<PAGE>
NICHOLAS--APPLEGATE-REGISTERED TRADEMARK-MUTUAL FUNDS
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INSTITUTIONAL INCOME PORTFOLIOS
PROSPECTUS
Nicholas-Applegate Mutual Funds is an open-end management investment company
comprised of a number of diversified investment portfolios, including the two
portfolios ("Portfolios") offered hereby. The Portfolios are generally offered
to institutional investors, high net worth individuals and participants in
certain mutual fund asset allocation programs.
Each Portfolio, unlike many other investment companies which directly acquire
and manage their own portfolios of securities, seeks to achieve its investment
objective by investing all of its assets in a corresponding series ("Fund") of
Nicholas-Applegate Investment Trust, which has the same objective as the
Portfolio. The Funds in turn invest their assets, including those of the
Portfolios, in portfolio securities. Accordingly, the investment experience of
each Portfolio will correspond directly with the investment experience of the
related Fund. Investors should carefully consider this investment approach. See
"Investment Objectives, Policies and Risk Considerations-- Special
Considerations Regarding Master/Feeder Structure," page 7, for additional
information regarding this unique structure. There can be no assurance that any
Portfolio or Fund will achieve its investment objective.
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High Yield Bond Institutional Portfolio seeks a high level of income and capital
growth. It invests in the Nicholas-Applegate High Yield Bond Fund, which invests
primarily in debt and equity securities, with an emphasis on lower quality debt
securities.
Strategic Income Institutional Portfolio seeks a high level of current income.
It invests in the Nicholas-Applegate Strategic Income Fund, which invests
primarily in convertible, lower quality and mortgage-backed debt securities.
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The Portfolios are designed for investors willing to assume additional risk
in return for seeking high return. Investors should carefully consider the risks
prior to investing.
THE ASSETS OF THE FUNDS MAY BE INVESTED WITHOUT LIMITATION IN DEBT SECURITIES
RATED BELOW INVESTMENT GRADE, SOMETIMES CALLED "JUNK BONDS," WHICH ARE
SPECULATIVE AND INVOLVE GREATER RISKS, INCLUDING RISK OF DEFAULT, THAN
HIGHER-RATED SECURITIES. SEE "APPENDIX: CORPORATE BOND RATINGS."
In addition, the Strategic Income Fund may borrow up to 33 1/3% of the value
of its total assets to buy securities, a speculative technique know as
"leverage" which subjects the Fund to greater risks than Funds that do not
borrow. See "Investment Objectives, Policies and Risk Considerations," page 7.
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Shares of the Portfolios and interests in the Funds are not bank deposits and
are not federally insured by, guaranteed by, obligations of or otherwise
supported by the U.S. Government, the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any other governmental agency. Investment in a
Portfolio involves investment risk, including possible loss of the principal
amount invested.
This Prospectus presents information you should know before investing in any
of the Portfolios. It should be retained for future reference. A Statement of
Additional Information for the Portfolios dated July 17, 1996 has been filed
with the Securities and Exchange Commission and is incorporated by reference
into this Prospectus. The Statement may be obtained, without charge, by writing
to the Trust, P.O. Box 82169, San Diego, California 92138-2169, or by calling
(800) 551-8643. Inquiries regarding any of the Portfolios can also be made by
calling (800) 551-8643.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
July 17, 1996
<PAGE>
NICHOLAS--APPLEGATE MUTUAL FUNDS
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INSTITUTIONAL INCOME PORTFOLIOS
High Yield Bond Institutional Portfolio
Strategic Income Institutional Portfolio
Table of Contents
Summary of Expenses................................................ 3
Prospectus Summary................................................. 4
Investment Objectives, Policies and Risk Considerations............ 7
Organization and Management........................................13
Purchasing Shares..................................................15
Investor Services..................................................17
Redeeming Shares...................................................19
Dividends, Distributions and Taxes.................................20
General Information................................................21
Appendix:
Investment Policies, Strategies
and Risks.......................................................23
Corporate Bond Ratings...........................................40
Prior Performance of Investment
Adviser.........................................................42
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No dealer, sales representative or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Prospectus, in connection with the offer contained herein, and, if given
or made, such other information or representations must not be relied upon as
having been authorized by the Portfolios or the Distributor. This Prospectus
does not constitute an offer by the Portfolios or the Distributor to sell or a
solicitation of any offer to buy any of the securities offered hereby in any
jurisdiction to any person to whom it is unlawful to make such offer in such
jurisdiction.
2
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SUMMARY OF EXPENSES
This table is designed to help you understand the costs of investing in each of
the Portfolios. These are based on the estimated expenses of each Portfolio for
its first year of operations, and because each Portfolio invests all of its
assets in a corresponding Fund, each Portfolio's expenses include its
proportionate share of the operating expenses of the corresponding Fund. Actual
expenses may be more or less than those shown.
<TABLE>
<CAPTION>
STRATEGIC
HIGH YIELD INCOME
BOND PORTFOLIO PORTFOLIO
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<S> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum sales charge on purchases (as a percentage
of offering price) None None
Sales charge on reinvested dividends None None
Deferred sales charge (as a percentage of original
purchase price or redemption proceeds, whichever
is lower) None None
Redemption fee None None
Exchange fee None None
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ANNUAL PORTFOLIO OPERATING EXPENSES AS A
PERCENTAGE OF AVERAGE NET ASSETS:
(after expense deferral)(1)
Management fees 0.60% 0.60%
All other expenses (after expense deferral)(1) 0.15% 0.15%
Total operating expenses (after expense
deferral)(1) 0.75% 0.75%
</TABLE>
The Board of Trustees of the Trust believes that the aggregate per share
expenses of each Portfolio are no greater than the expenses that the Portfolio
would incur if it retained the services of an investment adviser and the assets
of the Portfolio were invested directly in the types of securities held by the
corresponding Fund. For a detailed description of the expenses of the Portfolios
and the Funds in which they invest, see "Organization and Management."
- ---------------------------
(1)
The Investment Adviser of the Master Trust has agreed to waive or defer its
management fees payable by the Funds, and to absorb other operating expenses
payable by the Funds and the Portfolios, to ensure that the expenses for each
Portfolio (other than interest, taxes, brokerage commissions and other
portfolio transaction expenses, capital expenditures and extraordinary
expenses) will not exceed the following respective percentage of such
Portfolio's average net assets on an annual basis: High Yield Bond-0.75%;
Strategic Income-0.75%. In subsequent years, overall operating expenses for
each Portfolio will not fall below the applicable percentage limitation until
the Investment Adviser has fully recouped fees deferred or expenses paid by the
Investment Adviser under this agreement, as each Portfolio will reimburse the
Investment Adviser when operating expenses (before recoupment) for the
Portfolio are less than the applicable percentage limitation set forth above.
Accordingly, until all such deferred fees or expenses have been recouped by the
Investment Adviser, the Portfolio's expenses will be higher, and their yields
will be lower, than would otherwise be the case. See "Organization and
Management--Expense Limitation." Actual operating expenses for the Portfolios
for the fiscal year ended March 31, 1997 are estimated to be the following
respective percentages of such Portfolios' average net assets (annualized):
High Yield Bond-1.70%; Strategic Income-1.70%. The various operating expenses
of the Portfolios are further described under "Organization and Management."
Example of Portfolio Expenses. The following table illustrates the expenses that
an investor would pay on a hypothetical $1,000 investment in each of the
Portfolios over various time periods, assuming (1) a 5% annual return and (2)
redemption at the end of each time period. The Portfolios charge no redemption
fees.
<TABLE>
<CAPTION>
1 Year 3 Years
<S> <C> <C>
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High Yield Bond Portfolio $ 8 $ 24
Strategic Income Portfolio $ 8 $ 24
</TABLE>
This Example assumes that all dividends and other distributions are reinvested
and that the percentage amounts listed under the heading "Annual Portfolio
Operating Expenses" in the fee table above remain the same in the years shown.
