classes available for purchase by
domiciliaries of the countries or impose additional taxes on foreign investors.
Certain issuers may require governmental approval for the repatriation of
investment income, capital or the proceeds of sales of securities by foreign
investors. In addition, if a deterioration occurs in a country's balance of
payments, the country could impose temporary restrictions on foreign capital
remittances. The Fund could be adversely affected by delays in, or a refusal to
grant, any required governmental approval for repatriation of capital, as well
as by the application to the Fund of any restrictions on investments. Investing
in local markets may require the Fund to adopt special procedures, seek local
government approvals or take other actions, each of which may involve additional
costs to the Fund.
BRADY BONDS. The Fund may invest in Brady Bonds and other Sovereign Debt
of countries that have restructured or are in the process of restructuring
Sovereign Debt pursuant to the Brady Plan. Brady Bonds are Sovereign Debt
securities issued under the framework of the Brady Plan, an initiative announced
by former U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for
debtor nations to restructure their outstanding external commercial bank
indebtedness. In restructuring its external debt under the Brady Plan framework,
a debtor nation negotiates with its existing bank lenders as well as
multilateral institutions such as the IMF. The Brady Plan framework, as it has
developed, contemplates the exchange of commercial bank debt for newly issued
Brady Bonds. Brady Bonds may also be issued in respect of new money being
advanced by existing lenders in connection with the debt restructuring. The
World Bank and the IMF support the restructuring by providing funds pursuant to
loan agreements or other arrangements which enable the debtor nation to
collateralize the new Brady Bonds or to repurchase outstanding bank debt at a
discount.
Brady Plan debt restructurings totalling more than $80 billion have been
implemented to date in Mexico, Costa Rica, Venezuela, Uruguay, Nigeria,
Argentina and the Philippines and, in addition, Brazil has announced intentions
to issue Brady Bonds. There can be no assurance that the circumstances regarding
the issuance of Brady Bonds by these countries will not change. Investors should
recognize that Brady Bonds have been issued only recently, and accordingly do
not have a long payment history. Agreements implemented under the Brady Plan to
date are designed to achieve debt and debt-service reduction through specific
options negotiated by a debtor nation with its creditors. As a result, the
financial packages offered by each country differ. The types of options have
included the exchange of outstanding commercial bank debt for bonds issued at
100% of face value of such debt, which carry a below-market stated rate of
interest (generally known as par bonds), bonds issued at a discount from the
face value of such debt (generally known as discount bonds), bonds bearing an
interest rate which increases over time and bonds issued in exchange for the
advancement of new money by existing lenders. Regardless of the stated face
amount and stated interest rate of the various types of Brady Bonds, the Fund
will purchase Brady Bonds in secondary markets, as described below, in which the
price and yield to the investor reflect market conditions at the time of
purchase.
Certain Brady Bonds have been collateralized as to principal due at
maturity by U.S. Treasury zero coupon bonds with maturities equal to the final
maturity of such Brady Bonds. Collateral purchases are financed by the IMF, the
World Bank and the debtor nations' reserves. In the event of a default with
respect to collateralized Brady Bonds as a result of which the payment
obligations of the issuer are accelerated, the U.S. Treasury zero coupon
obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments which would have then been due on the Brady Bonds in the
normal course. In addition, interest payments on certain types of Brady Bonds
may be collateralized by cash or high grade securities in amounts that typically
represent between 12 and 18 months of interest accruals on these instruments
with the balance of the interest accruals being uncollateralized. Brady Bonds
are often viewed as having several valuation components: (1) the
5
<PAGE>
collateralized repayment of principal, if any, at final maturity, (2) the
collateralized interest payments, if any, (3) the uncollateralized interest
payments and (4) any uncollateralized repayment of principal at maturity (these
uncollateralized amounts constitute the 'residual risk'). In light of the
residual risk of Brady Bonds and, among other factors, the history of defaults
with respect to commercial bank loans by public and private entities of
countries issuing Brady Bonds, investments in Brady Bonds are to be viewed as
speculative. The Fund may purchase Brady Bonds with no or limited
collateralization, and will be relying for payment of interest and (except in
the case of principal collateralized Brady Bonds) repayment of principal
primarily on the willingness and ability of the foreign government to make
payment in accordance with the terms of the Brady Bonds. Brady Bonds issued to
date are purchased and sold in secondary markets through U.S. securities dealers
and other financial institutions and are generally maintained through European
transnational securities depositories.
STRUCTURED FOREIGN INVESTMENTS. The Fund may invest a portion of its
assets in interests in U.S. and foreign entities organized and operated solely
for the purpose of securitizing or restructuring the investment characteristics
of foreign securities. This type of securitization or restructuring involves the
deposit with or purchase by a U.S. or foreign entity, such as a corporation or
trust, of specified instruments (such as commercial bank loans or Brady Bonds)
and the issuance by that entity of one or more classes of securities
('Structured Foreign Investments') backed by, or representing interests in, the
underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued Structured Foreign Investments to create
securities with different investment characteristics such as varying maturities,
payment priorities and interest rate provisions, and the extent of the payments
made with respect to Structured Foreign Investments is dependent on the extent
of the cash flow on the underlying instruments.
The Structured Foreign Investments of the type in which the Fund typically
will invest will involve no credit enhancement. Accordingly, their credit risk
generally will be equivalent to that of the underlying instruments. The Fund is
permitted, however, to invest in classes of Structured Foreign Investments that
are subordinated to the right of payment of another class. Subordinated
Structured Foreign Investments typically have higher yields and present greater
risks than unsubordinated Structured Foreign Investments. Structured Foreign
Investments are typically sold in private placement transactions, and there
currently is no active trading market for Structured Foreign Investments.
YIELD FACTORS AND RATINGS
S&P, Moody's and other NRSROs are private services that provide ratings of
the credit quality of fixed income securities. A description of the range of
ratings assigned to fixed income securities by S&P and Moody's is included in
Appendix A to the Prospectus. The Fund may use these ratings in determining
whether to purchase, sell or hold a security. Mitchell Hutchins will assess
securities on the basis of the highest rating assigned by any NRSRO. It should
be emphasized, however, that ratings are general and are not absolute standards
of quality. Consequently, fixed income securities with the same maturity,
interest rate and rating may have different market prices. Also, rating agencies
may fail to make timely changes in credit ratings in response to subsequent
events. Consequently, the rating assigned to any particular security is not
necessarily a reflection of the issuer's current financial condition, which may
be better or worse than the rating would indicate. The rating assigned to a
security by Moody's or S&P does not reflect an assessment of the volatility of
the security's market value or of the liquidity of an investment in the
security.
Changes by NRSROs in their ratings of any fixed income security and in the
ability of an issuer to make payments of interest and principal may also affect
the value of these investments. Changes in the value of portfolio securities
generally will not affect cash income derived from such securities, but will
affect the Fund's net asset value. The Fund will not necessarily dispose of a
security when its rating is reduced below the rating at the time of purchase,
although Mitchell Hutchins will monitor all investments to determine whether
continued investment is consistent with the Fund's investment objectives.
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In addition to ratings assigned to individual security issues, Mitchell
Hutchins will analyze interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and
credit quality. With respect to its investments in Foreign and Emerging Market
Securities, the Fund also will analyze factors such as currency exchange rate
movements, credit risks of the foreign countries and issuers, and political and
social climate. The yields on fixed income securities are dependent on a variety
of factors, including general money market conditions, general conditions in the
bond market, the financial condition of the issuer, the size of the offering,
the maturity of the obligation and its rating. There is a wide variation in the
quality of fixed income securities, both within a particular classification and
between classifications. The obligations of an issuer of fixed income securities
are subject to the provisions of bankruptcy, insolvency and other laws affecting
the rights and remedies of bond holders or other creditors of an issuer;
litigation or other conditions may also adversely affect the power or ability of
issuers to meet their obligations for the payment of interest and repayment of
principal.
ILLIQUID SECURITIES
As indicated in the Prospectus, the Fund may invest up to 15% of its net
assets in illiquid securities. The term 'illiquid securities' for this purpose
means securities that cannot be disposed of within seven days in the ordinary
course of business at approximately the amount at which the Fund has valued the
securities and includes, among other things, purchased OTC options, repurchase
agreements maturing in more than seven days and restricted securities other than
those Mitchell Hutchins has determined are liquid pursuant to guidelines
established by the Trust's board of trustees. The assets used as cover for OTC
options written by the Fund will be considered illiquid unless the OTC options
are sold to qualified dealers who agree that the Fund may repurchase any OTC
option it writes at a maximum price to be calculated by a formula set forth in
the option agreement. The cover for an OTC option written subject to this
procedure would be considered illiquid only to the extent that the maximum
repurchase price under the formula exceeds the intrinsic value of the option.
Illiquid restricted securities may be sold only in privately negotiated
transactions or in public offerings with respect to which a registration
statement is in effect under the Securities Act of 1933 ('1933 Act'). Such
securities include those that are subject to restrictions contained in the
securities laws of other countries. However, securities that are freely
marketable in the country where they are principally traded, but would not be
freely marketable in the United States, will not be considered illiquid. Where
registration is required, the Fund may be obligated to pay all or part of the
registration expenses, and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the Fund might obtain a less favorable price
than prevailed when it decided to sell.
Not all restricted securities are illiquid. In recent years, a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and notes.
These instruments are often restricted securities because the securities are
sold in transactions not requiring registration. Institutional investors
generally will not seek to sell these instruments to the general public, but
instead will often depend either on an efficient institutional market in which
such unregistered securities can be readily resold or on an issuer's ability to
honor a demand for repayment. Therefore, the fact that there are contractual or
legal restrictions on resale to the general public or certain institutions is
not dispositive of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a 'safe harbor' from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted securities
have developed as a result of Rule 144A, providing both readily ascertainable
values for restricted securities and the ability to liquidate an investment to
satisfy share redemption orders or for other purposes. Such markets include
automated systems for the trading, clearance and settlement of unregistered
securities of domestic and foreign issuers, such as the
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PORTAL System sponsored by the National Association of Securities Dealers, Inc.
An insufficient number of qualified buyers interested in purchasing Rule
144A-eligible restricted securities held by the Fund, however, could affect
adversely the marketability of such portfolio securities, and the Fund might be
unable to dispose of such securities promptly or at favorable prices.
