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NICHOLAS-APPLEGATE-REGISTERED TRADEMARK- MUTUAL FUNDS
INSTITUTIONAL INCOME PORTFOLIOS
600 West Broadway, 30th Floor
San Diego, California 92101
(800) 551-8043
STATEMENT OF ADDITIONAL INFORMATION
July 17, 1996
Nicholas-Applegate Mutual Funds (the "Trust") is an open-end
management investment company currently offering a number of separate
diversified portfolios. This Statement of Additional Information contains
information regarding two of these portfolios (each a "Portfolio" and
collectively the "Portfolios"): Nicholas-Applegate High Yield Bond
Institutional Portfolio (the "High Yield Bond Portfolio") and Nicholas-Applegate
Strategic Income Institutional Portfolio (the "Strategic Income Portfolio").
This Statement of Additional Information is not a prospectus, but
contains information in addition to and more detailed than that set forth in the
Portfolios' Prospectus and should be read in conjunction with each such
Prospectus. Each Portfolio Prospectus may be obtained without charge by calling
or writing the Trust at the address and phone number given above.
TABLE OF CONTENTS
Page
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GENERAL INFORMATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
INVESTMENT OBJECTIVES, POLICIES AND RISKS. . . . . . . . . . . . . . . . . . 2
INVESTMENT RESTRICTIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . 21
TRUSTEES AND PRINCIPAL OFFICERS. . . . . . . . . . . . . . . . . . . . . . . 24
INVESTMENT ADVISER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
ADMINISTRATOR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29
DISTRIBUTOR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30
PORTFOLIO TRANSACTIONS AND BROKERAGE . . . . . . . . . . . . . . . . . . . . 30
PURCHASE AND REDEMPTION OF PORTFOLIO SHARES. . . . . . . . . . . . . . . . . 31
SHAREHOLDER SERVICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
NET ASSET VALUE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
PERFORMANCE INFORMATION. . . . . . . . . . . . . . . . . . . . . . . . . . . 39
CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT, INDEPENDENT
ACCOUNTANTS AND LEGAL COUNSEL . . . . . . . . . . . . . . . . . . . . . . 41
MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41
APPENDIX A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .A1
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GENERAL INFORMATION
The Trust and the Master Trust were organized in December 1992 as
business trusts under the laws of Delaware. The Trust offers shares of numerous
portfolios with differing sales load, shareholder service plan and distribution
plan arrangements, including Series A portfolios, Series B portfolios, Series C
portfolios, Institutional portfolios and Qualified Portfolios. This Statement
of Additional Information contains information regarding two Portfolios, the
High Yield Bond Portfolio and the Strategic Institutional Income Portfolio.
The various portfolios of the Trust seek to achieve their respective
investment objectives by investing all of their assets in corresponding series
of the Nicholas-Applegate Investment Trust (the "Master Trust"), an open-end
management investment company organized as a Delaware business trust. The
Master Trust offers shares of fourteen separate series (each a "Fund" and
collectively the "Funds") to the portfolios and other investment companies and
institutional investors, including the High Yield Bond Fund, in which the High
Yield Bond Portfolio invests, and the Strategic Income Fund, in which the
Strategic Income Portfolio invests.
INVESTMENT OBJECTIVES, POLICIES AND RISKS
The following discussion supplements the discussion of each Portfolio's
investment objective and policies as set forth in the Portfolios' Prospectus.
As each Portfolio seeks to achieve its investment objective by investing all of
its assets in a corresponding Fund with the same investment objective as the
Portfolio, the following discussion describes the various investment policies
and techniques employed by the Funds. There can be no assurance that the
investment objective of any of the Funds or Portfolios can be achieved.
CORPORATE DEBT SECURITIES
Each Fund invests in non-convertible debt securities of foreign and
domestic companies over a cross-section of industries. The debt securities in
which the Funds may invest will be of varying maturities and may include
corporate bonds, debentures, notes and other similar corporate debt instruments.
RISK OF INVESTING IN DEBT SECURITIES
There are a number of risks generally associated with an investment in
debt securities. Yields on short, intermediate, and long-term securities depend
on a variety of factors, including the general condition of the money and bond
markets, the size of a particular offering, the maturity of the obligation, and
the rating of the issue. Debt securities with longer maturities tend to produce
higher yields and are generally subject to potentially greater capital
appreciation and depreciation than obligations with short maturities and lower
yields. The market prices of debt securities usually vary, depending upon
available yields. An increase in interest rates will generally reduce the value
of such portfolio investments, and a decline in interest rates will generally
increase the value of such portfolio investments. The ability of the Funds to
achieve their investment objectives also depends on the continuing ability of
the issuers of the debt securities in which the Funds invest to meet their
obligations for the payment of interest and principal when due.
SHORT-TERM INVESTMENTS
Each of the Funds invests in any of the following securities and
instruments:
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BANK CERTIFICATES OF DEPOSIT, BANKERS' ACCEPTANCES AND TIME DEPOSITS.
Each Fund may acquire certificates of deposit, bankers' acceptances and time
deposits. Certificates of deposit are negotiable certificates issued against
funds deposited in a commercial bank for a definite period of time and earning a
specified return. Bankers' acceptances are negotiable drafts or bills of
exchange, normally drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning in effect that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
Certificates of deposit and bankers' acceptances acquired by the Funds will be
dollar-denominated obligations of domestic or foreign banks or financial
institutions which at the time of purchase have capital, surplus and undivided
profits in excess of $100 million (including assets of both domestic and foreign
branches), based on latest published reports, or less than $100 million if the
principal amount of such bank obligations are fully insured by the U.S.
Government.
A Fund holding instruments of foreign banks or financial institutions
may be subject to additional investment risks that are different in some
respects from those incurred by a fund which invests only in debt obligations of
U.S. domestic issuers. See "Foreign Investments" below. Such risks include
future political and economic developments, the possible imposition of
withholding taxes by the particular country in which the issuer is located on
interest income payable on the securities, the possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on these securities.
Domestic banks and foreign banks are subject to different governmental
regulations with respect to the amount and types of loans which may be made and
interest rates which may be charged. In addition, the profitability of the
banking industry depends largely upon the availability and cost of funds for the
purpose of financing lending operations under prevailing money market
conditions. General economic conditions as well as exposure to credit losses
arising from possible financial difficulties of borrowers play an important part
in the operations of the banking industry.
As a result of federal and state laws and regulations, domestic banks
are, among other things, required to maintain specified levels of reserves,
limited in the amount which they can loan to a single borrower, and subject to
other regulations designed to promote financial soundness. However, such laws
and regulations do not necessarily apply to foreign bank obligations that a Fund
may acquire.
In addition to purchasing certificates of deposit and bankers'
acceptances, to the extent permitted under their respective investment
objectives and policies stated above and in their Prospectus, the Funds may make
interest-bearing time or other interest-bearing deposits in commercial or
savings banks. Time deposits are non-negotiable deposits maintained at a
banking institution for a specified period of time at a specified interest rate.
SAVINGS ASSOCIATION OBLIGATIONS. The Funds may invest in certificates
of deposit (interest-bearing time deposits) issued by savings banks or savings
and loan associations that have capital, surplus and undivided profits in excess
of $100 million, based on latest published reports, or less than $100 million if
the principal amount of such obligations is fully insured by the U.S.
Government.
COMMERCIAL PAPER, SHORT-TERM NOTES AND OTHER CORPORATE OBLIGATIONS. The
Funds may invest a portion of their assets in commercial paper and short-term
notes. Commercial paper consists of unsecured promissory notes issued by
corporations. Issues of commercial paper and short-term notes will normally
have maturities of less than nine months and fixed rates of return, although
such instruments may have maturities of up to one year.
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Commercial paper and short-term notes will consist of issues rated at
the time of purchase "A-2" or higher by S&P, "Prime-l" or "Prime-2" by Moody's,
or similarly rated by another nationally recognized statistical rating
organization or, if unrated, will be determined by the Investment Adviser to be
of comparable quality. These rating symbols are described in Appendix A.
Corporate obligations include bonds and notes issued by corporations to
finance longer-term credit needs than supported by commercial paper. While such
obligations generally have maturities of ten years or more, the Funds may
purchase corporate obligations which have remaining maturities of one year or
less from the date of purchase and which are rated "AA" or higher by S&P or "Aa"
or higher by Moody's.
MONEY MARKET FUNDS
The Funds may under certain circumstances invest a portion of their
assets in money market funds. The Investment Company Act prohibits the Funds
from investing more than 5% of the value of their total assets in any one
investment company, or more than 10% of the value of their total assets in
investment companies as a group, and also restricts their investment in any
investment company to 3% of the voting securities of such investment company.
The Investment Adviser will not impose an advisory fee on assets of a Fund
invested in a money market mutual fund. However, an investment in a money
market mutual fund will involve payment by a Fund of its pro rata share of
advisory and administrative fees charged by such fund.
GOVERNMENT OBLIGATIONS
Each Fund may make short-term investments in U.S. Government
obligations. Such obligations include Treasury bills, certificates of
indebtedness, notes and bonds, and issues of such entities as the Government
National Mortgage Association ("GNMA"), Export-Import Bank of the United States,
Tennessee Valley Authority, Resolution Funding Corporation, Farmers Home
Administration, Federal Home Loan Banks, Federal Intermediate Credit Banks,
Federal Farm Credit Banks, Federal Land Banks, Federal Housing Administration,
Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage
Corporation, and the Student Loan Marketing Association.
Some of these obligations, such as those of the GNMA, are supported by
the full faith and credit of the U.S. Treasury; others, such as those of the
Export-Import Bank of the United States, are supported by the right of the
issuer to borrow from the Treasury; others, such as those of the FNMA, are
supported by the discretionary authority of the U.S. Government to purchase the
agency's obligations; still others, such as those of the Student Loan Marketing
Association, are supported only by the credit of the instrumentality. No
assurance can be given that the U.S. Government would provide financial support
to U.S. Government-sponsored instrumentalities if it is not obligated to do so
by law.
Each Fund may also invest in sovereign debt obligations of foreign
countries. A sovereign debtor's willingness or ability to repay principal and
interest in a timely manner may be affected by a number of factors, including
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 it
may be subject.
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VARIABLE AND FLOATING RATE INSTRUMENTS
Each of the Funds may acquire variable and floating rate instruments.
Such instruments are frequently not rated by credit rating agencies; however,
unrated variable and floating rate instruments purchased by a Fund will be
determined by the Investment Adviser under guidelines established by the Master
Trust's Board of Trustees to be of comparable quality at the time of the
purchase and rated instruments eligible for purchase by the Fund. In making
such determinations, the Investment Adviser will consider the earning power,
cash flow and other liquidity ratios of the issuers of such instruments (such
issuers include financial, merchandising, bank holding and other companies) and
will monitor their financial condition. An active secondary market may not exist
with respect to particular variable or floating rate instruments purchased by
the Fund. The absence of such an active secondary market could make it
difficult for the Fund to dispose of the variable or floating rate instrument
involved in the event of the issuer of the instrument defaulting on its payment
obligation or during periods in which the Fund is not entitled to exercise its
demand rights, and the Fund could, for these or other reasons, suffer a loss to
the extent of the default. Variable and floating rate instruments may be
secured by bank letters of credit.
PARTICIPATION INTERESTS
The Funds may invest in participation interests, subject to the
limitation on investments by the Funds in illiquid investments. Neither Fund
currently intends to invest more than 5% of its net assets in such interests.
Participation interests represent an undivided interest in or assignment of
a loan made by an issuing financial institution. No more than 5% of a Fund's
net assets can be invested in participation interests of the same issuing
borrower. Participation interests are primarily dependent upon the financial
strength of the borrowing corporation, which is obligated to make payments of
principal and interest on the loan, and there is a risk that such borrowers
may have difficulty making payments. In the event the borrower fails to pay
scheduled interest or principal payments, a Fund could experience a reduction
in its income and might experience a decline in the net asset value of its
shares. In the event of a failure by the financial institution to perform
its obligation in connection with the participation agreement, the Fund might
incur certain costs and delays in realizing payment or may suffer a loss of
principal and/or interest. The Investment Adviser has set certain
creditworthiness standards for issuers of loan participations and monitors
their creditworthiness.
MORTGAGE-RELATED SECURITIES
Each of the Funds may invest in U.S. mortgage-related securities.
Mortgage-related securities are derivative interests in pools of mortgage loans
made to U.S. residential home buyers, including mortgage loans made by savings
and loan institutions, mortgage bankers, commercial banks and others. Pools of
mortgage loans are assembled as securities for sale to investors by various
governmental, government-related and private organizations. The Funds may also
invest in debt securities which are secured with collateral consisting of U.S.
mortgage-related securities, and in other types of U.S. mortgage-related
securities.
U.S. MORTGAGE PASS-THROUGH SECURITIES. Interests in pools of
mortgage-related securities differ from other forms of debt securities, which
normally provide for periodic payment of interest in fixed amounts with
principal payments at maturity or specified call dates. Instead, these
securities provide a monthly payment which consists of both interest and
principal payments. In effect, these payments are a "pass-through" of the
monthly payments made by the individual borrowers on their residential mortgage
loans, net of any fees paid to the issuer or guarantor of such securities.
Additional payments are caused by repayments of principal resulting from the
sale of the underlying residential property, refinancing or foreclosure, net of
fees or costs which may be incurred. Some mortgage-related securities (such as
securities issued by the Government National Mortgage Association) are described
as "modified pass-throughs." These securities entitle the holder to receive all
interest and principal payments owed on the mortgage pool, net of
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certain fees, at the scheduled payment dates regardless of whether or not the
mortgagor actually makes the payment.
The principal governmental guarantor of U.S. mortgage-related securities
is the Government National Mortgage Association ("GNMA"). GNMA is a wholly
owned United States Government corporation within the Department of Housing and
Urban Development. GNMA is authorized to guarantee, with the full faith and
credit of the United States Government, the timely payment of principal and
interest on securities issued by institutions approved by GNMA (such as savings
and loan institutions, commercial banks and mortgage bankers) and backed by
pools of mortgages insured by the Federal Housing Agency or guaranteed by the
Veterans Administration.
Government-related guarantors include the Federal National Mortgage
Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
FNMA is a government-sponsored corporation owned entirely by private
stockholders and subject to general regulation by the Secretary of Housing and
Urban Development. FNMA purchases conventional residential mortgages not
insured or guaranteed by any government agency from a list of approved
seller/services which include state and federally chartered savings and loan
associations, mutual savings banks, commercial banks and credit unions and
mortgage bankers. FHLMC is a government-sponsored corporation created to
increase availability of mortgage credit for residential housing and owned
entirely by private stockholders. FHLMC issues participation certificates which
represent interests in conventional mortgages from FHLMC's national portfolio.
Pass-through securities issued by FNMA and participation certificates issued by
FHLMC are guaranteed as to timely payment of principal and interest by FNMA and
FHLMC, respectively, but are not backed by the full faith and credit of the
United States Government.
Although the underlying mortgage loans in a pool may have maturities of
up to 30 years, the actual average life of the pool certificates typically will
be substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Prepayment rates vary widely
and may be affected by changes in market interest rates. In periods of falling
interest rates, the rate of prepayment tends to increase, thereby shortening the
actual average life of the pool certificates. Conversely, when interest rates
are rising, the rate of prepayments tends to decrease, thereby lengthening the
actual average life of the certificates. Accordingly, it is not possible to
predict accurately the average life of a particular pool.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"). A CMO in which the Funds
may invest is a hybrid between a mortgage-backed bond and a mortgage
pass-through security. Like a bond, interest is paid, in most cases,
semiannually. CMOs may be collateralized by whole mortgage loans, but are more
typically collateralized by portfolios of mortgage pass-through securities
guaranteed by GNMA, FHLMC, FNMA or equivalent foreign entities.
CMOs are structured into multiple classes, each bearing a different
stated maturity. Actual maturity and average life depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal and
interest received from the pool of underlying mortgages, including prepayments,
is first returned to the class having the earliest maturity date or highest
maturity. Classes that have longer maturity dates and lower seniority will
receive principal only after the first class has been retired.
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FOREIGN INVESTMENTS
Each of the Funds may invest in securities of foreign issuers that are
not publicly traded in the United States. The Funds may also invest in
depository receipts.
DEPOSITORY RECEIPTS. American Depository Receipt ("ADRs") may be listed
on a national securities exchange or may trade in the over-the-counter market.
ADR prices are denominated in United States dollars; the underlying security may
be denominated in a foreign currency, although the underlying security may be
subject to foreign government taxes which would reduce the yield on such
securities.
The Funds may invest in U.S. dollar-denominated foreign securities
referred to as "Brady Bonds." These are debt obligations of foreign entities
that may be fixed-rate par bonds or floating-rate discount bonds and are
generally collateralized in full as to principal due at maturity by U.S.
Treasury zero coupon obligations that have the same maturity as the Brady Bonds.
