PAINEWEBBER U.S. GOVERNMENT INCOME FUND
PAINEWEBBER LOW DURATION U.S. GOVERNMENT INCOME FUND
PAINEWEBBER INVESTMENT GRADE INCOME FUND
PAINEWEBBER HIGH INCOME FUND
PAINEWEBBER STRATEGIC INCOME FUND
51 WEST 52ND STREET
NEW YORK, NEW YORK 10019-6114
STATEMENT OF ADDITIONAL INFORMATION
The five funds named above are series of professionally managed open-end
management investment companies (each a "Trust"). PaineWebber U.S. Government
Income Fund, PaineWebber Low Duration U.S. Government Income Fund ("Low Duration
Fund"), PaineWebber Investment Grade Income Fund and PaineWebber High Income
Fund are diversified series of PaineWebber Managed Investments Trust ("Managed
Trust"). PaineWebber Strategic Income Fund is a non-diversified series of
PaineWebber Securities Trust ("Securities Trust").
The investment adviser, administrator and distributor for each fund is
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
asset management subsidiary of PaineWebber Incorporated ("PaineWebber"). As
distributor for the funds, Mitchell Hutchins has appointed PaineWebber to serve
as the exclusive dealer for the sale of fund shares. Pacific Investment
Management Company ("PIMCO" or "sub-adviser") serves as sub-adviser for Low
Duration Fund.
Portions of each fund's Annual Report to Shareholders are incorporated by
reference into this Statement of Additional Information ("SAI"). The Annual
Reports accompany this SAI. You may obtain an additional copy of a fund's Annual
Report by calling toll-free 1-800-647-1568.
This SAI is not a prospectus and should be read only in conjunction with
the funds' current Prospectus, dated March 31, 2000. A copy of the Prospectus
may be obtained by calling any PaineWebber Financial Advisor or correspondent
firm or by calling toll-free 1-800-647-1568. This SAI is dated March 31, 2000.
TABLE OF CONTENTS
PAGE
The Funds and Their Investment Policies...................................2
The Funds' Investments, Related Risks and Limitations.....................4
Strategies Using Derivative Instruments..................................25
Organization; Trustees and Officers; Principal Holders and
Management Ownership of Securities....................................34
Investment Advisory, Administration and Distribution Arrangements........44
Portfolio Transactions...................................................51
Reduced Sales Charges, Additional Exchange and Redemption
Information and Other Services........................................54
Conversion of Class B Shares.............................................59
Valuation of Shares......................................................59
Performance Information..................................................60
Taxes....................................................................64
Other Information........................................................68
Financial Statements.....................................................69
Appendix................................................................A-1
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THE FUNDS AND THEIR INVESTMENT POLICIES
No fund's investment objective may be changed without shareholder
approval. Except where noted, the other investment policies of each fund may be
changed by its board without shareholder approval. As with other mutual funds,
there is no assurance that a fund will achieve its investment objective.
U.S. GOVERNMENT INCOME FUND AND LOW DURATION FUND. U.S. Government
Income Fund's investment objective is high current income consistent with the
preservation of capital and liquidity. Low Duration Fund's investment
objective is to achieve the highest level of income consistent with the
preservation of capital and low volatility of net asset value.
Low Duration Fund seeks to limit (but not eliminate) the volatility of net
asset value by normally maintaining an overall portfolio duration between one to
three years. U.S. Government Income Fund has no fixed portfolio duration policy.
"Duration" is a measure of the expected life of a fixed income security on a
present value basis and thus is a measure of interest rate risk.
Each fund normally invests at least 65% of its total assets in U.S.
government bonds (including mortgage-backed securities) and repurchase
agreements with respect to them. Each fund may invest up to 35% of its total
assets in privately issued mortgage- and asset-backed securities that, at the
time of purchase, are rated in the highest rating category by Standard & Poor's,
a division of The McGraw-Hill Companies, Inc. ("S&P"), Moody's Investors
Service, Inc. ("Moody's") or another nationally or internationally recognized
statistical rating organization ("rating agency") or, if unrated, are considered
to be of comparable quality by Mitchell Hutchins (or for Low Duration Fund the
sub-adviser).
Each fund has a fundamental policy of normally concentrating at least 25%
of its total assets in U.S. government and privately issued mortgage- and
asset-backed securities. This policy has the effect of increasing each fund's
exposure to the risks of these securities and might cause a fund's net asset
value to fluctuate more than otherwise would be the case. Some types of
mortgage-backed securities, including "interest only," "principal only" and
inverse floating classes of these securities, can be extremely volatile and may
become illiquid. Low Duration Fund does not invest in these classes of
mortgage-backed securities.
Each fund normally invests at least 65% of its total assets in
income-producing securities, which may include zero coupon bonds, other original
issue discount securities and (for U.S. Government Income Fund) principal only
mortgage-backed securities.
U.S. Government Income Fund may invest up to 10% of its net assets in
illiquid securities. Low Duration Fund may invest up to 15% of its net assets in
illiquid securities. Each fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33 1/3% of its
total assets. Each fund may purchase securities on a when-issued or delayed
delivery basis. Each fund may engage in dollar rolls and reverse repurchase
agreements, which are considered borrowings. A fund's borrowings may not exceed
33 1/3% of its total assets, except that each fund may borrow an additional 5%
of its total assets for temporary or emergency purposes. Each fund may invest in
the securities of other investment companies and may sell short "against the
box."
INVESTMENT GRADE INCOME FUND'S investment objective is to provide high
current income consistent with the preservation of capital and liquidity. The
fund normally invests at least 65% of its total assets in U.S. government and
investment grade corporate bonds, including mortgage-backed securities and money
market instruments. The fund's investments in money market instruments may
include repurchase agreements and commercial paper or variable amount master
notes whose issuers, at the time the security is purchased by the fund, have
outstanding either long-term bonds that are rated investment grade by S&P or
Moody's or commercial paper rated in the highest rating category by S&P or
Moody's. The fund also may invest up to 35% of its total assets in (1) corporate
bonds that are below investment grade, (2) preferred stocks, (3) convertible
securities and (4) asset-backed securities other than mortgage-backed
securities.
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Investment Grade Income Fund's ability to invest in mortgage- and
asset-backed securities is limited. The fund may invest in mortgage-backed
securities only if they are U.S. government issued or guaranteed or if, at the
time of purchase, they are investment grade. The fund may invest in asset-backed
securities only if, at the time of purchase, they are rated in one of the two
highest rating categories by S&P or Moody's. Also, the fund may not invest more
than 10% of its total assets in interest only and principal only classes of
mortgage-backed securities.
Up to 20% of Investment Grade Income Fund's net assets may be invested
in certain foreign securities. These are (1) U.S. dollar denominated
securities of foreign issuers or of foreign branches of U.S. banks that are
traded in the U.S. securities markets and (2) securities that are U.S. dollar
denominated but whose value is linked to the value of foreign currencies.
Investment Grade Income Fund normally invests at least 65% of its total
assets in income-producing securities, which may include zero coupon bonds,
other original issue discount securities, payment-in-kind securities and
principal only mortgage-backed securities. The fund also may invest up to 5% of
its net assets in fixed and floating rate loans through either participations in
or assignments of all or a portion of loans made by banks.
Investment Grade Income Fund may invest up to 10% of its net assets in
illiquid securities. The fund may purchase securities on a when-issued or
delayed delivery basis. The fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33 1/3% of its
total assets. The fund may borrow money from banks or through reverse repurchase
agreements for temporary or emergency purposes, but not in excess of 10% of its
total assets. The fund may invest in the securities of other investment
companies and may sell short "against the box."
HIGH INCOME FUND'S investment objective is to provide high income. The
fund normally invests at least 65% of its total assets in high yield,
income-producing corporate bonds that, at the time of purchase, are rated B or
better by S&P or Moody's, are comparably rated by another rating agency or, if
unrated, are considered to be of comparable quality by Mitchell Hutchins. The
fund may include in this 65% of its total assets any equity securities
(including common stocks and rights and warrants for equity securities) that are
attached to corporate bonds or are part of a unit including corporate bonds, so
long as the corporate bonds meet these quality requirements. The fund also may
invest up to 35% of its total assets in (1) bonds that are rated below B (and
rated as low as D by S&P or C by Moody's) or comparable unrated bonds, (2) U.S.
government bonds, (3) equity securities and (4) money market instruments,
including repurchase agreements.
Up to 35% of High Income Fund's net assets may be invested in securities
of foreign issuers, including securities that are U.S. dollar denominated but
whose value is linked to the value of foreign currencies. However, no more than
10% of the fund's net assets may be invested in securities of foreign issuers
that are denominated and traded in currencies other than the U.S. dollar.
Up to 25% of High Income Fund's total assets may be invested in bonds and
equity securities that are not paying current income. The fund may purchase
these securities if Mitchell Hutchins believes they have a potential for capital
appreciation.
High Income Fund normally invests at least 65% of its total assets in
income-producing securities, which may include zero coupon bonds, other original
issue discount securities, payment-in-kind securities and principal only
mortgage backed securities. The fund also may invest up to 5% of its net assets
in fixed and floating rate loans through either participations in or assignments
of all or a portion of loans made by banks.
High Income Fund may invest up to 10% of its net assets in illiquid
securities. The fund may purchase securities on a when-issued or delayed
delivery basis. The fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33 1/3% of its
total assets. The fund may borrow money from banks or through reverse repurchase
agreements for temporary or emergency purposes but not in excess of 10% of its
total assets. The fund may invest in the securities of other investment
companies and may sell short "against the box."
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STRATEGIC INCOME FUND'S primary investment objective is to achieve a high
level of current income. As a secondary investment objective, the fund seeks
capital appreciation. The fund strategically allocates its investments among
three distinct bond market categories: (1) U.S. government and investment grade
corporate bonds, including mortgage- and asset-backed securities; (2) U.S. high
yield corporate bonds, including convertible bonds, and preferred stock; and (3)
foreign and emerging market bonds. A portion of the fund's assets normally is
invested in each of these investment sectors. However, the fund has the
flexibility at any time to invest all or substantially all of its investments in
any one sector.
Strategic Income Fund may invest in high yield bonds that are rated as low
as D by S&P or C by Moody's.
The foreign and emerging market bonds in which Strategic Income Fund may
invest include (1) government bonds, including Brady bonds and other sovereign
debt, and bonds issued by multi-national institutions such as the International
Bank for Reconstruction and Development and the International Monetary Fund, (2)
corporate bonds and preferred stock issued by entities located in foreign
countries, or denominated in or indexed to foreign currencies, (3) interests in
foreign loan participations and assignments, and (4) foreign mortgage-backed
securities and other structured foreign investments. The fund may invest without
limit in securities of issuers located in any country in the world, including
both industrialized and emerging market countries. The fund generally is not
restricted in the portion of its assets that may be invested in a single country
or region, but its assets normally are invested in issuers located in at least
three countries. No more than 25% of the fund's total assets are invested in
securities issued or guaranteed by any single foreign government. The fund may
invest in foreign and emerging market bonds that do not meet any minimum credit
rating standard or that are unrated.
Mitchell Hutchins believes that Strategic Income Fund's strategy of sector
allocation should be less risky than investing in only one sector of the bond
market. Data from the Lehman Brothers Aggregate Bond Index, the Salomon Smith
Barney High Yield Master Index, the Merrill Lynch High Yield Index and the
Salomon Smith Barney World Government Bond Index indicate that these sectors are
not closely correlated. If successful, the fund's strategy should enable it to
achieve a higher level of investment return than if it invested exclusively in
any one investment sector or allocated a fixed proportion of its assets to each
investment sector.
Strategic Income Fund may invest up to 10% of its total assets in
preferred stock of U.S. and foreign issuers. It also may acquire equity
securities when attached to bonds or as part of a unit including bonds or in
connection with a conversion or exchange of bonds. The fund also may invest
without limit in certificates of deposit issued by banks and savings
associations and in bankers' acceptances.
Strategic Income Fund normally invests at least 65% of its total assets in
income-producing securities, which may include zero coupon bonds, other original
issue discount securities, payment-in-kind securities and principal only
mortgage-backed securities. The fund also may invest in fixed and floating rate
loans through either participations in or assignments of all or a portion of
loans made by banks.
Strategic Income Fund may invest up to 15% of its net assets in illiquid
securities. The fund may purchase securities on a when-issued or delayed
delivery basis. The fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33 1/3% of its
total assets. The fund may engage in dollar rolls and reverse repurchase
agreements, which are considered borrowings. The fund's borrowings may not
exceed 33 1/3% of its total assets, except that the fund may borrow an
additional 5% of its total assets for temporary or emergency purposes. The fund
may invest in the securities of other investment companies and may sell short
"against the box."
THE FUNDS' INVESTMENTS, RELATED RISKS AND LIMITATIONS
The following supplements the information contained in the Prospectus and
above concerning the funds' investments, related risks and limitations. Except
as otherwise indicated in the Prospectus or the SAI, the funds have established
no policy limitations on their ability to use the investments or techniques
discussed in these documents.
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BONDS are fixed or variable rate debt obligations, including bills, notes,
debentures, money market instruments and similar instruments and securities.
Mortgage- and asset-backed securities are types of bonds, and certain types of
income-producing, non-convertible preferred stocks may be treated as bonds for
investment purposes. Bonds generally are used by corporations, governments and
other issuers to borrow money from investors. The issuer pays the investor a
fixed or variable rate of interest and normally must repay the amount borrowed
on or before maturity. Many preferred stocks and some bonds are "perpetual" in
that they have no maturity date.
Bonds are subject to interest rate risk and credit risk. Interest rate
risk is the risk that interest rates will rise and that, as a result, bond
prices will fall, lowering the value of a fund's investments in bonds. In
general, bonds having longer durations are more sensitive to interest rate
changes than are bonds with shorter durations. Credit risk is the risk that an
issuer may be unable or unwilling to pay interest and/or principal on the bond.
Credit risk can be affected by many factors, including adverse changes in the
issuer's own financial condition or in economic conditions.
EQUITY SECURITIES. Equity securities include common stocks, most preferred
stocks and securities that are convertible into them, including common stock
purchase warrants and rights, equity interests in trusts, partnerships, joint
ventures or similar enterprises and depositary receipts. Common stocks, the most
familiar type, represent an equity (ownership) interest in a corporation.
Preferred stock has certain fixed income features, like a bond, but
actually it is equity that is senior to a company's common stock. Convertible
bonds may be converted into or exchanged for a prescribed amount of common stock
of the same or a different issuer within a particular period of time at a
specified price or formula. Some preferred stock also may be converted into or
exchanged for common stock. Depositary receipts typically are issued by banks or
trust companies and evidence ownership of underlying equity securities.
While past performance does not guarantee future results, equity
securities historically have provided the greatest long-term growth potential in
a company. However, their prices generally fluctuate more than other securities
and reflect changes in a company's financial condition and in overall market and
economic conditions. Common stocks generally represent the riskiest investment
in a company. It is possible that a fund may experience a substantial or
complete loss on an individual equity investment. While this is possible with
bonds, it is less likely.
CREDIT RATINGS; NON-INVESTMENT GRADE BONDS. Moody's, S&P and other rating
agencies are private services that provide ratings of the credit quality of
bonds and certain other securities. A description of the ratings assigned to
corporate bonds by Moody's and S&P is included in the Appendix to this SAI. The
process by which Moody's and S&P determine ratings for mortgage-backed
securities includes consideration of the likelihood of the receipt by security
holders of all distributions, the nature of the underlying assets, the credit
quality of the guarantor, if any, and the structural, legal and tax aspects
associated with these securities. Not even the highest such rating represents an
assessment of the likelihood that principal prepayments will be made by obligors
on the underlying assets or the degree to which such prepayments may differ from
that originally anticipated, nor do such ratings address the possibility that
investors may suffer a lower than anticipated yield or that investors in such
securities may fail to recoup fully their initial investment due to prepayments.
Credit ratings attempt to evaluate the safety of principal and interest
payments, but they do not evaluate the volatility of a bond's value or its
liquidity and do not guarantee the performance of the issuer. Rating agencies
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. There is a risk that rating agencies may downgrade a
bond's rating. Subsequent to a bond's purchase by a fund, it may cease to be
rated or its rating may be reduced below the minimum rating required for
purchase by the fund. The funds may use these ratings in determining whether to
purchase, sell or hold a security. It should be emphasized, however, that
ratings are general and are not absolute standards of quality. Consequently,
bonds with the same maturity, interest rate and rating may have different market
prices.
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In addition to ratings assigned to individual bond issues, Mitchell
Hutchins (or for Low Duration Fund the sub-adviser) will analyze interest rate
trends and developments that may affect individual issuers, including factors
such as liquidity, profitability and asset quality. The yields on bonds 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 bonds, both within a particular
classification and between classifications. An issuer's obligations under its
bonds 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
principal on their bonds.
Investment grade bonds are rated in one of the four highest rating
categories by Moody's or S&P, comparably rated by another rating agency or, if
unrated, determined by Mitchell Hutchins (or for Low Duration Fund the
sub-adviser) to be of comparable quality. Moody's considers bonds rated Baa (its
lowest investment grade rating) to have speculative characteristics. This means
that changes in economic conditions or other circumstances are more likely to
lead to a weakened capacity to make principal and interest payments than is the
case for higher rated bonds.
Non-investment grade bonds (commonly known as "junk bonds" and sometimes
referred to as "high yield" bonds) are rated Ba or lower by Moody's, BB or lower
by S&P, comparably rated by another rating agency or, if unrated, determined by
Mitchell Hutchins (or for Low Duration Fund the sub-adviser) to be of comparable
quality. A fund's investments in non-investment grade bonds entail greater risk
than its investments in higher rated bonds. Non-investment grade bonds are
considered predominantly speculative with respect to the issuer's ability to pay
interest and repay principal and may involve significant risk exposure to
adverse conditions. Non-investment grade bonds generally offer a higher current
yield than that available for investment grade issues; however, they involve
greater risks, in that they are especially sensitive 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 interest and principal and increase the possibility of default. In
addition, such issuers may not have more traditional methods of financing
available to them and may be unable to repay debt at maturity by refinancing.
The risk of loss due to default by such issuers is significantly greater because
such securities frequently are unsecured by collateral and will not receive
payment until more senior claims are paid in full.
The market for non-investment grade bonds, especially those of foreign
issuers, has expanded rapidly in recent years, which has been a period of
generally expanding growth and lower inflation. These securities will be
susceptible to greater risk when economic growth slows or reverses and when
inflation increases or deflation occurs. This has been reflected in recent years
by volatility in emerging market securities. In the past, many lower rated bonds
experienced substantial price declines reflecting an expectation that many
issuers of such securities might experience financial difficulties. As a result,
the yields on lower rated bonds rose dramatically. However, those higher yields
did not reflect the value of the income stream that holders of such securities
expected. Rather, they reflected the risk that holders of such securities could
lose a substantial portion of their value due to the issuers' financial
restructurings or defaults by the issuers. There can be no assurance that those
declines will not recur.
The market for non-investment grade bonds generally is thinner and less
active than that for higher quality securities, which may limit a fund's ability
to sell such securities at fair value in response to changes in the economy or
financial markets. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may also decrease the values and liquidity of
non-investment grade bonds, especially in a thinly traded market.
U.S. GOVERNMENT SECURITIES include direct obligations of the U.S.
Treasury (such as Treasury bills, notes or bonds) and obligations issued or
guaranteed as to principal and interest (but not as to market value) by the
U.S. government, its agencies or its instrumentalities. U.S. government
securities include mortgage-backed securities issued or guaranteed by
government agencies or government-sponsored enterprises. Other U.S.
government securities may be backed by the full faith and credit of the U.S.
government or supported primarily or solely by the creditworthiness of the
government-related issuer or, in the case of mortgage-backed securities, by
pools of assets.
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U.S. government securities also include separately traded principal and
interest components of securities issued or guaranteed by the U.S. Treasury,
which are traded independently under the Separate Trading of Registered
Interest and Principal of Securities ("STRIPS") program. Under the STRIPS
programs, the principal and interest components are individually numbered and
separately issued by the U.S. Treasury.
Treasury inflation-protected securities ("TIPS") (also known as
"inflation-indexed securities") are Treasury bonds on which the principal value
is adjusted daily in accordance with changes in the Consumer Price Index.
Interest on TIPS is payable semi-annually on the adjusted principal value. The
principal value of TIPS would decline during periods of deflation, but the
principal amount payable at maturity would not be less than the original par
amount. If inflation is lower than expected while a fund holds TIPS, the fund
may earn less on the TIPS than it would on conventional Treasury bonds. Any
increase in the principal value of TIPS is taxable in the year the increase
occurs, even though holders do not receive cash representing the increase at
that time. See "Taxes -- Other Information," below
ASSET-BACKED SECURITIES. Asset-backed securities have structural
characteristics similar to mortgage-backed securities, as discussed in more
detail below. 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 sales 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 may be guaranteed up to a certain amount and for a certain time
period by a letter of credit or pool insurance policy issued by a financial
institution unaffiliated with the issuer, or other credit enhancements may be
present.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect interests in pools of underlying mortgage loans that are secured by
real property. U.S. government mortgage-backed securities are issued or
guaranteed as to the payment of principal and interest (but not as to market
value) by Ginnie Mae (also known as the Government National Mortgage
Association), Fannie Mae (also known as the Federal National Mortgage
Association), Freddie Mac (also known as the Federal Home Loan Mortgage
Corporation) or other government sponsored enterprises. Other domestic
mortgage-backed securities are sponsored or issued by private entities,
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. Foreign mortgage-backed
securities may be issued by mortgage banks and other private or governmental
entities outside the United States and are supported by interests in foreign
real estate.
Mortgage-backed securities may be composed of one or more classes and may
be structured either as pass-through securities or collateralized debt
obligations. Multiple-class mortgage-backed securities are referred to herein as
"CMOs." Some CMOs are directly supported by other CMOs, which in turn are
supported by mortgage pools. Investors typically receive payments out of the
interest and principal on the underlying mortgages. The portions of these
payments that investors receive, as well as the priority of their rights to
receive payments, are determined by the specific terms of the CMO class. CMOs
involve special risk and evaluating them requires special knowledge.