The Example should not be considered a representation of past or future
expenses, and a Portfolio's actual expenses may be more or less than those
shown. The hypothetical 5% annual return is used for illustrative purposes only
and should not be interpreted as an estimate of a Portfolio's annual return, as
there can be no guarantee of a Portfolio's future performance.
3
<PAGE>
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PROSPECTUS SUMMARY
Nicholas-Applegate Mutual Funds (the "Trust") is an open-end management
investment company comprised of a number of diversified investment portfolios,
including the two Institutional Portfolios ("Portfolios") offered hereby. The
Portfolios are generally offered to institutional investors, high net worth
individuals and participants in certain mutual fund asset allocation programs.
Investment Objectives. The investment objectives of the Portfolios are described
on the front cover of this Prospectus. There can be no assurance that either
Portfolio will achieve its investment objectives. See "Investment Objectives,
Policies and Risk Considerations" and "Appendix: Investment Policies, Strategies
and Risks."
Master/Feeder Structure. The Portfolios seek to achieve their respective
investment objectives by investing all of their assets in corresponding series
("Funds") of Nicholas-Applegate Investment Trust (the "Master Trust"), a
diversified, open-end management investment company. The Funds have the same
investment objectives as the Portfolios which invest in them. The Funds, in
turn, hold investment securities. Although the "master/feeder" structure
employed by the Portfolios to achieve their investment objectives could provide
certain efficiencies and economies of scale, it could also have potential
adverse effects such as those resulting from large-scale redemptions by other
investors of their interests in the Funds, or from the failure by investors of a
Portfolio to approve a change in investment objectives and policies that has
been approved by the investors of the corresponding Fund. There may also be
other investment companies through which you can invest in the Funds which may
have higher or lower fees and expenses than those of the Portfolios. See
"Investment Objectives, Policies and Risk Considerations-Special Considerations
Regarding Master/Feeder Structure."
A Portfolio may cease investing in a corresponding Fund only if the Trust's
Board of Trustees determines that this is in the best interests of the Portfolio
and its investors, and only with the approval of the Portfolio's investors. In
such event the Board of Trustees would consider alternative arrangements such as
investing all of the Portfolio's assets in another investment company with the
same investment objective as the Portfolio or hiring an investment adviser to
manage the Portfolio's assets in accordance with the Portfolio's investment
policies. No assurance exists that satisfactory alternative arrangements would
be available.
Investment Risks and Considerations. Investment risks and other considerations
relevant to the securities in which the Portfolios invest through corresponding
Funds are described under "Investment Objectives, Policies and Risk
Considerations" and in the Appendix-Investment Policies, Strategies and Risks.
The Portfolios may be appropriate for long-term aggressive investors who
understand the potential risks and rewards of the securities in which the Funds
invest. To achieve these potential rewards, investors must be willing to accept
the Portfolios' greater price movements and risks. These risks include the
following:
Yields on debt obligations depend on a variety of factors, including the general
conditions of the money and bond markets, the size of a particular offering, the
maturity of the obligation, and the rating of the issue. Debt obligations with
longer maturities tend to produce higher yields and are generally subject to
potentially greater capital appreciation and depreciation than obligations with
shorter maturities and lower yields. The market prices of debt obligations vary
depending on 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.
4
<PAGE>
The ability of a Fund to achieve its investment objective also depends on the
continuing ability of the issuers of the debt securities in which it invests to
meet their obligations for the payment of interest and principal when due. Each
of the Funds is permitted to invest without limitation in convertible and debt
securities rated below investment grade, or in comparable unrated securities.
Such securities, commonly referred to as "junk bonds," are speculative and
subject to greater market fluctuations and risk of loss of income and principal
than higher rated bonds. In addition, each Fund may invest in equity securities
of such companies. As a result, the Portfolios' share prices may be volatile.
See "Appendix: Investment Policies, Strategies and Risks" and "Corporate Bond
Ratings" for a description of these securities and ratings.
The Strategic Income Fund may borrow up to 33 1/3% of the value of its total
assets from banks to buy securities. This speculative investment technique,
known as "leverage," may subject the Fund to various risks, including the
possibility that the Portfolio's net asset value per share will fluctuate more
than the net asset value of funds which do not borrow.
Each of the Funds is permitted to invest up to 50% of its net assets in zero
coupon securities, which may be subject to greater volatility as a result of
changes in prevailing interest rates than other debt securities.
Investments by the Funds in securities of foreign companies and governments
involve special risks in addition to the usual risks inherent in domestic
investments, including political or economic instability in the country of
issue, the possible imposition of exchange controls or other laws or
restrictions and fluctuations of foreign exchange rates. Settlement of
transactions in foreign markets may be delayed or less frequent than in the
U.S., and foreign governments may withhold taxes from dividends and interest
paid on securities held by the Funds. There is also likely to be less publicly
available information about certain foreign issuers than is available about U.S.
companies, and foreign companies are not generally subject to uniform financial
reporting standards comparable to those applicable to U.S. companies. In
addition,
investment in emerging markets involves greater risks than other foreign
investments, including less-developed economic and legal structures; less stable
political systems; illiquid securities markets; possible expropriations,
nationalization or confiscatory taxation; and possible foreign currency
devaluations and fluctuations.
Each of the Funds may purchase or write put and call options with respect to
debt securities, currencies and broadly-based indexes; effect transactions in
financial and currency futures contracts, and options on futures contracts;
enter into swap transactions; and engage in currency hedging transactions.
Although the Funds will generally enter into such transactions for hedging
purposes, the Strategic Income Fund may also enter into such transactions to
enhance potential gain; however, the Fund's net loss exposure resulting from
non-hedging transactions will not exceed 5% of its net assets at any time. These
are derivative instruments, whose value derives from the value of an underlying
security or index. Risks associated with the use of such instruments include the
possibility that the Investment Adviser's forecasts of interest rates, currency
rates of exchange and other factors are not correct; imperfect correlation
between the Fund's hedging technique and the asset or liability being hedged;
default by the other party to the transaction; and inability to close out a
position because of the lack of a liquid market. Investment in such derivative
instruments may not be successful, and may reduce the returns and increase the
volatility of the Funds. See "Appendix: Investment Policies, Strategies and
Risks" in this Prospectus and "Investment Objectives, Policies and Risks" in the
Statement of Additional Information.
The Funds may invest in equity securities, including common stocks, preferred
stocks, convertible equity securities and warrants, without regard to the size
or market capitalization of
5
<PAGE>
the companies issuing such securities. Although equity securities have a history
of long-term growth in value, these prices fluctuate based on changes in the
issuer's financial condition and on overall market and economic conditions. The
equity securities of smaller companies in which the Funds may invest are subject
to more volatile market movements than securities of larger, more established
companies because the issuers are typically more subject to changes in earnings
and prospects.
Each Fund may engage in short sales, which theoretically involve unlimited loss
potential and may be considered a speculative technique. See the description of
the risks of short sales under "Short Sales" in "Appendix: Investment Policies,
Strategies and Risks".
Each Fund may invest up to 15% of its net assets in illiquid securities. Each
Fund may enter into repurchase agreements and lend its portfolio securities,
which involve the risk of loss upon the default of the seller or borrower. The
Funds may also enter into reverse repurchase agreements and borrow money from
banks for temporary purposes which, among other things, may require the Funds to
sell portfolio securities to meet interest and principal payments at an
unfavorable time. See "Appendix: Investment Policies, Strategies and Risks."
The Funds commenced operation on the date of this Prospectus and have no
operating history.
Investment Adviser. The Trust has not retained the services of an investment
adviser for the Portfolios, as the Portfolios seek to achieve their investment
objectives by investing all of their assets in corresponding Funds.