The board of trustees has delegated the function of making day-to-day
determinations of liquidity to Mitchell Hutchins pursuant to guidelines approved
by the board. Mitchell Hutchins will take into account a number of factors in
reaching liquidity decisions, including (1) the frequency of trades for the
security, (2) the number of dealers that make quotes for the security, (3) the
number of dealers that have undertaken to make a market in the security, (4) the
number of other potential purchasers for the security and (5) the nature of the
security and how trading is effected (e.g., the time needed to sell the
security, how bids are solicited and the mechanics of transfer). Mitchell
Hutchins monitors the liquidity of restricted securities in the Fund's portfolio
and reports periodically on such decisions to the board of trustees.
CONVERTIBLE SECURITIES
The value of a convertible security is a function of its 'investment value'
(determined by its yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and its
'conversion value' (the security's worth, at market value, if converted into the
underlying common stock). The investment value of a convertible security is
influenced by changes in interest rates, with investment value declining as
interest rates increase and increasing as interest rates decline. The credit
standing of the issuer and other factors also may have an effect on the
convertible security's investment value. The conversion value of a convertible
security is determined by the market price of the underlying common stock. If
the conversion value is low relative to the investment value, the price of the
convertible security is governed principally by its investment value. Generally,
the conversion value decreases as the convertible security approaches maturity.
To the extent the market price of the underlying common stock approaches or
exceeds the conversion price, the price of the convertible security will be
increasingly influenced by its conversion value. A convertible security
generally will sell at a premium over its conversion value by the extent to
which investors place value on the right to acquire the underlying common stock
while holding a fixed income security.
A convertible security might be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for redemption,
the Fund will be required to permit the issuer to redeem the security, convert
it into the underlying common stock or sell it to a third party. Any of these
actions could have an adverse effect on the Fund's ability to achieve its
investment objectives.
WARRANTS
The Fund may acquire warrants for equity securities, debt securities and
commodities that are acquired as units with fixed income securities. Warrants
are securities permitting, but not obligating, their holder to subscribe for
other securities or commodities. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments. In addition, the value of a warrant does not
necessarily change with the value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to its expiration date. The
Fund does not intend to retain in its portfolio any common stock or commodity
received upon the exercise of a warrant and will sell the common stock or
commodity as promptly as practicable and in a manner that it believes will
reduce its risk of a loss in connection with the sale.
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REPURCHASE AGREEMENTS
Repurchase agreements are transactions in which the Fund purchases
securities from a bank or recognized securities dealer and simultaneously
commits to resell those securities to the bank or dealer at an agreed-upon date
and price reflecting a market rate of interest unrelated to the coupon rate or
maturity of the purchased securities. The Fund will maintain custody of the
underlying securities prior to their repurchase; thus, the obligation of the
bank or securities dealer to pay the repurchase price on the date agreed to
will, in effect, be secured by such securities. If the value of such securities
is less than the repurchase price, plus any agreed-upon additional amount, the
other party to the agreement will be required to provide additional collateral
so that at all times the collateral is at least equal to the repurchase price,
plus any agreed-upon additional amount. The difference between the total amount
to be received upon repurchase of the securities and the price which was paid by
the Fund upon acquisition will be accrued as interest and included in the Fund's
net investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to the Fund if the other party to
the repurchase agreement becomes bankrupt. The Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins to present minimal credit risks in accordance with guidelines
established by the Trust's board of trustees. Mitchell Hutchins will review and
monitor the creditworthiness of such institutions under the board's general
supervision.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus,
the Fund may purchase securities on a 'when-issued' or delayed delivery basis. A
security purchased on a when-issued or delayed delivery basis is recorded as an
asset on the commitment date and is subject to changes in market value generally
based upon changes in the level of interest rates. Thus, fluctuation in the
value of the security from the time of the commitment date will affect the
Fund's net asset value. When the Fund agrees to purchase securities on a
when-issued basis, its custodian segregates assets to cover the amount of the
commitment. See 'Investment Policies and Restrictions-Segregated Accounts.' The
Fund purchases when-issued securities only with the intention of taking
delivery, but may sell the right to acquire the security prior to delivery if
Mitchell Hutchins deems it advantageous to do so, which may result in capital
gain or loss to the Fund.
SEGREGATED ACCOUNTS. When the Fund enters into certain transactions that
involve obligations to make future payments to third parties, including dollar
rolls, reverse repurchase agreements or the purchase of securities on a
when-issued or delayed delivery basis, the Fund will maintain with an approved
custodian in a segregated account cash, U.S. government securities or other
liquid high-grade debt securities, marked to market daily, in an amount at least
equal to the Fund's obligation or commitment under such transactions. As
described below under 'Hedging and Related Income Strategies,' segregated
accounts may also be required in connection with certain transactions involving
options or futures contracts, interest rate protection transactions or forward
currency contracts.
SHORT SALES 'AGAINST THE BOX.' As indicated in the prospectus, the Fund
may engage in short sales of securities it owns or has the right to acquire at
no added cost through conversion or exchange of other securities it owns (short
sales 'against the box') to defer realization of gains or losses for tax or
other purposes. To make delivery to the purchaser in a short sale, the executing
broker borrows the securities being sold short on behalf of the Fund, and the
Fund is obligated to replace the securities borrowed at a date in the future.
When the Fund sells short, it will establish a margin account with the broker
effecting the short sale, and will deposit collateral with the broker. In
addition, the Fund will maintain with its custodian, in a segregated account,
the securities that could be used to cover the short sale. The Fund will incur
transaction costs, including interest expense, in connection with opening,
maintaining and closing short sales against the box. The Fund currently does not
intend to have obligations under short-sales that at any time during the coming
year exceed 5% of the Fund's net assets.
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The Fund might make a short sale 'against the box' in order to hedge
against market risks when Mitchell Hutchins believes that the price of a
security may decline, thereby causing a decline in the value of a security owned
by the Fund or a security convertible into or exchangeable for a security owned
by the Fund, or when Mitchell Hutchins wants to sell a security that the Fund
owns at a current price, but also wishes to defer recognition of gain or loss
for federal income tax purposes. In such case, any loss in the Fund's long
position after the short sale should be reduced by a gain in the short position.
Conversely, any gain in the long position should be reduced by a loss in the
short position. The extent to which gains or losses in the long position are
reduced will depend upon the amount of the securities sold short relative to the
amount of the securities the Fund owns, either directly or indirectly, and in
the case where the Fund owns convertible securities, changes in the investment
values or conversion premiums of such securities.
INVESTMENT LIMITATIONS OF THE FUND. The Fund will not:
(1) purchase any security if, as a result of that purchase, 25% or
more of the Fund's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies or instrumentalities or to municipal
securities.
(2) issue senior securities or borrow money, except as permitted under
the 1940 Act and then not in excess of 33 1/3% of the Fund's total assets
(including the amount of the senior securities issued but reduced by any
liabilities not constituting senior securities) at the time of the issuance
or borrowing, except that the Fund may borrow up to an additional 5% of its
total assets (not including the amount borrowed) for temporary or emergency
purposes.
(3) make loans, except through loans of portfolio securities or
through repurchase agreements, provided that for purposes of this
restriction, the acquisition of bonds, debentures, other debt securities or
instruments, or participations or other interests therein and investments
in government obligations, commercial paper, certificates of deposit,
bankers' acceptances or similar instruments will not be considered the
making of a loan.
(4) engage in the business of underwriting securities of other
issuers, except to the extent that the Fund might be considered an
underwriter under the federal securities laws in connection with its
disposition of portfolio securities.
(5) purchase or sell real estate, except that investments in
securities of issuers that invest in real estate and investments in
mortgage-backed securities, mortgage participations or other instruments
supported by interests in real estate are not subject to this limitation,
and except that the Fund may exercise rights under agreements relating to
such securities, including the right to enforce security interests and to
hold real estate acquired by reason of such enforcement until that real
estate can be liquidated in an orderly manner.
(6) purchase or sell physical commodities unless acquired as a result
of owning securities or other instruments, but the Fund may purchase, sell
or enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
The foregoing fundamental investment limitations cannot be changed without the
affirmative vote of the lesser of (a) more than 50% of the outstanding shares of
the Fund or (b) 67% or more of such shares present at a stockholders' meeting if
more than 50% of the outstanding shares are represented at the meeting in person
or by proxy. If a percentage restriction is adhered to at the time of an
investment or transaction, later changes in percentage resulting from a change
in values of portfolio securities or the amount of total assets will not be
considered a violation of any of the Fund's investment limitations, restrictions
or investment policies.
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The following investment restrictions are not fundamental and may be
changed by the Trust's board of trustees without shareholder approval.
The Fund will not:
(1) purchase or retain the securities of any issuer if, to the
knowledge of the Fund's management, the officers and trustees of the Trust
and the officers and directors of Mitchell Hutchins (each owning
beneficially more than 0.5% of the outstanding securities of the issuer)
own in the aggregate more than 5% of the securities of the issuer.
(2) purchase any security if as a result more than 5% of the Fund's
total assets would be invested in securities of companies that, together
with any predecessors, have been in continuous operation for less than
three years, provided, however, that this shall not apply to mortgage- and
asset-backed securities and Structured Foreign Investments.
(3) invest more than 15% of its net assets in illiquid securities, a
term that means securities that cannot be disposed of within seven days in
the ordinary course of business at approximately the amount at which the
Fund has valued the securities and includes, among other things, repurchase
agreements maturing in more than seven days.
(4) purchase securities of any one issuer if as a result the Fund
would own or hold 10% of the outstanding voting securities of that issuer,
except that up to 25% of the Fund's total assets may be invested without
regard to this limitation.
(5) make investments in warrants, valued at the lower of cost or
market, in excess of 5% of the value of its net assets, which amount may
include warrants that are not listed on the New York Stock Exchange, Inc.
('NYSE') or the American Stock Exchange, Inc. provided that such unlisted
warrants, valued at the lower of cost or market, do not exceed 2% of the
Fund's net assets, and further provided that this restriction does not
apply to warrants attached to, or sold as a unit with, other securities.
For purposes of this restriction, the term 'warrants' does not include
options on securities, currencies, stock or bond indices, or futures
contracts.