A major difference between mortgage-backed securities and traditional
bonds is that interest and principal payments are made more frequently (usually
monthly) and that principal may be repaid at any time because the underlying
mortgage loans may be prepaid at any time. When interest rates go down and
homeowners refinance their mortgages, mortgage-backed securities may be paid off
more quickly than investors expect. When interest rates rise, mortgage-backed
securities may be paid off more slowly than originally expected. Changes in the
rate or "speed" of these prepayments can cause the value of mortgage-backed
securities to fluctuate rapidly.
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Mortgage-backed securities also may decrease in value as a result of
increases in interest rates and, because of prepayments, may benefit less than
other bonds from declining interest rates. Reinvestments of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting a fund's yield. Actual prepayment experience may cause the yield of a
mortgage-backed security to differ from what was assumed when the fund purchased
the security. Prepayments at a slower rate than expected may lengthen the
effective life of a mortgage-backed security. The value of securities with
longer effective lives generally fluctuates more widely in response to changes
in interest rates than the value of securities with shorter effective lives.
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. Inverse floating rate CMO classes also
may be extremely volatile. These classes pay interest at a rate that decreases
when a specified index of market rates increases and vice versa.
The market for privately issued mortgage-backed securities is smaller and
less liquid than the market for U.S. government mortgage-backed securities.
Foreign mortgage-backed securities markets are substantially smaller than U.S.
markets, but have been established in several countries, including Germany,
Denmark, Sweden, Canada and Australia, and may be developed elsewhere. Foreign
mortgage-backed securities generally are structured differently than domestic
mortgage-backed securities, but they normally present substantially similar
investment risks as well as the other risks normally associated with foreign
securities.
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, including IO and PO classes of mortgage-backed
securities, can be extremely volatile, and these securities may become illiquid.
Mitchell Hutchins (or for Low Duration Fund the sub-adviser) seeks to manage the
funds' investments in mortgage-backed securities so that the volatility of each
fund's portfolio, taken as a whole, is consistent with its investment objective.
Management of portfolio duration is an important part of this. However,
computing the duration of mortgage-backed securities is complex. See, "The
Funds' Investments, Related Risks and Limitations -- Duration." If Mitchell
Hutchins (or for Low Duration Fund the sub-adviser) does not compute the
duration of mortgage-backed securities correctly, the value of the fund's
portfolio may be either more or less sensitive to changes in market interest
rates than intended. In addition, if market interest rates or other factors that
affect the volatility of securities held by a fund change in ways that Mitchell
Hutchins (or for Low Duration Fund the sub-adviser) does not anticipate, the
fund's ability to meet its investment objective may be reduced.
More information concerning these mortgage-backed securities and the
related risks of investments therein is set forth below. New types of
mortgage-backed securities are developed and marketed from time to time and,
consistent with their investment limitations, the funds expect to invest in
those new types of mortgage-backed securities that Mitchell Hutchins (or for Low
Duration Fund the sub-adviser) believe may assist the funds in achieving their
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investment objectives. Similarly, the funds may invest in mortgage-backed
securities issued by new or existing governmental or private issuers other than
those identified herein. The funds that may invest in foreign securities may
invest in foreign mortgage-backed securities, which may be structured
differently than domestic mortgage-backed securities.
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 certificateholders. 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 pay interest semi-annually and return
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 MORTGAGE-BACKED SECURITIES--Mortgage-backed securities issued by
Private Mortgage Lenders are structured similarly to 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 and Freddie Mac, they normally are
structured with one or more types of credit enhancement. See "The Funds'
Investments, Related Risks and Limitations--Types of Credit Enhancement." These
credit enhancements do not protect investors from changes in market value.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE
PASS-THROUGHS--CMOs are debt obligations that are collateralized by mortgage
loans or mortgage pass-through securities (collectively "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 of, and interest on, the Mortgage Assets (and in the case
of CMOs, any reinvestment income thereon) provide the funds to pay the 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
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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 accrued on all classes of a CMO (other than any PO class) on
a monthly, quarterly or semi-annual 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.
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 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 class, 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.
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: (1) liquidity protection and (2) loss protection. Loss protection
relates to 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. Loss protection 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. A 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.
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
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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 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. 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 was 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 a fund's yield.
ADJUSTABLE RATE MORTGAGE AND FLOATING RATE MORTGAGE-BACKED
Securities--Adjustable rate mortgage ("ARM") securities (sometimes referred to
as "ARMs") 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.
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 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. ARMs represent a right to receive
interest payments at a rate that is adjusted to reflect the interest earned on a
pool of ARM loans. These mortgage loans generally specify 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 ARM
loans specify limitations on the maximum amount by which the mortgage interest
rate may adjust for any single adjustment period. These mortgage loans also may
limit changes in the maximum amount by which the borrower's monthly payment may
adjust for any single adjustment period. If a monthly payment is not sufficient
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to pay the interest accruing on the ARM loan, any such excess interest is added
to the mortgage loan ("negative amortization"), which is repaid through future
payments. If a 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 loan. Borrowers
under these mortgage loans experiencing negative amortization may take longer to
build up their equity in the underlying property and may be more likely to
default.
ARM loans 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-rate 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 ARM loans might decrease. The rate of prepayments
with respect to ARM loans has fluctuated in recent years.
The rates of interest payable on certain ARM loans, and therefore on
certain ARM 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 securities supported by ARM loans 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
securities still tend to be less sensitive to interest rate fluctuations than
fixed-rate securities.
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
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.
INVESTING IN FOREIGN SECURITIES. Investing in foreign securities may
involve more risks than investing in U.S. securities. The value of foreign
securities is subject to economic and political developments in the countries
where the issuers operate and to changes in foreign currency values. Investments
in foreign securities 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 expropriation, confiscatory taxation, withholding taxes on
interest and/or dividends, limitations on the use of or transfer of fund assets
and political or social instability or diplomatic developments. Moreover,
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. In those European countries that have begun using the Euro as a common
currency unit, individual national economies may be adversely affected by the
inability of national governments to use monetary policy to address their own
economic or political concerns.
Securities of many foreign companies may be less liquid and their prices
more volatile than securities of comparable U.S. companies. From time to time
foreign securities may be difficult to liquidate rapidly without significantly
depressing the price of such securities. Foreign markets 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 some of a fund's assets are
uninvested and no return is earned thereon. The inability of a 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. Foreign securities trading practices, including
those involving securities settlement where fund assets may be released prior to
receipt of payment, may expose a fund to increased risk in the event of a failed
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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 costs of investing outside the United States frequently are higher
than those attributable to investing in the United States. 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 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.
Securities of foreign issuers may not be registered with the Securities
and Exchange Commission ("SEC"), and the issuers thereof may not be subject to
its reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers of securities held by a fund than is
available concerning U.S. companies. Foreign companies 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.
FOREIGN CURRENCY RISKS. Currency risk is the risk that changes in foreign
exchange rates may reduce the U.S. dollar value of a fund's foreign investments.
If the value of a foreign currency rises against the value of the U.S. dollar,
the value of a fund's investments that are denominated in, or linked to, that
currency will increase. Conversely, if the value of a foreign currency declines
against the value of the U.S. dollar, the value of such fund investments will
decrease. These changes may have a significant impact on the value of fund
shares. In some instances, a fund may use derivative strategies to hedge against
changes in foreign currency value. (See "Strategies Using Derivative
Instruments" below.) However, opportunities to hedge against currency risk may
not exist in certain markets, particularly with respect to emerging market
currencies, and even when appropriate hedging opportunities are available, a
fund may choose not to hedge against currency risk.
Generally, currency exchange rates are determined by supply and demand in
the foreign exchange markets and the relative merits of investments in different
countries. In the case of those European countries that use the Euro as a common
currency unit, the relative merits of investments in the common market in which
they participate, rather than the merits of investments in the individual
country, will be a determinant of currency exchange rates. Currency exchange
rates also can be affected by the intervention of the U.S. and foreign
governments or central banks, the imposition of currency controls, speculation,
devaluation or other political or economic developments inside and outside the
United States.
Each fund values its assets daily in U.S. dollars, and funds that hold
foreign currencies do not intend to convert them to U.S. dollars on a daily
basis. These funds may convert foreign currency to U.S. dollars from time to
time. A fund's foreign currencies may at times be held as "foreign currency call
accounts" at foreign branches of foreign or domestic banks. These accounts bear
interest at negotiated rates and are payable upon relatively short demand
periods. If a bank became insolvent, a fund could suffer a loss of some or all
of the amounts deposited.
The U.S. dollar value of fund assets that are denominated in foreign
currencies may be affected favorably or unfavorably by fluctuations in currency
rates and exchange control regulations. Further, a fund may incur costs in
connection with conversions between various currencies. Currency exchange
dealers realize a profit based on the difference between the prices at which
they are buying and selling various currencies. Thus, a dealer normally will
offer to sell a foreign currency to a fund at one rate, while offering a lesser
rate of exchange should a fund desire immediately to resell that currency to the
dealer. Funds that conduct currency exchange transactions do so either on a spot
(i.e., cash) basis at the spot rate prevailing in the foreign currency exchange
market, or through entering into forward, futures or options contracts to
purchase or sell foreign currencies.
EMERGING MARKET INVESTMENTS. The special risks of investing in foreign
securities are heightened in emerging markets. For example, many emerging market
currencies have experienced significant devaluations relative to the U.S. dollar
in recent years. Emerging market countries typically have economic and political
systems that are less fully developed and can be expected to be less stable than
those of developed countries. Emerging market countries may have policies that
restrict investment by foreigners, and there is a higher risk of government
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expropriation or nationalization of private property. The possibility of low or
nonexistent trading volume in the securities of companies in emerging markets
also may result in a lack of liquidity and in price volatility. Issuers in
emerging markets typically are subject to a greater degree of change in earnings
and business prospects than are companies in more developed markets.
INVESTMENT AND REPATRIATION RESTRICTIONS. Foreign investment in the
securities markets of several emerging market countries is restricted or
controlled to varying degrees. These restrictions may limit a fund's investment
in these countries and may increase its expenses. For example, certain countries
may require governmental approval prior to investments by foreign persons in a
particular company or industry sector or limit investment by foreign persons to
only a specific class of securities of a company, which may have less
advantageous terms (including price) than securities of the company available
for purchase by nationals. Certain countries may restrict or prohibit investment
opportunities in issuers or industries deemed important to national interests.
In addition, the repatriation of both investment income and capital from some
emerging market countries is subject to restrictions, such as the need for
certain government consents. Even where there is no outright restriction on
repatriation of capital, the mechanics of repatriation may affect certain
aspects of a fund's operations. These restrictions could make it undesirable to
invest in the countries to which they apply. In addition, if there is a
deterioration in a country's balance of payments or for other reasons, a country
may impose restrictions on foreign capital remittances abroad. A fund could be
adversely affected by delays in, or a refusal to grant, any required
governmental approval for repatriation, as well as by the application to it of
other restrictions on investments.
If, because of restrictions on repatriation or conversion, a fund were
unable to distribute substantially all of its net investment income and capital
gains within applicable time periods, the fund could be subject to federal
income and excise taxes that would not otherwise be incurred and could cease to
qualify for the favorable tax treatment afforded to regulated investment
companies under the Internal Revenue Code. If it did cease to qualify for that
treatment, it would become subject to federal income tax on all of its income
and net gains. See "Taxes -- Qualification as a Regulated Investment Company,"
below.
SOCIAL, POLITICAL AND ECONOMIC FACTORS. Many emerging market countries may
be subject to a greater degree of social, political and economic instability
than is the case in the United States. Any change in the leadership or policies
of these countries may halt the expansion of or reverse any liberalization of
foreign investment policies now occurring. Such instability may result from,
among other things, the following: (1) authoritarian governments or military
involvement in political and economic decision making, and changes in government
through extra-constitutional means; (2) popular unrest associated with demands
for improved political, economic and social conditions; (3) internal
insurgencies; (4) hostile relations with neighboring countries; and (5) ethnic,
religious and racial disaffection. Such social, political and economic
instability could significantly disrupt the financial markets in those countries
and elsewhere and could adversely affect the value of a fund's assets. In
addition, there may be the possibility of asset expropriations or future
confiscatory levels of taxation affecting a fund.
The economies of many emerging markets are heavily dependent upon
international trade and are accordingly affected by protective trade barriers
and the economic conditions of their trading partners, principally the United
States, Japan, China and the European Union. The enactment by the United States
or other principal trading partners of protectionist trade legislation,
reduction of foreign investment in the local economies and general declines in
the international securities markets could have a significant adverse effect
upon the securities markets of these countries. In addition, the economies of
some countries are vulnerable to weakness in world prices for their commodity
exports, including crude oil. A country whose exports are concentrated in a few
commodities could be vulnerable to a decline in the international price of such
commodities.
FINANCIAL INFORMATION AND LEGAL STANDARDS. Issuers in emerging market
countries generally are subject to accounting, auditing and financial standards
and requirements that differ, in some cases significantly, from those applicable
to U.S. issuers. In particular, the assets and profits appearing on the
financial statements of an emerging market issuer may not reflect its financial
position or results of operations in the way they would be reflected had the
financial statements been prepared in accordance with U.S. generally accepted
accounting principles. In addition, for an issuer that keeps accounting records
in local currency, inflation accounting rules may require, for both tax and
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accounting purposes, that certain assets and liabilities be restated on the
issuer's balance sheet in order to express items in terms of currency of
constant purchasing power. Inflation accounting may indirectly generate losses
or profits. Consequently, financial data may be materially affected by
restatements for inflation and may not accurately reflect the real condition of
those issuers and securities markets. Also, securities brokers and dealers in
other countries may not be as well capitalized as those in the United States, so
that they are more susceptible to financial failure in times of market,
political or economic stress.
In addition, existing laws and regulations are often inconsistently
applied. As legal systems in some of the emerging market countries develop,
foreign investors may be adversely affected by new laws and regulations, changes
to existing laws and regulations and preemption of local laws and regulations by
national laws. In circumstances where adequate laws exist, it may not be
possible to obtain swift and equitable enforcement of the law.
FOREIGN SOVEREIGN DEBT. Sovereign debt includes bonds that are issued by
foreign governments or their agencies, instrumentalities or political
subdivisions or by foreign central banks. Sovereign debt also may be issued by
quasi-governmental entities that are owned by foreign governments but are not
backed by their full faith and credit or general taxing powers. Investment in
sovereign debt involves special risks. The issuer of the debt or the
governmental authorities that control the repayment of the debt may be unable or
unwilling to repay principal and/or interest when due in accordance with the
terms of such debt, and the funds may have limited legal recourse in the event
of a default.
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 somewhat diminished. Political
conditions, especially a sovereign entity's willingness to meet the terms of its
debt obligations, are of considerable significance. Also, there can be no
assurance that the holders of commercial bank debt issued by 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 repay principal and
interest due 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.
The occurrence of political, social or diplomatic changes in one or more
of the countries issuing sovereign debt could adversely affect the funds'
investments. Political changes or a deterioration of a country's domestic
economy or balance of trade may affect the willingness of countries to service
their sovereign debt. While the funds' portfolios are managed in a manner that
is intended to minimize the exposure to such risks, there can be no assurance
that adverse political changes will not cause a fund to suffer a loss of
interest or principal on any of its sovereign debt holdings.
Certain emerging market countries are among the largest debtors to
commercial banks and foreign governments. Some emerging market countries have
from time to time declared moratoria on the payment of principal and interest on
external debt.
Some 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
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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 funds, 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 a fund. Certain countries in which a fund may 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
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. A 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 a 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. 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 International Monetary Fund, ("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 Bonds 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, a fund will purchase Brady Bonds 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 until 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 that would have then been due on the Brady Bonds in the
normal course. Interest payments on Brady Bonds may be wholly uncollateralized
or may be collateralized by cash or high grade securities in amounts that
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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 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. A 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.
STRUCTURED FOREIGN INVESTMENTS. This term generally refers to 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 usually 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 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 often dependent on the extent of the cash flow on the
underlying instruments.
Structured foreign investments frequently involve no credit enhancement.
Accordingly, their credit risk generally will be equivalent to that of the
underlying instruments. In addition, classes of structured foreign investments
may be subordinated to the right of payment of another class. Subordinated
structured foreign investments typically have higher yields and present greater
risks that 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.
CURRENCY-LINKED INVESTMENTS. The principal amount of securities that are
indexed to specific foreign currency exchange rates may be adjusted up or down
(but not below zero) at maturity to reflect changes in the exchange rate between
two currencies. A fund may experience loss of principal due to these
adjustments.
ZERO COUPON AND OTHER OID SECURITIES; PIK SECURITIES. Zero coupon
securities are securities on which no periodic interest payments are made but
instead are issued at a deep discount from their maturity value. The buyer of
these securities receives a rate of return by the gradual appreciation of the
security, which results from the fact that it will be paid at face value on a
specified maturity date. There are many types of zero coupon securities. Some
are issued in zero coupon form, including Treasury bills, notes and bonds that
have been stripped of (separated from) their unmatured interest coupons
(unmatured interest payments) and receipts or certificates representing
interests in such stripped debt obligations and coupons. Others are created by
brokerage firms that strip the coupons from interest-paying debt securities and
sell the principal and the coupons separately.
Other securities that are sold with original issue discount ("OID") (i.e.,
the difference between the issue price and the value at maturity) may provide
for some interest to be paid prior to maturity. In addition, payment-in-kind
("PIK") securities pay interest in additional securities, not in cash. OID and
PIK securities usually trade at a discount from their face value.
Zero coupon securities are generally more sensitive to changes in interest
rates than debt obligations of comparable maturities that make current interest
payments. This means that when interest rates fall, the value of zero coupon
securities rises more rapidly than securities paying interest on a current
basis. However, when interest rates rise, their value falls more dramatically.
Other OID securities and PIK securities also are subject to greater fluctuations
in market value in response to changing interest rates than debt securities of
comparable maturities that make current distributions of interest in cash.
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Because federal tax law requires that accrued OID and "interest" on PIK
securities be included currently in a fund's income (see "Taxes," below), a fund
might be required to distribute as a dividend an amount that is greater than the
total amount of cash it actually receives. These distributions would have to be
made from the fund's cash assets or, if necessary, from the proceeds of sales of
portfolio securities. A fund would not be able to purchase additional securities
with cash used to make these distributions, and its current income and the value
of its shares would ultimately be reduced as a result.
Certain zero coupon securities are U.S. Treasury notes and bonds that have
been stripped of their unmatured coupons or interests in such U.S. Treasury
securities or coupons. The staff of the SEC currently takes the position that
"stripped" U.S. government securities that are not issued through the U.S.
Treasury are not U.S. government securities. This technique is frequently used
with U.S. Treasury bonds to create CATS (Certificate of Accrual Treasury
Securities), TIGRs (Treasury Income Growth Receipts) and similar securities. As
long as the SEC takes this position, CATS and TIGRs, which are not issued
through the U.S. Treasury, will not be counted as U.S. government securities for
purposes of the 65% investment requirement applicable to U.S. Government Income
Fund and Low Duration Fund.
CONVERTIBLE SECURITIES. A convertible security is a bond, preferred stock
or other security that may be converted into or exchanged for a prescribed
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 or dividends 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 because
they have fixed income characteristics and (3) provide the potential for capital
appreciation if the market price of the underlying common stock increases. While
no securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock. However,
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed income
security.
A convertible security may 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 a 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. Investment
Grade Income Fund may convert convertible securities into equity and hold the
equity securities that it so acquires, but only for temporary purposes. The
other funds that may invest in convertible securities may hold any equity
securities they acquire upon conversion subject only to their limitations on
holding equity securities.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Investments in secured or unsecured
fixed or floating rate loans ("Loans") arranged through private negotiations
between a borrowing corporation, government or other entity and one or more
financial institutions ("Lenders") may be in the form of participations
("Participations") in Loans or assignments ("Assignments") of all or a portion
of Loans from third parties. Participations typically result in the fund's
having a contractual relationship only with the Lender, not with the borrower. A
fund has 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, a fund generally has no direct right to enforce
compliance by the borrower with the terms of the loan agreement relating to the
Loan, nor any rights of set-off against the borrower, and a fund may not
directly benefit from any collateral supporting the Loan in which it has
purchased the Participation. As a result, a fund assumes the credit risk of both
the borrower and the Lender that is selling the Participation. In the event of
the insolvency of the selling Lender, the fund may be treated as a general
creditor of that Lender and may not benefit from any set-off between the Lender
and the borrower. A fund will acquire Participations only if Mitchell Hutchins
determines that the selling Lender is creditworthy.
When a fund purchases Assignments from Lenders, it acquires direct rights
against the borrower on the Loan. In an Assignment, the fund is entitled to
receive payments directly from the borrower and, therefore, does not depend on
the selling bank to pass these payments onto the fund. However, because
Assignments are arranged through private negotiations between potential
assignees and assignors, the rights and obligations acquired by the fund as the
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purchaser of an Assignment may differ from, and be more limited than, those held
by the assigning Lender.
Assignments and Participations are generally not registered under the
Securities Act of 1933, as amended ("Securities Act"), and thus may be subject
to a fund's limitation on investment in illiquid securities. Because there may
be no liquid market for such securities, such securities may be sold only to a
limited number of institutional investors. The lack of a liquid secondary market
could have an adverse impact on the value of such securities and on a fund's
ability to dispose of particular Assignments or Participations when necessary to
meet the fund's liquidity needs or in response to a specific economic event,
such as a deterioration in the creditworthiness of the borrower.