Nicholas-Applegate Capital Management (the "Investment Adviser") serves as
investment adviser to the Funds. The Investment Adviser has been in the
investment advisory business since 1984 and currently manages approximately $30
billion of discretionary assets (including more than $12 billion of fixed income
securities) for numerous clients, including employee benefit plans of
corporations, public retirement systems and unions, university endowments,
foundations and other institutional investors, and individuals.
The Investment Adviser is compensated for its services to the Funds in the form
of monthly fees at the following annual rates: for the High Yield Bond Fund,
0.625% of Fund's average net assets; for the Strategic Income Fund, 0.625% of
the Fund's average net assets. See "Organization and Management."
Distributor. Nicholas-Applegate Securities (the "Distributor"), an affiliate of
the Investment Adviser, serves as distributor of shares of the Portfolios. The
Portfolios pay no distribution or other fees to the Distributor in connection
with services it provides.
Administrator, Transfer Agent and Custodian. Investment Company Administration
Corporation (the "Administrator") is the administrator for the Trust, with
responsibility for managing the daily business operations of the Portfolios,
subject to the supervision of the Trust's Board of Trustees. It also acts as
administrator for the Master Trust. PNC Bank (the "Custodian") is the custodian
for the Trust and the Master Trust, and State Street Bank and Trust Company (the
"Transfer Agent") is the transfer and dividend disbursing agent for the Trust.
Purchase of Shares. Shares of the Portfolios are generally offered to
institutional investors, high net worth individuals, and participants in certain
mutual fund asset allocation programs. Purchases may be made by check or by
wiring federal funds to the Transfer Agent. Shares are purchased at the next
offering price without any sales charge, after an order is received in proper
form by the Transfer Agent. The minimum initial investment is $250,000 and the
minimum subsequent investment is $10,000. The minimum initial and subsequent
investments are waived for individual participants of qualified retirement plans
and for certain
6
<PAGE>
others, and may be waived from time to time by the Distributor for other
investors. Shares of a Portfolio may also be purchased with securities which are
otherwise appropriate for investment by the Portfolio. See "Purchasing Shares."
Investor Services. The following services are provided to investors of a
Portfolio for their convenience and flexibility: an automatic investment plan;
automatic reinvestment and cross-reinvestment of dividends and capital gains
distributions; an exchange privilege; and automatic withdrawals. See "Investor
Services." Individual participants of qualified retirement plans should direct
inquiries to their plan sponsor or administrator.
Redeeming Shares. Shares of the Portfolios may be redeemed by writing to the
Transfer Agent or by telephone if telephone redemption privileges have been
established. Redemption proceeds will be wired to your bank. Participants of
qualified retirement plans must make redemption requests to the plan sponsor or
administrator. The price received for Portfolio shares redeemed is at the next
determined net asset value after the request is received by the Transfer Agent,
which may be more or less than the purchase price. No contingent deferred sales
charge or other fee is imposed on redemptions. See "Redeeming Shares."
Dividends, Distributions and Taxes. The Portfolios declare and pay monthly
dividends. The Portfolios make distributions at least annually of any net
capital gains. All dividends and distributions will be paid in the form of
additional shares at net asset value unless cash payment is requested.
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INVESTMENT OBJECTIVES, POLICIES AND RISK CONSIDERATIONS
The investment objectives, policies and risks of each Portfolio are discussed
below and in the "Appendix: Investment Policies, Strategies and Risks".
Special Considerations Regarding Master/Feeder Structure. The Portfolios seek to
achieve their investment objectives by investing all of their assets in
corresponding Funds, which have the same objectives as the Portfolios. The
Funds, in turn, hold investment securities. Accordingly, the investment
experience of each Portfolio will correspond directly with the investment
experience of the related Fund. For a description of the Funds' objectives,
policies, restrictions, management and expenses, see "Investment Objectives,
Policies and Risk Considerations" below, the Appendix and "Organization and
Management." There can be no assurance that any Portfolio or Fund will achieve
its investment objective. Each Portfolio's and Fund's investment objective is a
fundamental policy which may not be changed without the approval of the holders
of a majority of the outstanding shares of the Portfolio or Fund, respectively,
as defined in the Investment Company Act of 1940 (the "Investment Company Act").
Upon any such approval, each Portfolio will provide at least 30 days' written
notice to its investors before any change is made to its or the corresponding
Fund's investment objective.
There are certain risks to the Portfolios related to the use of the
"master/feeder" structure. Such risks include, but are not limited to, the
following: Large-scale redemptions by other investment companies of their
interests in the corresponding Funds, could have adverse effects, such as lack
of portfolio diversity and decreased economies of scale, and could result in the
shareholders of a Portfolio, as the remaining investor in the Fund, bearing all
the operating costs of the Fund and thus experiencing higher pro rata operating
expenses and lower returns than would otherwise be the case. In addition, the
total withdrawal by another investment company as an investor in a Fund will
cause the Fund to terminate automatically in 120 days,
7
<PAGE>
unless the corresponding Portfolio and any other investors in the Fund
unanimously agree to continue the business of the Fund. As the Portfolio is
required to submit such matters to a vote of its shareholders, it will be
required to incur the expenses of shareholder meetings in connection with such
withdrawals. If unanimous agreement is not reached to continue the Fund, the
Board of Trustees of the Trust would need to consider alternative arrangements
for the Portfolio, including investing all of the Portfolio's assets in another
investment company with the same investment objective as the Portfolio or hiring
an investment adviser to manage the Portfolio's assets in accordance with the
investment policies described below and in "Appendix: Investment Policies,
Strategies and Risks." The absence of substantial experience with the
master/feeder structure could result in accounting or other difficulties.
Failure by investors of a Portfolio to approve a change in the investment
objective and policies of a Portfolio parallel to a change that has been
approved by the investors of the corresponding Fund would require the Portfolio
to redeem its shares of the Fund; this could result in a distribution in kind to
the Portfolio of the portfolio securities of the Fund (rather than a cash
distribution), causing the Portfolio to incur brokerage fees or other
transaction costs in converting such securities to cash, reducing the
diversification of the Portfolio's investments and adversely affecting its
liquidity. Other shareholders in the Funds may have a greater ownership interest
in the Funds than the Portfolios' interest, and could thus have effective voting
control over the operation of the Funds.
The Trust's Board of Trustees believes that the Portfolios will achieve certain
efficiencies and economies of scale through the "master/feeder" structure, and
that the aggregate expenses of the Portfolios will be less than if the
Portfolios invested directly in the securities held by the Funds. However, other
investment companies that offer their shares to the public also may invest all
or substantially all of their assets in the Funds. Accordingly, there may be
other investment companies through which investors can invest indirectly in the
Funds. The fees charged by such other investment companies may be higher or
lower than those charged by the Portfolios, which may reflect, among other
things, differences in the nature and level of the services and features offered
by such companies to their investors. Information about the availability of
other investment companies that invest in the Funds can be obtained by calling
(800) 551-8643.
A Portfolio may cease investing in a corresponding Fund only if the Board of
Trustees of the Trust determines that such action is in the best interests of
the Portfolio and its investors, and only with the approval of the Portfolio's
investors. In that event, the Board of Trustees would consider alternative
arrangements, including investing all of the Portfolio's assets in another
investment company with the same investment objective as the Portfolio or hiring
an investment adviser to manage the Portfolio's assets in accordance with the
investment policies described below and in "Appendix: Investment Policies,
Strategies and Risks."
High Yield Bond Portfolio. The High Yield Bond Portfolio seeks a high level of
income and capital growth. It invests all of its assets in the
Nicholas-Applegate High Yield Bond Fund, which has the same investment objective
as the High Yield Bond Portfolio.
The High Yield Bond Fund invests primarily in domestic and foreign debt
instruments, convertible securities, and common and preferred stocks. The Fund
has broad flexibility to invest in instruments of any type or quality, but the
Investment Adviser expects to invest principally in debt instruments and
convertible securities with an emphasis on lower-quality securities. Convertible
securities are bonds, debentures, corporate notes or preferred stocks which pay
interest or dividends and which may be converted into common stock at the option
of the holder.