(6) purchase securities on margin, except for short-term credit
necessary for clearance of portfolio transactions and except that the Fund
may make margin deposits in connection with its use of financial options
and futures, forward and spot currency contracts, swap transactions and
other financial contracts or derivative instruments.
(7) engage in short sales of securities or maintain a short position,
except that the Fund may (a) sell short 'against the box' and (b) maintain
short positions in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(8) invest in oil, gas or mineral exploration or development programs
or leases, except that investments in securities of issuers that invest in
such programs or leases and investments in asset-backed securities
supported by receivables generated from such programs or leases are not
subject to this prohibition.
(9) invest in real estate limited partnerships.
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HEDGING AND RELATED INCOME STRATEGIES
As discussed in the Prospectus, Mitchell Hutchins may use a variety of
financial instruments ('Hedging Instruments'), including options, futures
contracts (sometimes referred to as 'futures') and options on futures contracts
to attempt to hedge the Fund's portfolio and to enhance income. Mitchell
Hutchins also may attempt to hedge the Fund's portfolio through the use of
foreign currency forward contracts and interest rate protection transactions.
Further information regarding certain of the Hedging Instruments that may be
used by the Fund is contained in Appendix C to the Fund's Prospectus.
Hedging strategies can be broadly categorized as 'short hedges' and 'long
hedges.' A short hedge is a purchase or sale of a Hedging Instrument intended
partially or fully to offset potential declines in the value of one or more
investments held in the Fund's portfolio. Thus, in a short hedge the Fund takes
a position in a Hedging Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged. For example, the
Fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, the Fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying security declines, the Fund might be
able to close out the put option and realize a gain to offset the decline in the
value of the security.
Conversely, a long hedge is a purchase or sale of a Hedging Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge, the Fund takes a position in a Hedging Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, the Fund could exercise the call and thus limit its
acquisition to the exercise price plus the premium paid and transaction costs.
Alternatively, the Fund might be able to offset the price increase by closing
out an appreciated call option and realizing a gain.
The Fund may purchase and write (sell) covered straddles on securities or
indices of debt securities. A long straddle is a combination of a call and a put
option purchased on the same security or on the same futures contract, where the
exercise price of the put is less than or equal to the exercise price of the
call. The Fund might enter into a long straddle when Mitchell Hutchins believes
that it is likely that interest rates will be more volatile during the term of
the option than the option pricing implies. A short straddle is a combination of
a call and a put written on the same security where the exercise price of the
put is less than or equal to the exercise price of the call. The Fund might
enter into a short straddle when Mitchell Hutchins believes that it is unlikely
that interest rates will be as volatile during the term of the option as the
option pricing implies.
Hedging Instruments on securities generally are used to hedge against price
movements in one or more particular securities positions that the Fund owns or
intends to acquire. Hedging Instruments on debt securities may be used to hedge
either individual securities or broad fixed income market sectors.
The use of Hedging Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded and
the Commodity Futures Trading Commission ('CFTC'). In addition, the Fund's
ability to use Hedging Instruments will be limited by tax considerations. See
'Taxes.'
In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins expects to discover additional opportunities
to develop in connection with options, futures contracts, forward currency
contracts and other hedging techniques. These new opportunities may become
available as Mitchell Hutchins develops new techniques, as regulatory
authorities broaden the range of permitted transactions and as new options,
futures contracts, forward currency contracts or other techniques are developed.
Mitchell Hutchins may utilize these opportunities to the extent that they are
consistent with the Fund's investment objectives and permitted
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by the Fund's investment limitations and applicable regulatory authorities. The
Fund's Prospectus or Statement of Additional Information will be supplemented to
the extent that new products or techniques involve materially different risks
than those described below or in the Prospectus.
SPECIAL RISKS OF HEDGING STRATEGIES
The use of Hedging Instruments involves special considerations and risks,
as described below. Risks pertaining to particular Hedging Instruments are
described in the sections that follow.
(1) Successful use of most Hedging Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities, currencies and
interest rate markets, which requires different skills than predicting changes
in the prices of individual securities. While Mitchell Hutchins is experienced
in the use of Hedging Instruments, there can be no assurance that any particular
hedging strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Hedging Instrument and price movements of the investments
being hedged. For example, if the value of a Hedging Instrument used in a short
hedge increased by less than the decline in value of the hedged investment, the
hedge would not be fully successful. Such a lack of correlation might occur due
to factors unrelated to the value of the investments being hedged, such as
speculative or other pressures on the markets in which Hedging Instruments are
traded. The effectiveness of hedges using Hedging Instruments on indices will
depend on the degree of correlation between price movements in the index and
price movements in the investments being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly or
partially offsetting the negative effect of unfavorable price movements in the
investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the Fund entered into a
short hedge because Mitchell Hutchins projected a decline in the price of a
security in the Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the Hedging Instrument. Moreover, if the price of the
Hedging Instrument declined by more than the increase in the price of the
security, the Fund could suffer a loss. In either such case, the Fund would have
been in a better position had it not hedged at all.
(4) As described below, the Fund might be required to maintain assets as
'cover,' maintain segregated accounts or make margin payments when it takes
positions in Hedging Instruments involving obligations to third parties (i.e.,
Hedging Instruments other than purchased options). If the Fund were unable to
close out its positions in such Hedging Instruments, it might be required to
continue to maintain such assets or accounts to make such payments until the
position expired or matured. These requirements might impair the Fund's ability
to sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a portfolio
security at a disadvantageous time. The Fund's ability to close out a position
in a Hedging Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of the other party to the transaction ('contra party') to enter
into a transaction closing out the position. Therefore, there is no assurance
that any hedging position can be closed out at a time and price that is
favorable to the Fund.
COVER FOR HEDGING STRATEGIES
Transactions using Hedging Instruments, other than purchased options,
expose the Fund to an obligation to another party. The Fund will not enter into
any such transactions unless it owns either (1) an offsetting ('covered')
position in securities, currencies or other options, futures contracts or
forward currency contracts or (2) cash and short-term debt securities, with a
value sufficient at all times to cover its potential obligations to the extent
not covered as provided in (1) above. The Fund will comply with SEC guidelines
regarding cover for hedging transactions
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<PAGE>
and will, if the guidelines so require, set aside cash, U.S. government
securities or other liquid, high-grade debt securities in a segregated account
with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Hedging Instrument is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion of
the Fund's assets to cover or segregated accounts could impede portfolio
management or the Fund's ability to meet redemption requests or other current
obligations.
OPTIONS
The Fund may purchase put and call options, and write covered put and call
options, on debt securities, on indices of debt securities and foreign
currencies. The purchase of call options serves as a long hedge, and the
purchase of put options serves as a short hedge. Writing covered put or call
options can enable the Fund to enhance income by reason of the premiums paid by
the purchasers of such options. Writing covered put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received for writing the option. However, if
the market price of the security underlying a put option the Fund has written
declines to less than the exercise price of the option, minus the premium
received, the Fund would expect to suffer a loss. Writing covered call options
serves as a limited short hedge because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing the
option. However, if the security appreciates to a price higher than the exercise
price of the call option, it can be expected that the option will be exercised
and the Fund will be obligated to sell the security at less than its market
value. All or a portion of the assets used as cover for OTC options written by
the Fund would be considered illiquid to the extent described under 'Investment
Policies and Restrictions--Illiquid Securities.'
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Generally, the OTC debt and foreign
currency options used by the Fund are European-style options. This means that
the option is only exercisable immediately prior to its expiration. This is in
contrast to American-style options, which are exercisable at any time prior to
the expiration date of the option. Options that expire unexercised have no
value.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit the Fund to realize the profit or
limit the loss on an option position prior to its exercise or expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange markets for options on debt securities and foreign currencies exist but
are relatively new, and these instruments are primarily traded on the OTC
market. Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction. In
contrast, OTC options are contracts between the Fund and its contra party
(usually a securities dealer or a bank) with no clearing organization guarantee.
Thus, when the Fund purchases or writes an OTC option, it relies on the contra
party to make or take delivery of the underlying investment upon exercise of the
option. Failure by the contra party to do so would result in the loss of any
premium paid by the Fund as well as the loss of any expected benefit of the
transaction. The Fund will enter into OTC option transactions only with contra
parties that have a net worth of at least $20 million.
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The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although the Fund
will enter into OTC options only with contra parties that are expected to be
capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the contra
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration.
If the Fund were unable to effect a closing transaction for an option it
had purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by the Fund could cause material losses because the Fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
The Fund may purchase and write put and call options on indices of debt
securities in much the same manner as the more traditional options discussed
above, except the index options may serve as a hedge against overall
fluctuations in the debt securities market (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
GUIDELINES FOR OPTIONS
The Fund's use of options is governed by the following guidelines, which
can be changed by the Trust's board of trustees without shareholder vote:
1. The Fund may purchase a put or call option, including any straddles or
spreads, only if the value of its premium, when aggregated with the premiums on
all other options purchased by the Fund, does not exceed 5% of the Fund's total
assets.
2. The aggregate value of securities underlying put options written by the
Fund determined as of the date the put options are written, will not exceed 50%
of the Fund's net assets.
3. The aggregate premiums paid on all options (including options on
securities, foreign currencies and indices of securities and options on futures
contracts) purchased by the Fund that are held at any time will not exceed 20%
of the Fund's net assets.
FUTURES
The Fund may purchase and sell interest rate futures contracts, debt and
equity index futures contracts and foreign currency futures contracts. The Fund
may also purchase put and call options, and write covered put and call options,
on futures in which it is allowed to invest. The purchase of futures or call
options thereon can serve as a long hedge, and the sale of futures or the
purchase of put options thereon can serve as a short hedge. Writing covered call
options on futures contracts can serve as a limited short hedge, and writing
covered put options on futures contracts can serve as a limited long hedge,
using a strategy similar to that used for writing covered options in securities
on indices.
Futures strategies also can be used to manage the average duration of the
Fund's portfolio. If Mitchell Hutchins wishes to shorten the average duration of
the Fund, the Fund may sell an interest rate or debt security index futures
contract or a call option thereon or purchase a put option on that futures
contract. If Mitchell Hutchins wishes to lengthen the average duration of the
Fund, the Fund may buy an interest rate or debt security index futures contract
or a call option thereon or sell a put option thereon.