However the Funds may also invest in uncollateralized Brady Bonds. Brady Bonds
are generally viewed as having three or four valuation components: (i) any
collateralized repayment of principal at final maturity; (ii) the collateralized
interest payments; (iii) the uncollateralized interest payments; and (iv) any
uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute what is referred to as the "residual risk" of such bonds).
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 zero coupon
U.S. Treasury securities held as collateral for the payment of principal will
not be distributed to investors, nor will such obligations be sold and the
proceeds distributed. The collateral will be held by the collateral agent to
the scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments which would have ben due on the Brady Bonds in the normal
course. In addition, 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 may be viewed as speculative.
RISKS OF INVESTING IN FOREIGN SECURITIES. Investments in foreign
securities involve certain inherent risks, including the following:
POLITICAL AND ECONOMIC FACTORS. Individual foreign economies of certain
countries may differ favorably or unfavorably from the United States' economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency, diversification and balance of payments
position. The internal politics of certain foreign countries may not be as
stable as those of the United States. Governments in certain foreign countries
also continue to participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these governments could
include restrictions on foreign investment, nationalization, expropriation of
goods or imposition of taxes, and could have a significant effect on market
prices of securities and payment of interest. The economies of many foreign
countries are heavily dependent upon international trade and are accordingly
affected by the trade policies and economic conditions of their trading
partners. Enactment by these trading partners of protectionist trade
legislation could have a significant adverse effect upon the securities markets
of such countries.
CURRENCY FLUCTUATIONS. Each Fund may invest in securities denominated
in foreign currencies. Accordingly, a change in the value of any such currency
against the U.S. dollar will result in a corresponding change in the U.S. dollar
value of the Fund's assets denominated in that currency. Such changes will also
affect the Fund's income. The value of the Fund's assets may also be affected
significantly by currency restrictions and exchange control regulations enacted
from time to time.
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MARKET CHARACTERISTICS. The Investment Adviser expects that most
foreign securities in which the Funds invest will be purchased in
over-the-counter markets or on exchanges located in the countries in which the
principal offices of the issuers of the various securities are located, if that
is the best available market. Foreign exchanges and markets may be more
volatile than those in the United States. While growing in volume, they usually
have substantially less volume than U.S. markets, and the Funds' portfolio
securities may be less liquid and more volatile than U.S. Government securities.
Moreover, settlement practices for transactions in foreign markets may differ
from those in United States markets, and may include delays beyond periods
customary in the United States. Foreign security trading practices, including
those involving securities settlement where Fund assets may be released prior to
receipt of payment or securities, may expose the Fund to increased risk in the
event of a failed trade or the insolvency of a foreign broker-dealer.
Transactions in options on securities, futures contracts, futures
options and currency contracts may not be regulated as effectively on foreign
exchanges as similar transactions in the United States, and may not involve
clearing mechanisms and related guarantees. The value of such positions also
could be adversely affected by the imposition of different exercise terms and
procedures and margin requirements than in the United States. The value of the
Fund's positions may also be adversely impacted by delays in its ability to act
upon economic events occurring in foreign markets during non-business hours in
the United States.
LEGAL AND REGULATORY MATTERS. Certain foreign countries may have less
supervision of securities markets, brokers and issuers of securities, and less
financial information available to issuers, than is available in the United
States.
TAXES. The interest payable on certain of the Funds' foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to the Portfolios' shareholders. A
shareholder otherwise subject to United States federal income taxes may, subject
to certain limitations, be entitled to claim a credit or deduction of U.S.
federal income tax purposes for his proportionate share of such foreign taxes
paid by the Funds.
COSTS. To the extent that the Funds invest in foreign securities, the
expense ratios of the Fund are likely to be higher than those of investment
companies investing in domestic securities, since the cost of maintaining the
custody of foreign securities is higher.
In considering whether to invest in the securities of a foreign company,
the Investment Adviser considers such factors as the characteristics of the
particular company, differences between economic trends and the performance of
securities markets within the U.S. and those within other countries, and also
factors relating to the general economic, governmental and social conditions of
the country or countries where the company is located. The extent to which a
Fund will be invested in foreign companies and countries and depository receipts
will fluctuate from time to time within the limitations described in the
Prospectus, depending on the Investment Adviser's assessment of prevailing
market, economic and other conditions.
PREFERRED STOCKS
The High Yield Bond Fund may invest in preferred stocks. Preferred
stock, unlike common stock, offers a stated dividend rate payable from a
corporation's earnings. Such preferred stock dividends may be cumulative or
non-cumulative, participating, or auction rate. If interest rates rise, the
fixed dividend on preferred stocks may be less attractive, causing the price of
preferred stocks to decline. Preferred stock may have mandatory sinking fund
provisions, as well as call/redemption provisions prior to maturity, a negative
feature when interest rates decline. Dividends on some preferred stock may be
"cumulative," requiring all or a portion of prior unpaid dividends to be paid.
Preferred stock also generally has a preference over common
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stock on the distribution of a corporation's assets in the event of liquidation
of the corporation, and may be "participating," which means that it may be
entitled to a dividend exceeding the stated dividend in certain cases. The
rights of preferred stocks on distribution of a corporation's assets in the
event of a liquidation are generally subordinate to the rights associated with a
corporation's debt securities.
CONVERTIBLE SECURITIES AND WARRANTS
The Funds may invest in convertible securities and warrants. A
convertible security is a fixed income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of the common stock of the same or a different issuer.
Convertible securities are senior to common stocks in an issuer's capital
structure, but are usually subordinated to similar non-convertible securities.
While providing a fixed income stream (generally higher in yield than the income
derivable from common stock but lower than that afforded by a similar
nonconvertible security), a convertible security also affords an investor the
opportunity, through its conversion feature, to participate in the capital
appreciation attendant upon a market price advance in the convertible security's
underlying common stock.
A warrant gives the holder a right to purchase at any time during a
specified period a predetermined number of shares of common stock at a fixed
price. Unlike convertible debt securities or preferred stock, warrants do no
pay a fixed dividend. Investments in warrants involve certain risks, including
the possible lack of a liquid market for resale of the warrants, potential price
fluctuations as a result of speculation or other factors, and failure of the
price of the underlying security to reach or have reasonable prospects of
reaching a level at which the warrant can be prudently exercised (in which event
the warrant may expire without being exercised, resulting in a loss of the
Fund's entire investment therein).
OPTIONS ON SECURITIES AND SECURITIES INDICES
PURCHASING PUT AND CALL OPTIONS. Each Fund is authorized to purchase
such options with respect to securities and currencies which are otherwise
eligible for purchase by the Fund, and related indexes, subject to certain
restrictions.
If a Fund purchases a put option, the Fund acquires the right to sell
the underlying security at a specified price at any time during the term of the
option (for "American-style" options) or on the option expiration date (for
"European-style" options). For example, purchasing put options may be used as a
portfolio investment strategy when the Investment Adviser perceives significant
short-term risk but substantial long-term appreciation for the underlying
security. The put option acts as an insurance policy, as it protects against
significant downward price movement while it allows full participation in any
upward movement. If a Fund is holding a security which it feels has strong
fundamentals, but for some reason may be weak in the near term, the Fund may
purchase a put option on such security, thereby giving itself the right to sell
such security at a certain strike price throughout the term of the option.
Consequently, the Fund will exercise the put only if the price of such security
falls below the strike price of the put. The difference between the put's
strike price and the market price of the underlying security on the date the
Fund exercises the put, less transaction costs, will be the amount by which the
Fund will be able to hedge against a decline in the underlying security. If
during the period of the option the market price for the underlying security
remains at or above the put's strike price, the put will expire worthless,
representing a loss of the price the Fund paid for the put, plus transaction
costs. If the price of the underlying security increases, the profit the Fund
realizes on the sale of the security will be reduced by the premium paid for the
put option less any amount for which the put may be sold.
If a Fund purchases a call option, it acquires the right to purchase the
underlying security at a specified price at any time during the term of the
option. For example, a Fund may purchase a call option
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on a security it intends to buy in the future, to seek to protect the Fund
against an increase in the price of the security. The Fund will exercise a call
option only if the price of the underlying security is above the strike price at
the time of exercise. If during the option period the market price for the
underlying security remains at or below the strike price of the call option, the
option will expire worthless, representing a loss of the price paid for the
option, plus transaction costs. If the call option has been purchased to hedge
against an increase in the price of the underlying security and the price of the
underlying security thereafter falls, the price of the security when purchased
will be increased by the premium paid for the call option less any amount for
which such option may be sold.
Prior to exercise or expiration, an option may be sold when it has
remaining value by a purchaser through a "closing sale transaction," which is
accomplished by selling an option of the same series as the option previously
purchased. A Fund generally will purchase only those options for which the
Investment Adviser believes there is an active secondary market to facilitate
closing transactions.
WRITING PUT AND CALL OPTIONS. Each Fund may also write covered put and
call options.
A put option is "covered" if a Fund holds cash or liquid high-grade debt
securities in a segregated account with the Custodian in an amount sufficient to
acquire the security, or holds a put option on the same security or index with
the same or a greater exercise price (or with a lesser price and with the
balance maintained as cash or liquid high grade debt securities). The writer of
a put option receives a premium and gives the purchaser the right to require the
writer to buy the security underlying the option at the exercise price.
A call option is "covered" if a Fund owns the security underlying the
call or has an absolute right to acquire the security without additional cash
consideration (or, if additional cash consideration is required, cash or cash
equivalents in such amount as are held in a segregated account by the
Custodian). The writer of a call option receives a premium and gives the
purchaser the right to buy the security underlying the option at the exercise
price. The writer has the obligation upon exercise of the option to deliver the
underlying security against payment of the exercise price during the option
period.
If the writer of an exchange-traded option wishes to terminate his
obligation, he may effect a "closing purchase transaction." This is
accomplished by buying an option of the same series as the option previously
written. A writer may not effect a closing purchase transaction after it has
been notified of the exercise of an option.
Effecting a closing transaction in the case of a written put option will
permit a Fund to permit the cash or other segregated collateral for other
investment purposes or to write another put option on the underlying security
with either a different exercise price, expiration date or both. Effecting a
closing transaction in the case of a written call option will permit the Fund to
write another call option on the underlying security with either a different
exercise price, expiration date or both; in addition, effecting a closing
transaction will permit the cash or proceeds from the concurrent sale of any
securities subject to the option to be used for other investments of the Fund.
If the Fund desires to sell a particular security from its portfolio on which it
has written a call option, it will effect a closing transaction prior to or
concurrent with the sale of the security.
A Fund will realize a gain from a closing transaction if the cost of the
closing transaction is less than the premium received from writing the option or
if the proceeds from the closing transaction are more than the premium paid to
purchase the option. A Fund will realize a loss from a closing transaction if
the cost of the closing transaction is more than the premium received from
writing the option or if the proceeds from the closing transaction are less than
the premium paid to purchase the option. However, because
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increases in the market price of a call option will generally reflect increases
in the market price of the underlying security, any loss to the Fund resulting
from the repurchase of a call option is likely to be offset in whole or in part
by appreciation of the underlying security owned by the Fund. Similarly,
because increases in the market price of a put option will generally reflect
decreases in the market price of the underlying security, any loss to the Fund
resulting from the repurchase of a put option is likely to be offset in whole or
in part by the depreciation of the underlying security if it were to be
purchased by the Fund.
INDEX OPTIONS. Each Fund may also purchase put and call options which
respect to the Standard & Poor's 500 stock price Index and other securities
indices. Such options may be purchased as a hedge against changes resulting
from market conditions in the values of securities which are held in a Fund's
portfolio or which it intends to purchase or sell, or when they are
economically appropriate for the reduction of risks inherent in the ongoing
management of the Fund.
The distinctive characteristics of options on indices create certain
risks that are not present with options generally. Because the value of an
index option depends upon movements in the level of the index rather than the
price of a particular security, whether the Fund will realize a gain or loss on
the purchase or sale of an option on an index depends upon movements in the
level of security prices in the markets generally rather than movements in the
price of a particular security. Accordingly, successful use by a Fund of
options on an index would be subject to the Investment Adviser's ability to
predict correctly movements in the direction of the markets generally. This
requires different skills and techniques than predicting changes in the price of
individual securities.
Index prices may be distorted if trading of certain securities included
in the index is interrupted. Trading of index options also may be interrupted
in certain circumstances, such as if trading were halted in a substantial number
of securities included in the index. If this were to occur, the Fund would not
be able to close out options which it had purchased, and if restrictions on
exercise were imposed, the Fund might be unable to exercise an option it holds,
which could result in substantial losses to the Fund. It is the policy of the
Funds to purchase put or call options only with respect to an index which the
Investment Adviser believes includes a sufficient number of securities to
minimize the likelihood of a trading halt in the index.
RISKS OF TRANSACTIONS IN OPTIONS. There are several risks associated
with transactions in options on securities and indices. Options may be more
volatile than the underlying instruments and, therefore, on a percentage basis,
an investment in options may be subject to greater fluctuation than an
investment in the underlying instruments themselves. There are also significant
differences between the securities and options markets that could result in an
imperfect correlation between these markets, causing a given transaction not to
achieve its objective. In addition, a liquid secondary market for particular
options may be absent for reasons which include the following: there may be
insufficient trading interest in certain options; restrictions may be imposed by
an exchange on opening transactions or closing transactions or both; trading
halts, suspensions or other restrictions may be imposed with respect to
particular classes or series of option of underlying securities; unusual or
unforeseen circumstances may interrupt normal operations on an exchange; the
facilities of an exchange or clearing corporation may not at all times be
adequate to handle current trading volume; or one or more exchanges could, for
economic or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or series of options),
in which event the secondary market on that exchange (or in that class or series
of options) would cease to exist, although outstanding options that had been
issued by a clearing corporation as a result of trades on that exchange would
continue to be exercisable in accordance with their terms.
A decision as to whether, when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events. The
extent to which a Fund may enter into options transactions may be limited by the
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Internal Revenue Code requirements for qualification of the corresponding
Portfolio as a regulated investment company. See "Taxes."
In addition, when trading options on foreign exchanges, many of the
protections afforded to participants in United States option exchanges will not
be available. For example, there may be no daily price fluctuation limits in
such exchanges or markets, and adverse market movements could therefore continue
to an unlimited extent over a period of time. Although the purchaser of an
option cannot lose more than the amount of the premium plus related transaction
costs, this entire amount could be lost. Moreover, the Fully Discretionary Fund
as an option writer could lose amounts substantially in excess of its initial
investment, due to the margin and collateral requirements typically associated
with such option writing. See "Dealer Options" below.
DEALER OPTIONS. The Funds will engage in transactions involving dealer
options as well as exchange-traded options. Certain risks are specific to
dealer options. While a Fund might look to a clearing corporation to exercise
exchange-traded options, if the Fund were to purchase a dealer option it would
need to rely on the dealer from which it purchased the option to perform if the
option were exercised. Failure by the dealer to do so would result in the loss
of the premium paid by the Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid market while
dealer options may not. Consequently, a Fund may generally be able to realize
the value of a dealer option it has purchased only by exercising or reselling
the option to the dealer who issued it. Similarly, when a Fund writes a dealer
option, the Fund may generally be able to close out the option prior to its
expiration only by entering into a closing purchase transaction with the dealer
to whom the Fund originally wrote the option. While the Funds will seek to
enter into dealer options only with dealers who will agree to and which are
expected to be capable of entering into closing transactions with the Funds,
there can be no assurance that a Fund will at any time be able to liquidate a
dealer option at a favorable price at any time prior to expiration. Unless the
Fund, as a covered dealer option writer, is able to effect a closing purchase
transaction, it will not be able to liquidate securities (or other assets) used
as cover until the option expires or is exercised. In the event of insolvency
of the other party, a Fund may be unable to liquidate a dealer option. With
respect to options written by a Fund, the inability to enter into a closing
transaction may result in material losses to the Fund. For example, because a
Fund must maintain a secured position with respect to any call option on a
security it writes, the Fund may not sell the assets which it has segregated to
secure the position while it is obligated under the option. This requirement
may impair the Fund's ability to sell portfolio securities at a time when such
sale might be advantageous.
The Staff of the Securities and Exchange Commission (the "Commission")
has taken the position that purchased dealer options are illiquid securities.
A Fund may treat the cover used for written dealer options as liquid if the
dealer agrees that the Fund may repurchase the dealer option it has written
for a maximum price to be calculated by a predetermined formula. In such
cases, the dealer option would be considered illiquid only to the extent the
maximum purchase price under the formula exceeds the intrinsic value of the
option. Accordingly, each Fund will treat dealer options as subject to the
Fund's limitation on illiquid securities. If the Commission changes its
position on the liquidity of dealer options, each Fund will change its
treatment of such instruments accordingly.