TEMPORARY AND DEFENSIVE INVESTMENTS; MONEY MARKET INVESTMENTS. Each fund
may invest in money market investments for temporary or defensive purposes, to
reinvest cash collateral from its securities lending activities or as part of
its normal investment program. Such investments include, among other things, (1)
securities issued or guaranteed by the U.S. government or one of its agencies or
instrumentalities, (2) commercial paper rated at least A-1 by S&P or P-1 by
Moody's (Low Duration Fund, Investment Grade Income Fund and U.S. Government
Income Fund) or without regard to rating (High Income Fund and Strategic Income
Fund), (3) bank certificates of deposit and bankers' acceptances; (4) repurchase
agreements; and (5) securities of other investment companies that invest
exclusively in money market instruments and similar private investment vehicles.
WARRANTS. Warrants are securities permitting, but not obligating, holders
to subscribe for other securities. 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.
ILLIQUID SECURITIES. The term "illiquid securities" for purposes of the
Prospectus and SAI means securities that cannot be disposed of within seven days
in the ordinary course of business at approximately the amount at which a fund
has valued the securities and includes, among other things, purchased
over-the-counter options, repurchase agreements maturing in more than seven days
and restricted securities other than those Mitchell Hutchins (or for Low
Duration Fund the sub-adviser) has determined are liquid pursuant to guidelines
established by each fund's board. The assets used as cover for over-the-counter
options written by a fund will be considered illiquid unless the
over-the-counter options are sold to qualified dealers that agree that the fund
may repurchase any over-the-counter options it writes at a maximum price to be
calculated by a formula set forth in the option agreements. The cover for an
over-the-counter 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. Under current SEC guidelines,
interest only and principal only classes of mortgage-backed securities generally
are considered illiquid. However, interest only and principal only 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 (or for Low Duration Fund the sub-adviser) has determined that they are
liquid pursuant to guidelines established by the applicable board. A fund may
not be able to readily liquidate its investments in illiquid securities and may
have to sell other investments if necessary to raise cash to meet its
obligations. The lack of a liquid secondary market for illiquid securities may
make it more difficult for a fund to assign a value to those securities for
purposes of valuing its portfolio and calculating its net asset value.
Restricted securities are not registered under the Securities Act and may
be sold only in privately negotiated or other exempted transactions or after a
Securities Act registration statement has become effective. Where registration
is required, a 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 a fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, a fund might obtain a less favorable price than
prevailed when it decided to sell.
Not all restricted securities are illiquid. If a fund that may invest
outside the United States holds foreign securities that are freely tradeable in
the country in which they are principally traded, those securities generally are
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not considered illiquid, even if they are restricted in the United States. A
large institutional market has developed for many U.S. and foreign securities
that are not registered under the Securities Act. 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.
Institutional markets for restricted securities also have developed as a
result of Rule 144A, which establishes a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. Such markets include automated systems for the
trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National Association
of Securities Dealers, Inc. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held by
a fund, however, could affect adversely the marketability of the securities, and
the fund might be unable to dispose of them promptly or at favorable prices.
Each board has delegated the function of making day-to-day determinations
of liquidity to Mitchell Hutchins (or for Low Duration Fund the sub-adviser)
pursuant to guidelines approved by the board. Mitchell Hutchins or the
sub-adviser takes 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 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 (or for Low Duration Fund the
sub-adviser) monitors the liquidity of restricted securities in each fund's
portfolio and reports periodically on such decisions to the applicable board.
Mitchell Hutchins (and for Low Duration Fund the sub-adviser) monitors
each fund's overall holdings of illiquid securities. If a fund's holdings of
illiquid securities exceeds its limitation on investments in illiquid securities
for any reason (such as a particular security becoming illiquid, changes in
relative market values of liquid and illiquid portfolio securities or
shareholder redemptions), Mitchell Hutchins (and for Low Duration Fund the
sub-adviser) will consider what action would be in the best interest of the fund
and its shareholders. Such action may include engaging in an orderly disposition
of securities to reduce the fund's holdings of illiquid securities. However, a
fund is not required immediately to dispose of illiquid securities under these
circumstances and Mitchell Hutchins (and for Low Duration Fund the sub-adviser),
with the concurrence of the fund's board, may determine that it is in the best
interests of the fund and its shareholders to continue to hold the illiquid
securities.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a
fund purchases securities or other obligations from a bank or securities dealer
(or its affiliate) and simultaneously commits to resell them to the counterparty
at an agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased obligations.
A fund maintains custody of the underlying obligations prior to their
repurchase, either through its regular custodian or through a special
"tri-party" custodian or sub-custodian that maintains separate accounts for both
the fund and its counterparty. Thus, the obligation of the counterparty to pay
the repurchase price on the date agreed to or upon demand is, in effect, secured
by such obligations.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including a possible decline in the market value of
the underlying obligations. If their value becomes less than the repurchase
price, plus any agreed-upon additional amount, the counterparty must 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 obligations and
the price that was paid by a fund upon acquisition is accrued as interest and
included in its net investment income. Repurchase agreements involving
obligations other than U.S. government securities (such as commercial paper and
corporate bonds) may be subject to special risks and may not have the benefit of
certain protections in the event of the counterparty's insolvency. If the seller
or guarantor becomes insolvent, the fund may suffer delays, costs and possible
losses in connection with the disposition of collateral. Each fund intends to
enter into repurchase agreements only with counterparties in transactions
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believed by Mitchell Hutchins (or for Low Duration Fund the sub-adviser) to
present minimum credit risks.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements involve the
sale of securities held by a fund subject to the fund's agreement to repurchase
the securities at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest. Reverse repurchase agreements are subject to each
fund's limitation on borrowings and may be entered into only with banks or
securities dealers or their affiliates. While a reverse repurchase agreement is
outstanding, a fund will maintain, in a segregated account with its custodian,
cash or liquid securities, marked to market daily, in an amount at least equal
to its obligations under the reverse repurchase agreement. See "The Funds'
Investments, Related Risks and Limitations -- Segregated Accounts."
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by a fund might be unable to deliver them when that fund seeks
to repurchase. If the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, the buyer or trustee or receiver may
receive an extension of time to determine whether to enforce that 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.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each fund may purchase
securities on a "when-issued" basis or may purchase or sell securities for
delayed delivery, i.e., for issuance or delivery to or by the fund later than a
normal settlement date at a stated price and yield. When-issued securities
include TBA ("to be announced") securities. TBA securities are usually
mortgage-backed securities that are purchased on a forward commitment basis with
an approximate principal amount and no defined maturity date. The actual
principal amount and maturity date are determined upon settlement when the
specific mortgage pools are assigned. A fund generally would not pay for such
securities or start earning interest on them until they are received. However,
when a fund undertakes a when-issued or delayed delivery obligation, it
immediately assumes the risks of ownership, including the risks of price
fluctuation. Failure of the issuer to deliver a security purchased by a 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.
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 a fund's net asset value. When a fund commits to purchase securities
on a when-issued or delayed delivery basis, its custodian segregates assets to
cover the amount of the commitment. See "The Funds' Investments, Related Risks
and Limitations--Segregated Accounts." A fund's when-issued and delayed delivery
purchase commitments could cause its net asset value per share to be more
volatile. A fund may sell the right to acquire the security prior to delivery if
Mitchell Hutchins (or for Low Duration Fund the sub-adviser) deems it
advantageous to do so, which may result in a gain or loss to the fund.
DOLLAR ROLLS. In a dollar roll, a fund sells TBA mortgage-backed or other
securities for delivery on the next regular settlement date for those securities
and, simultaneously, contracts to purchase substantially similar securities for
delivery on a later settlement date. Dollar rolls also are subject to a fund's
limitation on borrowings.
DURATION. Duration is a measure of the expected life of a bond on a
present value basis. Duration incorporates the bond's yield, coupon interest
payments, final maturity and call features into one measure and is one of the
fundamental tools used by Mitchell Hutchins (and for Low Duration Fund the
sub-adviser) in portfolio selection and yield curve positioning for a fund's
bond investments. Duration was developed as a more precise alternative to the
concept "term to maturity." Traditionally, a bond's "term to maturity" has been
used as a proxy for the sensitivity of the security's price to changes in
interest rates (which is the "interest rate risk" or "volatility" of the
security). However, "term to maturity" measures only the time until the
scheduled final payment on the bond, taking no account of the pattern of
payments prior to maturity.
Duration takes the length of the time intervals between the present time
and the time that the interest and principal payments are scheduled or, in the
case of a callable bond, expected to be made, and weights them by the present
values of the cash to be received at each future point in time. For any bond
with interest payments occurring prior to the payment of principal, duration is
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always less than maturity. For example, depending on its coupon and the level of
market yields, a Treasury note with a remaining maturity of five years might
have a duration of 4.5 years. For mortgage-backed and other securities that are
subject to prepayments, put or call features or adjustable coupons, the
difference between the remaining stated maturity and the duration is likely to
be much greater.
Duration allows Mitchell Hutchins (or for Low Duration Fund the
sub-adviser) to make certain predictions as to the effect that changes in the
level of interest rates will have on the value of a fund's portfolio of bonds.
For example, when the level of interest rates increases by 1%, a bond having a
positive duration of three years generally will decrease by approximately 3%.
Thus, if Mitchell Hutchins (or for Low Duration Fund the sub-adviser) calculates
the duration of a fund's portfolio of bonds as three years, it normally would
expect the portfolio to change in value by approximately 3% for every 1% change
in the level of interest rates. However, various factors, such as changes in
anticipated prepayment rates, qualitative considerations and market supply and
demand, can cause particular securities to respond somewhat differently to
changes in interest rates than indicated in the above example. Moreover, in the
case of mortgage-backed and other complex securities, duration calculations are
estimates and are not precise. This is particularly true during periods of
market volatility. Accordingly, the net asset value of a fund's portfolio of
bonds may vary in relation to interest rates by a greater or lesser percentage
than indicated by the above example.
Futures, options and options on futures have durations that, in general,
are closely related to the duration of the securities that underlie them.
Holding long futures or call option positions will lengthen portfolio duration
by approximately the same amount as would holding an equivalent amount of the
underlying securities. Short futures or put options have durations roughly equal
to the negative duration of the securities that underlie these positions, and
have the effect of reducing portfolio duration by approximately the same amount
as would selling an equivalent amount of the underlying securities.
There are some situations in which the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by the standard duration calculation is the case of mortgage-backed
securities. The stated final maturity of such securities is generally 30 years,
but current prepayment rates are critical in determining the securities'
interest rate exposure. In these and other similar situations, Mitchell Hutchins
(or for Low Duration Fund the sub-adviser) will use more sophisticated
analytical techniques that incorporate the economic life of a security into the
determination of its duration and, therefore, its interest rate exposure.
LENDING OF PORTFOLIO SECURITIES. Each fund is authorized to lend its
portfolio securities to broker-dealers or institutional investors that Mitchell
Hutchins deems qualified. Lending securities enables a fund to earn additional
income, but could result in a loss or delay in recovering these securities. The
borrower of a fund's portfolio securities must maintain acceptable collateral
with that fund's custodian in an amount, marked to market daily, at least equal
to the market value of the securities loaned, plus accrued interest and
dividends. Acceptable collateral is limited to cash, U.S. government securities
and irrevocable letters of credit that meet certain guidelines established by
Mitchell Hutchins. Each fund may reinvest any cash collateral in money market
investments or other short-term liquid investments including other investment
companies. A fund also may reinvest cash collateral in private investment
vehicles similar to money market funds, including one managed by Mitchell
Hutchins. In determining whether to lend securities to a particular
broker-dealer or institutional investor, Mitchell Hutchins will consider, and
during the period of the loan will monitor, all relevant facts and
circumstances, including the creditworthiness of the borrower. Each fund will
retain authority to terminate any of its loans at any time. Each fund may pay
fees in connection with a loan and may pay the borrower or placing broker a
negotiated portion of the interest earned on the reinvestment of cash held as
collateral. A fund will receive amounts equivalent to any dividends, interest or
other distributions on the securities loaned. Each fund will regain record
ownership of loaned securities to exercise beneficial rights, such as voting and
subscription rights, when regaining such rights is considered to be in the
fund's interest.
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Pursuant to procedures adopted by the boards governing each fund's
securities lending program, PaineWebber has been retained to serve as lending
agent for each fund. The boards also have authorized the payment of fees
(including fees calculated as a percentage of invested cash collateral) to
PaineWebber for these services. Each board periodically reviews all portfolio
securities loan transactions for which PaineWebber acted as lending agent.
PaineWebber also has been approved as a borrower under each fund's securities
lending program.
SHORT SALES "AGAINST THE BOX." Each 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 make delivery to the purchaser in a short sale, the executing broker
borrows the securities being sold short on behalf of a fund, and that fund is
obligated to replace the securities borrowed at a date in the future. When a
fund sells short, it establishes a margin account with the broker effecting the
short sale and deposits collateral with the broker. In addition, the fund
maintains, in a segregated account with its custodian, the securities that could
be used to cover the short sale. Each fund incurs transaction costs, including
interest expense, in connection with opening, maintaining and closing short
sales "against the box."
A fund might make a short sale "against the box" to hedge against market
risks when Mitchell Hutchins (or for Low Duration Fund the sub-adviser) 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. In such case, any loss in the fund's long
position after the short sale should be reduced by a corresponding gain in the
short position. Conversely, any gain in the long position after the short sale
should be reduced by a corresponding 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 a
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.
SEGREGATED ACCOUNTS. When a fund enters into certain transactions that
involve obligations to make future payments to third parties, including the
purchase of securities on a when-issued or delayed delivery basis, and reverse
repurchase agreements, it will maintain with an approved custodian in a
segregated account cash or liquid 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 "Strategies Using Derivative
Instruments," segregated accounts may also be required in connection with
certain transactions involving options, futures, forward currency contracts and
swaps.
INVESTMENTS IN OTHER INVESTMENT COMPANIES. Each fund may invest in
securities of other investment companies, subject to limitations imposed by the
Investment Company Act of 1940, as amended ("Investment Company Act"). Among
other things, these limitations currently restrict a fund's aggregate
investments in other investment companies to no more than 10% of its total
assets. A fund's investment in certain private investment vehicles are not
subject to this restriction. The shares of other investment companies are
subject to the management fees and other expenses of those companies, and the
purchase of shares of some investment companies requires the payment of sales
loads and (in the case of closed-end investment companies) sometimes substantial
premiums above the value of such companies' portfolio securities. At the same
time, a fund would continue to pay its own management fees and expenses with
respect to all its investments, including shares of other investment companies.
INVESTMENT LIMITATIONS OF THE FUNDS
FUNDAMENTAL LIMITATIONS. The following fundamental investment limitations
cannot be changed for a fund 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 the
shares of the fund present at a shareholders' 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 amount of total assets will not be considered a
violation of any of the following limitations. With regard to the borrowings
limitation in fundamental limitation (2), each fund will comply with the
applicable restrictions of Section 18 of the Investment Company Act.
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Each 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, and except that U.S.
Government Income Fund and Low Duration Fund, under normal circumstances, each
will invest 25% or more of its total assets in mortgage- and asset-backed
securities, which (whether or not issued or guaranteed by an agency or
instrumentality of the U.S. government) shall be considered a single industry
for purposes of this limitation.
(2) issue senior securities or borrow money, except as permitted under the
Investment Company 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.
The following interpretation applies to, but is not a part of, this
fundamental restriction: The fund's investments in master notes and 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.
In addition, U.S. Government Income Fund, Low Duration Fund, Investment
Grade Income Fund and High Income Fund each will not:
(7) purchase securities of any one issuer if, as a result, more than 5% of
the fund's total assets would be invested in securities of that issuer or the
fund would own or hold more than 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, and except that this limitation does not
apply to securities issued or guaranteed by the U.S. government, its agencies
and instrumentalities or to securities issued by other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental restriction: Mortgage- and asset-backed securities will not be
considered to have been issued by the same issuer by reason of the securities
having the same sponsor, and mortgage- and asset-backed securities issued by a
finance or other special purpose subsidiary that are not guaranteed by the
parent company will be considered to be issued by a separate issuer from the
parent company.
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NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions are
non-fundamental and may be changed by the vote of the appropriate board without
shareholder approval. 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 amount of total assets will not be
considered a violation of any of the following limitations.
Each fund will not:
(1) invest more than 10% of its net assets (15% of net assets for Low
Duration Fund and Strategic Income Fund) in illiquid securities.
(2) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
(3) 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.
(4) 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.
(5) purchase securities of other investment companies, except to the
extent permitted by the Investment Company Act and except that this limitation
does not apply to securities received or acquired as dividends, through offers
of exchange, or as a result of reorganization, consolidation, or merger (and
except that a fund will not purchase securities of registered open-end
investment companies or registered unit investment trusts in reliance on
Sections 12(d)(1)(F) or 12(d)(1)(G) of the Investment Company Act).
STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Mitchell Hutchins (and for
Low Duration Fund, the sub-adviser) may use a variety of financial instruments
("Derivative Instruments"), including certain options, futures contracts
(sometimes referred to as "futures") and options on futures contracts and swaps.
High Income Fund and Strategic Income Fund also may use forward currency
contracts. A fund may enter into transactions involving one or more types of
Derivative Instruments under which the full value of its portfolio is at risk.
Under normal circumstances, however, each fund's use of these instruments will
place at risk a much smaller portion of its assets. In particular, each fund may
use the Derivative Instruments described below.
A fund might not use any derivative instruments or strategies, and there
can be no assurance that using any strategy will succeed. If the Mitchell
Hutchins (or for Low Duration Fund the sub-adviser), is incorrect in its
judgment on market values, interest rates or other economic factors in using a
derivative instrument or strategy, a fund may have lower net income and a net
loss on the investment.
OPTIONS ON SECURITIES AND FOREIGN CURRENCIES--A call option is a
short-term 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 of the option or at specified
times or at the expiration of the option, depending on the type of option
involved. The writer of the call option, who receives the premium, has the
obligation, upon exercise of the option during the option term, 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 at specified times or at the expiration of the option,
depending on the type of option involved. The writer of the put option, who
receives the premium, has the obligation, upon exercise of the option during the
option term, to buy the underlying security or currency at the exercise price.
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OPTIONS ON SECURITIES INDICES--A securities index assigns relative values
to the securities included in the index and fluctuates with changes in the
market values of those securities. A securities index option operates in the
same way as a more traditional securities option, except that exercise of a
securities index option is effected with cash payment and does not involve
delivery of securities. Thus, upon exercise of a securities 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 securities
index.
SECURITIES INDEX FUTURES CONTRACTS--A securities 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 securities 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.
INTEREST RATE AND FOREIGN CURRENCY FUTURES CONTRACTS--Interest rate and
foreign currency futures contracts are bilateral agreements pursuant to which
one party agrees to make, and the other party agrees to accept, delivery of a
specified type of debt security or currency at a specified future time and at a
specified price. Although such futures contracts by their terms call for actual
delivery or acceptance of debt securities or currency, in most cases the
contracts are closed out before the settlement date without the making or taking
of delivery.
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 or at
specified times or at the expiration of the option, depending on the type of
option involved. Upon exercise of the option, the delivery of the futures
position to the holder of the option will be accompanied 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.
GENERAL DESCRIPTION OF STRATEGIES USING DERIVATIVE INSTRUMENTS. A fund may
use Derivative Instruments to attempt to hedge its portfolio and also to attempt
to enhance income or return or realize gains and to manage the duration of its
portfolio. A fund may use Derivative Instruments to maintain exposure to bonds
while maintaining a cash balance for fund management purposes (such as to
provide liquidity to meet anticipated shareholder sales of fund shares and for
fund operating expenses), to facilitate trading or to adjust its exposure to
different asset classes. High Income Fund and Strategic Income Fund also may use
Derivative Instruments on currencies, including forward currency contracts, to
hedge against price changes of securities that a fund owns or intends to acquire
that are attributable to changes in the value of the currencies in which the
securities are denominated. These funds may also use Derivative Instruments on
currencies to shift exposure from one currency to another or to attempt to
realize gains from favorable changes in exchange rates.
Hedging strategies can be broadly categorized as "short hedges" and "long
hedges." A short hedge is a purchase or sale of a Derivative Instrument intended
partially or fully to offset potential declines in the value of one or more
investments held in a fund's portfolio. Thus, in a short hedge a fund takes a
position in a Derivative Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged. For example, a
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, a 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, a fund might be
able to close out the put option and realize a gain to offset the decline in the
value of the security.
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Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that a fund intends to acquire. Thus, in a long
hedge, a fund takes a position in a Derivative Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, a 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, a fund could exercise the call and thus limit its acquisition
cost to the exercise price plus the premium paid and transaction costs.
Alternatively, a fund might be able to offset the price increase by closing out
an appreciated call option and realizing a gain.
A fund may purchase and write (sell) straddles on securities or indices of
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 equal to the exercise price of the call. A fund
might enter into a long straddle when Mitchell Hutchins (or for Low Duration
Fund the sub-adviser) believes it likely that the prices of the securities 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 equal to the exercise price of
the call. A fund might enter into a short straddle when Mitchell Hutchins (or
for Low Duration Fund the sub-adviser) believes it unlikely that the prices of
the securities will be as volatile during the term of the option as the option
pricing implies.
Derivative Instruments on securities or currencies generally are used to
hedge against price movements in one or more particular securities positions
that a fund owns or intends to acquire. Derivative Instruments on stock indices,
in contrast, generally are used to hedge against price movements in broad equity
market sectors in which a fund has invested or expects to invest. Derivative
Instruments on debt securities may be used to hedge either individual securities
or broad fixed income market sectors.
Income strategies using Derivative Instruments may include the writing of
covered options to obtain the related option premiums. Gain strategies may
include using Derivative Instruments to increase or decrease a fund's exposure
to different asset classes without buying or selling the underlying instruments.
A fund also may use derivatives to simulate full investment by the fund while
maintaining a cash balance for fund management purposes (such as to provide
liquidity to meet anticipated shareholder sales of fund shares and for fund
operating expenses).
The use of Derivative 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, a fund's
ability to use Derivative Instruments may be limited by tax considerations. See
"Taxes."