15
<PAGE>
The Fund may also write put options on interest rate futures contracts
while at the same time purchasing call options on the same futures contracts in
order synthetically to create a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage in
this strategy only when it is more advantageous to the Fund than is purchasing
the futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract, the Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, 'initial margin' consisting of cash, U.S. government
securities or other liquid, high-grade debt securities, in an amount generally
equal to 10% or less of the contract value. Margin must also be deposited when
writing an option on a futures contract, in accordance with applicable exchange
rules. Unlike margin in securities transactions, initial margin on futures
contracts does not represent a borrowing, but rather is in the nature of a
performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, the
Fund may be required by an exchange to increase the level of its initial margin
payment. Initial margin requirements might be increased generally by future
regulatory action.
Subsequent 'variation margin' payments are made to and from the futures
broker daily as the value of the futures or written option position varies, a
process known as 'marking to market.' Variation margin does not involve
borrowing, but rather represents a daily settlement of the Fund's obligations
with respect to an open futures or options position. When the Fund purchases an
option on a future, the premium paid plus transaction costs is all that is at
risk. In contrast, when the Fund purchases or sells a futures contract or writes
an option thereon, it is subject to daily variation margin calls that could be
substantial in the event of adverse price movements. If the Fund has
insufficient cash to meet daily variation margin requirements, it might need to
sell securities at a time when such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The Fund intends to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid, secondary market. However, there
can be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If the Fund were unable to liquidate a futures or options position due to
the absence of a liquid secondary market or the imposition of price limits, it
could incur substantial losses. The Fund would continue to be subject to market
risk with respect to the position. In addition, except in the case of purchased
options, the Fund would continue to be required to make daily variation margin
payments and might be required to maintain the position being hedged by the
future or option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and options markets are
subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or related options and the investments being hedged. Also, because
16
<PAGE>
initial margin deposit requirements in the futures market are less onerous than
margin requirements in the securities markets, there might be increased
participation by speculators in the futures markets. This participation also
might cause temporary price distortions. In addition, activities of large
traders in both the futures and securities markets involving arbitrage, 'program
trading' and other investment strategies might result in temporary price
distortions.
GUIDELINES FOR FUTURES AND RELATED OPTIONS
The Fund's use of futures and related options is governed by the following
guidelines which can be changed by the Trust's board of trustees without
shareholder vote:
1. To the extent the Fund enters into futures contracts and options on
futures positions including options on foreign currencies traded on a
commodities exchange, that are not for bona fide hedging purposes (as defined by
the CFTC), the aggregate initial margin and premiums on those positions
(excluding the amount by which options are 'in-the-money') may not exceed 5% of
the Fund's net assets.
2. The aggregate premiums paid on all options (including options on
securities, foreign currencies and indices of debt securities and options on
futures contracts) purchased by the Fund that are held at any time will not
exceed 20% of the Fund's net assets.
3. The aggregate margin deposits on all futures contracts and options
thereon held at any time by the Fund will not exceed 5% of the Fund's total
assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS
The Fund may use options and futures on foreign currencies, as described
above, and foreign currency forward contracts, as described below, to hedge
against movements in the values of the foreign currencies in which the Fund's
securities are denominated. Such currency hedges can protect against price
movements in a security that the Fund owns or intends to acquire that are
attributable to changes in the value of the currency in which it is denominated.
Such hedges do not, however, protect against price movements in the securities
that are attributable to other causes.
The Fund might seek to hedge against changes in the value of a particular
currency when no Hedging Instruments on that currency are available or such
Hedging Instruments are more expensive than certain other Hedging Instruments.
In such cases, the Fund may hedge against price movements in that currency by
entering into transactions using Hedging Instruments on another foreign currency
or basket of currencies, the values of which Mitchell Hutchins believes will
have a positive correlation to the value of the currency being hedged. The risk
that movements in the price of the Hedging Instrument will not correlate
perfectly with movements in the price of the currency being hedged is magnified
when this strategy is used.
The value of Hedging Instruments on foreign currencies depends on the value
of the underlying currency relative to the U.S. dollar. Because foreign currency
transactions occurring in the interbank market might involve substantially
larger amounts than those involved in the use of such Hedging Instruments, the
Fund could be disadvantaged by having to deal in the odd lot market (generally
consisting of transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Hedging Instruments until they reopen.
17
<PAGE>
Settlement of hedging transactions involving foreign currencies might be
required to take place within the country issuing the underlying currency. Thus,
the Fund might be required to accept or make delivery of the underlying foreign
currency in accordance with any U.S. or foreign regulations regarding the
maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
FORWARD CURRENCY CONTRACTS
The Fund may enter into forward currency contracts to purchase or sell
foreign currencies for a fixed amount of U.S. dollars or another foreign
currency. Such transactions may serve as long hedges--for example, the Fund may
purchase a forward currency contract to lock in the U.S. dollar price of a
security denominated in a foreign currency that the Fund intends to acquire.
Forward currency contract transactions may also serve as short hedges-for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
As noted above, the Fund may seek to hedge against changes in the value of
a particular currency by using forward contracts on another foreign currency or
a basket of currencies, the value of which Mitchell Hutchins believes will have
a positive correlation to the values of the currency being hedged. In addition,
the Fund may use forward currency contracts to shift exposure to foreign
currency fluctuations from one country to another. For example, if the Fund
owned securities denominated in a foreign currency and Mitchell Hutchins
believed that currency would decline relative to another currency, it might
enter into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in the second foreign currency. Transactions
that use two foreign currencies are sometimes referred to as 'cross hedging.'
Use of a different foreign currency magnifies the risk that movements in the
price of the Hedging Instrument will not correlate or will correlate unfavorably
with the foreign currency being hedged.
The cost to the Fund of engaging in forward currency contracts varies with
factors such as the currency involved, the length of the contract period and the
market conditions then prevailing. Because forward currency contracts are
usually entered into on a principal basis, no fees or commissions are involved.
When the Fund enters into a forward currency contract, it relies on the contra
party to make or take delivery of the underlying currency at the maturity of the
contract. Failure by the contra party to do so would result in the loss of any
expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the contra party. Thus, there can be no assurance
that the Fund will in fact be able to close out a forward currency contract at a
favorable price prior to maturity. In addition, in the event of insolvency of
the contra party, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Fund would continue
to be subject to market risk with respect to the position and would continue to
be required to maintain a position in securities denominated in the foreign
currency that is the subject of the hedge or to maintain cash or securities in a
segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the foreign
currency contract has been established. Thus, the Fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward currency contracts. The projection of
short-term currency market movements is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain.
18
<PAGE>
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS
The Fund may enter into forward currency contracts or maintain a net
exposure to such contracts only if: (1) the consummation of the contracts would
not obligate the Fund to deliver an amount of foreign currency in excess of the
value of the position being hedged by such contracts; or (2) the Fund maintains
cash, U.S. government securities or liquid, high-grade debt securities in a
segregated account in an amount not less than the value of its total assets
committed to the consummation of the contract and not covered as provided in (1)
above, as marked to market daily.
INTEREST RATE PROTECTION TRANSACTIONS
The Fund may enter into interest rate protection transactions, including
interest rate swaps and interest rate caps, collars and floors. Interest rate
swap transactions involve an agreement between two parties to exchange payments
that are based, respectively, on variable and fixed rates of interest and that
are calculated on the basis of a specified amount of principal (the 'notional
principal amount') for a specified period of time. Interest rate cap and floor
transactions involve an agreement between two parties in which the first party
agrees to make payments to the counterparty when a designated market interest
rate goes above (in the case of a cap) or below (in the case of a floor) a
designated level on predetermined dates or during a specified time period.
Interest rate collar transactions involve an agreement between two parties in
which payments are made when a designated market interest rate either goes above
a designated ceiling level or goes below a designated floor on predetermined
dates or during a specified time period. The Fund intends to use these
transactions as a hedge and not as a speculative investment. Interest rate
protection transactions are subject to risks comparable to those described above
with respect to other hedging strategies.
The Fund may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest rate
swaps on a net basis, i.e., the two payment streams are netted out, with the
Fund receiving or paying as the case may be, only the net amount of the two
payments. Inasmuch as these interest rate protection transactions are entered
into for good faith hedging purposes, and inasmuch as segregated accounts will
be established with respect to such transactions, Mitchell Hutchins and the Fund
believe such obligations do not constitute senior securities and, accordingly,
will not treat them as being subject to its borrowing restrictions. The net
amount of the excess, if any, of the Fund's obligations over its entitlements
with respect to each interest rate swap will be accrued on a daily basis and an
amount of cash, U.S. government securities or other liquid, high-grade debt
obligations having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by a custodian that satisfies
the requirements of the 1940 Act. The Fund also will establish and maintain such
segregated accounts with respect to its total obligations under any interest
rate swaps that are not entered into on a net basis and with respect to any
interest rate caps, collars and floors that are written by the Fund.
The Fund will enter into interest rate protection transactions only with
banks and recognized securities dealers believed by Mitchell Hutchins to present
minimal credit risks in accordance with guidelines established by the Trust's
board of trustees. If there is a default by the other party to such a
transaction, the Fund will have to rely on its contractual remedies (which may
be limited by bankruptcy, insolvency or similar laws) pursuant to the agreements
related to the transaction.
19
<PAGE>
TRUSTEES AND OFFICERS
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS;* AGE WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------- ------------------------- -------------------------------------------------------------
<S> <C> <C>
Margo N. Alexander;**49 Trustee and President Mrs. Alexander is president, chief executive officer and a
director of Mitchell Hutchins (since January 1995) and also
an executive vice-president and a director of PaineWebber.
Mrs. Alexander is president and a director or trustee of 30
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Richard Q. Armstrong; 60 Trustee Mr. Armstrong is chairman and principal of RQA Enterprises
78 West Brother Drive (management consulting firm) (since April 1991 and
Greenwich, CT 06830 principal occupation since March 1995). Mr. Armstrong is
also a director of HiLo Automotive Inc. He was chairman of
the board, chief executive officer and co-owner of
Adirondack Beverages (producer and distributor of soft
drinks and sparkling/still waters) (October 1993-March
1995). Mr. Armstrong was a partner of The New England
Consulting Group (management consulting firm) (December
1992-September 1993). He was managing director of LVMH U.S.