FOREIGN CURRENCY OPTIONS
Each Fund may buy or sell put and call options on foreign currencies. A
put or call option on a foreign currency gives the purchaser of the option to
right to sell or purchase a foreign currency at the exercise price until the
option expires. The Fund will use foreign currency options separately or in
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combination to control currency volatility. Among the strategies employed to
control currency volatility is an option collar. An option collar involves the
purchase of a put option and the simultaneous sale of call option on the same
currency with the same expiration date but with different exercise (or "strike")
prices. Generally, the put option will have an out-of-the-money strike price,
while the call option will have either an at-the-money strike price or and in-
the-money strike price. Foreign currency options are derivative securities.
Currency options traded on U.S. or other exchanges may be subject to position
limits which may limit the ability of the Fund to reduce foreign currency risk
using such options.
As with other kinds of option transactions, the writing of an option on
foreign currency will constitute only a partial hedge, up to the amount of the
premium received. The Fund could be required to purchase or sell foreign
currencies at disadvantageous exchange rates, thereby incurring losses. The
purchase of an option on foreign currency may constitute an effective hedge
against exchange rate fluctuations; however, in the event of an exchange rate
movements adverse to the Fund's position, the Fund may forfeit the entire amount
of the premium plus related transaction costs.
FORWARD CURRENCY CONTRACTS
Each Fund may enter into forward currency contracts in anticipation of
changes in currency exchange rates. A forward currency contract is an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. For example, the Fund
might purchase a particular currency or enter into a forward currency contract
to preserve the U.S. dollar price of securities it intends to or has contracted
to purchase. Alternatively, it might sell a particular currency on either a
spot or forward basis to hedge against an anticipated decline in the dollar
value of securities it intends to or has contracted to sell. Although this
strategy could minimize the risk of loss due to a decline in the value of the
hedged currency, it could also limit any potential gain from an increase in the
value of the currency.
FUTURES CONTRACTS AND RELATED OPTIONS
Each of the Funds may invest in futures contracts and options on futures
contracts as a hedge against changes in market conditions, interest rates or
currency exchange rates. The Funds will trade in such derivative securities for
bona fide hedging purposes and (in the case of the Strategic Income Fund)
otherwise, in accordance with the rules of the Commodity Futures Trading
Commission ("CFTC"). Each Fund will segregate liquid assets in a separate
account with its Custodian when required to do so by CFTC guidelines in order to
cover its obligation in connection with futures and options transactions.
No price is paid or received by a Fund upon the purchase or sale of a
futures contract. When it enters into a domestic futures contract, the Fund
will be required to deposit in a segregated account with its Custodian an amount
of cash or U.S. Treasury bills equal to approximately 5% of the contract amount.
This amount is known as initial margin. The margin requirements for foreign
futures contracts may be different.
The nature of initial margin in futures transactions is different from
that of margin in securities transactions. Futures contract margin does not
involve the borrowing of funds by the customer to finance the transactions.
Rather, the initial margin is in the nature of a performance bond or good faith
deposit on the contract which is returned to a Fund upon termination of the
futures contract, assuming all contractual obligations have been satisfied.
Subsequent payments (called variation margin) to and from the broker will be
made on a daily basis as the price of the underlying index fluctuates, to
reflect movements in the price of the contract making the long and short
positions in the futures contract more or less valuable. For example, when
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a Fund has purchased an index futures contract and the price of the underlying
index has risen, that position will have increased in value and the Fund will
receive from the broker a variation margin payment equal to that increase in
value. Conversely, when the Fund has purchased an index futures contract and
the price of the underlying index has declined, the position will be less
valuable and the Fund will be required to make a variation margin payment to the
broker.
At any time prior to expiration of a futures contract, a Fund may elect
to close the position by taking an opposite position, which will operate to
terminate the Fund's position in the futures contract. A final determination of
variation margin is made on closing the position. Additional cash is paid by or
released to the Fund, which realizes a loss or gain.
STOCK INDEX FUTURES. The High Yield Bond Fund may invest in futures
contracts on stock indices. Currently, stock index futures contracts can be
purchased or sold with respect to the S&P 500 Stock Price Index on the Chicago
Mercantile Exchange, the Major Market Index on the Chicago Board of Trade, the
New York Stock Exchange Composite Index on the New York Futures Exchange and the
Value Line Stock Index on the Kansas City Board of Trade. Foreign financial and
stock index futures are traded on foreign exchanges including the London
International Financial Futures Exchange, the Singapore International Monetary
Exchange, the Sydney Futures Exchange Limited and the Tokyo Stock Exchange.
INTEREST RATE OR FINANCIAL FUTURES CONTRACTS. The Funds may invest in
interest rate or financial futures contracts. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, a contract is made to purchase or sell a bond in the future for
a set price on a certain date. Historically, the prices for bonds established
in the futures markets have generally tended to move in the aggregate in concert
with cash market prices, and the prices have maintained fairly predictable
relationships.
The sale of an interest rate or financial futures contract by a Fund
would create an obligation by the Fund, as seller, to deliver the specific type
of financial instrument called for in the contract at a specific future time for
a specified price. A futures contract purchased by a Fund would create an
obligation by the Fund, as purchaser, to take delivery of the specific type of
financial instrument at a specific future time at a specific price. The
specific securities delivered or taken, respectively, at settlement date, would
not be determined until at or near that date. The determination would be in
accordance with the rules of the exchange on which the futures contract sale or
purchase was made.
Although interest rate or financial futures contracts by their terms
call for actual delivery or acceptance of securities, in most cases the
contracts are closed out before the settlement date without delivery of
securities. Closing out of a futures contract sale is effected by the Fund's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
in the sale exceeds the price in the offsetting purchase, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the Fund's entering
into a futures contract sale. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
The Funds deal only in standardized contracts on recognized exchanges.
Each exchange guarantees performance under contract provisions through a
clearing corporation, a nonprofit organization managed by the exchange
membership. Domestic interest rate futures contracts are traded in an auction
environment on the floors of several exchanges - principally, the Chicago Board
of Trade and the Chicago Mercantile Exchange. A public market now exists in
domestic futures contracts covering various financial
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instruments including long-term United States Treasury bonds and notes;
Government National Mortgage Association (GNMA) modified pass-through
mortgage-backed securities; three-month United States Treasury bills; and 90-day
commercial paper. A Fund may trade in any futures contract for which there
exists a public market, including, without limitation, the foregoing
instruments. International interest rate futures contracts are traded on the
London International Financial Futures Exchange, the Singapore International
Monetary Exchange, the Sydney Futures Exchange Limited and the Tokyo Stock
Exchange.
FOREIGN CURRENCY FUTURES CONTRACTS. Each Fund may use foreign currency
futures contracts for hedging purposes. A foreign currency futures contract
provides for the future sale by one party and purchase by another party of a
specified quantity of a foreign currency at a specified price and time. A
public market exists in futures contracts covering several foreign currencies,
including the Australian dollar, the Canadian dollar, the British pound, the
German mark, the Japanese yen, the Swiss franc, and certain multinational
currencies such the European Currency Unit ("ECU"). Other foreign currency
futures contracts are likely to be developed and traded in the future. The Fund
will only enter into futures contracts and futures options which are
standardized and traded on a U.S. or foreign exchange, board of trade, or
similar entity, or quoted on an automated quotation system.
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS. There are several risks
related to the use of futures as a hedging device. One risk arises because of
the imperfect correlation between movements in the price of the futures contract
and movements in the price of the securities which are the subject of the hedge.
The price of the future may move more or less than the price of the securities
being hedged. If the price of the future moves less than the price of the
securities which are the subject of the hedge, the hedge will not be fully
effective, but if the price of the securities being hedged has moved in an
unfavorable direction, a Fund would be in a better position than if it had not
hedged at all. If the price of the securities being hedged has moved in a
favorable direction, this advantage will be partially offset by the loss on the
future. If the price of the future moves more than the price of the hedged
securities, the Fund will experience either a loss or a gain on the future which
will not be completely offset by movements in the price of the securities which
are subject to the hedge.
To compensate for the imperfect correlation of movements in the price of
securities being hedged and movements in the price of the futures contract, a
Fund may buy or sell futures contracts in a greater dollar amount than the
dollar amount of securities being hedged if the historical volatility of the
prices of such securities has been greater than the historical volatility over
such time period of the future. Conversely, the Fund may buy or sell fewer
futures contracts if the historical volatility of the price of the securities
being hedged is less than the historical volatility of the futures contract
being used. It is possible that, when the Fund has sold futures to hedge its
portfolio against a decline in the market, the market may advance while the
value of securities held in the Fund's portfolio may decline. If this occurs,
the Fund will lose money on the future and also experience a decline in value in
its portfolio securities. However, the Investment Adviser believes that over
time the value of a diversified portfolio will tend to move in the same
direction as the market indices upon which the futures are based.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead. If the Fund then decides not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, it will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the stock index or cash market due to certain market distortions.
All participants in
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the futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal relationship between the index or cash market and futures markets. In
addition, the deposit requirements in the futures market are less onerous than
margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may also cause temporary
price distortions. As a result of price distortions in the futures market and
the imperfect correlation between movements in the cash market and the price of
securities and movements in the price of futures, a correct forecast of general
trends by the Investment Adviser may still not result in a successful hedging
transaction over a very short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Funds
intend to purchase or sell futures only on exchanges or boards of trade where
there appears to be an active secondary market, there is no assurance that a
liquid secondary market on an exchange or board of trade will exist for any
particular contract or at any particular time. In such event, it may not be
possible to close a futures position, and in the event of adverse price
movements, the Funds would continue to be required to make daily cash payments
of variation margin. When futures contracts have been used to hedge portfolio
securities, such securities will not be sold until the futures contract can be
terminated. In such circumstances, an increase in the price of the securities,
if any, may partially or completely offset losses on the futures contract.
However, as described above, there is no guarantee that the price of the
securities will in fact correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures contract.
Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
futures contract, no trades may be made on that day at a price beyond that
limit. The daily limit governs only price movement during a particular trading
day and therefore does not limit potential losses, because the limit may prevent
the liquidation of unfavorable positions. Futures contract prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of futures positions
and subjecting some futures traders to substantial losses.
Successful use of futures by a Fund is also subject to the Investment
Adviser's ability to predict correctly movements in the direction of the market.
For example, if the Fund has hedged against the possibility of a decline in the
market adversely affecting stocks held in its portfolio and stock prices
increase instead, the Fund will lose part or all of the benefit of the increased
value of the stocks which it has hedged because it will have offsetting losses
in its futures positions. In addition, in such situations, if the Fund has
insufficient cash, it may have to sell securities to meet daily variation margin
requirements. Such sales of securities may be, but will not necessarily be, at
increased prices which reflect the rising market. The Fund may have to sell
securities at a time when it may be disadvantageous to do so.
In the event of the bankruptcy of a broker through which a Fund engages
in transactions in futures contracts or options, the Fund could experience
delays and losses in liquidating open positions purchased or sold through the
broker, and incur a loss of all or part of its margin deposits with the broker.
OPTIONS ON FUTURES CONTRACTS. Each of the Funds may purchase options on
the futures contracts they can purchase or sell, as described above. A futures
option gives the holder, in return for the premium paid, the right to buy (call)
from or sell (put) to the writer of the option a futures contract at a specified
price at any time during the period of the option. Upon exercise, the writer of
the option is obligated to pay the difference between the cash value of the
futures contract and the exercise price. Like the buyer or
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seller of a futures contract, the holder or writer of an option has the right to
terminate its position prior to the scheduled expiration of the option by
selling, or purchasing an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss. There is no
guarantee that such closing transactions can be effected.
Investments in futures options involve some of the same considerations
as investments in futures contracts (for example, the existence of a liquid
secondary market). In addition, the purchase of an option also entails the risk
that changes in the value of the underlying futures contract will not be fully
reflected in the value of the option. Depending on the pricing of the option
compared to either the futures contract upon which it is based, or upon the
price of the securities being hedged, an option may or may not be less risky
than ownership of the futures contract or such securities. In general, the
market prices of options can be expected to be more volatile than the market
prices on the underlying futures contracts. Compared to the purchase or sale of
futures contracts, however, the purchase of call or put options on futures
contracts may frequently involve less potential risk to the Funds because the
maximum amount at risk is limited to the premium paid for the options (plus
transaction costs).
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS AND RELATED OPTIONS.
Except as otherwise described in the Portfolios' Prospectus, a Fund will not
engage in transactions in futures contracts or related options for speculation,
but only as a hedge against changes resulting from market conditions in the
values of securities held in the Fund's portfolio or which it intends to
purchase and where the transactions are economically appropriate to the
reduction of risks inherent in the ongoing management of the Funds. A Fund may
not purchase or sell futures or purchase related options if, immediately
thereafter, more than 25% of its net assets would be hedged. A Fund also may
not purchase or sell futures or purchase related options if, immediately
thereafter, the sum of the amount of margin deposits on the Fund's existing
futures positions and premiums paid for such options would exceed 5% of the
market value of the Fund's net assets.
Upon the purchase of futures contracts by a Fund, an amount of cash and
cash equivalents, equal to the market value of the futures contracts, will be
deposited in a segregated account with the Custodian or in a margin account with
a broker to collateralize the position and thereby insure that the use of such
futures is unleveraged.
These restrictions, which are derived from current federal and state
regulations regarding the use of options and futures by mutual funds, are not
"fundamental restrictions" and may be changed by the Trustees of the Master
Trust if applicable law permits such a change and the change is consistent with
the overall investment objective and policies of the Fund.
The extent to which a Fund may enter into futures and options
transactions may be limited by the Internal Revenue Code requirements for
qualification of the corresponding Portfolio as a regulated investment company.
See "Taxes."
INTEREST RATE AND CURRENCY SWAPS
INTEREST RATE SWAPS. As indicated in the Prospectus, an interest rate
swap is a contract between two entities ("counterparties") to exchange interest
payments (of the same currency) between the parties. In the most common
interest rate swap structure, one counterparty agrees to make floating rate
payments to the other counterparty, which in turn makes fixed rate payments to
the first counterparty. Interest payments are determined by applying the
respective interest rates to an agreed upon amount, referred to as the "notional
principal amount." In most such transactions, the floating rate payments are
tied to the London Interbank Offered Rate, which is the offered rate for short-
term Eurodollar deposits between major international banks. As there is no
exchange of principal amounts, an interest rate swap is not an investment or a
borrowing.
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CROSS CURRENCY SWAPS. A cross-currency swap is a contract between two
counterparties to exchange interest and principal payments in different
currencies. A cross-currency swap normally has an exchange of principal at
maturity (the final exchange); an exchange of principal at the start of the swap
(the initial exchange) is optional. An initial exchange of notional principal
amounts at the spot exchange rate serves the same function as a spot transaction
in the foreign exchange market (for an immediate exchange of foreign exchange
risk). An exchange at maturity of notional principal amounts at the spot
exchange rate serves the same function as a forward transaction in the foreign
exchange market (for a future transfer of foreign exchange risk). The currency
swap market convention is to use the spot rate rather than the forward rate for
the exchange at maturity. The economic difference is realized through the
coupon exchanges over the life of the swap. In contrast to single currency
interest rate swaps, cross-currency swaps involve both interest rate risk and
foreign exchange risk.
SWAP OPTIONS. Each Fund may invest in swap options. A swap option is a
contract that gives a counterparty the right (but not the obligation) to enter
into a new swap agreement or to shorten, extend, cancel or otherwise change an
existing swap agreement, at some designated future time on specified terms. It
is different from a forward swap, which is a commitment to enter into a swap
that starts a some future date with specified rates. A swap option may be
structured European-style (exercisable on the pre-specified date) or American-
style (exercisable during a designated period). The right pursuant to a swap
option must be exercised by the right holder. The buyer of the right to receive
fixed pursuant to a swap option is said to own a call.
CAPS AND FLOORS. Each Fund may also invest in interest rate and
currency caps and floors. An interest rate cap is a right to receive periodic
cash payments over the life of the cap equal to the difference between any
higher actual level of interest rates in the future and a specified strike (or
"cap") level. The cap buyer purchases protection for a floating rate move above
the strike. An interest rate floor is the right to receive periodic cash
payments over the life of the floor equal to the difference between any lower
actual level of interest rates in the future and a specified strike (or "floor")
level. The floor buyer purchases protection for a floating rate move below the
strike. The strikes are typically based on the three-month LIBOR (although
other indices are available) and are measured quarterly. Rights arising
pursuant to both caps and floors are exercised automatically if the strike is in
the money. Caps and floors eliminate the risk that the buyer fails to exercise
an in-the-money option.