In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins (or for Low Duration Fund the sub-adviser) may
discover additional opportunities in connection with Derivative Instruments and
with hedging, income and gain strategies. These new opportunities may become
available as regulatory authorities broaden the range of permitted transactions
and as new Derivative Instruments and techniques are developed. Mitchell
Hutchins (or for Low Duration Fund the sub-adviser) may use these opportunities
for a fund to the extent that they are consistent with the fund's investment
objective and permitted by its investment limitations and applicable regulatory
authorities. The Prospectus or SAI 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 STRATEGIES USING DERIVATIVE INSTRUMENTS. The use of
Derivative Instruments involves special considerations and risks, as described
below. Risks pertaining to particular Derivative Instruments are described in
the sections that follow.
(1) Successful use of most Derivative Instruments depends upon the ability
of Mitchell Hutchins (or for Low Duration Fund the sub-adviser) to predict
movements of the overall securities, interest rate or currency exchange markets,
which requires different skills than predicting changes in the prices of
individual securities. While Mitchell Hutchins (and for Low Duration Fund the
sub-adviser) are experienced in the use of Derivative Instruments, there can be
no assurance that any particular strategy adopted will succeed.
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(2) There might be imperfect correlation, or even no correlation, between
price movements of a Derivative Instrument and price movements of the
investments that are being hedged. For example, if the value of a Derivative
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 affecting the markets in which Derivative
Instruments are traded, rather than the value of the investments being hedged.
The effectiveness of hedges using Derivative Instruments on indices will depend
on the degree of correlation between price movements in the index and price
movements in the securities 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 a fund entered into a short
hedge because Mitchell Hutchins (or for Low Duration Fund the sub-adviser)
projected a decline in the price of a security in that 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 Derivative
Instrument. Moreover, if the price of the Derivative 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, a fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Derivative Instruments involving obligations to third parties
(i.e., Derivative Instruments other than purchased options). If the fund was
unable to close out its positions in such Derivative Instruments, it might be
required to continue to maintain such assets or accounts or make such payments
until the positions expired or matured. These requirements might impair a 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. A fund's ability to close out a position in
a Derivative 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 a counterparty 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 a fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the funds to an
obligation to another party. A fund will not enter into any such transactions
unless it owns either (1) an offsetting ("covered") position in securities,
currencies or other options or futures contracts or (2) cash or liquid
securities, with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. Each fund will
comply with SEC guidelines regarding cover for such transactions and will, if
the guidelines so require, set aside cash or liquid 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 Derivative Instrument is open, unless they are
replaced with similar assets. As a result, committing a large portion of a
fund's assets to cover positions or to segregated accounts could impede
portfolio management or the fund's ability to meet redemption requests or other
current obligations.
OPTIONS. The funds may purchase put and call options, and write (sell)
covered put or call options on securities in which they invest and related
indices and (for High Income Fund and Strategic Income Fund) on foreign
currencies. The purchase of call options may serve as a long hedge, and the
purchase of put options may serve as a short hedge. In addition, a fund may also
use options to attempt to realize gains by increasing or reducing its exposure
to an asset class without purchasing or selling the underlying securities.
Writing covered put or call options can enable a fund to enhance income by
reason of the premiums paid by the purchasers of such options. 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 affected fund will be obligated to sell the security at
less than its market value. 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
security depreciates to a price lower than the exercise price of the put option,
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it can be expected that the put option will be exercised and the fund will be
obligated to purchase the security at more than its market value. The securities
or other assets used as cover for over-the-counter options written by a fund
would be considered illiquid to the extent described under "The Funds'
Investments, Related Risks and Limitations--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. Options normally have expiration dates
of up to nine months. Generally, the over-the-counter debt options or foreign
currency options used by the funds 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. There are also other types of options
exercisable on certain specified dates before expiration. Options that expire
unexercised have no value.
A fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, a 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, a 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 a fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
The funds may purchase and write both exchange-traded and over-the-counter
options. Currently, many options on equity securities are exchange-traded.
Exchange markets for options on bonds and foreign currencies exist but are
relatively new, and these instruments are primarily traded on the
over-the-counter 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, over-the-counter options are contracts between a fund
and its counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when a fund purchases or writes an
over-the-counter option, it relies on the counterparty to make or take delivery
of the underlying investment upon exercise of the option. Failure by the
counterparty 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 funds' ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The funds intend 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
over-the-counter options only by negotiating directly with the counterparty, or
by a transaction in the secondary market if any such market exists. Although the
funds will enter into over-the-counter options only with counterparties that are
expected to be capable of entering into closing transactions with the funds,
there is no assurance that a fund will in fact be able to close out an
over-the-counter option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, a fund might be unable to close out
an over-the-counter option position at any time prior to its expiration.
If a 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 put or 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.
A fund may purchase and write put and call options on indices 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 a securities market
(or market sector) rather than anticipated increases or decreases in the value
of a particular security.
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LIMITATIONS ON THE USE OF OPTIONS. The use of options is governed by the
following guidelines, which can be changed by each fund's board without
shareholder vote:
(1) A fund may purchase a put or call option, including any straddle or
spread, only if the value of its premium, when aggregated with the premiums on
all other options held by the fund, does not exceed 5% of its total assets.
(2) The aggregate value of securities underlying put options written by a
fund, determined as of the date the put options are written, will not exceed 50%
of its net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by a fund that are held at any time will not exceed 20% of
its net assets.
FUTURES. The funds may purchase and sell securities index futures
contracts and interest rate futures contracts. High Income Fund and Strategic
Income Fund also may purchase and sell foreign currency futures contracts. A
fund may 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 on securities
or indices. In addition, a fund may purchase or sell futures contracts or
purchase options thereon to increase or reduce its exposure to an asset class
without purchasing or selling the underlying securities either as a hedge or to
enhance return or realize gains.
Futures strategies also can be used to manage the average duration of a
fund's portfolio. If Mitchell Hutchins (or for Low Duration Fund the
sub-adviser) wishes to shorten the average duration of a fund's portfolio, the
fund may sell a futures contract or a call option thereon, or purchase a put
option on that futures contract. If Mitchell Hutchins (or for Low Duration Fund
the sub-adviser) wishes to lengthen the average duration of the fund's
portfolio, the fund may buy a futures contract or a call option thereon, or sell
a put option thereon.
A fund may also write put options on 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. A fund will engage in this
strategy only when it is more advantageous to a 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 a 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, obligations of
the United States or obligations fully guaranteed as to principal and interest
by the United States, in an amount generally equal to 10% or less of the
contract value. Margin must also be deposited when writing a call 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 a fund at the termination of the transaction if all
contractual obligations have been satisfied. Under certain circumstances, such
as periods of high volatility, a fund may be required by an exchange to increase
the level of its initial margin payment, and initial margin requirements might
be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of each fund's obligations to or from a futures
broker. When a fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when a fund purchases or
sells a futures contract or writes a call option thereon, it is subject to daily
variation margin calls that could be substantial in the event of adverse price
movements. If a fund has insufficient cash to meet daily variation margin
requirements, it might need to sell securities at a time when such sales are
disadvantageous.
30
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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 funds intend 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 a fund were unable to liquidate a futures or related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. A fund would continue to be subject
to market risk with respect to the position. In addition, except in the case of
purchased options, a 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 related 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 options and the investments being hedged. Also, because 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.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The use of futures
and related options is governed by the following guidelines, which can be
changed by a fund's board without shareholder vote:
(1) The aggregate initial margin and premiums on futures contracts and
related options that are not for bona fide hedging purposes (as defined by the
CFTC), excluding the amount by which options are "in-the-money", may not exceed
5% of a fund's net assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by a fund that are held at any time will not exceed 20% of
its net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by a fund will not exceed 5% of its total assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. High Income
Fund and Strategic Income Fund may use options and futures on foreign
currencies, as described above, and forward currency 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 a 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.
A fund might seek to hedge against changes in the value of a particular
currency when no Derivative Instruments on that currency are available or such
Derivative Instruments are considered expensive. In such cases, the fund may
hedge against price movements in that currency by entering into transactions
31
<PAGE>
using Derivative Instruments on another currency or a basket of currencies, the
value of which Mitchell Hutchins believes will have a positive correlation to
the value of the currency being hedged. In addition, a fund may use forward
currency contracts to shift exposure to foreign currency fluctuations from one
country to another. For example, if a 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 Derivative Instrument will
not correlate or will correlate unfavorably with the foreign currency being
hedged.
The value of Derivative 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 Derivative
Instruments, a 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 Derivative Instruments until they reopen.
Settlement of Derivative Instruments involving foreign currencies might be
required to take place within the country issuing the underlying currency. Thus,
the funds 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. High Income Fund and Strategic Income 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, a 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, a 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.
The cost to a 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 a fund enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency at the maturity
of the contract. Failure by the counterparty to do so would result in the loss
of any expected benefit of the transaction.
As is the case with futures contracts, holders and writers 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 counterparty. Thus, there can be no assurance
that a 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 counterparty, a fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the fund would continue
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<PAGE>
to be subject to market risk with respect to the position, and would continue to
be required to maintain a position in the securities or currencies that are 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, a 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 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.
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS. High Income Fund and
Strategic Income 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
segregates with its custodian cash or liquid securities 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.
SWAP TRANSACTIONS. Swap transactions include swaps, caps, floors and
collars relating to interest rates, currencies, securities or other instruments.
Interest rate swaps involve an agreement between two parties to exchange
payments that are based, for example, 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 level on
predetermined dates or during a specified time period. Currency swaps, caps,
floors and collars are similar to interest rate swaps, caps, floors and collars
but they are based on currency exchange rates rather than interest rates. Equity
swaps or other swaps relating to securities or other instruments are also
similar, but they are based on changes in the value of the underlying securities
or instruments. For example, an equity swap might involve an exchange of the
value of a particular security or securities index in a certain notional amount
for the value of another security or index or for the value of interest on that
notional amount at a specified fixed or variable rate.
A fund may enter into interest rate swap transactions to preserve a return
or spread on a particular investment or portion of its portfolio or to protect
against any increase in the price of securities it anticipates purchasing at a
later date. A fund may use interest rate swaps, caps, floors and collars as a
hedge on either an asset-based or liability-based basis, depending on whether it
is hedging its assets or liabilities. Interest rate swap transactions are
subject to risks comparable to those described above with respect to other
derivatives strategies.
A fund will usually enter into interest rate swaps on a net basis, i.e.,
the two payment streams are netted out, with a fund receiving or paying, as the
case may be, only the net amount of the two payments. Because segregated
accounts will be established with respect to these transactions, Mitchell
Hutchins (and for Low Duration Fund the sub-adviser) believe such obligations do
not constitute senior securities and, accordingly, will not treat them as being
subject to a fund's borrowing restrictions. The net amount of the excess, if
any, of a fund's obligations over its entitlements with respect to each interest
rate swap will be accrued on a daily basis, and appropriate fund assets having
an aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account as described above in "The Funds'
Investments, Related Risks and Limitations--Segregated Accounts." A fund also
will establish and maintain such segregated accounts with respect to its total
obligations under any swaps that are not entered into on a net basis and with
respect to any caps, floors and collars that are written by the fund.
A fund will enter into interest rate swap transactions only with banks or
recognized securities dealers or their affiliates believed by Mitchell Hutchins
(or for Low Duration Fund the sub-adviser) to present minimal credit risk in
accordance with guidelines established by the fund's board. If there is a
default by the other party to such a transaction, a fund will have to rely on
33
<PAGE>
its contractual remedies (which may be limited by bankruptcy, insolvency or
similar laws) pursuant to the agreements related to the transaction.
ORGANIZATION; TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS AND MANAGEMENT
OWNERSHIP OF SECURITIES
Managed Trust was formed on November 21, 1986 as a business trust under
the laws of the Commonwealth of Massachusetts and has eight operating series.
Securities Trust was formed on December 3, 1992 as a business trust under the
laws of the Commonwealth of Massachusetts and has two operating series. Each
Trust is governed by a board of trustees, which is authorized to establish
additional series and to issue an unlimited number of shares of beneficial
interest of each existing or future series, par value $0.001 per share. The
applicable board oversees each fund's operations.
The trustees and executive officers of each Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
<S> <C> <C>
Margo N. Alexander*+; 53 Trustee and President Mrs. Alexander is Chairman (since March
1999), chief executive officer and a
director of Mitchell Hutchins (since
January 1995), and an executive vice
president and director of PaineWebber
(since March 1984). Mrs. Alexander is
president and director or trustee of 31
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Richard Q. Armstrong; 64 Trustee Mr. Armstrong is chairman and principal of
R.Q.A. Enterprises R.Q.A. Enterprises (management consulting
One Old Church Road firm) (since April 1991 and principal
Unit #6 occupation since March 1995). Mr.
Greenwich, CT 06830 Armstrong 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). He 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, Louis
Vuitton Moet Hennessey Corporation)
(1987-1991) and chairman of its wine and
spirits subsidiary, Schieffelin & Somerset
Company (1987-1991). Mr. Armstrong is a
director or trustee of 30 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
34
<PAGE>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
E. Garrett Bewkes, Jr.**+; 73 Trustee and Chairman of Mr. Bewkes is a director of Paine Webber
the Board of Trustees Group Inc. ("PW Group") (holding company
of PaineWebber and Mitchell 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. Mr.
Bewkes is a director or trustee of 34
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Richard R. Burt; 53 Trustee Mr. Burt is chairman of IEP Advisors, LLP
1275 Pennsylvania Ave, N.W. (international investments and consulting
Washington, D.C. 20004 firm) (since March 1994), a partner of
McKinsey & Company (management consulting
firm) (since 1991). He is also a director
of Archer-Daniels-Midland Co.
(agricultural commodities), Hollinger
International Co. (publishing), Homestake
Mining Corp. (gold mining), six investment
companies in the Deutsche Bank family of
funds, nine investment companies in the
Flag Investors Family of Funds, The
Central European Fund, Inc., The Germany
Fund, Inc., vice chairman of Anchor Gaming
(provides technology to gaming and
wagering industry) (since July 1999) and
chairman of Weirton Steel Corp. (makes and
finishes steel products) (since April
1996). 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 30 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
35
<PAGE>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
Mary C. Farrell**+; 50 Trustee Ms. Farrell is a managing director, senior
(Securities Trust only) 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 appears as
a regular panelist on Wall $treet 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, PaineWebber or one of their
affiliates serves as investment adviser.
Meyer Feldberg; 58 Trustee Mr. Feldberg is Dean and Professor of
Columbia University Management of the Graduate School of
101 Uris Hall Business, Columbia University. Prior to
New York, NY 10027 1989, he was president of the Illinois
Institute of Technology. Dean Feldberg is
also a director of Primedia Inc.
(publishing), Federated Department Stores,
Inc. (operator of department stores) and
Revlon, Inc. (cosmetics). Dean Feldberg is
a director or trustee of 33 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
George W. Gowen; 70 Trustee Mr. Gowen is a partner in the law firm of
666 Third Avenue Dunnington, Bartholow & Miller. Prior to
New York, NY 10017 May 1994, he was a partner in the law firm
of Fryer, Ross & Gowen. Mr. Gowen is a
director or trustee of 33 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
36
<PAGE>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
Frederic V. Malek; 63 Trustee Mr. Malek is chairman of Thayer Capital
1455 Pennsylvania Ave, N.W. Partners (merchant bank) and chairman of
Suite 350 Thayer Hotel Investors II and Lodging
Washington, DC 20004 Opportunities Fund (hotel investment
partnerships). From January 1992 to
November 1992, he 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.
and NWA Inc. (holding company of Northwest
Airlines 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 Aegis
Communications, Inc. (tele-services),
American Management Systems, Inc.
(management consulting and computer
related services), Automatic Data
Processing, Inc., (computing services), CB
Richard Ellis, Inc. (real estate
services), FPL Group, Inc. (electric
services), Global Vacation Group (packaged
vacations), HCR/Manor Care, Inc. (health
care), SAGA Systems, Inc. (software
company) and Northwest Airlines Inc. Mr.
Malek is a director or trustee of 30
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Carl W. Schafer; 64 Trustee Mr. Schafer is president of the Atlantic
66 Witherspoon Street, #1100 Foundation (charitable foundation
Princeton, NJ 08542 supporting mainly oceanographic
exploration and research). He is a
director of Labor Ready, Inc. (temporary
employment), Roadway Express, Inc.
(trucking), The Guardian Group of Mutual
Funds, the Harding, Loevner Funds, E.I.I.
Realty Trust (investment company), Evans
Systems, Inc. (motor fuels, convenience
store and diversified company), Electronic
Clearing House, Inc. (financial
transactions processing), Frontier Oil
Corporation and Nutraceutix, Inc.
(biotechnology company). Prior to January
1993, he was chairman of the Investment
Advisory Committee of the Howard Hughes
Medical Institute. Mr. Schafer is a
director or trustee of 30 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
37
<PAGE>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
Brian M. Storms*+; 45 Trustee Mr. Storms is president and chief
operating officer of Mitchell Hutchins
(since March 1999). Mr. Storms was
president of Prudential Investments
(1996-1999). Prior to joining Prudential
he was a managing director at Fidelity
Investments. Mr. Storms is a director or
trustee of 30 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
T. Kirkham Barneby*; 53 Vice President Mr. Barneby is a managing director and
(Managed Trust only) chief investment officer--quantitative
investments of Mitchell Hutchins. Mr.
Barneby is a vice president of seven
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Julieanna Berry*; 36 Vice President Ms. Berry is a first vice president and a
(Managed Trust only) portfolio manager of Mitchell Hutchins.
Ms. Berry is a vice president of two
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Tom Disbrow**, 34 Vice President and Mr. Disbrow is a first vice president and
Assistant Treasurer a senior manager of the mutual fund
finance department of Mitchell Hutchins.
Prior to November 1999, he was a vice
president of Zweig/Glaser Advisers. Mr.
Disbrow is a vice president and assistant
treasurer of 31 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
Donald R. Jones*; 39 Vice President Mr. Jones is a senior vice president and a
(Securities Trust only) 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,
PaineWebber or one of their affiliates
serves as investment adviser.
James F. Keegan*; 39 Vice President Mr. Keegan is a senior vice president and
(Managed Trust only) a portfolio manager of Mitchell Hutchins.
Prior to March 1996, he was director of
fixed income strategy and research of
Merrion Group, L.P. Mr. Keegan is a vice
president of six investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
38
<PAGE>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
John J. Lee**; 31 Vice President and Mr. Lee is a vice president and a manager
Assistant Treasurer of the mutual fund finance department of
Mitchell Hutchins. Prior to September
1997, he was an audit manager in the
financial services practice of Ernst &
Young LLP. Mr. Lee is a vice president and
assistant treasurer of 31 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Kevin J. Mahoney**; 34 Vice President and Mr. Mahoney is a first vice president and
Assistant Treasurer a senior manager of the mutual fund
finance department of Mitchell Hutchins.
From August 1996 through March 1999, he
was the manager of the mutual fund
internal control group of Salomon Smith
Barney. Prior to August 1996, he was an
associate and assistant treasurer for
BlackRock Financial Management L.P. Mr.
Mahoney is a vice president and assistant
treasurer of 31 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
Dennis McCauley*; 53 Vice President Mr. McCauley is a managing director and
chief investment officer--fixed income of
Mitchell Hutchins. Mr. McCauley is a vice
president of 22 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
Ann E. Moran**; 42 Vice President and Ms. Moran is a vice president and a
Assistant Treasurer manager of the mutual fund finance
department of Mitchell Hutchins. Ms. Moran
is a vice president and assistant
treasurer of 31 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
Dianne E. O'Donnell**; 47 Vice President and Ms. O'Donnell is a senior vice president
Secretary and deputy general counsel of Mitchell
Hutchins. Ms. O'Donnell is a vice
president and secretary of 30 investment
companies and a vice president and
assistant secretary of one investment
company for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Emil Polito*; 39 Vice President Mr. Polito is a senior vice president and
director of operations and control for
Mitchell Hutchins. Mr. Polito is a vice
president of 31 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
39
<PAGE>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
Victoria E. Schonfeld**; 49 Vice President Ms. Schonfeld is a managing director and
general counsel of Mitchell Hutchins and
(since July 1995) a senior vice president
of PaineWebber. Ms. Schonfeld is a vice
president of 30 investment companies and a
vice president and secretary of one
investment company for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Paul H. Schubert**; 37 Vice President and Mr. Schubert is a senior vice president
Treasurer and director of the mutual fund finance
department of Mitchell Hutchins. Mr.
Schubert is a vice president and treasurer
of 31 investment companies for which
Mitchell Hutchins, PaineWebber or one of
their affiliates serves as investment
adviser.
Nirmal Singh*; 43 Vice President Mr. Singh is a senior vice president and a
portfolio manager of Mitchell Hutchins.
Mr. Singh is a vice president of four
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Barney A. Taglialatela**; 39 Vice President and Mr. Taglialatela is a vice president and a
Assistant Treasurer manager of the mutual fund finance
department of Mitchell Hutchins. Mr.
Taglialatela is a vice president and
assistant treasurer of 31 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Mark A. Tincher*; 44 Vice President Mr. Tincher is a managing director and
chief investment officer--equities of
Mitchell Hutchins. Mr. Tincher is a vice
president of 12 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
Stuart Waugh*; 44 Vice President Mr. Waugh is a managing director and a
(Securities Trust only) 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, PaineWebber or one of their
affiliates serves as investment adviser.
40
<PAGE>
NAME AND ADDRESS; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------------ ----------------------------------------
Keith A. Weller**; 38 Vice President and Mr. Weller is a first vice president and
Assistant Secretary associate general 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 30 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
</TABLE>
- -------------
* This person's business address is 51 West 52nd Street, New York, New York
10019-6114.
** This person's business address is 1285 Avenue of the Americas, New York, New
York 10019.