Corporation (U.S. subsidiary of the French luxury goods
conglomerate, Luis Vuitton Moet Hennessey Corporation)
(1987-1994) and chairman of its wine and spirits
subsidiary, Schieffelin & Somerset Company (1987-1991). Mr.
Armstrong is a director or trustee of 29 investment
companies for which Mitchell Hutchins or PaineWebber serves
as investment adviser.
E. Garrett Bewkes, Trustee and Chairman Mr. Bewkes is a director of Paine Webber Group Inc. ('PW
Jr.;**69 of the Board of Group') (holding company of PaineWebber and Mitchell
Trustees Hutchins). Prior to December 1995, he was a consultant to
PW Group. Prior to 1988, he was chairman of the board,
president and chief executive officer of American Bakeries
Company. Mr. Bewkes is a director of Interstate Bakeries
Corporation and NaPro BioTherapeutics, Inc. Mr. Bewkes is a
director or trustee of 30 investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Richard R. Burt; 49 Trustee Mr. Burt is chairman of International Equity Partners
1101 Connecticut (international investments and consulting firm) (since
Avenue, N.W. March 1994) and a partner of McKinsey & Company (management
Washington, D.C. 20036 consulting firm) (since 1991). He is also a director of
American Publishing Company. He was the chief negotiator in
the Strategic Arms Reduction Talks with the former Soviet
Union (1989-1991) and the U.S. ambassador to the Federal
Republic of Germany (1985-1989). Mr. Burt is a director or
trustee of 29
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS;* AGE WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------- ------------------------- -------------------------------------------------------------
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Mary C. Farrell;**46 Trustee Ms. Farrell is a managing director, senior investment
strategist, and member of the Investment Policy Committee
of PaineWebber. Ms. Farrell joined PaineWebber in 1982. She
is a member of the Financial Women's Association and
Women's Economic Roundtable, and is employed as a regular
panelist on Wall Street Week with Louis Rukeyser. She also
serves on the Board of Overseers of New York University's
Stern School of Business. Ms. Farrell is a director or
trustee of 29 investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
<S> <C> <C>
Meyer Feldberg; 54 President Mr. Feldberg is Dean and Professor of Management of the
Columbia University Graduate School of Business, Columbia University. Prior to
101 Uris Hall 1989, he was president of the Illinois Institute of
New York, NY 10027 Technology. Dean Feldberg is also a director of AMSCO
International Inc., Federated Department Stores, Inc. and
New World Communications Group Incorporated. Dean Feldberg
is a director or trustee of 29 investment companies for
which Mitchell Hutchins or PaineWebber serves as investment
adviser.
George W. Gowen; 66 Trustee Mr. Gowen is a partner in the law firm of Dunnington,
666 Third Avenue Bartholow & Miller. Prior to May 1994, he was a partner in
New York, NY 10017 the law firm of Fryer, Ross & Gowen. Mr. Gowen is a
director of Columbia Real Estate Investments, Inc. Mr.
Gowen is a director or trustee of 29 investment companies
for which Mitchell Hutchins or PaineWebber serves as
investment adviser.
Frederic V. Malek; 59 Trustee Mr. Malek is chairman of Thayer Capital Partners (investment
901 15th Street, N.W. bank) and a co-chairman and director of CB Commercial Group
Suite 300 Inc. (real estate). From January 1992 to November 1992, he
Washington, D.C. 20005 was campaign manager of Bush-Quayle '92. From 1990 to 1992,
he was vice chairman and, from 1989 to 1990, he was
president of Northwest Airlines Inc., NWA Inc. (holding
company of Northwest Airlines Inc.) and Wings Holdings Inc.
(holding company of NWA Inc.). Prior to 1989, he was
employed by the Marriott Corporation (hotels, restaurants,
airline catering and contract feeding), where he most
recently was an executive vice president and president of
Marriott Hotels and Resorts. Mr. Malek is also a director
of American Management Systems, Inc., Automatic Data
Processing, Inc., Avis, Inc., FPL Group, Inc., ICF
International Manor Care, Inc., National Education
Corporation and Northwest Airlines Inc. Mr. Malek is a
director or trustee of 29 investment companies for which
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS;* AGE WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------- ------------------------- -------------------------------------------------------------
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Carl W. Schafer; 60 Trustee Mr. Schafer is president of the Atlantic Foundation
P.O. Box 1164 (charitable foundation supporting mainly oceanographic
Princeton, NJ 08542 exploration and research). He also is a director of Roadway
Express, Inc. (trucking), The Guardian Group of Mutual
Funds, Evans Systems, Inc. (a motor fuels, convenience
store and diversified company), Hidden Lake Gold Mines Ltd.
(gold mining), Electronic Clearing House, Inc. (financial
transactions processing), Wainoco Oil Corporation and
Nutraceutix Inc. (biotechnology). Prior to January 1993,
Mr. Schafer was chairman of the Investment Advisory
Committee of the Howard Hughes Medical Institute. Mr.
Schafer is a director or trustee of 29 investment companies
for which Mitchell Hutchins or PaineWebber serves as
investment adviser.
<S> <C> <C>
John R. Torell III; 56 Trustee Mr. Torell is chairman of Torell Management, Inc. (financial
767 Fifth Avenue advisory firm), chairman of Telesphere Corporation
Suite 4605 (electronic provider of financial information), and a
New York, NY 10153 partner of Zilkha & Company (merchant banking and private
investment company). He is the former chairman and chief
executive officer of Fortune Bancorp (1990-1991 and
1990-1994, respectively), the former chairman, president
and chief executive officer of CalFed, Inc. (savings
association) (1988 to 1989) and former president of
Manufacturers Hanover Corp. (bank) (prior to 1988). Mr.
Torrell is also a director of American Home Products Corp.,
Volt Information Sciences Inc., and New Colt Inc. (armament
manufacturer). Mr. Torell is a director or trustee of 29
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Teresa M. Boyle; 37 Vice President Ms. Boyle is a first vice president and manager--advisory
administration of Mitchell Hutchins. Prior to November
1993, she was compliance manager of Hyperion Capital
Management, Inc., an investment advisory firm. Prior to
April 1993, Ms. Boyle was a vice president and manager--
legal administration of Mitchell Hutchins. Ms. Boyle is a
vice president of 30 investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Donald R. Jones; 35 Vice President Mr. Jones is a first vice president and a portfolio manager
of Mitchell Hutchins. Prior to February 1996, he was a vice
president in the asset management group of First Fidelity
Bancorporation. Mr. Jones is a vice president of two
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS;* AGE WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------- ------------------------- -------------------------------------------------------------
Thomas J. Libassi; 37 Vice President Mr. Libassi is a senior vice president and a portfolio
manager of Mitchell Hutchins. Prior to May 1994, he was a
vice president of Keystone Custodian Funds Inc. with
portfolio management responsibility. Mr. Libassi is a vice
president of four investment companies for which Mitchell
Hutchins serves as investment adviser.
<S> <C> <C>
C. William Maher; 35 Vice President and Mr. Maher is a first vice president and a senior manager of
Assistant Treasurer the mutual fund finance division of Mitchell Hutchins. Mr.
Maher is a vice president and assistant treasurer of 30
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Dennis McCauley; 49 Vice President Mr. McCauley is a managing director and chief investment
officer--fixed income of Mitchell Hutchins. Prior to
December 1994, he was director of fixed income investments
of IBM Corporation. Mr. McCauley is a vice president of 19
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Ann E. Moran; 38 Vice President and Ms. Moran is a vice president of Mitchell Hutchins. Ms. Moran
Assistant Treasurer is a vice president and assistant treasurer of 30
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Dianne E. O'Donnell; 43 Vice President and Ms. O'Donnell is a senior vice president and deputy general
Secretary counsel of Mitchell Hutchins. Ms. O'Donnell is a vice
president and secretary of 29 investment companies for
which Mitchell Hutchins or PaineWebber serves as investment
adviser.
Victoria E. Schonfeld; 45 Vice President Ms. Schonfeld is a managing director and general counsel of
Mitchell Hutchins. Prior to May 1994, she was a partner in
the law firm of Arnold & Porter. Ms. Schonfeld is a vice
president of 30 investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Paul H. Schubert; 33 Vice President and Mr. Schubert is a first vice president and a senior manager
Assistant Treasurer of the mutual fund finance division of Mitchell Hutchins.
From August 1992 to August 1994, he was a vice president at
BlackRock Financial Management L.P. Prior to August 1992,
he was an audit manager with Ernst & Young LLP. Mr.
Schubert is a vice president and assistant treasurer of 30
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Nirmal Singh; 39 Vice President Mr. Singh is a first vice president and a portfolio manager
of Mitchell Hutchins. Prior to September 1993, he was a
member of the portfolio management team at Merrill Lynch
Asset Management, Inc. Mr. Singh is a vice
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS;* AGE WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------- ------------------------- -------------------------------------------------------------
president of five investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Julian F. Sluyters; 35 Vice President and Mr. Sluyters is a senior vice president and the director of
Treasurer the mutual fund finance division of Mitchell Hutchins.
Prior to 1991, he was an audit senior manager with Ernst &
Young LLP. Mr. Sluyters is a vice president and treasurer
of 30 investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
<S> <C> <C>
Mark A. Tincher; 40 Vice President Mr. Tincher is a managing director and chief investment
officer--U.S. equity investments of Mitchell Hutchins.
Prior to March 1995, he was a vice president and directed
the U.S. funds management and equity research areas of
Chase Manhattan Private Bank. Mr. Tincher is a vice
president of 14 investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Craig M. Varrelman; 37 Vice President Mr. Varrelman is a first vice president and a portfolio
manager of Mitchell Hutchins. Mr. Varrelman is a vice
president of five investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Stuart Waugh; 40 Vice President Mr. Waugh is a managing director and a portfolio manager of
Mitchell Hutchins responsible for global fixed income
investments and currency trading. Mr. Waugh is a vice
president of five investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Keith A. Weller; 34 Vice President and Mr. Weller is a first vice president and associate general
Assistant Secretary counsel of Mitchell Hutchins. Prior to May 1995, he was an
attorney in private practice. Mr. Weller is a vice
president and assistant secretary of 29 investment
companies for which Mitchell Hutchins or PaineWebber serves
as investment adviser.