8
<PAGE>
The High Yield Bond Fund may invest in a broad range of fixed-income securities
denominated in U.S. dollar and foreign currencies, including bonds, notes,
mortgage-backed securities and other real estate-related instruments,
asset-backed securities, and direct debt instruments, issued by U.S. and foreign
corporations or other entities, and sovereign debt securities of U.S. or foreign
governments or their agencies, authorities, instrumentalities or sponsored
enterprises. The Fund may purchase securities that pay interest on a fixed,
variable, floating or deferred basis. Under normal market conditions, at least
65% of the Fund's total assets will be invested in high-yield bonds (i.e., high
yield debt instruments with initial maturities of one year or more). The Fund is
not constrained as to the maximum maturity of its portfolio securities. The High
Yield Bond Fund may invest without limitation in debt securities rated below
investment grade or in unrated securities of comparable quality if the
Investment Adviser believes that the financial condition of the issuer or the
protection afforded to the particular securities is stronger than would
otherwise be indicated by such low ratings or the lack thereof. These debt
securities, commonly referred to as "junk bonds," are speculative and subject to
greater risk of loss of income and principal than higher rated securities, and
may be in default at the time they are purchased by the Fund. As a result, their
market prices tend to fluctuate more than higher-quality securities. The default
rate of lower-quality debt securities is likely to be higher when issuers have
difficulty meeting projected goals or obtaining additional financing, which
could occur during economic recessions or periods of high interest rates. They
may be thinly traded, making them difficult to sell promptly at an acceptable
price. Negative publicity or investor perceptions may make valuing such
securities difficult, and could hurt the Fund's ability to dispose of them. See
"Appendix: Investment Policies, Strategies and Risks" for a description of junk
bonds.
The High Yield Bond Fund may invest a portion of its assets (no more than 35% of
its total assets) in equity securities of U.S. and foreign companies. Such
companies may be in the earlier stages of development, growth companies,
cyclical companies or companies believed to be undergoing a basic change in
operations or markets which, in the opinion of the Investment Adviser, would
result in a significant improvement in earnings. The securities of such
companies may be subject to more volatile market movements than securities of
larger, more established companies. Although the Fund is not restricted in
investments in companies of any particular size, it currently intends to invest
principally in companies with capitalizations of at least $100 million at the
time of purchase. See "Appendix: Investment Policies, Strategies and Risks" for
a discussion of the risks associated with investment in such companies.
The High Yield Bond Fund may invest in securities issued by companies based or
operating in any country, including the United States. The Fund is not driven by
allocation considerations with respect to any particular countries, geographic
regions or economic sectors. The Investment Adviser currently selects its
portfolio securities from an investment universe of approximately 9,000 U.S.
companies and 12,000 foreign issuers in the 20 largest international markets.
Foreign countries in which investment opportunities will be sought include
Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong
Kong, Italy, Japan, Malaysia, the Netherlands, New Zealand, Norway, Singapore,
Spain, Sweden, Switzerland, the United Kingdom and the United States. However,
the Fund may also invest in securities issued by companies based in other
countries such as the countries of Eastern Europe and South America, Indonesia,
Korea, Mexico, the Philippines, Portugal and Thailand. The Fund may also invest
up to 10% of its total assets in closed-end country funds. An investment in such
funds may result in duplication of fees. See "Appendix: Investment Policies,
Strategies and Risks" for a discussion of the risks associated with investment
in foreign securities and emerging market countries.
9
<PAGE>
When investing in foreign securities, the High-Yield Bond Fund intends to invest
principally in foreign securities that are listed on a bona fide securities
exchange or are actively traded in an over-the-counter market (either within or
outside the issuer's domicile country). The Fund will not invest in securities
denominated in a foreign currency unless, at the time of investment, such
currency is considered by the Investment Adviser to be fully exchangeable into
United States dollars without significant legal restriction. The Fund may
purchase securities issued by the government of, or a company located in, one
nation but denominated in the currency of another nation (or in a multinational
currency unit).
The Fund may acquire over-the-counter and illiquid securities, and may utilize
techniques such as when-issued securities and firm commitment agreements,
forward roll transactions, swap transactions, futures contracts, short sales,
securities lending, and borrowing. See "Appendix: Investment Policies,
Strategies and Risks" and the Statement of Additional Information for a
description of the Fund's investment securities and techniques.
The High Yield Bond Fund may adopt a temporary defensive position during adverse
market conditions by investing principally in high quality money market
instruments, including short-term U.S. Government securities, negotiable
certificates of deposit, non-negotiable fixed time deposits, bankers'
acceptances, floating-rate notes and repurchase agreements, and high quality
preferred stocks.
Strategic Income Portfolio. The Strategic Income Portfolio seeks a high level of
current income. It invests all of its assets in the Nicholas-Applegate Strategic
Income Fund, which has the same investment objective as the Strategic Income
Portfolio.
The Strategic Income Fund invests principally in three domestic and foreign
market sectors: convertible securities; lower-rated, high yield debt securities;
and mortgage-backed securities, including collateralized mortgage obligations.
Under normal market conditions, the Fund will invest in each of these three
sectors, but from time to time the Investment Adviser will adjust the amounts
the Fund invests in each sector. By investing in all three sectors, the Fund
seeks to reduce the volatility of fluctuations in its net asset value per share,
because the overall securities price and interest rate movements in each of the
sectors are not necessarily correlated with each other. Changes in one sector
may be offset by changes in another sector that moves in a different direction.
However, the Fund may invest up to 100% of its assets in any one sector if the
Investment Adviser believes that in doing so the Fund can achieve its objective
without undue risk.
The Strategic Income Fund may invest in a broad range of fixed-income
securities, including bonds, notes, and mortgage-backed securities, asset-backed
securities, and direct debt instruments, issued by domestic and foreign
corporations and other entities, and sovereign debt securities of U.S. and
foreign governments or their agencies, authorities, instrumentalities or
sponsored enterprises. The Fund may purchase securities that pay interest on a
fixed, variable, or floating basis. The Fund will acquire listed or actively
traded securities of foreign issuers which are denominated in foreign currencies
considered to fully exchangeable into U.S. dollars, in the same manner as
described above for the High Yield Bond Fund. The average maturity of the Fund's
portfolio will be adjusted as the Investment Adviser determines market
conditions warrant. The Fund is not constrained as to the maturity of its
individual portfolio securities or its overall portfolio.
The Strategic Income Fund may invest without limitation in debt securities rated
below investment grade or in unrated securities of comparable quality if the
Investment Adviser believes that the financial condition of the issuer or the
protection afforded to the particular
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securities is stronger than would otherwise be indicated by such low ratings or
the lack thereof. These debt securities, commonly referred to as "junk bonds,"
are speculative and subject to greater risk of loss of income and principal than
higher rated securities, and may be in default at the time they are purchased by
the Fund. See "High Yield Bond Fund" above and "Appendix: Investment Policies,
Strategies and Risks" for a description of junk bonds.
Under normal market conditions, at least 65% of the Fund's total assets will be
invested in the income producing securities described above. The Strategic
Income Fund may also invest a portion of its assets (no more than 35% of its
total assets) in equity securities of U.S. and foreign companies. See "High
Yield Bond Fund" above and "Appendix: Investment Policies, Strategies and Risks"
for a description of such securities.
The Strategic Income Fund may acquire over-the-counter and illiquid securities,
and may utilize techniques such as when-issued securities and firm commitment
agreements, forward roll transactions, put and call options on securities, swap
transactions, futures contracts and options, securities lending, and borrowing.
See "Appendix: Investment Policies, Strategies and Risks" and the Statement of
Additional Information for a description of the Fund's investment securities and
techniques.
The Strategic Income Fund may adopt a temporary defensive position during
adverse market conditions by investing principally in high quality money market
instruments, including short-term U.S. Government securities, negotiable
certificates of deposit, non-negotiable fixed time deposits, bankers'
acceptances, floating-rate notes and repurchase agreements.