RISKS ASSOCIATED WITH SWAPS. The risks associated with interest rate
and currency swaps and interest rate caps and floors are similar to those
described above with respect to dealer options. In connection with such
transactions, a Fund relies on the other party to the transaction to perform its
obligations pursuant to the underlying agreement. If there were a default by
the other party to the transaction, the Fund would have contractual remedies
pursuant to the agreement, but could incur delays in obtaining the expected
benefit of the transaction or loss of such benefit. In the event of insolvency
of the other party, the Fund might be unable to obtain its expected benefit. In
addition, while each Fund will seek to enter into such transactions only with
parties which are capable of entering into closing transactions with the Fund,
there can be no assurance that a Fund will be able to close out such a
transaction with the other party, or obtain an offsetting position with any
other party, at any time prior to the end of the term of the underlying
agreement. This may impair a Fund's ability to enter into other transactions at
a time when doing so might be advantageous.
REPURCHASE AGREEMENTS
Each Fund may enter into repurchase agreements with respect to its
portfolio securities. Pursuant to such agreements, the Fund acquires securities
from financial institutions such as banks and broker-dealers as are deemed to be
creditworthy by the Investment Adviser, subject to the seller's agreement to
repurchase
B-18
<PAGE>
and the Fund's agreement to resell such securities at a mutually agreed upon
date and price. The repurchase price generally equals the price paid by the
Fund plus interest negotiated on the basis of current short-term rates (which
may be more or less than the rate on the underlying portfolio security).
Securities subject to repurchase agreements will be held by the Custodian or in
the Federal Reserve/Treasury Book-Entry System or an equivalent foreign system.
The seller under a repurchase agreement will be required to maintain the value
of the underlying securities at not less than 102% of the repurchase price under
the agreement. If the seller defaults on its repurchase obligation, the Fund
holding the repurchase agreement will suffer a loss to the extent that the
proceeds from a sale of the underlying securities is less than the repurchase
price under the agreement. Bankruptcy or insolvency of such a defaulting seller
may cause the Fund's rights with respect to such securities to be delayed or
limited. Repurchase agreements are considered to be loans under the Investment
Company Act.
WHEN-ISSUED SECURITIES, FORWARD COMMITMENTS AND DELAYED SETTLEMENTS
Each of the Funds may purchase securities on a "when-issued," forward
commitment or delayed settlement basis. In this event, the Custodian will set
aside cash or liquid portfolio securities equal to the amount of the commitment
in a separate account. Normally, the Custodian will set aside portfolio
securities to satisfy a purchase commitment. In such a case, a Fund may be
required subsequently to place additional assets in the separate account in
order to assure that the value of the account remains equal to the amount of the
Fund's commitment. It may be expected that the Fund's net assets will fluctuate
to a greater degree when it sets aside portfolio securities to cover such
purchase commitments than when it sets aside cash.
The Funds do not intend to engage in these transactions for speculative
purposes but only in furtherance of their investment objectives. Because a Fund
will set aside cash or liquid portfolio securities to satisfy its purchase
commitments in the manner described, the Fund's liquidity and the ability of the
Investment Adviser to manage it may be affected in the event the Fund's forward
commitments, commitments to purchase when-issued securities and delayed
settlements ever exceeded 15% of the value of its net assets.
A Fund will purchase securities on a when-issued, forward commitment or
delayed settlement basis only with the intention of completing the transaction.
If deemed advisable as a matter of investment strategy, however, a Fund may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
the Fund on the settlement date. In these cases the Fund may realize a taxable
capital gain or loss. When a Fund engages in when-issued, forward commitment
and delayed settlement transactions, it relies on the other party to consummate
the trade. Failure of such party to do so may result in a Fund's incurring a
loss or missing an opportunity to obtain a price credited to be advantageous.
The market value of the securities underlying a when-issued purchase,
forward commitment to purchase securities, or a delayed settlement and any
subsequent fluctuations in their market value is taken into account when
determining the market value of a Fund starting on the day the Fund agrees to
purchase the securities. A Fund does not earn interest on the securities it has
committed to purchase until they are paid for and delivered on the settlement
date.
BORROWING
The Trust has entered into a Credit Agreement on behalf of its various
Portfolios with several banks and Chemical Bank, as administrative agent for the
lenders, to borrow up to $50,000,000 from time to time for purposes of meeting
shareholder redemption requests without the necessity of requiring the Funds to
sell portfolio securities, at times when the Investment Adviser believes such
sales are not in the best interest of the Portfolio's shareholders, in order to
provide the Portfolios with cash to meet such redemption requests. The Credit
Agreement expires on April 10, 1997, unless renewed by the parties.
Under the Credit Agreement, each Portfolio may borrow, repay and reborrow
amounts (collectively, the "Revolving Credit Loans") in increments of $50,000,
provided the Revolving Credit Loans outstanding at any time aggregate at least
$350,000 (the "Credit Facility"). The Trust will pay a commitment fee at the
rate of 0.40% per annum of the average daily unused portion of the Credit
Facility, and may at any time terminate the Credit Agreement or reduce the
lenders' commitment thereunder in increments of $2,500,000.
While outstanding, the Revolving Credit Loans will bear interest,
fluctuating daily and payable monthly, at either of the following rates or a
combination thereof, at the Trust's option: (i) at the weighted average of the
rates on overnight federal funds transactions with members of the Federal
Reserve System arranged by federal funds brokers, plus 0.625% per annum; or (ii)
the prime rate of interest of Chemical Bank. If, as a result of changes in
applicable laws, regulations or quidelines with respect to the capital adequacy
of any lender, the return on such lender's capital is reduced, the Trust may be
required to adjust the rate of interest to compensate such lender for such
reduction. Each Revolving Credit Loan is payable in thirty days, and may be
prepaid at any time in increments of $100,000 without premium or penalty. No
Portfolio is liable for repayment of a Revolving Credit Loan to any other
Portfolio.
The Credit Agreement contains, among other things, covenants that require
each Portfolio to maintain certain minimum ratios of debt to net worth; limit
the ability of the Trust to incur other indebtedness and create liens on its
assets or quarantee obligations of others; merge or consolidate with, or sell
its assets to, others; make material changes in its method of conducting
business; make distributions to shareholders in excess of the requirements of
Subchapter M of the Internal Revenue Code in the event of a default under the
Credit Agreement; or make changes in fundamental investment policies. The
Credit Agreement also contains other terms and conditions customary in such
agreements, including various events of default.
LENDING PORTFOLIO SECURITIES
Each of the Funds may lend its portfolio securities in an amount not
exceeding 30% of its total assets to financial institutions such as banks and
brokers if the loan is collateralized in accordance with applicable regulations.
Under the present regulatory requirements which govern loans of portfolio
securities,
B-19
<PAGE>
the loan collateral must, on each business day, at least equal the value of the
loaned securities and must consist of cash, letters of credit of domestic banks
or domestic branches of foreign banks, or securities of the U.S. Government or
its agencies. To be acceptable as collateral, letters of credit must obligate a
bank to pay amounts demanded by the Fund if the demand meets the terms of the
letter. Such terms and the issuing bank would have to be satisfactory to the
Fund. Any loan might be secured by any one or more of the three types of
collateral. The terms of the Fund's loans must permit the Fund to reacquire
loaned securities on five days' notice or in time to vote on any serious matter
and must meet certain tests under the Internal Revenue Code.
ILLIQUID SECURITIES
Neither Fund may invest more than 15% of the value of its net assets in
securities that at the time of purchase have legal or contractual restrictions
on resale or are otherwise illiquid. The Investment Adviser will monitor the
amount of illiquid securities in the Fund's portfolio, under the supervision of
the Master Trust's Board of Trustees, to ensure compliance with the Fund's
investment restrictions.
Each Fund may invest in foreign securities that are restricted against
transfer within the United States or to United States persons. Although
securities subject to such transfer restrictions may be marketable abroad, they
may be less liquid than foreign securities of the same class that are not
subject to such restrictions. Unless these securities are acquired directly
from the issuer or its underwriter, the Fund treats such foreign securities
whose principal market is abroad as not subject to the investment limitation on
securities subject to legal or contractual restrictions on resale.
INVESTMENT RESTRICTIONS
The Trust, on behalf of the Portfolios, and the Master Trust, on behalf
of the corresponding Funds, have adopted the following fundamental policies that
cannot be changed without the affirmative vote of a majority of the outstanding
shares of the appropriate Portfolio or Fund, respectively (as defined in the
Investment Company Act). Whenever a Portfolio is requested to vote on a change
in the investment restrictions of a Fund, the Trust will hold a meeting of its
shareholders and will cast its vote as instructed by the shareholders. If the
investment restrictions of a Fund are changed, the corresponding Portfolio may
withdraw its investment in the Fund if the Trust's Board of Trustees determines
that withdrawal is in the best interests of the Portfolio and its shareholders,
but only upon shareholder approval. Upon such withdrawal, the Trust's Board
would consider alternative investments, including investing all of the
Portfolio's assets in another investment company with the same investment
objective, policies and restrictions as the Portfolio or hiring an investment
adviser to manage the Portfolio's assets in accordance with the investment
objectives, policies and restrictions of the Portfolio described in the
Portfolio's Prospectus and in this Statement of Additional Information.
All percentage limitations set forth below apply immediately after a
purchase or initial investment, and any subsequent change in any applicable
percentage resulting from market fluctuations will not require elimination of
any security from the relevant portfolio.
No Portfolio or Fund:
B-20
<PAGE>
1. May invest in securities of any one issuer if more than 5% of the
market value of its total assets would be invested in the securities of such
issuer, except that up to 25% of a Portfolio or Fund's total assets may be
invested without regard to this restriction and a Portfolio will be permitted to
invest all or a portion of its assets in a corresponding Fund or other
diversified, open-end management investment company with substantially the same
investment objective, policies and restrictions as the Portfolio. This
restriction also does not apply to investments by a Portfolio or Fund in
securities of the U.S. Government or any of its agencies and instrumentalities.
2. May purchase more than 10% of the outstanding voting securities, or
of any class of securities, of any one issuer, or purchase the securities of any
issuer for the purpose of exercising control or management, except that a
Portfolio will be permitted to invest all or a portion of its assets in a
corresponding Fund or other diversified, open-end management investment company
with substantially the same investment objective, policies and restrictions as
the Portfolio.
3. May invest 25% or more of the market value of its total assets in
the securities of issuers in any one particular industry, except that a
Portfolio will be permitted to invest all or a portion of its assets in a
corresponding Fund or other diversified, open-end management investment company
with substantially the same investment objective, policies and restrictions as
the Portfolio. This restriction does not apply to investments by a Portfolio or
Fund in securities of the U.S. Government or its agencies and instrumentalities.
4. May purchase or sell real estate. However, a Portfolio or Fund may
invest in securities secured by, or issued by companies that invest in, real
estate or interests in real estate.
5. May make loans of money, except that a Portfolio or Fund may
purchase publicly distributed debt instruments and certificates of deposit and
enter into repurchase agreements. Each Portfolio and Fund reserves the
authority to make loans of its portfolio securities in an aggregate amount not
exceeding 30% of the value of its total assets.
6. May borrow money on a secured or unsecured basis, except that (a)
the High Yield Bond Fund may borrow for temporary, extraordinary or emergency
purposes or for the clearance of transactions in amounts not exceeding 20% of
the value of its total assets at the time of the borrowing, and (b) the
Strategic Income Portfolio or Fund may borrow up to 33 1/3% of the value of
its Total assets for temporary, extraordinary or emergency purposes, for the
clearance of transactions, or to purchase securities. Pursuant to the
Investment Company Act, borrowings will only be made from banks and will be
made only to the extent that the value of the Fund's total assets, less its
liabilities other than borrowings, is equal to at least 300% of all
borrowings (including the proposed borrowing). If such asset coverage of
300% is not maintained, the Portfolio or Fund will take prompt action to
reduce its borrowings as required by applicable law.
7. May pledge or in any way transfer as security for indebtedness any
securities owned or held by it, except to secure indebtedness permitted by
restriction 6 above. This restriction shall not prohibit the Portfolios or
Funds from engaging in options, futures and foreign currency transactions.
8. May underwrite securities of other issuers, except insofar as it
may be deemed an underwriter under the Securities Act in selling portfolio
securities.
9. May invest more than 15% of the value of its net assets in
securities that at the time of purchase have legal or contractual restrictions
on resale or are otherwise illiquid.
10. May purchase securities on margin, except for initial and variation
margin on options and futures contracts, and except as set forth in
restriction 6 above.
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<PAGE>
11. May invest in securities of other investment companies, except
(a) that a Portfolio may invest all or a portion of its assets in a
corresponding Fund or other diversified, open-end management investment
company with the same investment objective, policies and restriction as the
Portfolio, (b) in compliance with the Investment Company Act and applicable
state securities laws, or (c) as part of a merger, consolidation, acquisition
or reorganization involving the Portfolio or Fund.
12. May issue senior securities, except that a Portfolio or Fund may
borrow money as permitted by restrictions 6 and 7 above. This restriction shall
not prohibit the Portfolios or Funds from engaging in options, futures and
foreign currency transactions.
13. May enter into transactions for the purpose of arbitrage, or invest
in commodities and commodities contracts, except that a Fund or Portfolio may
invest in futures contracts and related options in accordance with any rules of
the Commodity Futures Trading Commission.
14. May purchase or write options on securities, unless (i) aggregate
premiums on call options purchased by a Fund do not exceed 5% of its net assets,
(ii) aggregate premiums on put options purchased by a Fund do not exceed 5% of
its net assets, (iii) not more than 25% of a Fund's net assets would be hedged,
and (iv) not more than 25% of a Fund's net assets are used as cover for options
written by the Fund.
OPERATING RESTRICTIONS
As a matter of operating (not fundamental) policy adopted by the Boards
of Trustees of the Trust, no Portfolio or Fund:
1. May invest in interests in oil, gas or other mineral exploration or
development programs or leases, or real estate limited partnerships, although
a Portfolio or a Fund may invest in the securities of companies which invest in
or sponsor such programs.
2. May purchase any security if as a result the Portfolio or Fund
would then have more than 5% of its total assets (taken at current value)
invested in securities of companies (including predecessors) having a record of
less than three years of continuous operation, except (a) that a Portfolio may
invest all or a portion of its assets in a corresponding Fund or other
diversified, open-end management investment company with the same investment
objective, policies and restrictions as the Portfolio in compliance with the
Investment Company Act, or (b) as part of a merger, consolidation, acquisition
or reorganization involving the Portfolio or Fund.
3. May purchase securities of any issuer if any officer or trustee of
the Portfolio or Fund, or of the Administrator, the Distributor, or Investment
Adviser, owning more than 1/2 of 1% of the outstanding securities of such
issuer, own in the aggregate more than 5% of the outstanding securities of such
issuer.
4. May lend any securities from its portfolio unless the value of the
collateral received therefor is continuously maintained in an amount not less
than 100% of the value of the loaned securities by marking to market daily.
5. May invest in warrants, valued at the lower of cost or market, in
excess of 5% of the market value of the Porfolio's or Fund's net assets, or
in excess of 2% of the market value of the Portfolio's or Fund's net assets
if such warrants are not listed on the New York Stock Exchange or the
American Stock Exchange, as of the date of investment.
BLUE SKY RESTRICTIONS
In order to permit the sale of shares of a Portfolio in certain states,
the Boards of Trustees of the Trust and the Master Trust may, in its sole
discretion, adopt additional restrictions on investment policies more
B-22
<PAGE>
restrictive than those described above. Should either of such Boards determine
that any such restrictive policy is no longer in the best interests of such
respective trust or its investors, the Trust may cease offering shares of a
Portfolio in the state involved and the Boards of Trustees may revoke such
restrictive policy. Moreover, if the states involved no longer require any such
restrictive policy, the Board of Trustees may, at their sole discretion, revoke
such policy.
The Master Trust has agreed, in connection with certain undertakings
given by the Trust to the State of South Dakota, that (i) neither Fund will
invest more than 10% of its total assets in interests in real estate investment
trusts, (ii) neither Fund will invest more than 15% of its total assets in
equity securities of issuers which are not readily marketable, in securities of
issuers which the Portfolio or Fund is restricted from selling without
registration under the Securities Act (other than restricted securities eligible
for resale pursuant to Rule 144A under the Securities Act that have been
determined by the Master Trust's Board of Trustees to be liquid based upon the
trading markets for the securities), and securities of unseasoned issuers
referred to in restriction 2 above (these restrictions will not affect the
ability of a Portfolio to invest in securities of a corresponding Fund or other
diversified, open-end management investment companies with the same investment
objectives, policies and restrictions as the Portfolio), and (iii) the Master
Trust will provide adequate notice to the Trust of changes in these investment
restrictions to enable the Trust to provide at least 30 days advance notice of
such changes to its shareholders.
The Master Trust has agreed, in connection with certain undertakings
given by the Trust to the State of Ohio, that no Fund will invest more than 50%
of its total assets in the securities of issuers which together with any
predecessors have a record of less than three years continuous operation or
securities of issuers which are restricted as to disposition (including without
limitation securities issued pursuant to Rule 144A under the Securities Act of
1933).