</TABLE>
- ------------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
** Mrs. Alexander, Mr. Bewkes and Ms. Farrell are 'interested persons' of the
Trust as defined in the 1940 Act by virtue of their positions with PW Group,
PaineWebber and/or Mitchell Hutchins.
The Trust pays trustees who are not 'interested persons' of the Trust
$1,000 annually for each series and $150 for each board meeting and each
separate meeting of a board committee. The Trust presently has two series and
thus pays each such trustee $2,000 annually, plus any additional amounts due for
board or committee meetings. Certain committee chairs receive additional
compensation aggregating $15,000 annually from all the funds within the
PaineWebber fund complex. Trustees of the Trust who are 'interested persons'
receive no compensation from the Trust. All trustees are reimbursed for any
expenses incurred in attending meetings. Trustees and officers of the Trust own
in the aggregate less than 1% of the shares of the Fund.
24
<PAGE>
The table below includes certain information relating to the compensation
of the Trust's current trustees who held office with the Trust or other
PaineWebber funds during the fiscal year ended January 31, 1996.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
FROM THE
TRUST AND
THE
AGGREGATE TRUST
COMPENSATION COMPLEX
FROM PAID TO
NAME OF PERSON, POSITION THE TRUST* TRUSTEES**
- ---------------------------------------- ------------ ------------
<S> <C> <C>
Richard Q. Armstrong, Trustee........... $1,563 $ 9,000
Richard R. Burt, Trustee................ 750 $ 7,750
Meyer Feldberg, Trustee................. -- $106,375
George W. Gowen, Trustee -- $ 99,750
Frederic V. Malek, Trustee.............. -- $ 99,750
Carl W. Schafer, Trustee................ -- $118,175
John R. Torell III, Trustee............. 2,563 28,125
</TABLE>
- ------------------
Only independent members of the board of trustees are compensated by the Trust
and identified above; trustees who are 'interested persons,' as defined by the
1940 Act, do not receive compensation.
* Represents fees paid to each trustee during the fiscal year ended January 31,
1996; the Trust does not have a pension or retirement plan.
** Represents total compensation paid to each trustee during the calendar year
ended December 31, 1995.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of the Fund pursuant to a contract dated January 28,
1993, as supplemented by a Fee Agreement dated January 28, 1994, with the Trust
('Advisory Contract'). Under the Advisory Contract, the Fund pays Mitchell
Hutchins a fee of 0.75%, computed daily and paid monthly. For the fiscal year
ended January 31, 1996 and the fiscal period February 7, 1994 (commencement of
operations) through January 31, 1995, the Fund paid (or accrued) to Mitchell
Hutchins investment advisory and administration fees of $546,119 and $603,811,
respectively.
Under a service agreement with the Trust, PaineWebber provides certain
services not otherwise provided by the Fund's transfer agent. The agreement is
reviewed by the Trust's board of trustees annually. During the fiscal year ended
January 31, 1996 and the fiscal period February 7, 1994 (commencement of
operations) through January 31, 1995, the Fund paid (or accrued) to PaineWebber
service fees of $19,823 and $21,998, respectively.
Under the terms of the Advisory Contract, the Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. Expenses borne by the Fund include the following: (1) the cost
(including brokerage commissions) of securities purchased or sold by the Fund
and any losses incurred in connection therewith; (2) fees payable to and
expenses incurred on behalf of the Fund by Mitchell Hutchins; (3) organizational
expenses; (4) filing fees and expenses relating to the registration and
qualification of the Fund's shares under federal and state securities laws and
maintenance of such registrations and qualifications; (5) fees and salaries
payable to trustees and officers who are not interested persons (as defined in
the 1940 Act) of the Fund or Mitchell Hutchins; (6) all expenses incurred in
connection
25
<PAGE>
with the trustees' services, including travel expenses; (7) taxes (including any
income or franchise taxes) and governmental fees; (8) costs of any liability,
uncollectable items of deposit and other insurance or fidelity bonds; (9) any
costs, expenses or losses arising out of a liability of or claim for damages or
other relief asserted against the Trust or the Fund for violation of any law;
(10) legal, accounting and auditing expenses, including legal fees of special
counsel for the independent trustees; (11) charges of custodians, transfer
agents and other agents; (12) costs of preparing share certificates; (13)
expenses of setting in type and printing prospectuses, statements of additional
information and supplements thereto, reports and proxy materials for existing
shareholders, and costs of mailing such materials to shareholders; (14) any
extraordinary expenses (including fees and disbursements of counsel) incurred by
the Fund; (15) fees, voluntary assessments and other expenses incurred in
connection with membership in investment company organizations; (16) costs of
mailing and tabulating proxies and costs of meetings of shareholders, the board
and any committees thereof; (17) the cost of investment company literature and
other publications provided to trustees and officers and (18) costs of mailing,
stationery and communications equipment.
As required by state regulation, Mitchell Hutchins will reimburse the Fund
if and to the extent that the aggregate operating expenses of the Fund in any
fiscal year exceed applicable limits. Currently, the most restrictive such limit
applicable to the Fund is 2.5% of the first $30 million of the Fund's average
daily net assets, 2.0% of the next $70 million of its average daily net assets
and 1.5% of its average daily net assets in excess of $100 million. Certain
expenses, such as brokerage commissions, taxes, interest, distribution fees,
certain expenses attributable to investing outside the United States and
extraordinary items, are excluded from this limitation. No reimbursement
pursuant to this limitation was required for the fiscal year ended January 31,
1996 and the fiscal period February 7, 1994 (commencement of operations) to
January 31, 1995.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
Mitchell Hutchins in the performance of its duties or from reckless disregard of
its duties and obligations thereunder. The Advisory Contract terminates
automatically upon assignment and is terminable at any time without penalty by
the board of trustees or by vote of the holders of a majority of the Fund's
outstanding voting securities on 60 days' written notice to Mitchell Hutchins,
or by Mitchell Hutchins on 60 days' written notice to the Fund.
The following table shows the approximate net assets as of April 30, 1996,
sorted by category of investment objective, of the investment companies as to
which Mitchell Hutchins serves as adviser or sub-adviser. An investment company
may fall into more than one of the categories below.
<TABLE>
<CAPTION>
NET
ASSETS
INVESTMENT CATEGORY ($ MIL)
---------------------------------------- --------
<S> <C>
Domestic (excluding Money Market)....... $5,589.0
Global.................................. 2,851.3
Equity/Balanced......................... 3,052.1
Fixed Income (excluding Money Market)... 5,388.2
Taxable Fixed Income............... 3,736.1
Tax-Free Fixed Income.............. 1,652.1
Money Market Funds...................... 21,751.2
</TABLE>
26
<PAGE>
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of the PaineWebber mutual funds and other Mitchell Hutchins'
advisory accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition, the code of ethics puts restrictions on the timing of
personal investing in relation to trades by PaineWebber mutual funds and other
Mitchell Hutchins advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
the Class Y shares of the Fund under a distribution contract with the Trust
dated June 3, 1996 ('Distribution Contract') that requires Mitchell Hutchins to
use its best efforts, consistent with its other businesses, to sell shares of
the Fund. Shares of the Fund are offered continuously. Under an exclusive dealer
agreement between Mitchell Hutchins and PaineWebber dated June 3, 1996 relating
to the Class Y shares of the Fund ('Exclusive Dealer Agreement'), PaineWebber
and its correspondent firms sell the Fund's shares.
PORTFOLIO TRANSACTIONS
Subject to policies established by the board of trustees, Mitchell Hutchins
is responsible for the execution of the Fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
Mitchell Hutchins seeks to obtain the best net results for the Fund, taking into
account such factors as the price (including the applicable brokerage commission
or dealer spread), size of the order, difficulty of execution and operational
facilities of the firm involved. While Mitchell Hutchins generally seeks
reasonably competitive commission rates, payment of the lowest commission is not
necessarily consistent with obtaining the best net results. Generally, fixed
income securities are traded on the OTC market on a 'net' basis without a stated
commission through dealers acting for their own account and not as brokers.
Prices paid to dealers generally include a 'spread,' which is the difference
between the prices at which the dealer is willing to purchase and sell a
specific security at the time. The Fund has paid no brokerage commissions since
its inception.
The Fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The Fund contemplates that, consistent
with obtaining the best net results, brokerage transactions may be conducted
through Mitchell Hutchins or any of its affiliates, including PaineWebber. The
Trust's board of trustees has adopted procedures in conformity with Rule 17e-1
under the 1940 Act to ensure that all brokerage commissions paid to Mitchell
Hutchins or any of its affiliates are reasonable and fair. Specific provisions
in the Advisory Contract authorize Mitchell Hutchins and any affiliate thereof
which is a member of a national securities exchange to effect portfolio
transactions for the Fund on such exchange and to retain compensation in
connection with such transactions. Any such transactions will be effected and
related compensation paid only in accordance with applicable SEC regulations.
The Fund has paid no brokerage commissions to PaineWebber since its inception.
Transactions in futures contracts are executed through futures commission
merchants ('FCMs'). The Fund's procedures in selecting FCMs to execute the
Fund's transactions in futures contracts, including procedures permitting the
use of Mitchell Hutchins and its affiliates, are similar to those in effect with
respect to brokerage transactions in securities.
Consistent with the Fund's interests and subject to the review of the
Trust's board of trustees, Mitchell Hutchins may cause the Fund to purchase and
sell portfolio securities from and to dealers, or through brokers, which provide
the Fund with research, analysis, advice and similar services. In return for
such services, the Fund may pay to those brokers a higher commission than may be
charged by other brokers, provided that Mitchell Hutchins determines in good
faith that such commission is reasonable in terms either of that particular
transaction or of the overall responsibility of Mitchell Hutchins to the Fund
and its other clients and that the total commissions paid by the Fund
27
<PAGE>
will be reasonable in relation to the benefits to the Fund over the long term.
During the fiscal year ended January 31, 1996, the Fund directed no portfolio
transactions to brokers chosen because they provided research services.