Investment Techniques and Processes. The decision to invest assets of a Fund in
any particular debt security will be based on such factors as the Investment
Adviser's analysis of the effect of the yield to maturity of the security on the
average yield to maturity of the total debt security portfolio of the Fund, the
Investment Adviser's assessment of the credit quality of the issuer and other
factors the Investment Adviser deems relevant. In order to achieve the Fund's
investment objectives, the Investment Adviser will seek to add value by moving
portfolio investments among market sectors (e.g., U.S. Treasury securities,
corporate securities and mortgage-backed securities), positioning investments in
the most attractive maturities along the yield curve, selecting undervalued
investments in order to take advantage of lower prices and higher yields, and
varying the average maturity of the Fund's portfolio to reflect interest rate
forecasts. There can be no assurance that use of these techniques will be
successful.
The focus of the Investment Adviser's equity investment program is growth over
time-Registered Trademark-. In making decisions with respect to equity
securities for the Funds, the Investment Adviser uses a proprietary investment
methodology which is designed to capture positive change at an early stage. It
adheres rigorously to this methodology, and applies it to various segments of
the capital markets, domestically and internationally. This methodology consists
of investment techniques and processes designed to identify companies with
attractive earnings and dividend growth potential and to evaluate their
investment prospects. These techniques and processes include relationships with
an extensive network of brokerage and research firms located throughout the
world; computer-assisted fundamental analysis of thousands of domestic and
foreign companies; established criteria for the purchase and sale of individual
securities; portfolio structuring and rebalancing guidelines; securities trading
techniques; and continual monitoring and reevaluation of all holdings with a
view to maintaining the most attractive mix of investments. The Investment
Adviser collects data on approximately 26,000 companies in 35 countries
(adjusting for reporting and accounting differences). There can be no assurance
that use of this proprietary investment methodology will be successful.
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Investment Policies, Strategies and Risks. The Appendix and Statement of
Additional Information describe certain investment securities and techniques of
the Funds, and the associated risks. These include short-term investments in
cash and cash equivalents; investment in securities issued or guaranteed by the
U.S. Government or its agencies and instrumentalities; commercial paper of
domestic and foreign entities; municipal securities; zero coupon securities;
floating and variable rate demand notes and bonds; commercial paper; non-
convertible corporate debt securities; convertible securities, synthetic
convertible securities, and warrants; Eurodollar and Yankee Dollar instruments;
depository receipts; index and currency-linked securities; mortgage-backed
securities; other real estate-related instruments; asset-backed securities;
foreign securities; over-the-counter securities; when-issued and firm commitment
agreements; short sales; roll transactions; foreign exchange contracts; put and
call options; futures contracts and related options; interest rate and currency
swaps; repurchase agreements; and reverse repurchase requirements; illiquid
securities; securities lending; and borrowing.
Investment Restrictions. Each Portfolio and Fund is subject to certain
investment restrictions which constitute fundamental policies. Fundamental
policies may not be changed without the approval of the holders of a majority of
the outstanding shares of the affected Portfolio or Fund, respectively, as
defined in the Investment Company Act. An investment policy or restriction which
is not described as fundamental in this Prospectus or the Statement of
Additional Information may be changed or modified by the Board of Trustees of
the Trust or Master Trust, as the case may be, without shareholder approval.
The investment objective of each Fund and Portfolio is a fundamental policy.
Certain of the investment restrictions which are fundamental policies are set
forth below. Additional investment restrictions are discussed in the Appendix
and Statement of Additional Information.
1. No Portfolio or Fund may invest more than 5% of its total assets in the
securities of any one issuer. However, up to 25% of a Portfolio's or
Fund's total assets may be invested without regard to this limitation, and
this limitation does not apply to investments in securities of the U.S.
Government or its agencies and instrumentalities.
2. No Portfolio or Fund may purchase more than 10% of the outstanding voting
securities of any one issuer, or purchase the securities of any issuer for
the purpose of exercising control.
3. No Portfolio or Fund may invest 25% or more of its total assets in any one
particular industry; however, this restriction does not apply to the
securities of the U.S. Government, its agencies and instrumentalities.
4. No Portfolio or Fund may make loans of its portfolio securities in an
aggregate amount exceeding 30% of the value of its total assets.
5. The High Yield Bond Portfolio or Fund may not borrow money except from
banks for temporary, extraordinary or emergency purposes or for the
clearance of transactions and in an aggregate amount not exceeding 20% of
the value of its total assets. The Strategic Income Portfolio or Fund may
borrow up to 50% of the value of its net assets from banks for such
purposes or to buy securities.
6. No Portfolio or Fund may invest more than 15% of its net assets in
illiquid securities.
The investment restrictions described above do not apply to an investment by a
Portfolio of all of its assets in a corresponding Fund.
Portfolio Turnover. The Investment Adviser's investment approach results in
above-average portfolio turnover for each Fund as the Investment Adviser sells
portfolio securities when it
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believes the reasons for their initial purchase are no longer valid or when it
believes that the sale of a security owned by a Fund and the purchase of another
security of better value can enhance principal or increase income. A security
may also be sold to avoid a prospective decline in market value or purchased in
anticipation of a market rise. Although it is not possible to predict future
portfolio turnover rates accurately, and such rates may vary greatly from year
to year, the Investment Adviser anticipates that the annual portfolio turnover
rate for each Fund may be up to 300%, which is substantially greater than that
of many other investment companies. A high rate of portfolio turnover (100% or
more) will result in a Fund paying greater brokerage commissions on equity
securities (other than those effected with dealers on a principal basis) than
would otherwise be the case, which will be borne directly by the Fund and by
investors of the corresponding Portfolio. High Portfolio turnover should not
result in either Fund paying greater brokerage commission expense on debt
securities, as most transactions in debt securities are effected with dealers on
a principal basis. However, debt securities, as well as equity securities traded
on a principal basis, are subject to a mark-up by the dealers. High portfolio
turnover (100% or more) may also result in the realization of substantial net
capital gains, and any distributions derived from such gains may be ordinary
income for federal tax purposes.
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ORGANIZATION AND MANAGEMENT
Organization. Each Portfolio is a series of Nicholas-Applegate Mutual Funds, a
Delaware business trust. The Board of Trustees of the Trust, in addition to
reviewing the actions of the Trust's Administrator and Distributor, as set forth
below, decides upon matters of general policy with respect to each Portfolio.
See "General Information". The trustees and officers of the Trust and of the
Master Trust are described in the Statement of Additional Information. None of
the disinterested trustees of the Trust are the same individuals as the
disinterested trustees of the Master Trust.
Investment Adviser. The Trust has not retained the services of an investment
adviser for the Portfolios, as the Portfolios seek to achieve their investment
objectives by investing all of their assets in corresponding Funds.
Nicholas-Applegate Capital Management, 600 West Broadway, 30th Floor, San Diego,
California 92101, serves as the Investment Adviser to the Funds. The Investment
Adviser currently manages approximately $30 billion of discretionary assets
(including over $12 billion of fixed income assets) for numerous clients,
including employee benefit plans of corporations, public retirement systems and
unions, university endowments, foundations and other institutional investors,
and individuals. The Investment Adviser was organized in 1984 as a California
limited partnership. Its general partner is Nicholas-Applegate Capital
Management Holdings, L.P., a California limited partnership controlled by Arthur
E. Nicholas. He and 13 other partners manage a staff of approximately 325
employees.
As compensation for the services it provides, the Investment Adviser receives a
monthly fee at the following annual rates: for the High Yield Bond Fund, 0.60%
of the Fund's average net assets; for the Strategic Income Fund, 0.60% of the
Fund's average net assets.