TRUSTEES AND PRINCIPAL OFFICERS
TRUST
The names and addresses of the Trustees and principal officers of the
Trust, including their positions and principal occupations during the past five
years, are shown below. Trustees whose names are followed by an asterisk are
"interested persons" of the Trust (as defined by the Investment Company Act).
Unless otherwise indicated, the address of each Trustee and officer is 600 West
Broadway, 30th Floor, San Diego, California 92101.
FRED C. APPLEGATE, TRUSTEE AND CHAIRMAN OF THE BOARD OF TRUSTEES.
885 La Jolla Corona Court, La Jolla, California. President, Hightower
Management Co., a financial management firm (since January 1992); formerly
President, Nicholas-Applegate Capital Management (from August 1984 to December
1991). Director of Nicholas-Applegate Fund, Inc. (since 1987). Mr. Applegate's
interests in Nicholas-Applegate Capital Management, Inc., the general partner
of the Investment Adviser, were acquired by Mr. Nicholas in 1991 and 1992.
ARTHUR B. LAFFER, TRUSTEE.*/ 5405 Morehouse Drive, Suite 340, San Diego,
California. Chairman, A.B. Laffer, V.A. Canto & Associates, an economic
consulting firm (since 1979); Chairman, Laffer Advisors Incorporated, economic
consultants (since 1981); Director, Nicholas-Applegate Fund, Inc. (since 1987);
Director, U.S. Filter Corporation (since March 1991) and MasTec, Inc.
(construction) (since 1994); Chairman, Calport Asset Management, Inc. (since
1992); formerly Distinguished University Professor and
B-23
<PAGE>
Director, Pepperdine University (from Sept. 1985 to May 1988) and Professor of
Business Economics, University of Southern California (1976 to 1984).
Mr. Laffer is considered to be an "interested person" of the Trust because A.B.
Laffer, V.A. Canto & Associates received $100,000 in 1994 from the Investment
Adviser as compensation for consulting services provided from time to time to
the Investment Adviser.
CHARLES E. YOUNG, TRUSTEE. UCLA, 2147 Murphy Hall, Los Angeles,
California. Chancellor, UCLA (since 1968); Director, Nicholas-Applegate Fund,
Inc. (since 1992); Director, Intel Corp. (since 1974), Academy of Television
Arts and Sciences Foundation (since October 1988), Los Angeles World Affairs
Council (since 1977) and Town Hall of California (since 1982).
JOHN D. WYLIE, PRESIDENT. Partner (since January 1994), Chief
Investment Officer - Investor Services Group (since December 1995), and
Portfolio Manager (since January 1990), Nicholas-Applegate Capital Management.
Mr. Wylie is also the President of the Master Trust.
THOMAS PINDELSKI, CHIEF FINANCIAL OFFICER. Partner (since January 1996)
and Chief Financial Officer, Nicholas-Applegate Capital Management (since
January 1993), and Chief Financial Officer, Nicholas-Applegate Securities (since
January 1993), formerly Chief Financial Officer, Aurora Capital Partners/WSGP
Partners L.P., an investment partnership (from November 1988 to January 1993),
and Vice President and Controller, Security Pacific Merchant Banking Group (from
November 1986 to November 1988). Mr. Pindelski is also the Chief Financial
Officer of the Master Trust.
PETER J. JOHNSON, VICE PRESIDENT. Partner and Director-Client
Services/Marketing, Nicholas-Applegate Capital Management (since January 1992);
formerly, Marketing Director, Pacific Financial Asset Management Company, an
investment management firm (from July 1989 to December 1991), and Senior
Marketing Representative, Fidelity Investments Institutional Services (from
August 1987 to July 1989). Mr. Johnson is also a Vice President of the Master
Trust.
ASHLEY T. RABUN, VICE PRESIDENT. Partner (since January 1996) and
Director-Investor Services Group, Nicholas-Applegate Capital Management (since
May 1992) and Senior Vice President, Nicholas-Applegate Securities (since
December 1992); formerly Vice President - Marketing, Interinvest Corporation, an
asset management firm (from December 1990 to May 1992), and Vice President, Dean
Witter (from 1984 to 1990). Ms. Rabun is also a Vice President of the Master
Trust.
E. BLAKE MOORE, JR., SECRETARY. General Counsel and Secretary,
Nicholas-Applegate Capital Management and Nicholas-Applegate Securities (since
1993); formerly Attorney, Luce, Forward, Hamilton & Scripps (from 1989 to 1993).
Mr. Moore is also the Secretary of the Master Trust.
Each Trustee of the Trust who is not an officer or affiliate of the
Trust, the Investment Adviser or the Distributor receives an aggregate annual
fee of $10,000 for services rendered as a Trustee of the Trust, and $1,000 for
each meeting attended. Each Trustee is also reimbursed for out-of-pocket
expenses incurred as a Trustee.
The following table sets forth the aggregate compensation paid by the
Trust for the fiscal year ended March 31, 1996, to the Trustees who are not
affiliated with the Investment Adviser and the aggregate compensation paid to
such Trustees for service on the Trust's board and that of all other funds in
the "Trust complex" (as defined in Schedule 14A under the Securities Exchange
Act of 1934):
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<TABLE>
<CAPTION>
Pension or
Aggregate Retirement Estimated Total Compensation
Compensation Benefits Annual Benefits from Trust and Trust
Name from Trust Accrued as Part Upon Complex Paid to
of Trust Retirement Trustee
Expenses
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fred C. Applegate $15,000 None N/A $29,000 (45*)
Arthur B. Laffer $15,500 None N/A $31,500 (45*)
Charles E. Young $15,000 None N/A $31,000 (45*)
</TABLE>
* Indicates number of funds in Trust complex, including the Portfolios.
MASTER TRUST
The names and addresses of the Trustees and principal officers of the
Master Trust, including their positions and principal occupations during the
past five years, are shown below. The positions and principal occupations of
the officers during the past five years, are set forth above. Trustees whose
names are followed by an asterisk are "interested persons" of the Master Trust
(as defined by the Investment Company Act). Unless otherwise indicated, the
address of each Trustee and officer is 600 West Broadway, 30th Floor, San Diego,
California 92101.
ARTHUR E. NICHOLAS, TRUSTEE AND CHAIRMAN OF THE BOARD OF TRUSTEES.*/
Managing Partner and Chief Investment Officer, Nicholas-Applegate Capital
Management, since 1984, and Director and Chariman of the Board, Nicholas-
Applegate Securities. Director and Chairman of the Board of Directors of
Nicholas-Applegate Fund, Inc., a registered open-end investment company, since
1987.
DANN V. ANGELOFF, TRUSTEE. 727 West Seventh Street, Los Angeles,
California. President, The Angeloff Company, corporate financial advisers
(since 1976); Director, Nicholas-Applegate Fund, Inc. (since 1987); Trustee
(1979 to 1987) and University Counselor to the President (since 1987),
University of Southern California; Director, Public Storage, Inc., a real estate
investment trust (since 1980), Storage Properties, a real estate investment
trust (since 1989), Datametrics Corporation, a producer of computer peripherals
and communication products (since 1993), SEDA Specialty Packaging, Inc. (since
1993), and Bonded Motors, Inc., an automotive engine remanufacturer (since
1996).
WALTER E. AUCH, TRUSTEE. 6001 North 62nd Place, Paradise Valley,
Arizona. Director, Geotech Communications, Inc., a mobile radio
communications company (since 1987); Express America Corporation, a mortgage
banking company (since 1992); Fort Dearborn Fund (since 1987); Brinson Funds
(since 1994), Smith Barney VIP Fund (since 1988), Smith Barney Advisers Fund
(since 1981), and Smith Barney Trak Fund (since 1992), registered investment
companies; Pinco LP, an investment manager (since 1994); and Banyan Realty
Fund (since 1987), Banyan Strategic Land Fund (since 1987), Banyan Strategic
Land Fund II (since 1988), and Banyan Mortgage Fund (since 1988), real estate
investment trusts. Formerly Chairman and Chief Executive Officer, Chicago
Board Options Exchange (1979 to 1986) and Senior Executive Vice President,
Director and Member of the Executive Committee, PaineWebber, Inc. (until
1979).
THEODORE J. COBURN, TRUSTEE. 17 Cotswold Road, Brookline,
Massachusetts. Partner, Brown Coburn & Co., an investment banking firm (since
1991), and student, Harvard Divinity School and Harvard School of Education
(since September 1991); Director, Nicholas-Applegate Fund, Inc. (since 1987),
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<PAGE>
Emerging Germany Fund (since 1991), Premiere Radio Networks, Inc. (since 1991),
Sage Analytics International (since 1991), Tonight's Features, Ltd. (since
1995). Formerly Managing Director of Global Equity Transactions Group and
member of Board of Directors, Prudential Securities (from 1986 to June 1991).
DARLENE DEREMER, TRUSTEE.* 155 South Street, Wrentham, Massachusetts.
President and Founder, DeRemer Associates, a marketing consultant for the
financial services industry (since 1987); formerly Vice President and Director,
Asset Management Division, State Street Bank and Trust Company (from 1982 to
1987), and Vice President, T. Rowe Price & Associates (1979 to 1982); Director,
Jurika & Voyles Fund Group (since 1994), Nicholas-Applegate Strategic
Opportunities Ltd. (since 1994), Nicholas-Applegate Securities International
(since 1994), and King's Board Montessori School (Since 1995); Member of
Advisory Board, Financial Women's Association (since 1995). Ms. DeRemer is
considered to be an "interested person" of the Master Trust under the 1940 Act
because DeRemer Associates received $100,736 in 1995 and $54,247 in 1994 from
the Investment Adviser as compensation for consulting services provided in
connection with its institutional business.
GEORGE F. KEANE, TRUSTEE.* 450 Post Road East, Westport, Connecticut.
President Emeritus and Senior Investment Adviser, The Common Fund, a non-profit
investment management organization representing educational institutions (since
1993), after serving as its President (from 1971 to 1992); Member of Investment
Advisory Committee, New York State Common Retirement Fund (since 1982); Director
and Chairman of the Investment Committee, United Negro College Fund (since
1987); Director, Investor Responsibility Research Center (since 1987); Director,
United Educators Risk Retention Group (since 1989); Director, RCB Trust Company
(since 1991); Director, School, College and University Underwriters Ltd. (since
1986); Trustee, Fairfield University (since 1993); Director, The Bramwell Funds,
Inc. (since 1994); Chairman of the Board, Trigen Energy Corporation (since
1994); Director, Universal Stainless & Alloy Products, Inc. (since 1994).
Formerly President, Endowment Advisers, Inc. (from August 1987 to December
1992). Mr. Keane is considered to be an "interested person" of the Master Trust
under the 1940 Act because he is a registered representative of a broker-dealer.
JOHN D. WYLIE, PRESIDENT.
THOMAS PINDELSKI, CHIEF FINANCIAL OFFICER.
PETER J. JOHNSON, VICE PRESIDENT.
E. BLAKE MOORE, JR., SECRETARY.
Each Trustee of the Master Trust who is not an officer or affiliate of the
Master Trust, the Investment Adviser or the Distributor receives an aggregate
annual fee of $10,000 for services rendered as a Trustee of the Master Trust,
and $1,000 for each meeting attended. Each Trustee is also reimbursed for
out-of-pocket expenses incurred as a Trustee.
The following table sets for the aggregate compensation paid by the
Master Trust for the fiscal year ended March 31, 1996, to the Trustees who are
not affiliated with the Investment Adviser and the aggregate compensation paid
to such Trustees for service on the Master Trust's board and that all other
funds in the "Master Trust complex" (as defined in Schedule 14A under the
Securities Exchange Act of 1934):
B-26
<PAGE>
<TABLE>
<CAPTION>
Pension or Total
Retirement Compensation
Aggregate Benefits Estimated from Master Trust
Compensation Accrued as Part Annual and Master Trust
from Master of Master Trust Benefits Upon Complex Paid to
Name Trust Expenses Retirement Trustee
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Dann V. Angeloff $15,500 None N/A $32,500 (13*)
Walter E. Auch $15,000 None N/A $15,000 (12*)
Theodore J. Coburn $15,000 None N/A $29,000 (13*)
Darlene DeRemer $15,000 None N/A $15,000 (12*)
George F. Keane $15,000 None N/A $15,000 (12*)
</TABLE>
* Indicates total number of funds in Master Trust complex, including the Funds.
INVESTMENT ADVISER
The Trust has not engaged the services of an investment adviser with
respect to the Portfolios because the Portfolios invest all of their assets in
corresponding Funds. The Investment Adviser to the Master Trust is
Nicholas-Applegate Capital Management, a California limited partnership, with
offices at 600 West Broadway, 30th Floor, San Diego, California 92101.
The Investment Adviser was organized in 1984 to manage discretionary
accounts investing in publicly traded securities for a variety of investors.
Its general partner is Nicholas-Applegate Capital Management Holdings, L.P., a
California limited partnership, the general partner of which is Nicholas-
Applegate Capital Management Holdings, Inc., a California corporation owned by
Mr. Nicholas. The Investment Adviser currently has fourteen partners (including
Mr. Nicholas) who manage a staff of approximately 325 employees, including 28
portfolio managers.
Personnel of the Investment Adviser may invest in securities for their own
accounts pursuant to a Code of Ethics that sets forth all partners' and
employees' fiduciary responsibilities regarding the Funds, establishes
procedures for personal investing, and restricts certain transactions. For
example, all personal trades in most securities require pre-clearance, and
participation in initial public offerings is prohibited. In addition,
restrictions on the timing of personal investing in relation to trades by the
Funds and on short-term trading have been adopted.
Under the Investment Advisory Agreement between the Master Trust and
the Investment Adviser with respect to the Funds, the Master Trust retains the
Investment Adviser to manage the Funds' investment portfolios, subject to the
direction of the Master Trust's Board of Trustees. The Investment Adviser is
authorized to determine which securities are to be bought or sold by the Funds
and in what amounts.
The Investment Advisory Agreement provides that the Investment Adviser
will not be liable for any error of judgment or for any loss suffered by a Fund
or the Master Trust in connection with the matters to which the Investment
Advisory Agreement relates, except for liability resulting from willful
misfeasance, bad faith or gross negligence in the performance of its duties or
by reason of the Investment Adviser's reckless disregard of its duties and
obligations under the Investment Advisory Agreement. The Master Trust has
agreed to indemnify the Investment Adviser against liabilities, costs and
expenses that the Investment Adviser may incur in connection with any action,
suit, investigation or other proceeding arising out of or otherwise based on any
action actually or allegedly taken or omitted to be taken by the Investment
Adviser in connection with the performance of its duties or obligations under
the Investment Advisory Agreement or otherwise as an investment adviser of the
Master Trust. The Investment Adviser is not entitled to
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<PAGE>
indemnification with respect to any liability to the Master Trust or its
shareholders by reason of willful misfeasance, bad faith or gross negligence in
the performance of its duties, or of its reckless disregard of its duties and
obligations under the Investment Advisory Agreement.
The Investment Advisory Agreement provides that it will terminate in
the event of its assignment (as defined in the Investment Company Act). The
Investment Advisory Agreement may be terminated with respect to any Fund by the
Master Trust (by the Board of Trustees of the Master Trust or vote of a majority
of the outstanding voting securities of the Fund, as defined in the Investment
Company Act) or the Investment Adviser upon not more than 60 days' written
notice, without payment of any penalty. The Investment Advisory Agreement
provides that it will continue in effect with respect to each Fund for a period
of more than two years from its execution only so long as such continuance is
specifically approved at least annually in conformity with the Investment
Company Act.
EXPENSE LIMITATION
The Investment Advisory Agreement, the Investment Adviser has
agreed to defer its management fees payable by each Fund, and to absorb other
expenses payable by each Fund and Portfolio (including administrative fees
and distribution expenses for the Portfolio, and the Portfolio's allocable
share of the operating expenses of the corresponding Fund, but excluding
interest, taxes, brokerage commissions and other costs incurred in connection
with portfolio securities transactions, organizational expenses and other
capitalized expenditures and extraordinary expenses), to ensure that the
operating expenses for the Portfolios do not exceed the amounts specified in
the Portfolios' prospectus. Amounts payable pursuant to these arrangements
are settled monthly.
In addition, each of the Portfolios is subject to certain limitations
on expenses imposed by state securities laws. At present, the only expense
limitation in effect is in California. Under California law, each Portfolio
will be subject to an annual expense limitation equal to the sum of 2.5% of the
first $30 million of the Portfolio's average net assets, 2.0% of the next
$70 million of average net assets, and 1.5% of the remaining average net assets.
If a Portfolio's expenses (excluding interest, brokerage commissions litigation
expenses and certain other items), including its allocable share of the expenses
incurred by the corresponding Fund, were to exceed such limit in any fiscal
year, the Investment Adviser has agreed to bear the amount of such excess to the
extent required by such limitations.
ADMINISTRATOR
The Administrator of the Trust is Investment Company Administration
Corporation, 4455 East Camelback Road, Suite 261-E, Phoenix, Arizona 85018.