Portfolio transactions will not be directed by the Fund to dealers solely
on the basis of research services provided. For purchases or sales with
broker-dealer firms which act as principal, Mitchell Hutchins seeks best
execution. Although Mitchell Hutchins may receive certain research or execution
services in connection with these transactions, Mitchell Hutchins will not
purchase securities at a higher price or sell securities at a lower price than
would otherwise be paid if no weight was attributed to the services provided by
the executing dealer. Moreover, Mitchell Hutchins will not enter into any
explicit soft dollar arrangements relating to principal transactions and will
not receive in principal transactions the types of services which could be
purchased for hard dollars. Mitchell Hutchins may engage in agency transactions
in OTC equity and debt securities in return for research and execution services.
These transactions are entered into only in compliance with procedures ensuring
that the transaction (including commissions) is at least as favorable as it
would have been if effected directly with a market-maker that did not provide
research or execution services. These procedures include Mitchell Hutchins
receiving multiple quotes from dealers before executing the transactions on an
agency basis.
Research services furnished by dealers or brokers with or through which the
Fund effects securities transactions may be used by Mitchell Hutchins in
advising other funds or accounts and, conversely, research services furnished to
Mitchell Hutchins by dealers or brokers in connection with other funds or
accounts Mitchell Hutchins advises may be used by Mitchell Hutchins in advising
the Fund. Information and research received from such brokers or dealers will be
in addition to, and not in lieu of, the services required to be performed by
Mitchell Hutchins under the Advisory Contract.
Investment decisions for the Fund and for other investment accounts managed
by Mitchell Hutchins will be made independently of each other in the light of
differing considerations for the various accounts. The same investment decision,
however, may occasionally be made for the Fund and one or more of such accounts.
In such cases, simultaneous transactions are inevitable. Purchases or sales are
then averaged as to price and allocated between the Fund and such other
account(s) as to amount according to a formula deemed equitable to the Fund and
such account(s). While in some cases this practice could have a detrimental
effect upon the price or value of the security as far as the Fund is concerned
or upon its ability to complete its entire order, in other cases it is believed
that coordination and the ability to participate in volume transactions will be
beneficial to the Fund.
The Fund will not purchase securities that are offered in underwritings in
which Mitchell Hutchins or any of its affiliates is a member of the underwriting
or selling group except pursuant to the procedures adopted by the Trust's board
of trustees in conformity with Rule 10f-3 under the 1940 Act. Among other
things, these procedures require that the commission or spread paid in
connection with such a purchase be reasonable and fair, that the purchase be at
not more than the public offering price prior to the end of the first business
day after the date of the public offering and that Mitchell Hutchins and its
affiliates not participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER
Portfolio turnover may vary greatly from year to year and will not be a
limiting factor when Mitchell Hutchins deems portfolio changes appropriate. A
higher turnover rate may involve correspondingly greater transaction costs,
which will be borne directly by the Fund. The Fund's annual portfolio turnover
rate will be calculated by dividing the lesser of the Fund's annual sales or
purchases of portfolio securities (exclusive of purchases or sales of securities
whose maturities at the time of acquisition were one year or less) by the
monthly average value of the long-term securities in the portfolio during the
year. During the fiscal year ended January 31, 1996 and the fiscal period
February 7, 1994
28
<PAGE>
(commencement of operations) through January 31, 1995, the portfolio turnover
rate was 91% and 117%, respectively.
VALUATION OF SHARES
The Fund determines the net asset value per share for Class Y shares as of
the close of regular trading (currently 4:00 p.m., Eastern time) on the NYSE on
each Business Day. Currently the NYSE is closed on the observance of the
following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Securities that are listed on U.S. and foreign stock exchanges are valued
at the last sale price on the date the securities are valued or, lacking any
sales on such day, at the last available bid price. In cases where securities
are traded on more than one exchange, the securities are generally valued on the
exchange considered by Mitchell Hutchins as the primary market. Securities
traded in the OTC market and listed on the Nasdaq Stock Market ('Nasdaq') are
valued at the last trade price on Nasdaq at 4:00 p.m., Eastern time; other OTC
securities are valued at the last bid price available prior to valuation.
Futures contracts, forward currency contracts and options are valued on the
basis of market quotations, if any. Securities and assets for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Trust's board of trustees. All
investments quoted in foreign currency are valued daily in U.S. dollars on the
basis of the foreign currency exchange rate prevailing at the time such
valuation is determined by the Fund's custodian.
Foreign currency exchange rates are generally determined prior to the close
of trading on the NYSE. Occasionally events affecting the value of foreign
investments and such exchange rates occur between the time at which they are
determined and the close of regular trading on the NYSE, which events will not
be reflected in a computation of the Fund's net asset value on that day. If
events materially affecting the value of such investments or currency exchange
rates occur during such time period, the investments will be valued at their
fair value as determined in good faith by or under the direction of the Trust's
board of trustees. The foreign currency exchange transactions of the Fund
conducted on a spot (that is, cash) basis are valued at the spot rate for
purchasing or selling currency prevailing on the foreign exchange market. This
rate under normal market conditions differs from the prevailing exchange rate in
an amount generally less than one-tenth of one percent due to the costs of
converting from one currency to another.
PERFORMANCE INFORMATION
The Fund's performance data quoted in advertising and other promotional
materials ('Performance Advertisements') represents past performance and are not
intended to indicate future performance. The investment return and principal
value of an investment will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes
('Standardized Return') used in the Fund's Performance Advertisements are
calculated according to the following formula:
<TABLE>
<S> <C> <C> <C>
P(1 + T)n = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares of Class Y
T = average annual total return of shares of Class Y
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at the beginning of
that period.
</TABLE>
29
<PAGE>
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or 'T' in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over the
period. All dividends and other distributions are assumed to have been
reinvested at net asset value.
The Fund also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ('Non-Standardized Return'). The Fund calculates Non-Standardized Return
for specified periods of time by assuming an investment of $1,000 in Fund shares
and assuming the reinvestment of all dividends and other distributions. The rate
of return is determined by subtracting the initial value of the investment from
the ending value and by dividing the remainder by the initial value.
YIELD. Yields used in the Fund's Performance Advertisements are calculated
by dividing the Fund's interest income attributable to a Class of shares for a
30-day period ('Period'), net of expenses attributable to such Class, by the
average number of shares of such Class entitled to receive dividends during the
Period and expressing the result as an annualized percentage (assuming
semiannual compounding) of the net asset value per share at the end of the
Period. Yield quotations are calculated according to the following formula:
<TABLE>
<C> <C> <S>
6
YIELD = 2[ (a - b + 1) - 1 ]
------
cd
where: a = interest earned during the Period attributable to a Class of shares
expenses accrued for the Period attributable to a Class of shares (net of
reimbursements) the average daily number of shares of the Class outstanding
b = during the Period that were
c = entitled to receive dividends
d = the net asset value per share on the last day of the Period.
</TABLE>
Except as noted below, in determining interest income earned during the
Period (variable 'a' in the above formula), the Fund calculates interest earned
on each debt obligation held by it during the Period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the Period or,
if the obligation was purchased during the Period, the purchase price plus
accrued interest and (2) dividing the yield to maturity by 360, and multiplying
the resulting quotient by the market value of the obligation (including actual
accrued interest) to determine the interest income on the obligation for each
day of the period that the obligation is in the portfolio. Once interest earned
is calculated in this fashion for each debt obligation held by the Fund,
interest earned during the Period is then determined by totalling the interest
earned on all debt obligations. For purposes of these calculations, the maturity
of an obligation with one or more call provisions is assumed to be the next date
on which the obligation reasonably can be expected to be called or, if none, the
maturity date.
OTHER INFORMATION. In Performance Advertisements, the Fund may compare its
Standardized Return and/or its Non-Standardized Return with data published by
Lipper Analytical Services, Inc. ('Lipper'), CDA Investment Technologies, Inc.
('CDA'), Wiesenberger Investment Companies Service ('Wiesenberger'), Investment
Company Data, Inc. ('ICD') or Morningstar Mutual funds ('Morningstar'), with the
performance of recognized stock and other indices, including (but not limited
to) the Standard & Poor's 500 Composite Stock Price Index, the Dow Jones
Industrial Average, the Russell 2000 Index, the Wilshire 5000 Index, the Lehman
Aggregate Bond Index, the Salomon Brothers High Yield Index, the Salomon
Brothers World Government Bond Index, the Merrill Lynch High Yield Index,
30-year and 10-year U.S. Treasury bonds, the Morgan Stanley Capital
International World Index and changes in the Consumer Price Index as published
by the U.S. Department of Commerce. The Fund also may refer
30
<PAGE>
in such materials to mutual fund performance rankings and other data, such as
comparative asset, expense and fee levels, published by Lipper, CDA,
Wiesenberger, ICD or Morningstar. Performance Advertisements also may refer to
discussions of the Fund and comparative mutual fund data and ratings reported in
independent periodicals, including (but not limited to) The Wall Street Journal,
Money Magazine, Forbes, Business Week, Financial World, Barron's, Fortune, The
New York Times, The Chicago Tribune, The Washington Post and The Kiplinger
Letters. Comparisons in Performance Advertisements may be in graphic form.
The Fund may include discussions or illustrations of the effects of
compounding in Performance Advertisements. 'Compounding' refers to the fact
that, if dividends or other distributions on a Fund investment are reinvested by
being paid in additional Fund shares, any future income or capital appreciation
of the Fund would increase the value, not only of the original Fund investment,
but also of the additional Fund shares received through reinvestment. As a
result, the value of the Fund investment would increase more quickly than if
dividends or other distributions had been paid in cash.
The Fund may also compare its performance with the performance of bank
certificates of deposit ('CDs') as measured by the CDA Certificate of Deposit
Index, the Bank Rate Monitor National Index and the averages of yields of CDs of
major banks published by Banxquote (R) Money Markets. In comparing the Fund's
performance to CD performance, investors should keep in mind that bank CDs are
insured in whole or in part by an agency of the U.S. government and offer fixed
principal and fixed or variable rates of interest, and that bank CD yields may
vary depending on the financial institution offering the CD and prevailing
interest rates. Shares of the Fund are not insured or guaranteed by the U.S.
government and returns and net asset value will fluctuate. The securities held
by the Fund generally have longer maturities than most CDs and may reflect
interest rate fluctuations for longer term securities.