The Funds are managed under the general supervision of John D. Wylie, the Chief
Investment Officer-Investor Services Group of the Investment Adviser. The
Investment Adviser's fixed income management team headed by Fred S. Robertson
III, the Chief Investment Officer -- Fixed Income of the Investment Adviser,
will be primarily responsible for the Investment Adviser's day-to-day management
of the Funds' portfolios. Mr. Robertson has managed institutional accounts for
the Investment Adviser since May 1995; for more than five years
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prior to May 1995, he managed institutional accounts for Criterion Investment
Management Company, which was acquired by the Investment Adviser at that time.
Mr. Wylie has managed institutional accounts for the Investment Adviser for more
than the last five years.
For historical performance information regarding institutional accounts managed
by the Investment Adviser that have investment objectives, policies, strategies
and risks substantially similar to those of the Portfolios, see "Appendix: Prior
Performance of Investment Adviser."
Administrator. Investment Company Administration Corporation, a Delaware
corporation, is the Administrator of each Portfolio. Pursuant to an
Administration Agreement with the Trust, and subject to the supervision of the
Board of Trustees of the Trust, the Administrator supervises the overall
administration of the Trust. Its responsibilities include preparing and filing
all documents required for compliance by the Trust with applicable laws and
regulations, arranging for the maintenance of books and records of the Trust and
supervision of other organizations that provide services to the Trust. Certain
officers of the Trust are also provided by the Administrator. For the services
it provides to the Trust, the Administrator receives an annual fee of between
$5,000 and $35,000 for each of the groups of portfolios of the Trust investing
in the various series of the Master Trust; the fee is allocated among various
series of the Trust, including the Portfolios, in accordance with relative net
asset values. The Administrator provides similar services as the administrator
of the Master Trust, subject to the supervision of its Board of Trustees, and is
compensated separately for the services rendered to each Fund at an annual rate
of approximately 0.015% of the average daily net assets of the Fund.
Expense Limitation. To limit the expenses of each Portfolio, the Investment
Adviser has agreed to defer its management fees payable by the Funds, and to
absorb the other operating expenses payable by the Funds and the Portfolios, to
ensure that the expenses of each Portfolio (excluding interest, taxes, brokerage
commissions and other portfolio transaction expenses, capital expenditures and
extraordinary expenses, but including such Portfolio's proportionate share of
the corresponding Fund's similar operating expenses) do not exceed the following
respective percentage of such Portfolio's average net assets on an annual basis
or any lower expense limitation imposed by any state during any fiscal period:
High Yield Bond Fund-- 0.75%; Strategic Income Fund--0.75%. Each Portfolio will
reimburse the Investment Adviser for fees deferred or other expenses paid by the
Investment Adviser pursuant to this agreement in later years in which operating
expenses for the Portfolio are less than the applicable percentage limitation
set forth above for any such year. No interest, carrying or finance charge will
be paid by a Portfolio with respect to any amounts representing fees deferred or
other expenses paid by the Investment Adviser. In addition, no Portfolio or Fund
will be required to repay any unreimbursed amounts to the Investment Adviser
upon termination or non-renewal of its Investment Advisory Agreement with the
Master Trust.
Distributor. Nicholas-Applegate Securities, 600 West Broadway, 30th Floor, San
Diego, California 92101, a California limited partnership, serves as the
Distributor of shares of each Portfolio. The general partner of the Distributor
is Nicholas-Applegate Capital Management Holdings, L.P. and its limited partner
is the Investment Adviser.
Custodian and Transfer and Dividend Disbursing Agent. PNC Bank, Airport Business
Center, International Court 2, 200 Stevens Drive, Lester, Pennsylvania, 19113,
serves as Custodian for the Portfolios and the Funds. PFPC Inc., an affiliate of
the Custodian, provides accounting services to the Portfolios and the Funds.
State Street Bank and Trust Company, 2 Heritage Drive, 7th Floor, North Quincy,
Massachusetts 02171, is the Transfer Agent and the Dividend Disbursing Agent for
the Portfolios.
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Portfolio Transactions and Brokerage. The Investment Adviser is responsible for
the Funds' portfolio transactions and the allocation of the brokerage business.
In executing such transactions, the Investment Adviser seeks to obtain the best
price and execution for the Funds. Subject to obtaining the best price and
execution, the Investment Adviser may effect transactions through brokers who
sell shares of the Portfolios or provide research services to the Investment
Adviser.
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PURCHASING SHARES
How to Purchase Shares. Shares of the Portfolios are offered to institutional
investors, high net worth individuals and participants in mutual fund asset
allocation programs sponsored by certain broker-dealers. Shares of the
Portfolios are also offered to former limited partners and participants of
certain investment partnerships and pooled trusts previously managed by the
Investment Adviser (the "former partners"); to partners, officers and employees
of the Investment Adviser and Distributor and their immediate family members; to
trustees and officers of the Trust and the Master Trust and their immediate
family members; and to certain other persons determined from time to time by the
Distributor.
Investments by individual participants of qualified retirement plans are made
through their plan sponsor or administrator, who is responsible for transmitting
all orders for the purchase, redemption and exchange of Portfolio shares. The
availability of an investment by a plan participant in the Portfolios, and the
procedures for investing, depend upon the provisions of the qualified retirement
plan and whether the plan sponsor or administrator has contracted with the Trust
or the Transfer Agent for special processing services, including subaccounting.
Other institutional investors and eligible purchasers must arrange for services
through the Transfer Agent or Distributor by calling (800) 551-8043.
Shares of the Portfolios may be purchased at net asset value without a sales
charge. The minimum initial investment is $250,000 and the minimum subsequent
investment is $10,000. The minimum initial and subsequent investments are waived
for individual participants of qualified retirement plans and for the former
partners and trust participants described above, and may be waived from time to
time by the Distributor for other investors (but not below $10,000). Shares will
be purchased for a participant of a qualified retirement plan only upon receipt
by the plan's recordkeeper of the participant's funds accompanied by the
information necessary to determine the proper share allocation for the
participant.
An account may be opened by completing and signing an account application and
sending it to the address indicated on the application. Account applications can
be obtained from the Distributor or Transfer Agent. Individual participants of
qualified retirement plans can obtain an account application from their plan
sponsor or administrator. Plan sponsors and administrators will be responsible
for forwarding to the Transfer Agent all relevant information and account
applications for plan participants.
Purchases of shares of the Portfolio can be made by check or by wiring federal
funds to the Transfer Agent. Checks should be in U.S. dollars and made payable
to Nicholas-Applegate Mutual Funds or, in the case of a retirement account, the
custodian or trustee. Third party checks will not be accepted. Checks should be
sent to the Transfer Agent, State Street Bank and Trust Company, P.O. Box 8326,
Boston, Massachusetts 02266-8326, Attention: Nicholas-Applegate Mutual Funds.
Please specify the name of the Portfolio, the account number
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assigned by the Transfer Agent, and your name. See "Purchase by Wire" below for
wiring instructions. Shares of a Portfolio may also be purchased with securities
which are otherwise appropriate for investment by the Portfolio.
Purchase by Wire. Purchases of shares of the Portfolios can only be made by
wiring federal funds to the Transfer Agent. Before wiring federal funds, you
must first telephone the Transfer Agent at (800) 551-8043 (toll-free) between
the hours of 8:00 A.M. and 4:00 P.M. (Eastern time) on a day when the New York
Stock Exchange is open for normal trading to receive an account number. The
following information will be requested: your name, address, tax identification
number, dividend distribution election, amount being wired and wiring bank.
Instructions should then be given by you to your bank to transfer funds by wire
to the Portfolio's Transfer Agent, State Street Bank and Trust Company, 225
Franklin Street, Boston, Massachusetts, 02110, ABA No. 011000028, DDA No.