+ Mrs. Alexander, Mr. Bewkes, Ms. Farrell and Mr. Storms are "interested
persons" of each fund as defined in the Investment Company Act by virtue of
their positions with Mitchell Hutchins, PaineWebber, and/or PW Group.
Board members are compensated as follows:
o MANAGED TRUST has eight operating series and pays each board member
who is not an "interested person" of the Trust $1,000 annually for
each series. Therefore, Managed Trust pays each such board member
$8,000 annually, plus any additional amounts due for board or
committee meetings.
o SECURITIES TRUST has two operating series and pays each board member
who is not an "interested person" of the Trust $1,000 annually for
Strategic Income Fund and an additional $1,500 annually for its
second series. Therefore, Securities Trust pays each such board
member $2,500 annually, plus any additional amounts due for board or
committee meetings.
Each Trust pays up to $150 per series for each board meeting and each
separate meeting of a board committee. Each chairman of the audit and contract
review committees of individual funds within the PaineWebber fund complex
receives additional compensation, aggregating $15,000 annually, from the
relevant funds. All board members are reimbursed for any expenses incurred in
attending meetings. Because PaineWebber, Mitchell Hutchins and (for Low Duration
Fund) the sub-adviser) perform substantially all the services necessary for the
operation of the Trusts and each fund, the Trusts require no employees. No
officer, director or employee of Mitchell Hutchins or PaineWebber presently
receives any compensation from a Trust for acting as a board member or officer.
The table below includes certain information relating to the compensation
by each Trust of its current board members and the compensation of those board
members from all PaineWebber funds during the periods indicated.
41
<PAGE>
<TABLE>
<CAPTION>
AGGREGATE
AGGREGATE COMPENSATION TOTAL COMPENSATION
COMPENSATION FROM FROM THE TRUSTS
FROM MANAGED SECURITIES AND THE FUND
NAME OF PERSON, POSITION TRUST* TRUST* COMPLEX**
------------------------ ------ ------ ---------
<S> <C> <C> <C>
Richard Q. Armstrong,
Trustee........................... $12,030 $1,780 $104,650
Richard R. Burt,
Trustee........................... 11,850 1,750 102,850
Meyer Feldberg,
Trustee........................... 12,030 2,432 119,650
George W. Gowen,
Trustee........................... 14,711 1,780 119,650
Frederic V. Malek,
Trustee........................... 12,030 1,780 104,650
Carl W. Schafer,
Trustee........................... 12,030 1,780 104,650
</TABLE>
- --------------------
+ Only independent board members are compensated by the PaineWebber funds and
identified above; board members who are "interested persons," as defined by
the Investment Company Act, do not receive compensation from the funds.
* Represents fees paid to each board member from the Trust indicated for the
fiscal year ended November 30, 1999.
** Represents total compensation paid during the calendar year ended December
31, 1999, to each board member by 31 investment companies (34 in the case of
Messrs. Feldberg and Gowen) for which Mitchell Hutchins, PaineWebber or one
of their affiliates served as investment adviser. No fund within the
PaineWebber fund complex has a bonus, pension, profit sharing or retirement
plan.
PRINCIPAL HOLDERS AND MANAGEMENT OWNERSHIP OF SECURITIES
As of March 1, 2000, trustees and officers owned in the aggregate less
than 1% of the outstanding shares of any class of each Trust.
As of March 3, 2000, the following shareholders were shown in the funds'
records as owning 5% or more of any class of a fund's shares:
42
<PAGE>
PERCENTAGE OF SHARES
NAME AND ADDRESS* BENEFICIALLY OWNED AS
----------------- OF MARCH 3, 2000
---------------------
U.S. GOVERNMENT INCOME FUND
Northern Trust Company as Trustee 61.33% of
FBO PaineWebber 401(k) Plan Class Y shares
LOW DURATION FUND
Chestnut III 71.97% of
Class A shares
Barry Seeman 5.01% of
Ruth Seeman Class B shares
Village of Caseyville Police 10.46% of
Pension Fund Class B shares
Dr. Alicia C. Faxon 7.24% of
Class Y shares
PaineWebber CDN FBO 8.29% of
George M. Edmonds Class Y shares
Gina Gilbert 9.65% of
Class Y shares
Mitchell Hutchins Portfolios 9.92% of
Class Y shares
INVESTMENT GRADE INCOME FUND
PaineWebber CDN FBO 5.08% of
Gertrude A. Tormey Class Y shares
HIGH INCOME FUND
PaineWebber CDN FBO 11.55% of
Gertrude A. Tormey Class Y shares
Jerry M. Zeigler 6.05% of
Class Y shares
PaineWebber CDN FBO 9.68% of
Charles A. Chard Class Y shares
PaineWebber CDN FBO 5.37% of
Char L. Brown Class Y shares
STRATEGIC INCOME FUND
PaineWebber CDN FBO 5.65% of
Paula S. Bradnan Class Y shares
Edward Y. Eyraud TTEE FBO 7.04% of
The Joseph A. Eyraud Profit Class Y shares
Sharing Plan
Jerry M. Zeigler 8.20% of
Class Y shares
Charles A. Chard 8.59% of
Class Y shares
Anne L. Solnit as Trustee of the 9.58% of
Anne L. Solnit Trust Dtd 5/6/97 Class Y shares
43
<PAGE>
- ----------------
* The shareholders listed may be contacted c/o Mitchell Hutchins Asset
Management Inc., 51 West 52nd Street, New York, NY 10019-6114.
INVESTMENT ADVISORY, ADMINISTRATION AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY AND ADMINISTRATION ARRANGEMENTS. Mitchell Hutchins
acts as the investment adviser and administrator to each fund pursuant to
separate contracts (each an "Advisory Contract") with each Trust. Under the
applicable Advisory Contract, Strategic Income Fund pays Mitchell Hutchins an
annual fee of 0.75% of its average daily net assets, and each of the other four
funds pays Mitchell Hutchins an annual fee of 0.50% of its average daily net
assets. All fees paid under the Advisory Contracts are computed daily and paid
monthly.
Under the terms of the Advisory Contracts, each fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of a Trust not readily identifiable as belonging to a
specific series of the Trust are allocated among series by or under the
direction of the Trust's board in such manner as the board deems fair and
equitable. Expenses borne by each 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 board members and officers who are not interested persons (as defined
in the Investment Company Act) of the applicable Trust or Mitchell Hutchins; (6)
all expenses incurred in connection with the board members' services, including
travel expenses; (7) taxes (including any income or franchise taxes) and
governmental fees; (8) costs of any liability, uncollectible 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
applicable Trust or fund for violation of any law; (10) legal, accounting and
auditing expenses, including legal fees of special counsel for the independent
board members; (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 board members and officers; and (18) costs of mailing, stationery
and communications equipment.
Under each Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Trust or a
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. Each Advisory Contract terminates
automatically upon assignment and is terminable at any time without penalty by
the applicable board 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 Trust.
During each of the fiscal years indicated, Mitchell Hutchins earned (or
accrued) advisory fees in the amounts set forth below:
44
<PAGE>
FISCAL YEARS ENDED NOVEMBER 30,
1999 1998 1997
---- ---- ----
U.S. Government Income Fund... $1,537,271 $1,751,719 $1,979,329
Low Duration Fund............. 683,166 708,240 819,616
Investment Grade Income Fund.. 1,402,342 1,456,093 1,464,164
High Income Fund.............. 2,408,964 3,036,812 2,918,855
Strategic Income Fund ........ 840,960 779,494 520,540*
- ------------
* Prior to fee waiver of $13,206. Net fees paid by Strategic Income Fund
were $507,334.
For the fiscal year ended November 30, 1999, Mitchell Hutchins voluntarily
waived a portion of its fee (as set forth below) under certain Advisory
Contracts in connection with certain funds' investment of cash collateral from
securities lending in a private investment vehicle managed by Mitchell Hutchins.
AMOUNT
FUND WAIVED
---- ------
U.S. Government Income Fund... $13,511
Low Duration Fund ............ 0
Investment Grade Income Fund.. 2,056
High Income Fund.............. 0
Strategic Income Fund......... 31
The Advisory Contracts authorize Mitchell Hutchins to retain one or more
sub-advisers but do not require Mitchell Hutchins to do so. Mitchell Hutchins
has entered into a separate sub-investment advisory contract with PIMCO
("Sub-Advisory Contract") pursuant to which PIMCO serves as sub-adviser for Low
Duration Fund. Under the Sub-Advisory Contract, Mitchell Hutchins (not the fund)
pays PIMCO a fee in the annual amount of 0.25% of the fund's average daily net
assets. For the fiscal years ended November 30, 1999, November 30, 1998 and
November 30, 1997, Mitchell Hutchins paid or accrued sub-advisory fees to PIMCO
of $341,583, $354,120, and $409,808, respectively. PIMCO, a Delaware general
partnership, is a registered investment adviser and a subsidiary partnership of
PIMCO Advisors L.P. ("PIMCO Advisors"). The general partners of PIMCO Advisors
are PIMCO Advisors Holding L.P. ("PAH"), a publicly traded company listed on the
New York Stock Exchange under the symbol "PA", and PIMCO Partners, G.P., a
general partnership between Pacific Life Insurance Company and PIMCO Partners,
LLC, a limited liability company controlled by the PIMCO managing directors.
PIMCO is one of the largest fixed income management firms in the nation.
Included among PIMCO's institutional clients are many "Fortune 500" companies.
On October 31 1999, PIMCO Advisors, PAH and Allianz AG ("Allianz") announced
that they had reached a definitive agreement pursuant to which Allianz will
acquire majority ownership of PIMCO Advisors and its subsidiaries, including
PIMCO (the "Allianz Transaction"). Under the terms of the transaction, Allianz
will acquire all of PAH, the publicly traded general partner of PIMCO Advisors.
Pacific Life Insurance Company will retain an approximate 30% interest in PIMCO
Advisors. The Allianz Transaction is currently expected to be completed in the
second quarter of 2000.
Under the Sub-Advisory Contract, PIMCO will not be liable for any error of
judgment or mistake of law or for any loss suffered by Managed Investments
Trust, Low Duration Fund, its shareholders or Mitchell Hutchins in connection
with the Sub-Advisory Contract, except any liability to any of them to which
PIMCO would otherwise be subject by reason of willful misfeasance, bad faith or
gross negligence on its part in the performance of its duties or from reckless
disregard by it of its obligations and duties under the Sub-Advisory Contract.
The Sub-Advisory Contract terminates automatically upon its assignment or the
termination of the Advisory Contract and is terminable at any time without
penalty by Managed Trust's board or by vote of the holders of a majority of Low
Duration Fund's outstanding voting securities on 60 days' notice to PIMCO, or by
PIMCO on 120 days' written notice to Mitchell Hutchins. The Sub-Advisory
Contract also may be terminated by Mitchell Hutchins (1) upon material breach by
PIMCO of its representations and warranties, which breach shall not have been
cured within a 20 day period after notice of such breach; (2) if PIMCO becomes
45
<PAGE>
unable to discharge its duties and obligations under the Sub-Advisory Contract;
or (3) upon 120 days' notice to PIMCO.
TRANSFER AGENCY-RELATED SERVICES. PFPC (not the funds) pays PaineWebber
for certain transfer agency-related services that PFPC has delegated to
PaineWebber. Prior to August 1, 1997, under an agreement between the applicable
Trust and PaineWebber, PaineWebber provided those services to each fund. Under
these agreements, PaineWebber earned (or accrued) the amounts set forth below
during 1997:
EIGHT MONTHS ENDED
JULY 31, 1997
-------------
U.S. Government Income Fund... $73,833
Low Duration Fund................... 36,963
Investment Grade Income Fund.. 48,036
High Income Fund.............. 81,517
Strategic Income Fund......... 10,503
SECURITIES LENDING. During the fiscal years ended November 30, 1999,
November 30, 1998 and November 30, 1997, the funds paid (or accrued) the
following fees to PaineWebber for its services as securities lending agent:
FUND FISCAL YEAR ENDED NOVEMBER 30,
1999 1998 1997
---- ---- ----
U.S. Government Income Fund.. $37,641 $2,938 $672
Low Duration Fund............ 0 0 0
Investment Grade Income Fund. 8,655 24,433 0
High Income Fund............. 0 0 0
Strategic Income Fund........ 338 8,573 4,254
NET ASSETS. The following table shows the approximate net assets as of
February 29, 2000, sorted by category of investment objective, of the investment
companies as to which Mitchell Hutchins serves as adviser or sub-adviser. An
investment company may fall into more than one of the categories below.
NET ASSETS
INVESTMENT CATEGORY ($MIL)
------------------- ------
Domestic (excluding Money Market).................. $ 9,931.5
Global............................................. 4,757.8
Equity/Balanced.................................... 10,115.9
Fixed Income (excluding Money Market).............. 4,573.4
Taxable Fixed Income............................ 3,146.1
Tax-Free Fixed Income........................... 1,427.3
Money Market Funds................................. 39,977.1
46
<PAGE>
PERSONAL TRADING POLICIES. The funds, their investment adviser and their
principal underwriter each have adopted a code of ethics under rule 17j-1 of the
Investment Company Act, which permits personnel covered by the rule to invest in
securities that may be purchased or held by a fund but prohibits fraudulent,
deceptive or manipulative conduct in connection with that personal investing.
PIMCO also has adopted a code of ethics under rule 17j-1.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
each class of shares of each fund under separate distribution contracts with
each Trust (collectively, "Distribution Contracts"). Each Distribution Contract
requires Mitchell Hutchins to use its best efforts, consistent with its other
businesses, to sell shares of the applicable fund. Shares of each fund are
offered continuously. Under separate exclusive dealer agreements between
Mitchell Hutchins and PaineWebber relating to each class of shares of the funds
(collectively, "Exclusive Dealer Agreements"), PaineWebber and its correspondent
firms sell each fund's shares. Mitchell Hutchins is located at 51 West 52nd
Street, New York, New York 10019-6114 and PaineWebber is located at 1285 Avenue
of the Americas, New York, New York 10019.
Under separate plans of distribution pertaining to the Class A, Class B
and Class C shares of each fund adopted by each Trust in the manner prescribed
under Rule 12b-1 under the Investment Company Act (each, respectively, a "Class
A Plan," "Class B Plan" and "Class C Plan," and collectively, "Plans"), each
fund pays Mitchell Hutchins a service fee, accrued daily and payable monthly, at
the annual rate of 0.25% of the average daily net assets of each class of
shares. Under the Class B Plan, each fund pays Mitchell Hutchins a distribution
fee, accrued daily and payable monthly, at the annual rate of 0.75% of the
average daily net assets of the Class B shares. Under the Class C Plan, each
fund pays Mitchell Hutchins a distribution fee, accrued daily and payable
monthly, at the annual rate of 0.50% of the average daily net assets of the
Class C shares. There is no distribution plan with respect to the funds' Class Y
shares and the funds pay no service or distribution fees with respect to their
Class Y shares.
Mitchell Hutchins uses the service fees under the Plans for Class A, B and
C shares primarily to pay PaineWebber for shareholder servicing, currently at
the annual rate of 0.25% of the aggregate investment amounts maintained in each
fund by PaineWebber clients. PaineWebber then compensates its Financial Advisors
for shareholder servicing that they perform and offsets its own expenses in
servicing and maintaining shareholder accounts.
Mitchell Hutchins uses the distribution fees under the Class B and Class C
Plans to:
o Offset the commissions it pays to PaineWebber for selling each
fund's Class B and Class C shares, respectively.
o Offset each fund's marketing costs attributable to such classes,
such as preparation, printing and distribution of sales literature,
advertising and prospectuses to prospective investors and related
overhead expenses, such as employee salaries and bonuses.
PaineWebber compensates Financial Advisors when Class B and Class C shares
are bought by investors, as well as on an ongoing basis. Mitchell Hutchins
receives no special compensation from any of the funds or investors at the time
Class B or C shares are bought.
Mitchell Hutchins receives the proceeds of the initial sales charge paid
when Class A shares are bought and of the contingent deferred sales charge paid
upon sales of shares. These proceeds may be used to cover distribution expenses.
The Plans and the related Distribution Contracts for Class A, Class B and
Class C shares specify that each fund must pay service and distribution fees to
Mitchell Hutchins for its service- and distribution-related activities, not as
reimbursement for specific expenses incurred. Therefore, even if Mitchell
Hutchins' expenses exceed the service or distribution fees it receives, the
funds will not be obligated to pay more than those fees. On the other hand, if
Mitchell Hutchins' expenses are less than such fees, it will retain its full
fees and realize a profit. Expenses in excess of service and distribution fees
47
<PAGE>
received or accrued through the termination date of any Plan will be Mitchell
Hutchins' sole responsibility and not that of the funds. Annually, the board of
each fund reviews the Plans and Mitchell Hutchins' corresponding expenses for
each class separately from the Plans and expenses of the other classes.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the applicable board at least quarterly, and the board members will
review, reports regarding all amounts expended under the Plan and the purposes
for which such expenditures were made, (2) the Plan will continue in effect only
so long as it is approved at least annually, and any material amendment thereto
is approved, by the applicable board, including those board members who are not
"interested persons" of the Trust and who have no direct or indirect financial
interest in the operation of the Plan or any agreement related to the Plan,
acting in person at a meeting called for that purpose, (3) payments by a fund
under the Plan shall not be materially increased without the affirmative vote of
the holders of a majority of the outstanding shares of the relevant class of the
fund and (4) while the Plan remains in effect, the selection and nomination of
board members who are not "interested persons" of the Trust shall be committed
to the discretion of the board members who are not "interested persons" of that
Trust.
In reporting amounts expended under the Plans to the board members,
Mitchell Hutchins allocates expenses attributable to the sale of each class of
each fund's shares to such class based on the ratio of sales of shares of such
class to the sales of all three classes of shares. The fees paid by one class of
a fund's shares will not be used to subsidize the sale of any other class of
fund shares.
The funds paid (or accrued) the following service and/or distribution fees
to Mitchell Hutchins under the Class A, Class B and Class C Plans during the
fiscal year ended November 30, 1999:
<TABLE>
<CAPTION>
U.S. INVESTMENT
GOVERNMENT LOW GRADE INCOME HIGH INCOME STRATEGIC
INCOME FUND DURATION FUND FUND FUND INCOME FUND
----------- ------------- ---- ---- -----------
<S> <C> <C> <C> <C> <C>
Class A........ $637,848 $135,190 $524,546 $610,271 $97,242
Class B........ 172,005 72,407 336,809 1,425,449 429,035
Class C........ 170,768 538,438 248,190 693,522 220,329
</TABLE>
Mitchell Hutchins estimates that it and its parent corporation,
PaineWebber, incurred the following shareholder service-related and
distribution-related expenses with respect to each fund during the fiscal year
ended November 30, 1999:
<TABLE>
<CAPTION>
U.S. INVESTMENT
GOVERNMENT LOW DURATION GRADE INCOME HIGH INCOME STRATEGIC
INCOME FUND FUND FUND FUND INCOME FUND
----------- ---- ---- ---- -----------
<S> <C> <C> <C> <C> <C>
CLASS A
Marketing and advertising............ $248,373 $198,635 $330,555 $479,274 $135,638
Amortization of commissions.......... 0 0 0 0 0
Printing of prospectuses and SAIs.... 4,975 1,568 3,439 12,801 541
Branch network costs allocated and
interest expense..................... 957,635 184,663 682,751 939,991 104,321
Service fees paid to PaineWebber
Financial Advisors................... 247,066 52,362 203,239 234,882 37,705
48
<PAGE>
U.S. INVESTMENT
GOVERNMENT LOW DURATION GRADE INCOME HIGH INCOME STRATEGIC
INCOME FUND FUND FUND FUND INCOME FUND
----------- ---- ---- ---- -----------
CLASS B
Marketing and advertising............ $16,466 $26,703 $51,945 $280,995 $148,307
Amortization of commissions.......... 61,070 26,029 119,255 487,776 153,378
Printing of prospectuses and SAIs.... 347 101 435 5,129 587
Branch network costs allocated and
interest expense..................... 72,022 27,102 125,349 544,766 134,203
Service fees paid to PaineWebber
Financial Advisors................... 16,639 7,011 32,594 136,931 41,552
CLASS C
Marketing and advertising............ $22,126 $264,608 $51,897 $181,847 $101,760
Amortization of commissions.......... 44,096 139,035 64,529 177,909 56,915
Printing of prospectuses and SAIs.... 463 1,135 479 4,454 417
Branch network costs allocated and
interest expense..................... 86,167 247,298 108,706 355,743 79,207
Service fees paid to PaineWebber
Financial Advisors................... 22,049 69,517 32,048 88,954 28,458
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing the funds' shares. These
internal costs encompass office rent, salaries and other overhead expenses of
various departments and areas of operations of Mitchell Hutchins. "Branch
network costs allocated and interest expense" consist of an allocated portion of
the expenses of various PaineWebber departments involved in the distribution of
the funds' shares, including the PaineWebber retail branch system.
In approving each fund's overall Flexible Pricing(SERVICEMARK) system of
distribution, the applicable board considered several factors, including that
implementation of Flexible Pricing would (1) enable investors to choose the
purchasing option best suited to their individual situation, thereby encouraging
current shareholders to make additional investments in the fund and attracting
new investors and assets to the fund to the benefit of the fund and its
shareholders, (2) facilitate distribution of the fund's shares and (3) maintain
the competitive position of the fund in relation to other funds that have
implemented or are seeking to implement similar distribution arrangements.
In approving the Class A Plan, each board considered all the features of
the distribution system, including (1) the conditions under which initial sales
charges would be imposed and the amount of such charges, (2) Mitchell Hutchins'
belief that the initial sales charge combined with a service fee would be
attractive to PaineWebber Financial Advisors and correspondent firms, resulting
in greater growth of the fund than might otherwise be the case, (3) the
advantages to the shareholders of economies of scale resulting from growth in
the fund's assets and potential continued growth, (4) the services provided to
the fund and its shareholders by Mitchell Hutchins, (5) the services provided by
PaineWebber pursuant to its Exclusive Dealer Agreement with Mitchell Hutchins
and (6) Mitchell Hutchins' shareholder service-related expenses and costs.