Pursuant to an Administration Agreement with the Trust, the
Administrator is responsible for performing all administrative services required
for the daily business operations of the Trust, subject to the supervision of
the Board of Trustees of the Trust. The Administrator has no supervisory
responsibility over the investment operations of the Portfolios. The management
or administrative services of the Administrator for the Trust are not exclusive
under the terms of the Administration Agreement and the Administrator is free
to, and does, render management and administrative services to others.
Investment Company Administration Corporation also serves as the Administrator
for the Master Trust.
For its services, the Administrator receives under the Administration
Agreement $35,000 for each grouping of five similar portfolios (e.g., Core
Growth Portfolio A, Portfolio B, Portfolio C, Institutional and Qualified
Portfolios), $20,000 for each grouping of four similar portfolios, $25,000 for
each grouping of three similar portfolios, $20,000 for a grouping of two similar
portfolios and $5,000 for one portfolio, except as
B-28
<PAGE>
follows: The Administrator receives $15,000 for its services with respect to
the Emerging Growth Portfolios. Such fees will be allocated among the series in
each grouping based on relative net asset values. For its services to the
Master Trust, the Administrator receives, pursuant to an Administration
Agreement, a monthly fee at the following annual rates: 0.05% on the first $100
million of aggregate net assets of the Funds, 0.04% on the next $150 million,
0.03% on the next $300 million, 0.02% on the next $300 million, and 0.01% on the
portion of aggregate net assets of the Funds in excess of $850 million. The
Administrator will receive a minimum of $150,000 per year allocated among the
Funds based on average net assets.
In connection with its management of the affairs of the Trust, the
Administrator pays the salaries and expenses of all its personnel and pays all
expenses incurred in connection with managing the ordinary course of the
business of the Trust, other than expenses assumed by the Trust as described
below.
Under the terms of the Administration Agreement, the Trust is
responsible for the payment of the following expenses: (a) the fees and
expenses incurred by the Trust in connection with the management of the
investment and reinvestment of their assets, (b) the fees and expenses of
Trustees and officers of the Trust who are not affiliated with the
Administrator, the Investment Adviser, (c) out-of-pocket travel expenses for the
officers and Trustees of the Trust and other expenses of Board of Trustees'
meetings, (d) the fees and certain expenses of the Custodian, (e) the fees and
expenses of the Transfer and Dividend Disbursing Agent that relate to the
maintenance of each shareholder account, (f) the charges and expenses of the
Trust's legal counsel and independent accountants, (g) brokerage commissions and
any issue or transfer taxes chargeable to Trustees and officers of the Trust in
connection with securities transactions, (h) all taxes and corporate fees
payable by the Trust to federal, state and other governmental agencies, (i) the
fees of any trade association of which the Trust may be a member, (j) the cost
of maintaining the Trust's existence, taxes and interest, (k) the cost of
fidelity and liability insurance, (l) the fees and expenses involved in
registering and maintaining the registration of the Trust and of its shares with
the Commission and registering the Trust as a broker or dealer and qualifying
their shares under state securities laws, including the preparation and printing
of the Trust's registration statement, prospectuses and statements of additional
information, (m) allocable communication expenses with respect to investor
services and all expenses of shareholders' and Board of Trustees' meetings and
of preparing, printing and mailing prospectuses and reports to shareholders,
(n) litigation and indemnification expenses and other extraordinary expenses
not incurred in the ordinary course of the business of the Trust, and (o)
expenses assumed by the Trust pursuant to any plan of distribution adopted in
conformity with Rule 12b-1 under the Investment Company Act.
The Administration Agreement provides that the Administrator will not
be liable for any error of judgment or for any loss suffered by the Trust in
connection with the matters to which the Administration Agreement relates,
except a loss resulting from the Administrator's willful misfeasance, bad faith,
gross negligence or reckless disregard of its duties. The Administration
Agreement will terminate automatically if assigned, and may be terminated
without penalty by either the Administrator or the Trust (by the Board of
Trustees of the Trust or vote of a majority of the outstanding voting securities
of the Trust, as defined in the Investment Company Act), upon 60 days' written
notice. The Administration Agreement will continue in effect only so long as
such continuance is specifically approved at least annually in conformity with
the Investment Company Act.
DISTRIBUTOR
Nicholas-Applegate Securities (the "Distributor"), 600 West Broadway,
30th Floor, San Diego, California 92101, is the principal underwriter and
distributor for the Trust and, in such capacity, is responsible for distributing
shares of the Portfolios. The Distributor is a California limited partnership
organized in 1992 to
B-29
<PAGE>
distribute shares of registered investment companies. Its general partner is
Nicholas-Applegate Capital Management, Holdings, L.P., the general partner of
the Investment Adviser.
Pursuant to its Distribution Agreement with the Trust, the Distributor
has agreed to use its best efforts to effect sales of shares of the Portfolios,
but is not obligated to sell any specified number of shares. The Distribution
Agreement contains provisions with respect to renewal and termination similar to
those in the Investment Advisory Agreement discussed above. Pursuant to the
Distribution Agreement, the Trust has agreed to indemnify the Distributor to the
extent permitted by applicable law against certain liabilities under the
Securities Act.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to policies established by the Master Trust's Board of
Trustees, the Investment Adviser is primarily responsible for the execution of
the Funds' portfolio transactions and the allocation of the brokerage business.
In executing such transactions, the Investment Adviser will seek to obtain the
best price and execution for the Funds, taking into account such factors as
price, size of order, difficulty and risk of execution and operational
facilities of the firm involved. Fixed income securities in which the Funds
invest are generally traded in the over-the-counter markets, and the Funds deal
directly with the dealers who make markets in such securities except in those
circumstances where better prices and execution are available elsewhere. The
allocation of orders among dealers are reviewed periodically by the Board of
Trustees of the Master Trust.
The Funds have no obligation to deal with any dealer or group of
dealers in executing transactions in portfolio securities. Subject to obtaining
the best price and execution, broker-dealers who sell shares of the Portfolios
or provide supplemental research, market and statistical information and other
research services and products to the Investment Adviser may receive orders for
transactions by the Funds. Such information, services and products are those
which brokerage houses customarily provide to institutional investors, and
include items such as statistical and economic data, research reports on
particular companies and industries, and computer software used for research
with respect to investment decisions. Information, services and products so
received are in addition to and not in lieu of the services required to be
performed by the Investment Adviser under the Investment Advisory Agreement, and
the expenses of the Investment Adviser are not necessarily reduced as a result
of the receipt of such supplemental information, services and products. Such
information, services and products may be useful to the Investment Adviser in
providing services to clients other than the Master Trust, and not all such
information, services and products are used by the Investment Adviser in
connection with the Funds. Similarly, such information, services and products
provided to the Investment Adviser by brokers and dealers through whom other
clients of the Investment Adviser effect securities transactions may be useful
to the Investment Adviser in providing services to the Funds. The Investment
Adviser is authorized to pay higher commission on brokerage transactions for the
Funds to brokers in order to secure the information, services and products
listed above, subject to review by the Board of Trustees of the Master Trust
from time to time as to the extent and continuation of this practice.
Although investment decisions for the Master Trust are made
independently from those of the other accounts managed by the Investment
Adviser, investments of the kind made by the Funds may often also be made by
such other accounts. When a purchase or sale of the same security is made at
substantially the same time on behalf of the Funds and one or more other
accounts managed by the Investment Adviser, available investments are allocated
in the discretion of the Investment Adviser by such means as, in its judgment,
result in fair treatment. The Investment Adviser aggregates orders for
purchases and sales of securities of the same issuer on the same day among the
Funds and its other managed accounts, and the price paid to or received by the
Funds and those accounts is the average obtained in those orders. In some
B-30
<PAGE>
cases, such aggregation and allocation procedures may affect adversely the price
paid or received by the Funds or the size of the position purchased or sold by
the Funds.
In the over-the-counter market, securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without a
stated commission, although the price of the security usually includes a profit
to the dealer. In underwritten offerings, securities are purchased at a fixed
price which includes an amount of compensation to the underwriter, generally
referred to as the underwriter's commission or discount. On occasion, certain
money market instruments and agency securities may be purchased directly from
the issuer, in which case no commissions or discounts are paid.
PURCHASE AND REDEMPTION OF PORTFOLIO SHARES
Shares of the Portfolios may be purchased and redeemed at their net
asset value without any initial or deferred sales charge by former partners of
Whitehall Partners and Coventry Partners, California limited partnerships, who
received shares of the Core Growth Institutional Portfolio and Income & Growth
Institutional Portfolio, respectively, in the reorganization and conversion of
such partnerships into such Institutional Portfolios. Similarly, shares of the
Portfolios may be purchased and redeemed at their net asset value without any
initial or deferred sales charge by former partners and participants of
Stratford Partners and Nicholas-Applegate Emerging Growth Pooled Trust who
received shares of the Emerging Growth Institutional Portfolio in the
reorganization and conversion of such partnerships and pooled trust into such
Institutional Portfolio.
The price paid for purchase and redemption of shares of the Portfolios
is based on the net asset value per share, which is calculated once daily at the
close of trading (normally 4:00 P.M. New York time) each day the New York Stock
Exchange is open. The New York Stock Exchange is currently closed on weekends
and on the following holidays: New Year's Day, Washington's Birthday, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas
Day. The offering price is effective for orders received by the Transfer Agent
prior to the time of determination of net asset value. Dealers are responsible
for promptly transmitting purchase orders to the Transfer Agent. The Trust
reserves the right in its sole discretion to suspend the continued offering of
the Portfolios' shares and to reject purchase orders in whole or in part when
such rejection is in the best interests of the Trust and the affected
Portfolios.
SHAREHOLDER SERVICES
The services offered by the Trust to shareholders of the Portfolios
can vary, depending on the needs of the qualified retirement plan or other
institutional investor, and should be arranged by contacting the Trust, the
Distributor, the Administrator or the Transfer Agent.
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of shares of a Portfolio, a Shareholder
Investment Account is established for each investor under which the shares are
held for the investor by the Transfer Agent. Whenever a transaction takes place
in the Shareholder Investment Account, the shareholder will be mailed a
statement showing the transaction and the status of the Account. No
certificates will be issued for shares of the Portfolios.
B-31
<PAGE>
AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS
For the convenience of investors, all dividends and distributions are
automatically reinvested in full and fractional shares of the applicable
Portfolio at net asset value. An investor may direct the Transfer Agent in
writing not less than five full business days prior to the record date to have
subsequent dividends and/or distributions sent in cash rather than reinvested.
In the case of recently purchased shares for which registration instructions
have not been received on the record date, cash payment will be made directly to
the dealer. Any shareholder who receives a cash payment representing a dividend
or distribution may reinvest such distribution at net asset value by returning
the check or the proceeds to the Transfer Agent within 30 days after the payment
date. Such investment will be made at the net asset value per share next
determined after receipt of the check or proceeds by the Transfer Agent.
AUTOMATIC INVESTMENT PLAN
Under the Automatic Investment Plan, an investor may arrange to have a
fixed amount automatically invested in shares of a Portfolio on a monthly or
quarterly basis on any day of the month or quarter by authorizing his or her
bank account to be debited to invest specified dollar amounts in shares of the
Portfolio. The investor's bank must be a member of the Automatic Clearing House
System. Stock certificates are not issued to participants of the Automatic
Investment Plan. Participation in the Plan will begin within 30 days after
receipt of the account application. If the investor's bank account cannot be
charged due to insufficient funds, a stop-payment order or closing of the
account, the investor's Plan may be terminated and the related investment
reversed. The investor may change the amount of the investment or discontinue
the Plan at any time by writing to the Transfer Agent. Further information
about this program and an application form can be obtained from the Transfer
Agent or the Distributor.
CROSS-REINVESTMENT OF DIVIDENDS AND DISTRIBUTIONS
A shareholder in a Portfolio may elect to cross-reinvest dividends
or dividends and capital gain distributions paid by that Portfolio (the
"paying Portfolio") into any other Institutional Portfolio (the "receiving
Portfolio") subject to the following conditions: (i) the aggregate value of
the shareholder's account(s) in the paying Portfolio(s) must equal or exceed
$5,000 (this condition is waived if the value of the account in the receiving
Portfolio equals or exceeds that Portfolio's minimum initial investment
requirement), (ii) as long as the value of the account in the receiving
Portfolio is below that Portfolio's minimum initial investment requirement,
dividends and capital gain distributions paid by the receiving Portfolio must
be automatically reinvested in the receiving Portfolio, (iii) there is no
cross-reinvestment from a Portfolio to a portfolio of any series other than
the Institutional Portfolios, and (iv) if this privilege is discontinued with
respect to a particular receiving Portfolio, the value of the account in that
Portfolio must equal or exceed the Fund's minimum initial investment
requirement or the Portfolio will have the right, if the shareholder fails to
increase the value of the account to such minimum within 90 days after being
notified of the deficiency, automatically to redeem the account and send the
proceeds to the shareholder. These cross-reinvestments of dividends and
capital gain distributions will be at net asset value (without a sales
charge).
AUTOMATIC WITHDRAWAL
The Transfer Agent arranges for the redemption by the Portfolio of
sufficient shares, deposited by the shareholder with the Transfer Agent, to
provide the withdrawal payment specified. Withdrawal payments should not be
considered as dividends, yield or income. Automatic investments may not be made
into a shareholder account from which there are automatic withdrawals.
Withdrawals of amounts exceeding reinvested dividends and distributions and
increases in share value will reduce the aggregate value of the shareholder's
account.
B-32
<PAGE>
REDEMPTION IN KIND
The Trust intends to pay in cash for all shares of a Portfolio
redeemed, but when the Master Trust makes payment to a Portfolio in readily
marketable investment securities, the Trust reserves the right to make payment
wholly or partly in shares of such securities. In such cases, a shareholder may
incur brokerage costs in converting such securities to cash. However, the Trust
has elected to be governed by the provisions of Rule 18f-1 under the Investment
Company Act, pursuant to which it is obligated to pay in cash all requests for
redemptions by any shareholder of record, limited in amount with respect to each
shareholder during any 90-day period to the lesser of $250,000 or 1% of the net
asset value of the Trust at the beginning of such period.
NET ASSET VALUE
The net asset value of a share of a Portfolio is calculated by
dividing (i) the value of the securities held by the Portfolio (I.E., the
value of its investments in a Fund), plus any cash or other assets, minus all
liabilities (including accrued estimated expenses on an annual basis), by
(ii) the total number of shares of the Portfolio outstanding. The net asset
value of an interest in a Fund is calculated in the same manner. The value
of the investments and assets of the Portfolio or a Fund is determined each
business day. Investment securities, including ADRs and EDRs, that are
traded on a stock exchange or on the NASDAQ National Market System are valued
at the last sale price as of the close of business on the New York Stock
Exchange (normally 4:00 P.M. New York time) on the day the securities are
being valued, or lacking any sales, at the mean between the closing bid and
asked prices. Securities listed or traded on certain foreign exchanges whose
operations are similar to the United States over-the-counter market are
valued at the price within the limits of the latest available current bid and
asked prices deemed by the Investment Adviser as best to reflect fair value.
A security which is listed or traded on more than one exchange is valued at
the quotation on the exchange determined to be the primary market for such
security by the Investment Adviser. Listed securities that are not traded on
a particular day and other over-the-counter securities are valued at the mean
between the closing bid and asked prices.
In the event that the New York Stock Exchange or the national
securities exchange on which stock or stock options are traded adopt different
trading hours on either a permanent or temporary basis, the Boards of Trustees
of the Trust and the Master Trust will reconsider the time at which net asset
value is computed. In addition, the asset value of the Portfolio or the Fund
may be computed as of any time permitted pursuant to any exemption, order or
statement of the Commission or its staff.
Long-term debt obligations are valued at quoted bid prices for such
securities or, if such prices are not available, at prices for securities of
comparable maturity, quality and type; however, when the Investment Adviser
deems it appropriate, prices obtained for the day of valuation from a bond
pricing service will be used, as discussed below. Debt securities with
maturities of 60 days or less are valued at amortized cost if their term to
maturity from date of purchase is less than 60 days, or by amortizing, from the
sixty-first day prior to maturity, their value on the sixty-first day prior to
maturity if their term to maturity from date of purchase by the Portfolio or the
Fund is more than 60 days, unless this is determined by the Board of Trustees of
the Master Trust not to represent fair value. Repurchase agreements are valued
at cost plus accrued interest.
U.S. Government securities are traded in the over-the-counter market
and are valued at the last available bid prices, except that securities with a
demand feature exercisable within one to seven days are valued at par. Such
valuations are based on quotations of one or more dealers that make markets in
the securities as obtained from such dealers, or on the evaluation of a pricing
service.