TAXES
In order to continue to qualify for treatment as a regulated investment
company ('RIC') under the Internal Revenue Code, the Fund must distribute to its
shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income, net short-term
capital gain and net gains from certain foreign currency transactions)
('Distribution Requirement') and must meet several additional requirements.
Among these requirements are the following: (1) the Fund must derive at least
90% of its gross income each taxable year from dividends, interest, payments
with respect to securities loans and gains from the sale or other disposition of
securities or foreign currencies, or other income (including gains from options,
futures or forward currency contracts) derived with respect to its business of
investing in securities or those currencies ('Income Requirement'); (2) the Fund
must derive less than 30% of its gross income each taxable year from the sale or
other disposition of securities, or any of the following, that were held for
less than three months-options, futures or forward contracts (other than those
on foreign currencies), or foreign currencies (or options, futures or forward
contracts thereon) that are not directly related to the Fund's principal
business of investing in securities (or options and futures with respect to
securities) ('Short-Short Limitation'); (3) at the close of each quarter of the
Fund's taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. government securities, securities of
other RICs and other securities, with these other securities limited, in respect
of any one issuer, to an amount that does not exceed 5% of the value of the
Fund's total assets and that does not represent more than 10% of the issuer's
outstanding voting securities; and (4) at the close of each quarter of the
Fund's taxable year, not more than 25% of the value of its total assets may be
invested in securities (other than U.S. government securities or the securities
of other RICs) of any one issuer.
31
<PAGE>
Dividends and other distributions declared by the Fund in October, November
or December of any year and payable to shareholders of record on a date in any
of those months will be deemed to have been paid by the Fund and received by the
shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. Accordingly, those distributions will be
taxed to shareholders for the year in which that December 31 falls.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares. Investors
also should be aware that, if shares are purchased shortly before the record
date for any dividend or capital gain distribution, the investor will pay full
price for the shares and receive some portion of the price back as a taxable
distribution.
The Fund will be subject to a nondeductible 4% excise tax ('Excise Tax') to
the extent it fails to distribute by the end of any calendar year substantially
all of its ordinary income for that year and capital gain net income for the
one-year period ending on October 31 of that year, plus certain other amounts.
Interest and dividends on foreign securities received by the Fund may be
subject to income, withholding or other taxes imposed by foreign countries and
U.S. possessions that would reduce the yield on its securities. Tax conventions
between certain countries and the United States may reduce or eliminate these
foreign taxes, however, and many foreign countries do not impose taxes on
capital gains in respect of investments by foreign investors. If more than 50%
of the value of the Fund's total assets at the close of its taxable year
consists of securities of foreign corporations, it will be eligible to, and may,
file an election with the Internal Revenue Service that will enable its
shareholders, in effect, to receive the benefit of the foreign tax credit with
respect to any foreign and U.S. possessions income taxes paid by it for that
year. Pursuant to the election, the Fund would treat those taxes as dividends
paid to its shareholders and each shareholder would be required to (1) include
in gross income, and treat as paid by him, his proportionate share of those
taxes, (2) treat his share of those taxes and of any dividend paid by the Fund
that represents income from foreign or U.S. possessions sources as his own
income from those sources and (3) either deduct the taxes deemed paid by him in
computing his taxable income or, alternatively, use the foregoing information in
calculating the foreign tax credit against his federal income tax. The Fund will
report to its shareholders within 60 days after the end of each taxable year
their respective shares of the income from sources within, and taxes paid to,
foreign countries and U.S. possessions if it makes this election. Potential
investors should note, however, that the Fund expects that it normally will not
satisfy the above-referenced 50%-of-assets test and that, as a result, it
normally will be unable to make the election, with the consequence that foreign
and U.S. possessions taxes imposed on the Fund would not be deductible or
creditable by its shareholders.
The Fund may invest in the stock of 'passive foreign investment companies'
('PFICs'). A PFIC is a foreign corporation that, in general, meets either of the
following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, the Fund will be subject to
federal income tax on a portion of any 'excess distribution' received on the
stock of a PFIC or of any gain on disposition of that stock (collectively 'PFIC
income'), plus interest thereon, even if the Fund distributes the PFIC income as
a taxable dividend to its shareholders. The balance of the PFIC income will be
included in the Fund's investment company taxable income and, accordingly, will
not be taxable to it to the extent that income is distributed to its
shareholders.
If the Fund invests in a PFIC and elects to treat the PFIC as a 'qualified
electing fund,' then, in lieu of the foregoing tax and interest obligation, the
Fund will be required to include in income each year its pro rata share of the
qualified electing fund's annual ordinary earnings and net capital gain (the
excess of net long-term capital gain over net short-term capital loss)--which
the Fund likely would have to distribute to satisfy the Distribution Requirement
32
<PAGE>
and avoid imposition of the Excise Tax--even if those earnings and gain are not
received by the Fund. In most instances it will be very difficult, if not
impossible, to make this election because of certain requirements thereof.
Pursuant to proposed regulations, open-end RICs, such as the Fund, would be
entitled to elect to 'mark-to-market' their stock in certain PFICs.
'Marking-to-market,' in this context, means recognizing as gain for each taxable
year the excess, as of the end of that year, of the fair market value of each
such PFIC's stock over the adjusted basis in that stock (including
mark-to-market gain for each prior year for which an election was in effect).
The Fund may acquire zero coupon or other securities issued with OID. As a
holder of such securities, the Fund would have to include in its gross income
the OID that accrues on the securities during the taxable year, even if it
receives no corresponding payment on them during the year. Similarly, the Fund
must include in its gross income securities it receives as 'interest' on
payment-in-kind securities. Because the Fund annually must distribute
substantially all of its investment company taxable income, including any
accrued OID and other non-cash income, to satisfy the Distribution Requirement
and avoid imposition of the Excise Tax, the Fund may be required in a particular
year to distribute as a dividend an amount that is greater than the total amount
of cash it actually receives. Those distributions will be made from the Fund's
cash assets or from the proceeds of sales of portfolio securities, if necessary.
The Fund may realize capital gains or losses from those sales, which would
increase or decrease its investment company taxable income and/or net capital
gain. In addition, any such gains may be realized on the disposition of
securities held for less than three months. Because of the Short-Short
Limitation, any such gains would reduce the Fund's ability to sell other
securities, or certain options, futures, forward currency contracts or foreign
currency positions, held for less than three months that it might wish to sell
in the ordinary course of its portfolio management.
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the character
and timing of recognition of the gains and losses the Fund realizes in
connection therewith. Gains from the disposition of foreign currencies (except
certain gains that may be excluded by future regulations), and gains from
options, futures and forward currency contracts derived by the Fund with respect
to its business of investing in securities or foreign currencies, will qualify
as permissible income under the Income Requirement. However, income from the
disposition of options and futures contracts (other than those on foreign
currencies) will be subject to the Short-Short Limitation if they are held for
less than three months. Income from the disposition of foreign currencies, and
options, futures and forward contracts on foreign currencies also will be
subject to the Short-Short Limitation if they are held for less than three
months and are not directly related to the Fund's principal business of
investing in securities (or options and futures with respect to securities).
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a 'designated hedge' will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
Short-Short Limitation. Thus, only the net gain (if any) from the designated
hedge will be included in gross income for purposes of that limitation. The Fund
will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent the Fund does not qualify for this
treatment, it may be forced to defer the closing out of certain options,
futures, forward currency contracts and foreign currency positions beyond the
time when it otherwise would be advantageous to do so, in order for the Fund to
continue to qualify as a RIC.
33
<PAGE>
OTHER INFORMATION
PaineWebber Securities Trust is an entity of the type commonly known as a
'Massachusetts business trust.' Under Massachusetts law, shareholders of the
Fund could, under certain circumstances, be held personally liable for the
obligations of the Trust or the Fund. However, the Declaration of Trust
disclaims shareholder liability for acts or obligations of the Trust or the Fund
and requires that notice of such disclaimer be given in each note, bond,
contract, instrument, certificate or undertaking made or issued by the trustees
or by any officers or officer by or on behalf of the Trust or the Fund, the
trustees or any of them in connection with the Trust. The Declaration of Trust
provides for indemnification from the Fund's property for all losses and
expenses of any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder's incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund itself would
be unable to meet its obligations, a possibility that Mitchell Hutchins believes
is remote and not material. Upon payment of any liability incurred by a
shareholder solely by reason of being or having been a shareholder, the
shareholder paying such liability will be entitled to reimbursement from the
general assets of the Fund. The trustees intend to conduct the operations of the
Fund in such a way as to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of the Fund.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C., 20036-1800, counsel to the Trust, has passed
upon the legality of the shares offered by the Prospectus. Kirkpatrick &
Lockhart LLP also acts as counsel to PaineWebber and Mitchell Hutchins in
connection with other matters.
INDEPENDENT ACCOUNTANTS. Price Waterhouse LLP, 1177 Avenue of the
Americas, New York, NY 10036, serves as independent accountants for the Fund.
FINANCIAL STATEMENTS
The Fund's Annual Report to Shareholders for the fiscal year ended January
31, 1996 is a separate document supplied with this Statement of Additional
Information and the financial statements, accompanying notes and report of
independent accountants appearing therein are incorporated herein by this
reference.
34
<PAGE>
No person has been authorized to give any information or to make any
representations not contained in the Prospectus or in this Statement of
Additional Information in connection with the offering made by the Prospectus
and, if given or made, such information or representations must not be relied
upon as having been authorized by the Fund or its distributor. The Prospectus
and this Statement of Additional Information do not constitute an offering by
the Fund or by the distributor in any jurisdiction in which such offering may
not lawfully be made.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Investment Policies and Restrictions............ 1
Hedging and Related Income Strategies........... 12
Trustees and Officers........................... 20
Investment Advisory and Distribution
Arrangements.................................. 25
Portfolio Transactions.......................... 27
Valuation of Shares............................. 29
Performance Information......................... 29
Taxes........................................... 31
Other Information............................... 34
Financial Statements............................ 34
</TABLE>
(Copyright) 1996 PaineWebber Incorporated
PaineWebber
Strategic
Income Fund
Class Y Shares
------------------------------------------------------
Statement of Additional Information
June 3, 1996
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PaineWebber