In approving the Class B Plan, the board of each fund considered all the
features of the distribution system, including (1) the conditions under which
contingent deferred sales charges would be imposed and the amount of such
charges, (2) the advantage to investors in having no initial sales charges
deducted from fund purchase payments and instead having the entire amount of
their purchase payments immediately invested in fund shares, (3) Mitchell
Hutchins' belief that the ability of PaineWebber Financial Advisors and
correspondent firms to receive sales commissions when Class B shares are sold
and continuing service fees thereafter while their customers invest their entire
purchase payments immediately in Class B shares would prove attractive to the
Financial Advisors and correspondent firms, resulting in greater growth of the
fund than might otherwise be the case, (4) the advantages to the shareholders of
49
<PAGE>
economies of scale resulting from growth in the fund's assets and potential
continued growth, (5) the services provided to the fund and its shareholders by
Mitchell Hutchins, (6) the services provided by PaineWebber pursuant to its
Exclusive Dealer Agreement with Mitchell Hutchins and (7) Mitchell Hutchins'
shareholder service- and distribution-related expenses and costs. The board
members also recognized that Mitchell Hutchins' willingness to compensate
PaineWebber and its Financial Advisors, without the concomitant receipt by
Mitchell Hutchins of initial sales charges, was conditioned upon its expectation
of being compensated under the Class B Plan.
In approving the Class C Plan, each board considered all the features of
the distribution system, including (1) the advantage to investors in having no
initial sales charges deducted from fund purchase payments and instead having
the entire amount of their purchase payments immediately invested in fund
shares, (2) the advantage to investors in being free from contingent deferred
sales charges upon redemption for shares held more than one year and paying for
distribution on an ongoing basis, (3) Mitchell Hutchins' belief that the ability
of PaineWebber Financial Advisors and correspondent firms to receive sales
compensation for their sales of Class C shares on an ongoing basis, along with
continuing service fees, while their customers invest their entire purchase
payments immediately in Class C shares and generally do not face contingent
deferred sales charges, would prove attractive to the Financial Advisors and
correspondent firms, resulting in greater growth to the fund than might
otherwise be the case, (4) the advantages to the shareholders of economies of
scale resulting from growth in the fund's assets and potential continued growth,
(5) the services provided to the fund and its shareholders by Mitchell Hutchins,
(6) the services provided by PaineWebber pursuant to its Exclusive Dealer
Agreement with Mitchell Hutchins and (7) Mitchell Hutchins' shareholder service-
and distribution-related expenses and costs. The board members also recognized
that Mitchell Hutchins' willingness to compensate PaineWebber and its Financial
Advisors, without the concomitant receipt by Mitchell Hutchins of initial sales
charges or contingent deferred sales charges upon redemption after one year
following purchase was conditioned upon its expectation of being compensated
under the Class C Plan.
With respect to each Plan, the boards considered all compensation that
Mitchell Hutchins would receive under the Plan and the Distribution Contract,
including service fees and, as applicable, initial sales charges, distribution
fees and contingent deferred sales charges. The boards also considered the
benefits that would accrue to Mitchell Hutchins under each Plan in that Mitchell
Hutchins would receive service, distribution and advisory fees that are
calculated based upon a percentage of the average net assets of a fund, which
fees would increase if the Plan were successful and the fund attained and
maintained significant asset levels.
Under the Distribution Contract between each Trust and Mitchell Hutchins
for the Class A shares for the fiscal years set forth below, Mitchell Hutchins
earned the following approximate amounts of sales charges and retained the
following approximate amounts, net of concessions to PaineWebber as exclusive
dealer.
<TABLE>
<CAPTION>
FISCAL YEARS ENDED NOVEMBER 30,
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
U.S. GOVERNMENT INCOME FUND
Earned....................... $ 24,995 $ 32,953 $ 13,156
Retained.................... 1,726 5,284 1,562
LOW DURATION FUND
Earned....................... 126,998 84,972 14,824
Retained.................... 1,800 1,664 261
INVESTMENT GRADE INCOME FUND
Earned....................... 70,668 151,513 51,469
Retained.................... 4,388 7,946 4,100
HIGH INCOME FUND
Earned....................... 303,464 419,260 506,732
Retained.................... 22,045 33,441 36,405
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
FISCAL YEARS ENDED NOVEMBER 30,
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
STRATEGIC INCOME FUND
Earned....................... 48,955 163,983 157,647
Retained.................... 6,139 12,827 11,028
</TABLE>
Mitchell Hutchins earned and retained the following contingent deferred
sales charges paid upon certain redemptions of Class A, Class B and Class C
shares for the fiscal year ended November 30, 1999:
<TABLE>
<CAPTION>
U.S. INVESTMENT
GOVERNMENT LOW DURATION GRADE INCOME HIGH INCOME STRATEGIC
INCOME FUND FUND FUND FUND INCOME FUND
----------- ---- ---- ---- -----------
<S> <C> <C> <C> <C> <C>
Class A............... $ 0 $ 0 $ 0 $ 0 $ 0
Class B............... 47,957 19,192 120,424 442,931 146,545
Class C............... 2,829 9,891 6,884 18,779 5,483
</TABLE>
PORTFOLIO TRANSACTIONS
Subject to policies established by each board, Mitchell Hutchins (or for
Low Duration Fund the sub-adviser) is responsible for the execution of each
fund's portfolio transactions and the allocation of brokerage transactions. In
executing portfolio transactions, Mitchell Hutchins (or for Low Duration Fund
the sub-adviser) seeks to obtain the best net results for a fund, taking into
account such factors as the price (including the applicable brokerage commission
or dealer spread), size of order, difficulty of execution and operational
facilities of the firm involved. Generally, bonds are traded on the
over-the-counter market on a "net" basis without a stated commission through
dealers acting for their own accounts and not through brokers. Prices paid to
dealers in principal transactions 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. While Mitchell Hutchins (and for Low
Duration Fund the sub-adviser) generally seek reasonably competitive commission
rates, payment of the lowest commission is not necessarily consistent with
obtaining the best net results.
During the fiscal years indicated, the funds paid the brokerage
commissions set forth below:
FISCAL YEARS ENDED NOVEMBER 30,
1999 1998 1997
---- ---- ----
U.S. Government Income Fund.. $16,320 $121,482 $105,150
Low Duration Fund............ 640 0 0
Investment Grade Income Fund. 0 5,412 2,400
High Income Fund............. 23,954 8,104 2,939
Strategic Income Fund........ 6,033 10,079 0
The funds have no obligation to deal with any broker or group of brokers
in the execution of portfolio transactions. The funds contemplate that,
consistent with the policy of obtaining the best net results, brokerage
transactions may be conducted through Mitchell Hutchins or its affiliates,
including PaineWebber, (or for Low Duration Fund brokerage affiliates of the
sub-adviser). Each board has adopted procedures in conformity with Rule 17e-1
under the Investment Company Act to ensure that all brokerage commissions paid
to PaineWebber or brokerage affiliates of the sub-adviser are reasonable and
51
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fair. Specific provisions in the Advisory Contracts and the Sub-Advisory
Contract authorize Mitchell Hutchins and the sub-adviser, respectively, and any
of their affiliates that is a member of a national securities exchange to effect
portfolio transactions for the applicable 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. None of the funds paid brokerage commissions to PaineWebber or, in
the case of Low Duration Fund, brokerage affiliates of the sub-adviser during
the last three fiscal years.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
funds' procedures in selecting FCMs to execute their transactions in futures
contracts, including procedures permitting the use of Mitchell Hutchins and its
affiliates or affiliates of the sub-adviser, are similar to those in effect with
respect to brokerage transactions in securities.
In selecting brokers, Mitchell Hutchins (or for Low Duration Fund the
sub-adviser) will consider the full range and quality of a broker's services.
Consistent with the interests of the funds and subject to the review of each
board, Mitchell Hutchins (or for Low Duration Fund the sub-adviser) may cause a
fund to purchase and sell portfolio securities through brokers who provide
Mitchell Hutchins (or for Low Duration Fund the sub-adviser) with brokerage or
research services. The funds may pay those brokers a higher commission than may
be charged by other brokers, provided that Mitchell Hutchins or (or for Low
Duration Fund the sub-adviser) determines in good faith that such commission is
reasonable in terms either of that particular transaction or of the overall
responsibility of Mitchell Hutchins (or for Low Duration Fund the sub-adviser),
to that fund and its other clients.
Research services obtained from brokers may include written reports,
pricing and appraisal services, analysis of issues raised in proxy statements,
educational seminars, subscriptions, portfolio attribution and monitoring
services, and computer hardware, software and access charges which are directly
related to investment research. Research services may be received in the form of
written reports, online services, telephone contacts and personal meetings with
securities analysts, economists, corporate and industry spokespersons and
government representatives.
For the fiscal year ended November 30, 1999, the funds did not direct any
portfolio transactions to brokers chosen because they provide research,
analysis, advice and similar services.
For purchases or sales with broker-dealer firms that act as principal,
Mitchell Hutchins (or for Low Duration Fund the sub-adviser) seeks best
execution. Although Mitchell Hutchins or (or for Low Duration Fund the
sub-adviser) may receive certain research or execution services in connection
with these transactions, Mitchell Hutchins (and for Low Duration Fund the
sub-adviser) 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. Mitchell Hutchins (or for Low
Duration Fund the sub-adviser) may engage in agency transactions in
over-the-counter 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.
Research services and information received from brokers or dealers are
supplemental to Mitchell Hutchins' (or for Low Duration Fund the sub-adviser's)
own research efforts and, when utilized, are subject to internal analysis before
being incorporated into their investment processes. Information and research
services furnished by brokers or dealers through which or with which the funds
effect securities transactions may be used by Mitchell Hutchins (or for Low
Duration Fund the sub-adviser) in advising other funds or accounts and,
conversely, research services furnished to Mitchell Hutchins or the sub-adviser
by brokers or dealers in connection with other funds or accounts that either of
them advises may be used in advising the funds.
Investment decisions for a fund and for other investment accounts managed
by Mitchell Hutchins (or for Low Duration Fund by the sub-adviser) are made
independently of each other in light of differing considerations for the various
accounts. However, the same investment decision may occasionally be made for a
fund and one or more of such accounts. In such cases, simultaneous transactions
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<PAGE>
are inevitable. Purchases or sales are then averaged as to price and allocated
between that 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 a 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 funds will not purchase securities that are offered in underwritings
in which PaineWebber (or for Low Duration Fund an affiliate of the sub-adviser)
is a member of the underwriting or selling group, except pursuant to procedures
adopted by each board pursuant to Rule 10f-3 under the Investment Company Act.
Among other things, these procedures require that the spread or commission paid
in connection with such a purchase be reasonable and fair, 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 PaineWebber or any affiliate
thereof or an affiliate of the sub-adviser not participate in or benefit from
the sale to the funds.
As of November 30, 1999, the funds owned securities issued by their
regular broker-dealers as follows:
Low Duration Fund: collateralized mortgage obligation of Prudential
Securities CMO Trust, Series 18, Class E ($3,165,782); repurchase
agreement with State Street Bank & Trust Co. ($6,134,000).
Investment Grade Income Fund: collateralized mortgage obligation of CS
First Boston Mortgage Securities Corp. Series 1998-C2, Class A2
($4,708,200); corporate bond issued by Lehman Brothers Holdings
Incorporated ($6,857,760); repurchase agreements with State Street Bank &
Trust Co. ($10,000,000) and SG Warburg ($10,910,000).
Strategic Income Fund: collateralized mortgage obligation of CS First
Boston Mortgage Securities Corp. Series 1997-C2, Class A2 ($3,869,400);
DLJ Commercial Mortgage Corp. Series 1998-CG1, Class A1B ($950,700); First
Union Lehman Brothers Mortgage Trust, Series 1997-C2, Class A3
($6,586,768); repurchase agreement with Zions Bancorp ($3,087,000).
US Government Income Fund: collateralized mortgage obligation of CS First
Boston Mortgage Securities Corp., Series 1997-2, Class A ($1,344,314); CS
First Boston Mortgage Securities Corp., Series 1998-C2, Class A2
($4,708,200); DLJ Commercial Mortgage Corp., Series 1998-CF2, Class A1A
($3,582,664); Morgan Stanley Capital I, Series 1997-ALIC, Class A1B
($3,623,771); Morgan Stanley Capital I, Series 1997-WF1, Class A1
($4,911,041); repurchase agreement with Dresdner Bank AG ($2,648,000).
PORTFOLIO TURNOVER. The funds' annual portfolio turnover rates may vary
greatly from year to year, but they will not be a limiting factor when
management deems portfolio changes appropriate. The portfolio turnover rate is
calculated by dividing the lesser of a 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 securities in the portfolio during the year.
The funds' respective portfolio turnover rates for the fiscal years shown
were:
FISCAL YEARS ENDED NOVEMBER 30,
1999 1998
---- ----
U.S. Government Income Fund......... 375% 370%
Low Duration Fund................... 270% 411%
Investment Grade Income Fund........ 195% 173%
High Income Fund.................... 62% 161%
Strategic Income Fund............... 226% 192%
53
<PAGE>
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
WAIVERS OF SALES CHARGES/CONTINGENT DEFERRED SALES CHARGES -- CLASS A
SHARES. The following additional sales charge waivers are available for Class A
shares if you:
o Purchase shares through a variable annuity offered only to qualified
plans. For investments made pursuant to this waiver, Mitchell
Hutchins may make payments out of its own resources to PaineWebber
and to the variable annuity's sponsor, adviser or distributor in a
total amount not to exceed l% of the amount invested;
o Acquire shares through an investment program that is not sponsored
by PaineWebber or its affiliates and that charges participants a fee
for program services, provided that the program sponsor has entered
into a written agreement with PaineWebber permitting the sale of
shares at net asset value to that program. For investments made
pursuant to this waiver, Mitchell Hutchins may make a payment to
PaineWebber out of its own resources in an amount not to exceed 1%
of the amount invested. For subsequent investments or exchanges made
to implement a rebalancing feature of such an investment program,
the minimum subsequent investment requirement is also waived;
o Acquire shares in connection with a reorganization pursuant to which
a fund acquires substantially all of the assets and liabilities of
another fund in exchange solely for shares of the acquiring fund; or
o Acquire shares in connection with the disposition of proceeds from
the sale of shares of Managed High Yield Plus Fund Inc. that were
acquired during that fund's initial public offering of shares and
that meet certain other conditions described in its prospectus.
In addition, reduced sales charges on Class A shares are available through
the combined purchase plan or through rights of accumulation described below.
Class A share purchases of $1 million or more are not subject to an initial
sales charge; however, if a shareholder sells these shares within one year after
purchase, a contingent deferred sales charge of 1% of the offering price or the
net asset value of the shares at the time of sale by the shareholder, whichever
is less, is imposed.
COMBINED PURCHASE PRIVILEGE -- CLASS A SHARES. Investors and eligible
groups of related fund investors may combine purchases of Class A shares of the
funds with concurrent purchases of Class A shares of any other PaineWebber
mutual fund and thus take advantage of the reduced sales charges indicated in
the tables of sales charges for Class A shares in the Prospectus. The sales
charge payable on the purchase of Class A shares of the funds and Class A shares
of such other funds will be at the rates applicable to the total amount of the
combined concurrent purchases.
An "eligible group of related fund investors" can consist of any
combination of the following:
(a) an individual, that individual's spouse, parents and children;
(b) an individual and his or her individual retirement account ("IRA");
(c) an individual (or eligible group of individuals) and any company
controlled by the individual(s) (a person, entity or group that
holds 25% or more of the outstanding voting securities of a
corporation will be deemed to control the corporation, and a
partnership will be deemed to be controlled by each of its general
partners);
(d) an individual (or eligible group of individuals) and one or more
employee benefit plans of a company controlled by the individual(s);
54
<PAGE>
(e) an individual (or eligible group of individuals) and a trust created
by the individual(s), the beneficiaries of which are the individual
and/or the individual's spouse, parents or children;
(f) an individual and a Uniform Gifts to Minors Act/Uniform Transfers to
Minors Act account created by the individual or the individual's
spouse;
(g) an employer (or group of related employers) and one or more
qualified retirement plans of such employer or employers (an
employer controlling, controlled by or under common control with
another employer is deemed related to that other employer); or
(h) individual accounts related together under one registered investment
adviser having full discretion and control over the accounts. The
registered investment adviser must communicate at least quarterly
through a newsletter or investment update establishing a
relationship with all of the accounts.
RIGHTS OF ACCUMULATION -- CLASS A SHARES. Reduced sales charges are
available through a right of accumulation, under which investors and eligible
groups of related fund investors (as defined above) are permitted to purchase
Class A shares of the funds among related accounts at the offering price
applicable to the total of (1) the dollar amount then being purchased plus (2)
an amount equal to the then-current net asset value of the purchaser's combined
holdings of Class A fund shares and Class A shares of any other PaineWebber
mutual fund. The purchaser must provide sufficient information to permit
confirmation of his or her holdings, and the acceptance of the purchase order is
subject to such confirmation. The right of accumulation may be amended or
terminated at any time.
REINSTATEMENT PRIVILEGE -- CLASS A SHARES. Shareholders who have redeemed
Class A shares of a fund may reinstate their account without a sales charge by
notifying the transfer agent of such desire and forwarding a check for the
amount to be purchased within 365 days after the date of redemption. The
reinstatement will be made at the net asset value per share next computed after
the notice of reinstatement and check are received. The amount of a purchase
under this reinstatement privilege cannot exceed the amount of the redemption
proceeds. Gain on a redemption is taxable regardless of whether the
reinstatement privilege is exercised, although a loss arising out of a
redemption will not be deductible to the extent the reinstatement privilege is
exercised within 30 days after redemption, in which event an adjustment will be
made to the shareholder's tax basis for shares acquired pursuant to the
reinstatement privilege. Gain or loss on a redemption also will be readjusted
for federal income tax purposes by the amount of any sales charge paid on Class
A shares, under the circumstances and to the extent described in "Taxes --
Special Rule for Class A Shareholders," below.
WAIVERS OF CONTINGENT DEFERRED SALES CHARGES -- CLASS B SHARES. The
maximum 5% contingent deferred sales charge (3% for Low Duration Fund) applies
to sales of shares during the first year after purchase. The charge generally
declines by 1% annually, reaching zero after six years (four years for Low
Duration Fund). Among other circumstances, the contingent deferred sales charge
on Class B shares is waived where a total or partial redemption is made within
one year following the death of the shareholder. The contingent deferred sales
charge waiver is available where the decedent is either the sole shareholder or
owns the shares with his or her spouse as a joint tenant with right of
survivorship. This waiver applies only to redemption of shares held at the time
of death.
PURCHASES OF CLASS Y SHARES THROUGH THE PACE(SERVICEMARK) MULTI ADVISOR
PROGRAM. An investor who participates in the PACE(SERVICEMARK) Multi Advisor
Program is eligible to purchase Class Y shares. The PACE(SERVICEMARK) Multi
Advisor Program is an advisory program sponsored by PaineWebber that provides
comprehensive investment services, including investor profiling, a personalized
asset allocation strategy using an appropriate combination of funds, and a
quarterly investment performance review. Participation in the PACE(SERVICEMARK)
Multi Advisor Program is subject to payment of an advisory fee at the effective
maximum annual rate of 1.5% of assets. Employees of PaineWebber and its
affiliates are entitled to a waiver of this fee. Please contact your PaineWebber
Financial Advisor or PaineWebber's correspondent firms for more information
concerning mutual funds that are available through the PACE(SERVICEMARK) Multi
Advisor Program.
55
<PAGE>
PURCHASES OF CLASS A SHARES THROUGH THE PAINEWEBBER
INSIGHTONE(SERVICEMARK) PROGRAM. Investors who purchase shares through the
PaineWebber InsightOne(SERVICEMARK) Program are eligible to purchase Class A
shares without a sales load. The PaineWebber InsightOne(SERVICEMARK) Program
offers a nondiscretionary brokerage account to investors for an asset-based fee
at an annual rate of up to 1.5% of the assets in the account. Account holders
may purchase or sell certain investment products without paying commissions or
other markups/markdowns.
PURCHASES AND SALES OF CLASS Y SHARES FOR PARTICIPANTS IN PW 401(K) PLUS
PLAN. The trustee of the PW 401(k) Plus Plan, a defined contribution plan
sponsored by PW Group, buys and sells Class Y shares of the funds that are
included as investment options under the Plan to implement the investment
choices of individual plan participants with respect to their PW Plan
contributions. Individual plan participants should consult the Summary Plan
Description and other plan material of the PW 401(k) Plus Plan (collectively,
"Plan Documents") for a description of the procedures and limitations applicable
to making and changing investment choices. Copies of the Plan Documents are
available from the Benefits Connection, 100 Halfday Road, Lincolnshire, IL 60069
or by calling 1-888-PWEBBER (1-888-793-2237). As described in the Plan
Documents, the price at which Class Y shares are bought and sold by the trustee
of PW 401(k) Plus Plan might be more or less than the price per share at the
time the participants made their investment choices.
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the funds may be exchanged for shares of the
corresponding class of most other PaineWebber mutual funds. Class Y shares are
not eligible for exchange. Shareholders will receive at least 60 days' notice of
any termination or material modification of the exchange offer, except no notice
need be given if, under extraordinary circumstances, either redemptions are
suspended under the circumstances described below or a fund temporarily delays
or ceases the sales of its shares because it is unable to invest amounts
effectively in accordance with the fund's investment objective, policies and
restrictions.