Options, futures contracts and options thereon, which are traded on
exchanges, are valued at their last sale or settlement price as of the close of
such exchanges or, if no sales are reported, at the mean between the last
reported bid and asked prices. If an options or futures exchange closes later
than 4:00 p.m. New York time, the options or futures traded on it are valued
based on the sale price, or on the mean between the bid and ask prices, as the
case may be, as of 4:00 p.m. New York time.
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<PAGE>
Trading in securities on foreign securities exchanges and
over-the-counter markets is normally completed well before the close of business
day in New York. In addition, foreign securities trading may not take place on
all business days in New York, and may occur in various foreign markets on days
which are not business days in New York and on which net asset value is not
calculated. The calculation of net asset value may not take place
contemporaneously with the determination of the prices of portfolio securities
used in such calculation. Events affecting the values of portfolio securities
that occur between the time their prices are determined and the close of the New
York Stock Exchange will not be reflected in the calculation of net asset value
unless the Board of Trustees of the Master Trust deems that the particular event
would materially affect net asset value, in which case an adjustment will be
made. Assets or liabilities initially expressed in terms of foreign currencies
are translated prior to the next determination of the net asset value into U.S.
dollars at the spot exchange rates at 1:00 p.m. New York time or at such other
rates as the Investment Adviser may determine to be appropriate in computing net
asset value.
Securities and assets for which market quotations are not readily
available, or for which the Master Trust's Board of Trustees or persons
designated by the Board determine that the foregoing methods do not accurately
reflect current market value, are valued at fair value as determined in good
faith by or under the direction of the Master Trust's Board of Trustees. Such
valuations and procedures will be reviewed periodically by the Board of
Trustees.
The Master Trust may use a pricing service approved by its Board of
Trustees. Prices provided by such a service represent evaluations of the mean
between current bid and asked market prices, may be determined without exclusive
reliance on quoted prices, and may reflect appropriate factors such as
institution-size trading in similar groups of securities, yield, quality, coupon
rate, maturity, type of issue, individual trading characteristics, indications
of values from dealers and other market data. Such services may use electronic
data processing techniques and/or a matrix system to determine valuations. The
procedures of such services are reviewed periodically by the officers of the
Master Trust under the general supervision and responsibility of its Board of
Trustees, which may replace a service at any time if it determines that it is in
the best interests of the Funds to do so.
TAXES
MASTER TRUST'S TAX STATUS
Each Fund of the Master Trust will be treated as a partnership rather
than as a regulated investment company or a corporation under the Internal
Revenue Code (the "Code"). As a partnership under the Code, any interest,
dividends and gains or losses of the Master Trust attributable to each Fund will
be deemed to have been "passed through" to the Trust and other investors in such
Fund, regardless of whether such interest, dividends or gains have been
distributed by the Fund or such losses have been realized and recognized by the
Trust and other investors. Therefore, to the extent a Fund were to accrue but
not distribute any interest, dividends or gains, the Trust and other investors
in the Fund would be deemed to have realized and recognized their proportionate
shares of interest, dividends, gains or losses realized and recognized by the
Fund without receipt of any corresponding distribution. However, the Master
Trust will seek to minimize recognition by investors in the Funds of interest,
dividends, gains or losses allocable to the Funds without a corresponding
distribution.
REGULATED INVESTMENT COMPANY
The Trust has elected to qualify each Portfolio as a regulated
investment company under Subchapter M of the Code, and intends that each
Portfolio will remain so qualified.
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As a regulated investment company, a Portfolio will not be liable for
federal income tax on its income and gains provided it distributes all of its
income and gains currently. Qualification as a regulated investment company
under the Code requires, among other things, that each Portfolio (a) derive at
least 90% of its gross income from dividends, interest, payments with respect to
securities loans, and gains from the sale or other disposition of securities or
foreign currencies, or other income (including, but not limited to, gains from
options, futures or forward contracts) derived with respect to its business of
investing in such securities or currencies; (b) derive less than 30% of its
gross income from the sale or other disposition of stock, securities, options,
futures, forward contracts, certain foreign currencies and certain options,
futures, and forward contracts on foreign currencies held less than three
months; (c) diversify its holdings so that, at the end of each fiscal quarter,
(i) at least 50% of the market value of the Portfolio's assets is represented by
cash, U.S. Government securities and securities of other regulated investment
companies, and other securities (for purposes of this calculation generally
limited, in respect of any one issuer, to an amount not greater than 5% of the
market value of the Portfolio's assets and 10% of the outstanding voting
securities of such issuer) and (ii) not more than 25% of the value of its assets
is invested in the securities of any one issuer (other than U.S. Government or
foreign government securities or the securities of other regulated investment
companies), or two or more issuers which the Trust controls and which are
determined to be engaged in the same or similar trades or businesses; and
(d) distribute at least 90% of its investment company taxable income (which
includes dividends, interest, and net short-term capital gains in excess of net
long-term capital losses) each taxable year.
A Portfolio generally will be subject to a nondeductible excise tax of
4% to the extent that it does not meet certain minimum distribution requirements
as of the end of each calendar year. To avoid the tax, a Portfolio must
distribute during each calendar year an amount equal to the sum of (1) at least
98% of its ordinary income and net capital gain (not taking into account any
capital gains or losses as an exception) for the calendar year, (2) at least 98%
of its capital gains in excess of its capital losses (and adjusted for certain
ordinary losses) for the twelve month period ending on October 31 of the
calendar year, and (3) all ordinary income and capital gains for previous years
that were not distributed during such years. A distribution will be treated as
paid on December 31 of the calendar year if it is declared by the Portfolio in
October, November, or December of that year to shareholders of record on a date
in such a month and paid by the Portfolio during January of the following year.
Such distributions will be taxable to shareholders (other than those not subject
to federal income tax) in the calendar year in which the distributions are
declared, rather than the calendar year in which the distributions are received.
To avoid the excise tax, the Portfolios intend to make timely distributions of
their income in compliance with these requirements and anticipate that they will
not be subject to the excise tax.
Dividends paid by a Portfolio from ordinary income, and distributions
of the Portfolio's net realized short-term capital gains, are taxable to its
shareholders as ordinary income. Distributions to corporate shareholders will
be eligible for the 70% dividends received deduction to the extent that the
income of the Portfolios is derived from dividends on common or preferred stock
of domestic corporations. Dividend income earned by a Portfolio will be
eligible for the dividends received deduction only if the Portfolio and
corresponding Fund have satisfied a 46-day holding period requirement with
respect to the underlying portfolio security (91 days in the case of dividends
derived from preferred stock). In addition, a corporate shareholder must have
held its shares in the Portfolio for not less than 46 days (91 days in the case
of dividends derived from preferred stock) in order to claim the dividend
received deduction. Not later than 60 days after the end of its taxable year,
the Portfolio will send to its shareholders a written notice designating the
amount of any distributions made during such year which may be taken into
account by its shareholders for purposes of such deduction provisions of the
Code. Net capital gain distributions are not eligible for the dividends
received deduction.
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Under the Code, any distributions designated as being made from net
capital gains are taxable to a Portfolio's shareholders as long-term capital
gains, regardless of the holding period of such shareholders. Such
distributions of net capital gains will be designated by the Portfolio as a
capital gains distribution in a written notice to its shareholders which
accompanies the distribution payment. Any loss on the sale of shares held for
less than six months will be treated as a long-term capital loss for federal tax
purposes to the extent a shareholder receives net capital gain distributions on
such shares. The maximum federal income tax rate applicable to long-term
capital gains is currently 28% for individual shareholders and 35% for corporate
shareholders. Dividends and distributions are taxable as such whether received
in cash or reinvested in additional shares of a Portfolio.
Any loss realized on a sale, redemption or exchange of shares of a
Portfolio by a shareholder will be disallowed to the extent the shares are
replaced within a 61-day period (beginning 30 days before the disposition of
shares). Shares purchased pursuant to the reinvestment of a dividend will
constitute a replacement of shares.
A shareholder who acquires shares of a Portfolio and sells or
otherwise disposes of such shares within 90 days of acquisition may not be
allowed to include certain sales charges incurred in acquiring such shares for
purposes of calculating gain or loss realized upon a sale or exchange of shares
of the Portfolio if the shareholder acquires shares in a Portfolio of the Trust
pursuant to a reinvestment right that reduces the sales charges in the
subsequent acquisition of shares.
SPECIAL TAX CONSIDERATIONS
U.S. GOVERNMENT OBLIGATIONS. Income received on direct U.S.
Government obligations is exempt from tax at the state level when received
directly and may be exempt, depending on the state, when received by a
shareholder from a Portfolio provided that certain conditions are satisfied.
Interest received on repurchase agreements collateralized by U.S. Government
obligations normally is not exempt from state taxation. The Trust will inform
shareholders annually of the percentage of income and distributions derived from
direct U.S. Government obligations. Shareholders should consult their tax
advisers to determine whether any portion of the income dividends received from
the Portfolio is considered tax exempt in their particular states.
With respect to investments that are sold at original issue discount
and thus do not make periodic cash interest payments, a Fund and the
corresponding Portfolio will be required to include as part of their current
income the imputed interest on such obligations even though the Fund and the
Portfolio have not received any interest payment on such obligations during that
period. The Fund may have to sell portfolio securities to distribute such
imputed income, which may occur at a time when the Investment Adviser would not
have chosen to sell such securities and which may result in a taxable gain or
loss.
SECTION 1256 CONTRACTS. Many of the options, futures contracts and
forward contracts used by the Funds are "section 1256 contracts." Any gains or
losses on section 1256 contracts are generally credited 60% long-term and 40%
short-term capital gains or losses ("60/40") although gains and losses from
hedging transactions, certain mixed straddles and certain foreign currency
transactions from such contracts may be treated as ordinary in character. Also,
section 1256 contracts held by the Funds at the end of each taxable year (and,
for purposes of the 4% excise tax, on certain other dates as prescribed under
the Code) are "marked to market" with the result that unrealized gains or losses
are treated as though they were realized and the resulting gain or loss is
treated as ordinary or 60/40 gain or loss, depending on the circumstances.
STRADDLE RULES. Generally, the hedging transactions and certain other
transactions in options, futures and forward contracts undertaken by the Funds
may result in "straddles" for U.S. federal income tax
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purposes. The straddle rules may affect the character of gains (or losses)
realized by the Portfolios. In addition, losses realized by the Portfolio on
positions that are part of a straddle may be deferred under the straddle rules,
rather than being taken into account in calculating the taxable income for the
taxable year in which such losses are realized. Because only a few regulations
implementing the straddle rules have been promulgated, the tax consequences of
transactions in options, futures and forward contracts to the Portfolio are not
entirely clear. The transactions may increase the amount of short-term capital
gain realized by the Portfolio which is taxed as ordinary income when
distributed to shareholders.
The Portfolios may make one or more of the elections available under
the Code which are applicable to straddles. If the Portfolios make any of the
elections, the amount, character and timing of the recognition of gains or
losses from the affected straddle positions will be determined under rules that
vary according to the election(s) made. The rules applicable under certain of
the elections operate to accelerate the recognition of gains or losses from the
affected straddle positions.
Because applications of the straddle rules may affect the character of
gains or losses, defer losses and/or accelerate the recognition of gains or
losses from the affected straddle positions, the amount which must be
distributed to the shareholders, and which will be taxed to shareholders as
ordinary income or long-term capital gain, may be increased or decreased
substantially as compared to a fund that did not engage in such hedging
transactions.
The 30% limit on gains from the disposition of certain options,
futures, and forward contracts held less than three months and the qualifying
income and diversification requirements applicable to the Portfolios' and the
Funds' assets may limit the extent to which the Funds will be able to engage in
transactions in options, futures contracts or forward contracts.
SECTION 988 GAINS AND LOSSES. Under the Code, gains or losses
attributable to fluctuations in exchange rates which occur between the time a
Fund accrues interest or other receivables or accrues expenses or other
liabilities denominated in a foreign currency and the time the Fund actually
collects such receivables or pays such liabilities generally are treated as
ordinary income or loss. Similarly, gains or losses on disposition of debt
securities denominated in a foreign currency and on disposition of certain
futures attributable to fluctuations in the value of the foreign currency
between the date of disposition also are treated as ordinary gain or loss.
These gains and losses, referred to under the Code as "section 988" gains or
losses, may increase or decrease the amount of the Portfolio's investment
company taxable income to be distributed to the shareholders.
SWAPS. No definitive guidance currently exists with respect to the
classification of interest rate swaps and cross-currency swaps as securities or
foreign currencies for purposes of certain of the tests described above.
Accordingly, to avoid the possibility of disqualification as a regulated
investment company, each Fund will limit its positions in swaps to transactions
for the purpose of hedging against interest rate or currency fluctuation risks,
and will treat swaps as excluded assets for purposes of determining compliance
with the diversification test.
FOREIGN TAX. Income received by a Fund from sources within foreign
countries may be subject to withholding and other taxes imposed by such
countries. Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. In addition, the Investment Adviser intends to manage the
Funds with the intention of minimizing foreign taxation in cases where it is
deemed prudent to do so. If more than 50% of the value of a Fund's total assets
at the close of its taxable year consists of securities of foreign corporations,
the Fund will be eligible to elect to "pass-through" to the Portfolio's
shareholders the amount of foreign income and similar taxes paid by the Fund.
Each shareholder will be notified within 60 days after the
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close of the Portfolio's taxable year whether the foreign taxes paid by the Fund
will be "pass-through" for that year.
Generally, a credit for foreign taxes is subject to the limitation
that it may not exceed the shareholder's U.S. tax attributable to his or her
total foreign source taxable income. For this purpose, if the pass-through
election is made, the source of the Fund's income will flow through to
shareholders of the Portfolio. With respect to such election, gains from the
sale of securities will be treated as derived from U.S. sources and certain
currency fluctuation gains, including fluctuation gains from foreign currency
denominated debt securities, receivables and payables will be treated as
ordinary income derived from U.S. sources. The limitation on the foreign tax
credit is applied separately to foreign source passive income, and to certain
other types of income. Shareholders may be unable to claim a credit for the
full amount of their proportion at share of the foreign taxes paid by the Fund.
The foreign tax credit is modified for purposes of the federal alternative
minimum tax and can be used to offset only 90% of the alternative minimum tax
imposed on corporations and individuals and foreign taxes generally are not
deductible in computing alternative minimum taxable income.
SHORT SALES. Generally, capital gain or loss realized by a Fund in
a short sale may be long-term or short-term depending on the holding period
of the short position. Under a special rule, however, the capital gain will
be short-term gain if (1) as of the date of the short sale, the fund owned
property for the short-term holding period that was substantially identical
to that which the Fund used to close the sale or (2) after the short sale and
on or before its closing, the Fund acquired substantially similar property.
Similarly, if property substantially identical to that sold short was held by
the Fund for the long-term holding period as of the date of the short sale,
any loss on closing the short position will be long-term capital loss. These
special rules do not apply to substantially similar property to the extent
such property exceeds the property used by the Fund to close its short
position.
ORIGINAL ISSUE DISCOUNT. Some of the debt securities (with a fixed
maturity date of more than one year from the date of issuance) that may be
acquired by the Funds may be treated as debt securities that are issued
originally at a discount. Generally, the amount of the original issue discount
("OID") is treated as interest income and is included in income over the term of
the debt security, even though payment of that amount is not received until a
later time, usually when the debt security matures. A portion of the OID
includable in income with respect to certain high-yield corporation debt
securities may be treated as a dividend for federal income tax purposes.
Some of the debt securities (with a fixed maturity date of more than
one year from the date of issuance) that may be acquired by the Funds in the
secondary market may be treated as having market discount. Generally, any gain
recognized on the disposition of, and any partial payment of principal on, a
debt security having market discount is treated as ordinary income to the extent
the gain, or principal payment, does not exceed the "accrued market discount" on
such debt security. Market discount generally accrues in equal daily
installments. The Funds may make one or more of the elections applicable to
debt securities having market discount, which could affect the character and
timing the recognition of income.
Some of the debt securities (with a fixed maturity date of one year or
less from the date of issuance) that may be acquired by the Funds may be treated
as having an acquisition discount, or OID in the case of certain types of debt
securities. Generally, a Fund will be required to include the acquisition
discount, or OID, in income over the term of the debt security, even though
payment of that amount is not received until a later time, usually when the debt
security matures. The Fund may make one or more of the elections applicable to
the debt securities having acquisition discount, or OID, which could affect the
character and timing of recognition of income.
The Portfolios generally will be required to distribute dividends to
shareholders representing discount on debt securities that is currently
includable in income, even though cash representing such income may not have
been received by the Funds. Cash to pay such dividends may be obtained from
sales proceeds of securities held by the Funds.
OTHER TAX INFORMATION
The Portfolios may be required to withhold for U.S. federal income
taxes 31% of all taxable distributions payable to shareholders who fail to
provide the Portfolios with their correct taxpayer identification number or to
make required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. Corporate shareholders and
certain other shareholders specified in the
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Code generally are exempt from such backup withholding. Backup withholding is
not an additional tax. Any amounts withheld may be credited against the
shareholder's U.S. federal tax liability.