9904-645-0 Attention: Nicholas-Applegate Mutual Funds, specifying on the wire
the name of the Portfolio, the account number assigned by the Transfer Agent and
your name. If you arrange for receipt by the Transfer Agent of federal funds
prior to close of trading (currently 4:00 P.M., Eastern time) of the New York
Stock Exchange on a day when the Exchange is open for normal trading, you may
purchase shares of the Portfolio as of that day. Your bank is likely to charge
you a fee for wire transfers.
Subsequent purchases by wire may be made at any time by calling the Transfer
Agent and wiring federal funds as outlined above.
Individual participants of qualified retirement plans should purchase Portfolio
shares through their plan sponsor or administrator who is responsible for
forwarding payment to the Transfer Agent.
Share Price. Shares are purchased at the next offering price after the order is
received in proper form by the Transfer Agent or a sub-transfer agent. An order
in proper form must include all correct and complete information, documents and
signatures required to process your purchase, as well as a check or bank wire
payment properly drawn and collectable. For purchases by a qualified retirement
plan, an order in proper form is defined as receipt of funds and the information
necessary to determine the proper share allocation for each participant. The
price per share is its net asset value, which is determined as of the close of
trading of the New York Stock Exchange on each day the Exchange is open for
normal trading. Orders received before 4:00 P.M. (Eastern time) on a day when
the Exchange is open for normal trading will be processed as of the close of
trading on that day. Otherwise, processing will occur on the next business day.
To determine a Portfolio's net asset value per share, the current value of the
Portfolio's total assets, less all liabilities, is divided by the total number
of shares outstanding, and the result is rounded to the nearer cent.
Retirement Plans. You may invest in each Portfolio through various retirement
plans including IRAs, Simplified Employee Plan (SEP) IRAs, 403(b) plans, 457
plans, and all qualified retirement plans (including 401(k) plans). For further
information about any of the plans, agreements, applications and annual fees,
contact the Distributor or your dealer. To determine which retirement plan is
appropriate for you, please consult your tax adviser.
Other Portfolios. Currently, the Trust has thirteen Institutional Portfolios.
Two Institutional Income Portfolios are offered pursuant to this Prospectus;
eleven other domestic and global Institutional Portfolios are offered pursuant
to separate prospectuses which can be obtained by calling (800) 551-8643. The
Distributor also offers shares of other portfolios of the Trust which invest in
the same Funds of the Master Trust as the Portfolios. These other portfolios
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have different sales charges and other expenses than the Portfolios, which may
affect their performance. Information about these other portfolios can be
obtained from your dealer or by calling (800) 551-8045.
Other Purchase Information. The Portfolios reserve the right to reject any
purchase order or to suspend or modify the continuous offering of their shares.
Purchases of Portfolio shares will be made in full and fractional shares. In the
interest of economy and convenience, certificates for shares will generally not
be issued.
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INVESTOR SERVICES
Automatic Investment Plan. Investors may make regular monthly or quarterly
investments in the Portfolio through automatic withdrawals of specified amounts
from their bank account once an automatic investment plan is established.
Individual participants of qualified retirement plans may make regular
investments in the Portfolio through payroll deductions in accordance with
procedures adopted by the plan sponsor or administrator. Further details about
this service and an application form are available from the Transfer Agent or
from your plan sponsor or administrator.
Automatic Reinvestment. Dividends and capital gain distributions are reinvested
in additional shares at no sales charge unless you indicate otherwise on the
account application. You may elect to have dividends and capital gain
distributions paid in cash.
Cross-Reinvestment. You may cross-reinvest dividends or dividends and capital
gain distributions paid by one Portfolio into shares of any other Institutional
Portfolio, subject to conditions outlined in the Statement of Additional
Information and the applicable provisions of the qualified retirement plan.
Exchange Privilege. Shares of a Portfolio may be exchanged into shares of any
other Institutional Portfolio by writing to the Transfer Agent, State Street
Bank and Trust Company, Attention: Nicholas-Applegate Mutual Funds, P.O. Box
8326, Boston, Massachusetts 02266-8326. Please specify the name of the
applicable series, the number of shares or dollar amount to be exchanged and
your name and account number. Shares may also be exchanged by telephoning the
Transfer Agent at (800) 551-8043 or by sending the Transfer Agent a facsimile at
(617) 774-2651, between the hours of 8:00 A.M. and 4:00 P.M. (Eastern time) on a
day when the New York Stock Exchange is open for normal trading (see "Telephone
Privilege" below). The Trust's exchange privilege is not intended to afford
shareholders a way to speculate on short-term market movements. Accordingly the
Trust reserves the right to limit the number of exchanges an investor or
participant may make in any year, to avoid excessive Portfolio expenses.
Individual participants of qualified retirement plans may exchange shares
(depending upon the provisions of the plan) by written or telephone request
through the plan sponsor or administrator. Such participants may exchange shares
only for shares of other Institutional Portfolios that are included in their
plan. In addition, the exchange privilege may not be available to investors who
are eligible to purchase shares of a Portfolio as a result of agreements between
the Distributor and certain broker-dealers, financial planners and similar
institutions.
Before effecting an exchange, you should obtain the currently effective
prospectus of the series into which the exchange is to be made. All exchanges
will be made on the basis of the relative
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net asset values of the two series next determined after a completed request is
received. Exchange purchases are subject to the minimum investment requirements
of the series being purchased. An exchange will be treated as a redemption and
purchase for tax purposes.
Telephone Privilege. Investors may exchange or redeem shares by telephone if
they have elected the telephone privilege on their account applications.
Participants in qualified retirement plans may make telephone requests only
through their plan sponsor or administrator and only if such service is offered
under the plan. Investors should realize that by electing the telephone
privilege, they may be giving up a measure of security that they may have if
they were to exchange or redeem their shares in writing. Furthermore, in periods
of severe market or economic conditions, telephone exchanges or redemptions may
be difficult to implement, in which case investors should mail or send by
overnight delivery a written exchange or redemption request to the Transfer
Agent. Overnight deliveries should be sent to the Transfer Agent, Attention:
Nicholas-Applegate Mutual Funds, 2 Heritage Drive, 7th Floor, North Quincy,
Massachusetts 02171. Requests for telephone exchanges or redemptions received
before 4:00 P.M. (Eastern time) on a day when the New York Stock Exchange is
open for normal trading will be processed as of the close of trading on that
day. Otherwise, processing will occur on the next business day. All exchanges or
redemptions will be made on the basis of the relative net asset values of the
two series next determined after a completed request is received.
The Trust will employ procedures designed to provide reasonable assurance that
instructions communicated by telephone are genuine and, if it does not do so, it
may be liable for any losses due to unauthorized or fraudulent instructions. The
procedures employed by the Trust include requiring personal identification by
account number and social security number, tape recording of telephone
instructions, and providing written confirmation of transactions. The Trust
reserves the right to refuse a telephone exchange or redemption request if it
believes, for example, that the person making the request is neither the record
owner of the shares being exchanged or redeemed nor otherwise authorized by the
investor to request the exchange or redemption. Investors will be promptly
notified of any refused request for a telephone exchange or redemption. No
Portfolio or its agents will be liable for any loss, liability or cost which
results from acting upon instructions of a person reasonably believed to be an
investor with respect to the telephone privilege.
Automatic Withdrawal Plan. An automatic withdrawal plan may be established by an
investor or by a qualified retirement plan sponsor or administrator for its
participants subject to the requirements of the plan and applicable Federal law.
Individual participants of qualified retirement plans must establish automatic
withdrawal plans with the plan sponsor or administrator rather than the Trust.
Automatic withdrawals of $250 or more may be made on a monthly, quarterly,
semi-annual or annual basis if you have an account of at least $15,000 when the
automatic withdrawal plan begins. Withdrawal proceeds will normally be received
prior to the end of the period designated. All income dividends and capital gain
distributions on shares under the Automatic Withdrawal Plan must be reinvested
in additional shares of the Portfolio. For the protection of investors and the
Trust, wiring instructions must be on file prior to executing any request for
the wire transfer of automatic withdrawal proceeds.