If conditions exist that make cash payments undesirable, each fund
reserves the right to honor any request for redemption by making payment in
whole or in part in securities chosen by the fund and valued in the same way as
they would be valued for purposes of computing the fund's net asset value. Any
such redemption in kind will be made with readily marketable securities, to the
extent available. If payment is made in securities, a shareholder may incur
brokerage expenses in converting these securities into cash. Each fund has
elected, however, to be governed by Rule 18f-1 under the Investment Company Act,
under which it is obligated to redeem shares solely in cash up to the lesser of
$250,000 or 1% of its net asset value during any 90-day period for one
shareholder. This election is irrevocable unless the SEC permits its withdrawal.
The funds may suspend redemption privileges or postpone the date of
payment during any period (1) when the New York Stock Exchange is closed or
trading on the New York Stock Exchange is restricted as determined by the SEC,
(2) when an emergency exists, as defined by the SEC, that makes it not
reasonably practicable for a fund to dispose of securities owned by it or fairly
to determine the value of its assets or (3) as the SEC may otherwise permit. The
redemption price may be more or less than the shareholder's cost, depending on
the market value of a fund's portfolio at the time.
SERVICE ORGANIZATIONS. A fund may authorize service organizations, and
their agents, to accept on its behalf purchase and redemption orders that are in
"good form" in accordance with the policies of those service organizations. A
fund will be deemed to have received these purchase and redemption orders when a
service organization or its agent accepts them. Like all customer orders, these
orders will be priced based on the fund's net asset value next computed after
receipt of the order by the service organizations or their agents. Service
organizations may include retirement plan service providers who aggregate
purchase and redemption instructions received from numerous retirement plans or
plan participants.
AUTOMATIC INVESTMENT PLAN. PaineWebber offers an automatic investment plan
with a minimum initial investment of $1,000 through which a fund will deduct $50
or more on a monthly, quarterly, semi-annual or annual basis from the investor's
bank account to invest directly in the fund. Participation in the automatic
investment plan enables an investor to use the technique of "dollar cost
averaging." When an investor invests the same dollar amount each month under the
plan, the investor will purchase more shares when a fund's net asset value per
share is low and fewer shares when the net asset value per share is high. Using
56
<PAGE>
this technique, an investor's average purchase price per share over any given
period will be lower than if the investor purchased a fixed number of shares on
a monthly basis during the period. Of course, investing through the automatic
investment plan does not assure a profit or protect against loss in declining
markets. Additionally, because the automatic investment plan involves continuous
investing regardless of price levels, an investor should consider his or her
financial ability to continue purchases through periods of both low and high
price levels.
SYSTEMATIC WITHDRAWAL PLAN. The systematic withdrawal plan allows
investors to set up monthly, quarterly (March, June, September and December),
semi-annual (June and December) or annual (December) withdrawals from their
PaineWebber mutual fund accounts. Minimum balances and withdrawals vary
according to the class of shares:
o Class A and Class C shares. Minimum value of fund shares is $5,000;
minimum withdrawals of $100.
o Class B shares. Minimum value of fund shares is $10,000; minimum
monthly, quarterly, and semi-annual and annual withdrawals of $100,
$200, $300 and $400, respectively.
Withdrawals under the systematic withdrawal plan will not be subject to a
contingent deferred sales charge if the investor withdraws no more than 12% of
the value of the fund account when the investor signed up for the Plan (for
Class B shares, annually; for Class A and Class C shares, during the first year
under the Plan). Shareholders who elect to receive dividends or other
distributions in cash may not participate in this plan.
An investor's participation in the systematic withdrawal plan will
terminate automatically if the "Initial Account Balance" (a term that means the
value of the fund account at the time the investor elects to participate in the
systematic withdrawal plan), less aggregate redemptions made other than pursuant
to the systematic withdrawal plan, is less than the minimum values specified
above. Purchases of additional shares of a fund concurrent with withdrawals are
ordinarily disadvantageous to shareholders because of tax liabilities and, for
Class A shares, initial sales charges. On or about the 20th of a month for
monthly, quarterly, semi-annual and annual plans, PaineWebber will arrange for
redemption by the funds of sufficient fund shares to provide the withdrawal
payments specified by participants in the funds' systematic withdrawal plan. The
payments generally are mailed approximately five Business Days (defined under
"Valuation of Shares") after the redemption date. Withdrawal payments should not
be considered dividends, but redemption proceeds. If periodic withdrawals
continually exceed reinvested dividends and other distributions, a shareholder's
investment may be correspondingly reduced. A shareholder may change the amount
of the systematic withdrawal or terminate participation in the systematic
withdrawal plan at any time without charge or penalty by written instructions
with signatures guaranteed to PaineWebber or PFPC Inc. Instructions to
participate in the plan, change the withdrawal amount or terminate participation
in the plan will not be effective until five days after written instructions
with signatures guaranteed are received by PFPC. Shareholders may request the
forms needed to establish a systematic withdrawal plan from their PaineWebber
Financial Advisors, correspondent firms or PFPC at 1-800-647-1568.
INDIVIDUAL RETIREMENT ACCOUNTS. Self-directed IRAs are available through
PaineWebber in which purchases of shares of PaineWebber mutual funds and other
investments may be made. Investors considering establishing an IRA should review
applicable tax laws and should consult their tax advisers.
TRANSFER OF ACCOUNTS. If investors holding shares of a fund in a
PaineWebber brokerage account transfer their brokerage accounts to another firm,
the fund shares will be moved to an account with PFPC. However, if the other
firm has entered into a selected dealer agreement with Mitchell Hutchins
relating to the fund, the shareholder may be able to hold fund shares in an
account with the other firm.
57
<PAGE>
PAINEWEBBER RMA RESOURCE ACCUMULATION PLAN(SERVICEMARK);
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(REGISTERED) (RMA)(REGISTERED)
Shares of PaineWebber mutual funds (each a "PW Fund" and, collectively,
the "PW Funds") are available for purchase through the RMA Resource Accumulation
Plan ("Plan") by customers of PaineWebber and its correspondent firms who
maintain Resource Management Accounts ("RMA accountholders"). The Plan allows an
RMA accountholder to continually invest in one or more of the PW Funds at
regular intervals, with payment for shares purchased automatically deducted from
the client's RMA account. The client may elect to invest at monthly or quarterly
intervals and may elect either to invest a fixed dollar amount (minimum $100 per
period) or to purchase a fixed number of shares. A client can elect to have Plan
purchases executed on the first or fifteenth day of the month. Settlement occurs
three Business Days (defined under "Valuation of Shares") after the trade date,
and the purchase price of the shares is withdrawn from the investor's RMA
account on the settlement date from the following sources and in the following
order: uninvested cash balances, balances in RMA money market funds, or margin
borrowing power, if applicable to the account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment requirements)
and must complete and submit the RMA Resource Accumulation Plan Client Agreement
and Instruction Form available from PaineWebber. The investor must have received
a current prospectus for each PW Fund selected prior to enrolling in the Plan.
Information about mutual fund positions and outstanding instructions under the
Plan are noted on the RMA accountholder's account statement. Instructions under
the Plan may be changed at any time, but may take up to two weeks to become
effective.
The terms of the Plan, or an RMA accountholder's participation in the
Plan, may be modified or terminated at any time. It is anticipated that, in the
future, shares of other PW Funds and/or mutual funds other than the PW Funds may
be offered through the Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING. Periodic investing in the PW
Funds or other mutual funds, whether through the Plan or otherwise, helps
investors establish and maintain a disciplined approach to accumulating assets
over time, de-emphasizing the importance of timing the market's highs and lows.
Periodic investing also permits an investor to take advantage of "dollar cost
averaging." By investing a fixed amount in mutual fund shares at established
intervals, an investor purchases more shares when the price is lower and fewer
shares when the price is higher, thereby increasing his or her earning
potential. Of course, dollar cost averaging does not guarantee a profit or
protect against a loss in a declining market, and an investor should consider
his or her financial ability to continue investing through periods of both low
and high share prices. However, over time, dollar cost averaging generally
results in a lower average original investment cost than if an investor invested
a larger dollar amount in a mutual fund at one time.
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the Plan,
an investor must have opened an RMA account with PaineWebber or one of its
correspondent firms. The RMA account is PaineWebber's comprehensive asset
management account and offers investors a number of features, including the
following:
o monthly Premier account statements that itemize all account
activity, including investment transactions, checking activity and
Gold MasterCard(REGISTERED) transactions during the period, and
provide unrealized and realized gain and loss estimates for most
securities held in the account;
o comprehensive year-end summary statements that provide information
on account activity for use in tax planning and tax return
preparation;
o automatic "sweep" of uninvested cash into the RMA accountholder's
choice of one of the six RMA money market funds--RMA Money Market
Portfolio, RMA U.S. Government Portfolio, RMA Tax-Free Fund, RMA
California Municipal Money Fund, RMA New Jersey Municipal Money Fund
and RMA New York Municipal Money Fund. AN INVESTMENT IN A MONEY
MARKET FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT
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INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH A
MONEY MARKET FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT
$1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN A
MONEY MARKET FUND.
o check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
o Gold MasterCard, with or without a line of credit, which provides
RMA accountholders with direct access to their accounts and can be
used with automatic teller machines worldwide. Purchases on the Gold
MasterCard are debited to the RMA account once monthly, permitting
accountholders to remain invested for a longer period of time;
o unlimited electronic funds transfers and a bill payment service for
an additional fee;
o 24-hour access to account information through toll-free numbers, and
more detailed personal assistance during business hours from the RMA
Service Center;
o expanded account protection for the net equity securities balance in
the event of the liquidation of PaineWebber. This protection does
not apply to shares of funds that are held at PFPC and not through
PaineWebber; and
o automatic direct deposit of checks into your RMA account and
automatic withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
CONVERSION OF CLASS B SHARES
Class B shares of a fund will automatically convert to Class A shares of
that fund, based on the relative net asset values per share of the two classes,
as of the close of business on the first Business Day (as defined under
"Valuation of Shares") of the month in which the sixth anniversary of the
initial issuance of such Class B shares occurs. For the purpose of calculating
the holding period required for conversion of Class B shares, the date of
initial issuance shall mean (1) the date on which such Class B shares were
issued or (2) for Class B shares obtained through an exchange, or a series of
exchanges, the date on which the original Class B shares were issued. For
purposes of conversion to Class A shares, Class B shares purchased through the
reinvestment of dividends and other distributions paid in respect of Class B
shares will be held in a separate sub-account. Each time any Class B shares in
the shareholder's regular account (other than those in the sub-account) convert
to Class A shares, a pro rata portion of the Class B shares in the sub-account
will also convert to Class A shares. The portion will be determined by the ratio
that the shareholder's Class B shares converting to Class A shares bears to the
shareholder's total Class B shares not acquired through dividends and other
distributions.
The conversion feature is subject to the continuing availability of an
opinion of counsel to the effect that the dividends and other distributions paid
on Class A and Class B shares will not result in "preferential dividends" under
the Internal Revenue Code and that the conversion of shares does not constitute
a taxable event. If the conversion feature ceased to be available, the Class B
shares would not be converted and would continue to be subject to their higher
ongoing expenses beyond six years from the date of purchase. Mitchell Hutchins
has no reason to believe that this condition will not continue to be met.
VALUATION OF SHARES
Each fund determines its net asset value per share separately for each
class of shares, normally as of the close of regular trading (usually 4:00 p.m.,
Eastern time) on the New York Stock Exchange on each Business Day, which is
defined as each Monday through Friday when the New York Stock Exchange is open.
Prices will be calculated earlier when the New York Stock Exchange closes early
because trading has been halted for the day. Currently the New York Stock
Exchange is closed on the observance of the following holidays: New Year's Day,
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Martin Luther King, Jr. 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 normally
are valued at the last sale price on the day 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 (or for Low Duration Fund
the sub-adviser) as the primary market. Securities traded in the
over-the-counter market and listed on The Nasdaq Stock Market ("Nasdaq")
normally are valued at the last available sale price on Nasdaq prior to
valuation; other over-the-counter securities are valued at the last bid price
available prior to valuation. Where market quotations are readily available,
portfolio securities are valued based upon market quotations, provided those
quotations adequately reflect, in the judgment of Mitchell Hutchins (or for Low
Duration Fund the sub-adviser), the fair value of the security. Where those
market quotations are not readily available, securities are valued based upon
appraisals received from a pricing service using a computerized matrix system or
based upon appraisals derived from information concerning the security or
similar securities received from recognized dealers in those securities. All
other securities and other assets are valued at fair value as determined in good
faith by or under the direction of the applicable board. It should be recognized
that judgment often plays a greater role in valuing thinly traded securities,
including many lower rated bonds, than is the case with respect to securities
for which a broader range of dealer quotations and last-sale information is
available. The amortized cost method of valuation generally is used to value
debt obligations with 60 days or less remaining until maturity, unless the
applicable board determines that this does not represent fair value.
All investments quoted in foreign currency will be valued daily in U.S.
dollars on the basis of the current foreign currency exchange rate. Foreign
currency exchange rates are generally determined prior to the close of regular
trading on the New York Stock Exchange. 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 trading on the New York Stock Exchange,
which events would not be reflected in the computation of a 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 applicable board. The foreign currency exchange transactions of
the funds conducted on a spot (i.e., cash) basis are valued at the spot rate for
purchasing or selling currency prevailing on the foreign exchange market. Under
normal market conditions this rate differs from the prevailing exchange rate by
less than one-tenth of one percent due to the costs of converting from one
currency to another.
PERFORMANCE INFORMATION
The funds' performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represent 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 each fund's Performance Advertisements are
calculated according to the following formula:
P(1 + T)n = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares
of a specified class
T = average annual total return of shares of that class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at
the beginning of that period.
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. In calculating the ending redeemable value, for Class A shares, the
maximum 4.0% sales charge (3.0% for Low Duration Fund) is deducted from the
initial $1,000 payment and, for Class B and Class C shares, the applicable
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contingent deferred sales charge imposed on a redemption of Class B or Class C
shares held for the period is deducted. All dividends and other distributions
are assumed to have been reinvested at net asset value.
The funds 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 funds calculate 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. Neither
initial nor contingent deferred sales charges are taken into account in
calculating Non-Standardized Return; the inclusion of those charges would reduce
the return.
Both Standardized Return and Non-Standardized Return for Class B shares
for periods of over six years reflect conversion of the Class B shares to Class
A shares at the end of the sixth year.
The following tables show performance information for each class of the
funds' shares outstanding for the periods indicated. All returns for periods of
more than one year are expressed as an average annual return.
<TABLE>
<CAPTION>
U.S. GOVERNMENT INCOME FUND
CLASS CLASS A CLASS B CLASS C CLASS Y
(INCEPTION DATE) (08/31/84) (07/01/91) (07/02/92) (09/11/91)
---------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended November 30, 1999:
Standardized Return*............... (6.02)% (7.55)% (3.34)% (1.87)%
Non-Standardized Return......... (2.14)% (2.93)% (2.65)% (1.87)%
Five Years ended November 30, 1999:
Standardized Return*............... 5.45% 5.15% 5.76% 6.62%
Non-Standardized Return......... 6.30% 5.47% 5.76% 6.62%
Ten Years ended November 30, 1999
Standardized Return................. 5.34% N/A N/A N/A
Non-Standardized Return......... 5.78% N/A N/A N/A
Inception to November 30, 1999:
Standardized Return*............... 7.16% 4.53% 3.36% 4.95%
Non-Standardized Return......... 7.45% 4.53% 3.36% 4.95%
LOW DURATION FUND
CLASS CLASS A CLASS B CLASS C CLASS Y
(INCEPTION DATE) (05/03/93) (05/03/93) (05/03/93) (10/20/95)
---------------- ---------- ---------- ---------- ----------
Year ended November 30, 1999:
Standardized Return*............... (0.92)% (2.18)% 0.18% 1.81%
Non-Standardized Return......... 1.99% 0.71% 0.90% 1.81%
Five Years ended November 30, 1999:
Standardized Return*............... 5.62% 5.30% 5.53% N/A
Non-Standardized Return......... 6.26% 5.30% 5.53% N/A
Inception to November 30, 1999:
Standardized Return*............... 3.79% 3.38% 3.62% 5.47%
Non-Standardized Return......... 4.29% 3.38% 3.62% 5.47%
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<PAGE>
INVESTMENT GRADE INCOME FUND
CLASS CLASS A CLASS B CLASS C CLASS Y
(INCEPTION DATE) (08/31/84) (07/01/91) (07/02/92) (02/20/98)
---------------- ---------- ---------- ---------- ----------
Year ended November 30, 1999:
Standardized Return*............... (5.56)% (7.07)% (2.89)% (1.43)%
Non-Standardized Return......... (1.62)% (2.46)% (2.20)% (1.43)%
Five Years ended November 30, 1999:
Standardized Return*............... 6.91% 6.64% 7.23% N/A
Non-Standardized Return......... 7.78% 6.95% 7.23% N/A
Ten Years ended November 30, 1999
Standardized Return................. 7.38% N/A N/A N/A
Non-Standardized Return......... 7.82% N/A N/A N/A
Inception to November 30, 1999:
Standardized Return*............... 8.80% 7.02% 5.95% 1.14%
Non-Standardized Return......... 9.09% 7.02% 5.95% 1.14%
HIGH INCOME FUND
CLASS CLASS A CLASS B CLASS C CLASS Y
(INCEPTION DATE) (08/31/84) (07/01/91) (07/02/92) (02/20/98)
---------------- ---------- ---------- ---------- ----------
Year ended November 30, 1999:
Standardized Return*............... (1.71)% (2.97)% 1.06% 2.68%
Non-Standardized Return......... 2.42% 1.63% 1.75% 2.68%
Five Years ended November 30, 1999:
Standardized Return*............... 6.27% 6.04% 6.58% N/A
Non-Standardized Return......... 7.15% 6.31% 6.58% N/A
Ten Years ended November 30, 1999:
Standardized Return................. 9.37% N/A N/A N/A
Non-Standardized Return......... 9.81% N/A N/A N/A
Inception to November 30, 1999:
Standardized Return*............... 9.24% 9.07% 6.52% (3.41)%
Non-Standardized Return......... 9.53% 9.07% 6.52% (3.41)%
STRATEGIC INCOME FUND
CLASS CLASS A CLASS B CLASS C CLASS Y
(INCEPTION DATE) (02/07/94) (02/07/94) (02/07/94) (02/17/98)
---------------- ---------- ---------- ---------- ----------
Year ended November 30, 1999:
Standardized Return*............... (2.52)% (3.94)% 0.32% 1.91%
Non-Standardized Return......... 1.56% 0.76% 1.03% 1.91%
Five Years ended November 30, 1999:
Standardized Return*............... 7.08% 6.85% 7.42% N/A
Non-Standardized Return......... 7.96% 7.15% 7.42% N/A
Inception to November 30, 1999:
Standardized Return*............... 4.48% 4.31% 4.69% 0.48%
Non-Standardized Return......... 5.22% 4.43% 4.69% 0.48%
</TABLE>
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- --------------
* All Standardized Return figures for Class A shares reflect deduction of
the current maximum sales charge of 4.0% (3.0% for Low Duration Fund). All
Standardized Return figures for Class B and Class C shares reflect
deduction of the applicable contingent deferred sales charges imposed on a
redemption of shares held for the period. Class Y shares do not impose an
initial or contingent deferred sales charge; therefore, the performance
information is the same for both standardized return and non-standardized
return for the periods indicated.
YIELD. Yields used in each 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 semi-annual compounding) of the maximum offering price per
share (in the case of Class A shares) or the net asset value per share (in the
case of Class B and Class C shares) at the end of the Period. Yield quotations
are calculated according to the following formula:
[OBJECT OMITTED]
YIELD =
where: a = interest earned during the Period attributable to a class of
shares
b = expenses accrued for the Period attributable to a class of
shares (net of reimbursements)
c = the average daily number of shares of a class outstanding
during the Period that were entitled to receive dividends
d = the maximum offering price per share (in the case of Class A
shares) or the net asset value per share (in the case of
Class B and Class C shares) on the last day of the Period.
Except as noted below, in determining interest income earned during the
Period (variable "a" in the above formula), each 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 totaling 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. With respect to Class A shares, in calculating the maximum
offering price per share at the end of the Period (variable "d" in the above
formula), the fund's current maximum 4.0% (3.0% for Low Duration Fund) initial
sales charge on Class A shares is included.
The following table shows the yield for each class of shares of each fund
for the 30-day period ended November 30, 1999:
<TABLE>
<CAPTION>
U.S. INVESTMENT
GOVERNMENT LOW DURATION GRADE INCOME HIGH INCOME FUND STRATEGIC
INCOME FUND FUND FUND INCOME FUND
----------- ---- ---- -----------
<S> <C> <C> <C> <C> <C>
Class A........... 5.60% 4.75% 6.79% 12.11% 7.17%
Class B........... 5.03% 4.05% 6.30% 11.85% 6.65%
Class C........... 5.30% 4.26% 6.58% 12.13% 6.91%
Class Y........... 6.16% 5.17% 7.38% 12.93% 7.73%
</TABLE>
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OTHER INFORMATION. In Performance Advertisements, the funds may compare
their Standardized Return and/or their Non-Standardized Return with data
published by Lipper Inc. ("Lipper") for U.S. government funds (U.S. Government
Income Fund and Low Duration Fund), corporate bond (BBB) funds (Investment Grade
Income Fund) and high yield funds (High Income Fund), CDA Investment
Technologies, Inc. ("CDA"), Wiesenberger Investment Companies Service
("Wiesenberger"), Investment Company Data, Inc. ("ICD") or Morningstar Mutual
Funds ("Morningstar"), or with the performance of U.S. Treasury securities of
various maturities, recognized stock, bond and other indices, including (but not
limited to) the Salomon Brothers Bond Index, CS First Boston High Yield Bond
Index, Merrill Lynch High Yield Indices, Lehman Bond Index, Lehman
Government/Corporate Bond Index, the Standard & Poor's 500 Composite Stock Price
Index ("S&P 500"), the Dow Jones Industrial Average, and changes in the Consumer
Price Index as published by the U.S. Department of Commerce. These comparisons
also may include economic data and statistics published by the U.S. Bureau of
Labor Statistics, such as the cost of living index, information and statistics
on the residential mortgage market or the market for mortgage-backed securities,
such as those published by the Federal Reserve Bank, the Office of Thrift
Supervision, Ginnie Mae, Fannie Mae and Freddie Mac and the Lehman
Mortgage-Backed Securities Index. Each fund also may refer in these 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
funds and comparative mutual fund data and ratings reported in independent
periodicals, including 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 funds 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 in
additional fund shares, any future income or capital appreciation of a 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 a fund investment would increase more quickly than if dividends or other
distributions had been paid in cash.