The Trust may also be subject to state or local taxes in certain other
states where it is deemed to be doing business. Further, in those states which
have income tax laws, the tax treatment of the Trust and of shareholders of a
Portfolio with respect to distributions by the Portfolio may differ from federal
tax treatment. Distributions to shareholders may be subject to additional state
and local taxes. Shareholders should consult their own tax advisers regarding
specific questions as to federal, state or local taxes.
PERFORMANCE INFORMATION
The Trust may from time to time advertise total returns and yields for
the Portfolios, compare Portfolio performance to various indices, and publish
rankings of the Portfolios prepared by various ranking services. Any
performance information should be considered in light of the Portfolio's and
Fund's investment objectives and policies, characteristics and quality of the
its portfolio, and the market conditions during the given time period, and
should not be considered to be representative of what may be achieved in the
future.
TOTAL RETURN
The total return for a Portfolio is computed by assuming a
hypothetical initial payment of $1,000. It is assumed that all investments are
made at net asset value (as opposed to market price) and that all of the
dividends and distributions by the Portfolio over the relevant time periods are
invested at net asset value. It is then assumed that, at the end of each
period, the entire amount is redeemed without regard to any redemption fees or
costs. The average annual total return is then determined by calculating the
annual rate required for the initial payment to grow to the amount which would
have been received upon redemption. Total return does not take into account any
federal or state income taxes.
Total return is computed according to the following formula:
n
P(1 + T) = ERV
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value at the end of the period (or fractional
portion thereof) of a hypothetical $1,000 payment made at the
beginning of the period.
YIELD
The yield for a Portfolio (other than the Money Market Portfolios) is
calculated based on a 30-day or one-month period, according to the following
formula:
6
Yield = 2[{a - b + 1) -1]
-----
{c x d }
For purposes of this formula, "a" is total dividends and interest
earned during the period; "b" is total expenses accrued for the period (net of
reimbursements); "c" is the average daily number of shares
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outstanding during the period that were entitled to receive dividends; and "d"
is the maximum offering price per share on the last day of the period.
COMPARISON TO INDICES AND RANKINGS
Performance information for a Portfolio may be compared to various
unmanaged indices, such as: the Lehman Brothers Government/Corporate Bond Index,
the Lehman Brothers Aggregate Bond Index, and the Salomon Brothers Broad Index
(for the Fully Discretionary Portfolio); the Merrill Lynch 1 to 3-Year Treasury
Index (for the Short-Intermediate Portfolio); and indices prepared by Lipper
Analytical Services. Unmanaged indices (I.E., other than Lipper) generally do
not reflect deductions for administrative and management costs and expenses.
Performance rankings are prepared by a number of mutual fund ranking
entities that are independent of the Trust and its affiliates. These entities
categorize and rank funds by various criteria, including fund type, performance
over a given period of years, total return, standardized yield, variations in
sales charges and risk\reward considerations.
CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT,
INDEPENDENT ACCOUNTANTS AND LEGAL COUNSEL
PNC Bank, Airport Business Center, International Court 2, 200 Stevens
Drive, Lester, Pennsylvania 19113, serves as Custodian for the portfolio
securities and cash of the Portfolios and Funds and in that capacity maintains
certain financial and accounting books and records pursuant to agreements with
the Trust and Master Trust. PFPC Inc., 103 Bellevue Parkway, Wilmington,
Delaware, an affiliate of the Custodian, provides additional accounting services
to the Portfolios and Funds.
State Street Bank and Trust Company, 2 Heritage Drive, 7th Floor,
North Quincy, Massachusetts, 02171, serves as the Dividend Disbursing Agent and
as the Transfer Agent for the Portfolios and Funds. The Transfer Agent provides
customary transfer agency services to the Trust, including the handling of
shareholder communications, the processing of shareholder transactions, the
maintenance of shareholder account records, and related functions. The Dividend
Disbursing Agent provides customary dividend disbursing services to the Trust,
including payment of dividends and distributions and related functions.
The following act as sub-transfer agents for the Portfolios:
Financial Data Services, Inc., 4800 Deer Lake Drive, 2nd Floor, Jacksonville,
Florida 32246; and William M. Mercer Plan Participant Services, Inc., 1417 Lake
Cook Road, Deerfield, Illinois 60015.
Ernst & Young, L.L.P., 515 South Flower Street, Los Angeles,
California 90071, serves as the independent accountants for the Trust and Master
Trust, and in that capacity examines the annual financial statements of the
Trust and Master Trust.
Paul, Hastings, Janofsky & Walker, 555 South Flower Street, Los
Angeles, California 90071, is legal counsel for the Trust and Master Trust. It
also acts as legal counsel for the Investment Adviser and Distributor.
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MISCELLANEOUS
SHARES OF BENEFICIAL INTEREST
The Trust is currently comprised of 47 series of shares -- eight A
Portfolios, eight B Portfolios, eight C Portfolios, fourteen Institutional
Portfolios, one Money Market Portfolio and eight Qualified Portfolios.
On any matter submitted to a vote of shareholders of the Trust, all
shares then entitled to vote will be voted by the affected series unless
otherwise required by the Investment Company Act, in which case all shares of
the Trust will be voted in the aggregate. For example, a change in a Portfolio's
fundamental investment policies would be voted upon only by shareholders of that
Portfolio, as would the approval of any advisory or distribution contract for
the Portfolio. However, all shares of the Trust may vote together in the
election or selection of Trustees, principal underwriters and accountants for
the Trust.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Trust shall not be deemed to have been effectively acted
upon unless approved by a majority of the outstanding shares of the series of
the Trust affected by the matter. Under Rule 18f-2, a series is presumed to be
affected by a matter, unless the interests of each series in the matter are
identical or the matter does not affect any interest of such class or series.
Under Rule 18f-2 the approval of an investment advisory agreement or any change
in a fundamental investment policy would be effectively acted upon with respect
to a Portfolio only if approved by a majority of its outstanding shares.
However, the rule also provides that the ratification of independent public
accountants, the approval of principal underwriting contracts and the election
of directors may be effectively acted upon by the shareholders of the Trust
voting without regard to Portfolio.
As used in the Portfolios' Prospectus and in this Statement of
Additional Information, the term "majority," when referring to approvals to
be obtained from shareholders of a Portfolio, means the vote of the lesser of
(i) 67% of the shares of the Portfolio represented at a meeting if the
holders of more than 50% of the outstanding shares of the Portfolio are
present in person or by proxy, or (ii) more than 50% of the outstanding
shares of the Portfolio. The term "majority," when referring to the approvals
to be obtained from shareholders of the Trust, means the vote of the lesser
of (i) 67% of the Trust's shares represented at a meeting if the holders of
more than 50% of the Trust's outstanding shares are present in person or by
proxy, or (ii) more than 50% of the Trust's outstanding shares. Shareholders
are entitled to one vote for each full share held and fractional votes for
fractional shares held. Unless otherwise provided by law (for example, by
Rule 18f-2 discussed above) or by the Trust's Declaration of Trust or Bylaws,
the Trust may take or authorize any action upon the favorable vote of the
holders of more than 50% of the outstanding shares of the Trust.
Whenever a Portfolio or the Trust is requested to vote on a matter
with respect to the Master Trust, the Trust will hold a meeting of its
shareholders and will cast its votes as instructed by such shareholders and, in
the case of a matter affecting only a Fund, as instructed by the shareholders of
the corresponding Portfolio(s).
The Trust will dispense with annual meetings of shareholders in any
year in which it is not required to elect Trustees under the Investment Company
Act. However, the Trust undertakes to hold a special meeting of its
shareholders for the purpose of voting on the question of removal of a Trustee
or Trustees if requested in writing by the holders of at least 10% of the
Trust's outstanding voting securities, and to assist in communicating with other
shareholders as required by Section 16(c) of the Investment Company Act.
Each share of a Portfolio represents an equal proportional interest in
the Portfolio with each other share and is entitled to such dividends and
distributions out of the income earned on the assets belonging to
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the Portfolio as are declared in the discretion of the Trustees. In the event
of the liquidation or dissolution of the Trust, shareholders of a Portfolio are
entitled to receive the assets attributable to the Portfolio that are available
for distribution, and a distribution of any general assets not attributable to a
particular Portfolio that are available for distribution in such manner and on
such basis as the Trustees in their sole discretion may determine.
Shareholders are not entitled to any preemptive rights. All shares,
when issued, will be fully paid and nonassessable by the Trust.
DECLARATIONS OF TRUST
In accordance with Delaware law and in connection with the tax
treatment sought by the Master Trust, the Master Trust's Declaration of Trust
provides that its investors will be personally and jointly and severally
responsible (with rights of contribution INTER SE in proportion to their
respective ownership interests in the Master Trust) for the Master Trust's
liabilities and obligations in the event that the Master Trust fails to satisfy
such liabilities and obligations. However, to the extent assets are available
from the Master Trust, the Master Trust will indemnify each investor from any
claim or liability to which the investor may become subject solely by reason of
his or her having been an investor, and will reimburse the investor for all
legal and other expenses reasonably incurred by him or her in connection with
any such claim or liability.
The Declarations of Trust of both the Trust and Master Trust provide
that obligations of the Trust and the Master Trust are not binding upon their
respective Trustees, officers, employees and agents individually and that the
Trustees, officers, employees and agents will not be liable to the trusts or
their respective investors for any action or failure to act, but nothing in the
Declarations of Trust protect a Trustee, officer, employee or agent against any
liability to the trusts or their respective investors to which the Trustee,
officer, employee or agent would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence, or reckless disregard of his or her
duties. The Declarations of Trust also provide that the debts, liabilities,
obligations and expenses incurred, contracted for or existing with respect to a
designated Portfolio or Fund shall be enforceable against the assets and
property of such Portfolio or Fund only (and, in the case of a Fund, its
investors), and not against the assets or property of any other Portfolio or
Fund (or in the case of a Portfolio, the investors therein).
REGISTRATION STATEMENT
The Registration Statement of the Trust and the Master Trust,
including the Portfolios' Prospectuses, the Statements of Additional Information
and the exhibits filed therewith, may be examined at the office of the
Commission in Washington, D.C. Statements contained in the Portfolios'
Prospectuses or the Statements of Additional Information as to the contents of
any contract or other document referred to herein or in the Prospectuses are not
necessarily complete, and, in each instance, reference is made to the copy of
such contract or other document filed as an exhibit to these Registration
Statements, each such statement being qualified in all respects by such
reference.
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APPENDIX A
DESCRIPTION OF SECURITIES RATINGS
The following paragraphs summarize the descriptions for the rating symbols
of securities.
COMMERCIAL PAPER
The following paragraphs summarize the description for the rating
symbols of commercial paper.
MOODY'S INVESTORS SERVICE, INC.
Moody's short-term debt ratings, which are also applicable to
commercial paper investments permitted to be made by the Master Trust, are
opinions of the ability of issuers to repay punctually their senior debt
obligations which have an original maturity not exceeding one year. Moody's
employs the following designations, all judged to be investment grade, to
indicate the relative repayment capacity of rated issuers:
PRIME 1: Issuers (or related supporting institutions) rated PRIME-1
have a superior ability for repayment of short-term promissory obligations.
PRIME-1 repayment ability will often be evidenced by the following
characteristics: (A) leading market positions in well-established industries;
(B) high rates of return on funds employed; (C) conservative capitalization
structures with moderate reliance on debt and ample asset protection; (D) broad
margins in earnings coverage of fixed financial charges and high internal cash
generation; and (E) well-established access to a range of financial markets and
assured sources of alternate liquidity.
PRIME-2: Issuers rated PRIME-2 (or related supporting institutions)
have a strong ability for repayment of senior short-term debt obligations. This
will normally be evidenced by many of the characteristics cited above in the
PRIME-1 category but to a lesser degree. Earning 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 rated PRIME-3 (or related supporting institutions)
have an acceptable ability for repayment of short-term debt 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.
STANDARD & POOR'S CORPORATION
Standard & Poor's ratings are a current assessment of the likelihood
of timely payment of debt having an original maturity of no more than 365 days.
The ratings are based on current information furnished to Standard & Poor's by
the issuer and obtained by Standard & Poor's from other sources it considers
reliable. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. Issues within the "A"
category are delineated with the numbers 1, 2, and 3 to indicate the relative
degree of safety, as follows:
A-1
<PAGE>
A-1: This designation indicates the degree of safety regarding timely
payment is overwhelming or very strong. Those issuers determined to possess
overwhelming safety characteristics are denoted with a "PLUS" (+) designation.
A-2: Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as overwhelming as for
issues designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity
for timely payment. They are, however, more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher designations.
B: Issues rated "B" are regarded as having only an adequate capacity
for timely payment. However, such capacity may be damaged by changing
conditions or short-term adversities.
C: Issues rated "C" are regarded as having a doubtful capacity for
payment.
FITCH INVESTORS SERVICE, INC.
F-1+: Exceptionally strong credit quality. Commercial paper assigned
this rating is regarded as having the strongest degree of assurance for timely
payment.
F-1: Very strong credit quality. Issues assigned this rating reflect
an assurance of timely payment only slightly less in degree than issues rated
F-1+.
F-2: Good credit quality. Commercial paper assigned this rating has
a satisfactory degree of assurance for timely payment but the margin of safety
is not as great as for issuers assigned F-1+ and F-1 ratings.
F-3: Fair credit quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely payment is
adequate, however, near term adverse changes could cause these securities to be
rated below investment grade.
DUFF & PHELPS
The three rating categories of Duff & Phelps for investment grade
commercial paper are "Duff 1," "Duff 2" and "Duff 3." Duff & Phelps employs
three designations, "Duff 1+," Duff 1" and "Duff 1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
DUFF 1+ - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
DUFF 1 - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
DUFF 1- - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
A-2
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DUFF 2 - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
DUFF 3 - Debt possesses satisfactory liquidity, and other protection
factors qualify issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
DUFF 4 - Debt possesses speculative investment characteristics.
DUFF 5 - Issuer has failed to meet scheduled principal and/or interest
payments.
THOMSON BANKWATCH
Thomson BankWatch commercial paper ratings assess the likelihood of an
untimely payment of principal or interest of debt having a maturity of one year
or less which is issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the ratings used by Thomson BankWatch:
TBW-1 - This designation represents Thomson BankWatch's highest rating
category and indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
TBW-2 - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
TBW-3 - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
IBCA
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
A1+ - Obligations are supported by the highest capacity for timely
repayment.
A1 - Obligations are supported by a strong capacity for timely
repayment.
A2 - Obligations are supported by a satisfactory capacity for timely
repayment, although such capacity may be susceptible to adverse changes in
business, economic, or financial conditions.
A3 - Obligations are supported by an adequate capacity for timely
repayment. Such capacity is more susceptible to adverse changes in business,
economic, or financial conditions than for obligations in higher categories.
DUFF & PHELPS
A-3
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The following summarizes the ratings used by Duff & Phelps for
corporate and municipal long-term debt:
AAA - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
AA - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
A - Debt possesses protection factors which are average but adequate.
However, risk factors are more variable and greater in periods of economic
stress.
BBB - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
BB, B, CCC, DD, AND DP - Debt that possesses one of these ratings is
considered to be below investment grade. Although below investment grade, debt
rated "BB" is deemed likely to meet obligations when due. Debt rated "B"
possesses the risk that obligations will not be met when due. Debt rated "CCC"
is well below investment grade and has considerable uncertainty as to timely
payment of principal, interest or preferred dividends. Debt rated "DD" is a
defaulted debt obligation, and the rating "DP" represents preferred stock with
dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
FITCH INVESTORS SERVICE, INC.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
AAA - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F-1+."
A - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
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BB, B, CCC, CC, C, DDD, DD, AND D - Bonds that possess one of these
ratings are considered by Fitch to be speculative investments. The ratings "BB"
to "C" represent Fitch's assessment of the likelihood of timely payment of
principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
ICBA
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
AAA - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk significantly.
AA - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
A - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may lead
to increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
BB, B, CCC, CC, AND C - Obligations are assigned one of these ratings
where it is considered that speculative characteristics are present. "BB"
represents the lowest degree of speculation and indicates a possibility of
investment risk developing. "C" represents the highest degree of speculation
and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within major rating categories.
THOMSON BANKWATCH
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
AAA - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
A-5
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AA - This designation indicates a superior ability to repay principal
and interest on a timely basis with limited incremental risk versus issues rated
in the highest category.
A - This designation indicates that the ability to repay principal and
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
BBB - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
BB, B, CCC, AND CC, - These designations are assigned by Thomson
BankWatch to non-investment grade long-term debt. Such issues are regarded as
having speculative characteristics regarding the likelihood of timely payment of
principal and interest. "BB" indicates the lowest degree of speculation and
"CC" the highest degree of speculation.
D - This designation indicates that the long-term debt is in default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
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