The funds may also compare their 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(REGISTERED) Money Markets. In comparing the
funds' 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 funds are not insured or guaranteed by
the U.S. government and returns and net asset values will fluctuate. The debt
securities held by the funds generally have longer maturities than most CDs and
may reflect interest rate fluctuations for longer term debt securities. An
investment in any fund involves greater risks than an investment in either a
money market fund or a CD.
TAXES
BACKUP WITHHOLDING. Each fund is required to withhold 31% of all
dividends, capital gain distributions and redemption proceeds payable to
individuals and certain other non-corporate shareholders who do not provide the
fund or PaineWebber with a correct taxpayer identification number. Withholding
at that rate also is required from dividends and capital gain distributions
payable to those shareholders who otherwise are subject to backup withholding.
SALE OR EXCHANGE OF FUND SHARES. A shareholder's sale (redemption) of fund
shares may result in a taxable gain or loss, depending on whether the
shareholder receives more or less than his or her adjusted basis for the shares
(which normally includes any initial sales charge paid on Class A shares). An
exchange of any fund's shares for shares of another PaineWebber mutual fund
generally will have similar tax consequences. In addition, if a fund's shares
are bought within 30 days before or after selling other shares of the fund
(regardless of class) at a loss, all or a portion of that loss will not be
deductible and will increase the basis of the newly purchased shares.
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<PAGE>
SPECIAL RULE FOR CLASS A SHAREHOLDERS. A special tax rule applies when a
shareholder sells or exchanges Class A shares of a fund within 90 days of
purchase and subsequently acquires Class A shares of the same or another
PaineWebber mutual fund without paying a sales charge due to the 365-day
reinstatement privilege or the exchange privilege. In these cases, any gain on
the sale or exchange of the original Class A shares would be increased, or any
loss would be decreased, by the amount of the sales charge paid when those
shares were bought, and that amount would increase the basis of the PaineWebber
mutual fund shares subsequently acquired.
CONVERSION OF CLASS B SHARES. A shareholder will recognize no gain or loss
as a result of a conversion from Class B shares to Class A shares.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY. Each fund intends to
continue to qualify for treatment as a regulated investment company ("RIC")
under the Internal Revenue Code. To so qualify, a 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 gains and net gains from certain foreign currency transactions)
("Distribution Requirement") and must meet several additional requirements. For
each fund, these requirements include 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 contracts) derived with respect to its
business of investing in securities or those currencies ("Income Requirement");
(2) 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 (3)
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.
By qualifying for treatment as a RIC, a fund (but not its shareholders)
will be relieved of federal income tax on the part of its investment company
taxable income and net capital gain (i.e., the excess of net long-term capital
gain over net short-term capital loss) that it distributes to its shareholders.
If any fund failed to qualify for treatment as a RIC for any taxable year, (1)
it would be taxed as an ordinary corporation on the full amount of its taxable
income for that year without being able to deduct the distributions it makes to
its shareholders and (2) the shareholders would treat all those distributions,
including distributions of net capital gain, as dividends (that is, ordinary
income) to the extent of the fund's earnings and profits. In addition, the fund
could be required to recognize unrealized gains, pay substantial taxes and
interest and make substantial distributions before requalifying for RIC
treatment.
OTHER INFORMATION. Dividends and other distributions declared by a 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.
U.S. Government Income Fund and Low Duration Fund each invests exclusively
in debt securities and receives no dividend income; accordingly, no portion of
the dividends or other distributions paid by these funds is eligible for the
dividends-received deduction allowed to corporations. Although Investment Grade
Income Fund, High Income Fund and Strategic Income Fund are authorized to hold
equity securities, it is expected that any dividend income received by these
funds will be minimal.
If shares of a fund 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 shareholder will
pay full price for the shares and receive some portion of the price back as a
taxable distribution.
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<PAGE>
Each 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 November 30 of that year, plus certain
other amounts.
Dividends and interest received, and gains realized, by a fund on foreign
securities may be subject to income, withholding or other taxes imposed by
foreign countries and U.S. possessions (collectively "foreign taxes") that would
reduce the return on its securities. Tax conventions between certain countries
and the United States, however, may reduce or eliminate foreign taxes, 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 Strategic Income 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 would enable its shareholders, in effect, to
receive the benefit of the foreign tax credit with respect to any foreign taxes
it paid. Pursuant to the election, the fund would treat those taxes as dividends
paid to its shareholders and each shareholder (1) would be required to include
in gross income, and treat as paid by him or her, his or her proportionate share
of those taxes, (2) would be required to treat his or her share of those taxes
and of any dividend paid by the fund that represents income from foreign or U.S.
possessions sources as his or her own income from those sources, and (3) could
either deduct the foreign taxes deemed paid by him or her in computing his or
her taxable income or, alternatively, use the foregoing information in
calculating the foreign tax credit against his or her federal income tax. If
Strategic Income Fund makes this election, it will report to its shareholders
shortly after each taxable year their respective shares of foreign taxes paid
and the income from sources within, and taxes paid to, foreign countries and
U.S. possessions. Individuals who have no more than $300 ($600 for married
persons filing jointly) of creditable foreign taxes included on Forms 1099 and
all of whose foreign source income is "qualified passive income" may elect each
year to be exempt from the extremely complicated foreign tax credit limitation,
in which event they would be able to claim a foreign tax credit without having
to file the detailed Form 1116 that otherwise is required.
Each fund may invest in the stock of "passive foreign investment
companies" ("PFICs") if that stock is a permissible investment. A PFIC is any
foreign corporation (with certain exceptions) 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, a 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 from 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 it distributes that income
to its shareholders.
If a fund invests in a PFIC and elects to treat the PFIC as a "qualified
electing fund" ("QEF"), 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 QEF's annual ordinary earnings and net capital gain--which it
may have to distribute to satisfy the Distribution Requirement and avoid
imposition of the Excise Tax--even if the QEF does not distribute those earnings
and gain to the fund. In most instances it will be very difficult, if not
impossible, to make this election because of certain of its requirements.
Each fund may elect to "mark to market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of a PFIC's stock over
a fund's adjusted basis therein as of the end of that year. Pursuant to the
election, a fund also would be allowed to deduct (as an ordinary, not capital,
loss) the excess, if any, of its adjusted basis in PFIC stock over the fair
market value thereof as of the taxable year-end, but only to the extent of any
net mark-to-market gains with respect to that stock included by the fund for
prior taxable years under the election (and under regulations proposed in 1992
that provided a similar election with respect to the stock of certain PFICs). A
fund's adjusted basis in each PFIC's stock with respect to which it has made
this election will be adjusted to reflect the amounts of income included and
deductions taken thereunder.
The use of hedging strategies, such as writing (selling) and purchasing
options and futures contracts and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the amount,
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character and timing of recognition of the gains and losses a 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 a fund with respect
to its business of investing in securities or foreign currencies, will be
treated as qualifying income under the Income Requirement.
Certain futures, foreign currency contracts and listed nonequity options
(such as those on a securities index) in which a fund may invest may be subject
to section 1256 of the Internal Revenue Code ("section 1256 contracts"). Any
section 1256 contracts a fund holds at the end of each taxable year generally
must be "marked-to-market" (that is, treated as having been sold at that time
for their fair market value) for federal income tax purposes, which the result
that unrealized gains or losses will be treated as though they were realized.
Sixty percent of any net gain or loss recognized on these deemed sales, and 60%
of any net realized gain or loss from any actual sales of section 1256
contracts, will be treated as long-term capital gain or loss, and the balance
will be treated as short-term capital gain or loss. These rules may operate to
increase the amount that a fund must distribute to satisfy the Distribution
Requirement (i.e., with respect to the portion treated as short-term capital
gain), which will be taxable to its shareholders as ordinary income, and to
increase the net capital gain a fund recognizes, without in either case
increasing the cash available to the fund. A fund may elect not to have the
foregoing rules apply to any "mixed straddle" (that is, a straddle, clearly
identified by the fund in accordance with applicable regulations, at least one
(but not all) the positions of which are section 1256 contracts), although doing
so may have the effect of increasing the relative proportion of net short-term
capital gain (taxable as ordinary income) and thus increasing the amount of
dividends that must be distributed.
Offsetting positions in any actively traded security, option, futures or
forward currency contract entered into or held by a fund may constitute a
"straddle" for federal income tax purposes. Straddles are subject to certain
rules that may affect the amount, character and timing of a fund's gains and
losses with respect to positions of the straddle by requiring, among other
things, that (1) loss realized on disposition of one position of a straddle be
deferred to the extent of any unrealized gain in an offsetting position until
the latter position is disposed of, (2) the fund's holding period in certain
straddle positions not begin until the straddle is terminated (possibly
resulting in gain being treated as short-term rather than long-term capital
gain) and (3) losses recognized with respect to certain straddle positions, that
otherwise would constitute short-term capital losses, be treated as long-term
capital losses. Applicable regulations also provide certain "wash sale" rules,
which apply to transactions where a position is sold at a loss and a new
offsetting position is acquired within a prescribed period, and "short sale"
rules applicable to straddles. Different elections are available to the funds,
which may mitigate the effects of the straddle rules, particularly with respect
to mixed straddles.
When a covered call option written (sold) by a fund expires, it will
realize a short-term capital gain equal to the amount of the premium it received
for writing the option. When a fund terminates its obligations under such an
option by entering into a closing transaction, it will realize a short-term
capital gain (or loss), depending on whether the cost of the closing transaction
is less (or more) than the premium it received when it wrote the option. When a
covered call option written by a fund is exercised, the fund will be treated as
having sold the underlying security, producing long-term or short-term capital
gain or loss, depending on the holding period of the underlying security and
whether the sum of the option price received on the exercise plus the premium it
received when it wrote the option is more or less than the basis of the
underlying security.
If a fund has an "appreciated financial position"--generally, an interest
(including an interest through an option, futures or forward currency contract
or short sale) with respect to any stock, debt instrument (other than "straight
debt") or partnership interest the fair market value of which exceeds its
adjusted basis--and enters into a "constructive sale" of the position, the fund
will be treated as having made an actual sale thereof, with the result that gain
will be recognized at that time. A constructive sale generally consists of a
short sale, an offsetting notional principal contract or a futures or forward
currency contract entered into by a fund or a related person with respect to the
same or substantially identical property. In addition, if the appreciated
financial position is itself a short sale or such a contract, acquisition of the
underlying property or substantially identical property will be deemed a
constructive sale. The foregoing will not apply, however, to a fund's
transaction during any taxable year that otherwise would be treated as a
constructive sale if the transaction is closed within 30 days after the end of
that year and the fund holds the appreciated financial position unhedged for 60
days after that closing (i.e., at no time during that 60-day period is the
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fund's risk of loss regarding that position reduced by reason of certain
specified transactions with respect to substantially identical or related
property, such as having an option to sell, being contractually obligated to
sell, making a short sale or granting an option to buy substantially identical
stock or securities).
A fund may acquire (1) zero coupon or other securities issued with
original issue discount or (2) Treasury inflation-protected securities, on which
principal is adjusted based on changes in the Consumer Price Index. A fund must
include in its gross income the portion of the OID that accrues on those
securities, and the amount of any principal increases on TIPS, during the
taxable year, even if the fund receives no corresponding payment on them during
the year. Similarly, Investment Grade Income Fund, High Income Fund and
Strategic Income Fund each must include in its gross income securities it
receives as "interest" on payment-in-kind securities. Each fund has elected
similar treatment with respect to securities purchased at a discount from their
face value ("market discount"). Because a fund annually must distribute
substantially all of its investment company taxable income, including any
accrued OID, market discount and other non-cash income, to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax, it might 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
would have to be made from the fund's cash assets or from the proceeds of sales
of portfolio securities, if necessary. A fund might realize capital gains or
losses from those sales, which would increase or decrease its investment company
taxable income and/or net capital gain.
The foregoing is only a general summary of some of the important federal
tax considerations generally affecting the funds and their shareholders. No
attempt is made to present a complete explanation of the federal tax treatment
of the funds' activities, and this discussion is not intended as a substitute
for careful tax planning. Accordingly, potential investors are urged to consult
their own tax advisers for more detailed information and for information
regarding any state, local or foreign taxes applicable to the funds and to
dividends and other distributions therefrom.
OTHER INFORMATION
MASSACHUSETTS BUSINESS TRUSTS. Each Trust is an entity of the type
commonly known as a "Massachusetts business trust." Under Massachusetts law,
shareholders of a fund could, under certain circumstances, be held personally
liable for the obligations of the fund or its Trust. However, each Trust's
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 board members or by any officers or officer by or on behalf of the Trust
or the fund, the board members or any of them in connection with the Trust. Each
Declaration of Trust provides for indemnification from the relevant 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 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 would be entitled to
reimbursement from the general assets of the relevant fund. The board members
intend to conduct each fund's operations in such a way as to avoid, as far as
possible, ultimate liability of the shareholders for liabilities of the fund.
CLASSES OF SHARES. A share of each class of a fund represents an identical
interest in that fund's investment portfolio and has the same rights, privileges
and preferences. However, each class may differ with respect to sales charges,
if any, distribution and/or service fees, if any, other expenses allocable
exclusively to each class, voting rights on matters exclusively affecting that
class, and its exchange privilege, if any. The different sales charges and other
expenses applicable to the different classes of shares of the funds will affect
the performance of those classes. Each share of a fund is entitled to
participate equally in dividends, other distributions and the proceeds of any
liquidation of that fund. However, due to the differing expenses of the classes,
dividends and liquidation proceeds on Class A, B, C and Y shares will differ.
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VOTING RIGHTS. Shareholders of each fund are entitled to one vote for each
full share held and fractional votes for fractional shares held. Voting rights
are not cumulative and, as a result, the holders of more than 50% of all the
shares of a Trust may elect all of the board members of that Trust. The shares
of a fund will be voted together, except that only the shareholders of a
particular class of a fund may vote on matters affecting only that class, such
as the terms of a Rule 12b-1 Plan as it relates to the class. The shares of each
series of Managed Trust and Securities Trust will be voted separately, except
when an aggregate vote of all the series is required by law.
The funds do not hold annual meetings. Shareholders of record of no less
than two-thirds of the outstanding shares of a Trust may remove a board member
through a declaration in writing or by vote cast in person or by proxy at a
meeting called for that purpose. A meeting will be called to vote on the removal
of a board member at the written request of holders of 10% of the outstanding
shares of a Trust.
CLASS-SPECIFIC EXPENSES. Each fund may determine to allocate certain of
its expenses (in addition to service and distribution fees) to the specific
classes of its shares to which those expenses are attributable. For example,
Class B and Class C shares bear higher transfer agency fees per shareholder
account than those borne by Class A or Class Y shares. The higher fee is imposed
due to the higher costs incurred by the transfer agent in tracking shares
subject to a contingent deferred sales charge because, upon redemption, the
duration of the shareholder's investment must be determined in order to
determine the applicable charge. Although the transfer agency fee will differ on
a per account basis as stated above, the specific extent to which the transfer
agency fees will differ between the classes as a percentage of net assets is not
certain, because the fee as a percentage of net assets will be affected by the
number of shareholder accounts in each class and the relative amounts of net
assets in each class.
PRIOR NAMES. Prior to October 20, 1995, Low Duration Fund was known as
"PaineWebber Short-Term U.S. Government Income Fund." Prior to November 10,
1995, the Class C shares of all the funds were called "Class D" shares, and the
Class Y shares of U.S. Government Income Fund and Low Duration Fund were called
"Class C" shares.
CUSTODIAN AND RECORDKEEPING AGENT; TRANSFER AND DIVIDEND AGENT. State
Street Bank and Trust Company, located at One Heritage Drive, North Quincy,
Massachusetts 02171, serves as custodian and recordkeeping agent for each fund
and employs foreign sub-custodians approved by the respective boards in
accordance with applicable requirements under the Investment Company Act to
provide custody of the funds' foreign assets. PFPC Inc., a subsidiary of PNC
Bank, N.A., serves as each fund's transfer and dividend disbursing agent. It is
located at 400 Bellevue Parkway, Wilmington, DE 19809.
COMBINED PROSPECTUS. Although each fund is offering only its own shares,
it is possible that a fund might become liable for a misstatement in the
Prospectus about another fund. The board of each fund has considered this factor
in approving the use of a single, combined Prospectus.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800
Massachusetts Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to
the funds. Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber and
Mitchell Hutchins in connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for U.S. Government Income Fund, Low Duration
Fund, Investment Grade Income Fund and High Income Fund. PricewaterhouseCoopers
LLP, 1177 Avenue of the Americas, New York, New York 10036, serves as
independent accountants for Strategic Income Fund.
FINANCIAL STATEMENTS
Each fund's Annual Report to Shareholders for its last fiscal year ended
November 30, 1999 is a separate document supplied with this SAI, and the
financial statements, accompanying notes and report of independent auditors or
independent accountants appearing therein are incorporated herein by this
reference.
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APPENDIX
RATINGS INFORMATION
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
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 sometime in the future; Baa. Bonds which are rated Baa are considered
as medium-grade obligations, i.e., they are neither highly protected nor poorly
secured. Interest payment 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.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; A. An obligation rated A is
somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than obligations in higher rated categories. However, the
obligor's capacity to meet its financial commitment on the obligation is still
strong; BBB. An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation; BB, B, CCC, CC, C, D. Obligations rated BB, B, CCC, CC and C
are regarded as having significant speculative characteristics. BB indicates the
least degree of speculation and C the highest. While such obligations will
likely have some quality and protective characteristics, these may be outweighed
by large uncertainties or major exposures to adverse conditions; BB. An
obligation rated BB is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse
business, financial, or economic conditions which could lead to the obligor's
inadequate capacity to meet its financial commitment on the obligation; B. An
obligation rated B is more vulnerable to nonpayment than obligations rated BB,
but the obligor currently has the capacity to meet its financial commitment on
A-1
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the obligation. Adverse business, financial, or economic conditions will likely
impair the obligor's capacity or willingness to meet its financial commitment on
the obligation; CCC. An obligation rated CCC is currently vulnerable to
nonpayment and is dependent upon favorable business, financial and economic
conditions for the obligor to meet its financial commitment on the obligation.
In the event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the
obligation; CC. An obligation rated CC is currently highly vulnerable to
nonpayment; C. The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued; D. An obligation rated D is in payment default.
The D rating category is used when payments on an obligation are not made on the
date due even if the applicable grace period has not expired, unless 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 or the taking of a
similar action if payments on an obligation are jeopardized.
CI. The rating CI is reserved for income bonds on which no interest is
being paid.
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.
r. This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
PRIME-1. Issuers assigned this highest rating have a superior ability for
repayment of senior short-term debt obligations. Prime-1 repayment ability will
often be evidenced by the following characteristics: Leading market positions in
well established industries; high rates of return on funds employed;
conservative capitalization structures with moderate reliance on debt and ample
asset protection; broad margins in earnings coverage of fixed financial charges
and high internal cash generation; well established access to a range of
financial markets and assured sources of alternate liquidity.
PRIME-2. Issuers assigned this rating have a strong ability for repayment of
senior short-term debt obligations. This will normally be evidenced by many of
the characteristics cited above, but to a lesser degree. Earnings trends and
coverage ratios, while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
PRIME-3. Issuers assigned this rating have an acceptable capacity for
repayment of senior short-term obligations. The effect of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
NOT PRIME. Issuers assigned this rating do not fall within any of the Prime
rating categories.
DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS
A-1. A short-term obligation rated A-1 is rated in the highest category by
S&P. The obligor's capacity to meet its financial commitment on the obligation
is strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong. A-2. A short-term
obligation rated A-2 is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rating categories. However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory. A-3. A short-term obligation rated
A-3 exhibits adequate protection parameters. However, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity of the obligor to meet its financial commitment on the obligation. B. A
short-term obligation rated B is regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its financial
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commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor's inadequate capacity to meet its financial
commitments on the obligation. C. A short-term obligation rated C is currently
vulnerable to nonpayment and is dependent upon favorable business, financial and
economic conditions for the obligor to meet its financial commitment on the
obligation. D. A short-term obligation rated D is in payment default. The D
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless 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 or the taking of a similar
action if payments on an obligation are jeopardized.
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YOU SHOULD RELY ONLY ON THE
INFORMATION CONTAINED OR
REFERRED TO IN THE PROSPECTUS
AND THIS STATEMENT OF
ADDITIONAL INFORMATION. THE
FUND AND ITS DISTRIBUTOR HAVE
NOT AUTHORIZED ANYONE TO
PROVIDE YOU WITH INFORMATION
THAT IS DIFFERENT. THE PaineWebber
PROSPECTUS AND THIS STATEMENT U.S. Government Income Fund
OF ADDITIONAL INFORMATION ARE
NOT AN OFFER TO SELL SHARES OF PaineWebber
THE FUNDS IN ANY JURISDICTION Low Duration U.S. Government Income Fund
WHERE THE FUNDS OR THEIR
DISTRIBUTOR MAY NOT LAWFULLY PaineWebber
SELL THOSE SHARES. Investment Grade Income Fund
------------ PaineWebber
High Income Fund
PaineWebber
Strategic Income Fund
------------------------------------------
Statement of Additional Information
March 31, 2000
------------------------------------------
(C)2000 PaineWebber Incorporated. All rights reserved.
PAINEWEBBER