Account Statements. An account is opened in accordance with applicable
registration instructions. Transactions in the account, such as additional
investments and dividend reinvestments, will be reflected on regular
confirmation statements from the Transfer Agent (for qualified retirement plans,
such statements will be provided by the plan sponsor or administrator).
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Reports to Investors. Each Portfolio will send its investors annual and
semi-annual reports. The financial statements appearing in annual reports will
be audited by independent accountants. In order to reduce duplicate mailing and
printing expenses, the Portfolio may provide one annual and semi-annual report
and annual prospectus per household. In addition, quarterly unaudited financial
data are available from the Portfolios upon request.
Investor Inquiries. Investor inquiries should be addressed to the Trust, P.O.
Box 82169, San Diego, California 92138-2169, or by telephone, at (800) 551-8643
(toll free). Individual participants of qualified retirement plans should direct
inquiries to their plan sponsor or administrator.
The services referred to above are available only in states where the Portfolio
to be purchased may be legally offered and may be terminated or modified at any
time upon 60 days' written notice. Investors seeking to add to, change or cancel
their selection of available services should contact their plan administrator or
sponsor, or the Transfer Agent at the address and telephone number provided
above.
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REDEEMING SHARES
How to Redeem Shares. Shares of a Portfolio may be redeemed by writing to the
Transfer Agent, State Street Bank and Trust Company, Attention:
Nicholas-Applegate Mutual Funds, P.O. Box 8326, Boston, Massachusetts
02266-8326. Redemptions by participants in qualified retirement plans must be
made in writing to the plan sponsor or administrator rather than the Trust.
Please specify the name of the Portfolio, the number of shares or dollar amount
to be sold and your name and account number. The price received for the shares
redeemed is at the next determined net asset value for the Portfolio shares
after the redemption request is received by the Transfer Agent. No charge will
be imposed by the Trust or the Transfer Agent for redemptions.
The signature on a redemption request must be exactly as names appear on the
Portfolio's account records, and the request must be signed by the minimum
number of persons designated on the account application that are required to
effect a redemption. Requests by participants of qualified retirement plans must
include all other signatures required by the plan and applicable Federal law.
If redemption is requested by a corporation, partnership, trust or fiduciary,
written evidence of authority acceptable to the Transfer Agent must be submitted
before such request will be accepted. If the proceeds of the redemption exceed
$50,000, are to be paid to a person other than the record owner, are to be sent
to an address other than the address on the Transfer Agent's records, or are to
be paid to a corporation, partnership, trust or fiduciary, the signature(s) on
the redemption request may be required to be guaranteed by an "eligible
guarantor", which includes a bank or savings and loan association that is
federally insured or a member firm of a national securities exchange.
Redemptions by Telephone. If an election is made on the account application (or
subsequently in writing), redemptions of shares may be requested by contacting
the Transfer Agent by telephone at (800) 551-8043 or by facsimile at (617)
774-2651 between the hours of 8:00 A.M. and 4:00 P.M. (Eastern time) on a day
when the New York Stock Exchange is open for normal trading. Investors should
state the name of the Portfolio, the number of shares or dollar amount to be
sold and their name and account number. Participants of qualified retirement
plans may make telephonic or facsimile redemption requests through their plan
sponsor or
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administrator, provided that such service is offered under the plan and
satisfactory arrangements have been made with the Transfer Agent. Redemption
requests received by the Transfer Agent before 4:00 P.M. (Eastern time) on a day
when the New York Stock Exchange is open for normal trading will be processed
that day. Otherwise, processing will occur on the next business day. See
"Shareholder Services--Telephone Privilege" above.
Redemption Payments. Payment for shares presented for redemption will ordinarily
be wired to your bank one business day after redemption is requested, but may
take up to seven days after receipt by the Transfer Agent of a written or
telephonic redemption request except as indicated below. Such payment may be
postponed or the right of redemption suspended at times when the New York Stock
Exchange is closed for other than customary weekends and holidays, when trading
on such Exchange is restricted, when an emergency exists as a result of which
disposal by a Portfolio of securities owned by it is not reasonably practicable
or it is not reasonably practicable for the Portfolio fairly to determine the
value of its net assets, or during any other period when the Securities and
Exchange Commission, by order, so permits. Payment for redemption of recently
purchased shares will be delayed until the Transfer Agent has been advised that
the purchase check has been honored, up to 15 calendar days from the time of
receipt of the purchase check by the Transfer Agent. Such delay may be avoided
by purchasing shares by wire or by certified or official bank check.
Involuntary Redemption. In order to reduce expenses of a Portfolio, the Trust
may redeem all of the shares of any investor whose account has a net asset value
of less than $10,000 due to redemptions other than a shareholder who is a
participant in a qualified retirement plan. The Trust will give such investors
60 days' prior written notice in which to purchase sufficient additional shares
to avoid such redemption.
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DIVIDENDS, DISTRIBUTIONS AND TAXES
The Trust intends to qualify each Portfolio as a regulated investment company
under the Internal Revenue Code. Accordingly, the Portfolios will not be subject
to federal income taxes on its net investment income and capital gains, if any,
that they distribute to their investors. All dividends out of net investment
income, together with distributions of short-term capital gains, will be taxable
as ordinary income to the investors whether or not reinvested. Any net long-term
capital gains distributed to investors will be taxable as such to the investors,
whether or not reinvested and regardless of the length of time an investor has
owned his shares.
The Portfolios declare and pay monthly dividends of net investment income. The
Portfolios make distributions at least annually of their net capital gains, if
any. In determining amounts of capital gains to be distributed by a Portfolio,
any capital loss carryovers from prior years will be offset against its capital
gains. Under U.S. Treasury Regulations, the Portfolios are required to withhold
and remit to the U.S. Treasury 31% of the dividends, capital gains and
redemption proceeds on the accounts of those investors who fail to furnish their
correct tax identification numbers on IRS Form W-9 (or IRS Form W-8, in the case
of certain foreign investors) with the required certifications regarding the
investor's status under the federal income tax law or who are subject to backup
withholding for failure to include payments of interest or dividends on their
returns. Notwithstanding the foregoing, dividends of net income and short-term
capital gains to a foreign investor will generally be subject to U.S.
withholding at the rate of 30% (or lower treaty rate).
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The Trust may elect to "pass through" to a Portfolio's shareholders the amount
of foreign income taxes paid by the Portfolio. The Trust will make such an
election only if it is deemed to be in the best interests of the shareholders.
If this election is made, shareholders of the Portfolio will be required to
include in their gross income their pro rata share of foreign taxes paid by the
Portfolio. However, shareholders will be able to treat their pro rata share of
foreign taxes as either an itemized deduction or a foreign credit against U.S.
income taxes (but not both) on their tax return.
The Funds are not required to pay federal income taxes on their net investment
income and capital gains, as they are treated as partnerships for tax purposes.
Any interest, dividends and gains or losses of a Fund will be deemed to have
been "passed through" to the corresponding Portfolio and other investors in the
Fund, regardless of whether such interest, dividends or gains have been
distributed by the Fund or losses have been realized by the Portfolio and such
other investors.
Investors should consult their own tax advisers regarding specific questions as
to federal, state or local taxes. See "Taxes" in the Statement of Additional
Information.
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GENERAL INFORMATION
Performance Information. From time to time the Trust may advertise each
Portfolio's total return and yield. These figures are based on historical
earnings and are not intended to indicate future performance. Total return shows
how much an investment in the Portfolio would have increased (or decreased) over
a specified period of time (I.E., one, five or ten years or since inception of
the Portfolio) assuming that all distributions and dividends by the Trust to
investors of the Portfolio were reinvested on the reinvestment dates during the
period. Total return does not take into account any federal or state income
taxes which may be payable by the investor. Yield will be calculated on a 30-day
period pursuant to a formula prescribed by the Securities and Exchange
Commission (the "Commission"). The Trust also may include comparative
performance information in advertising or marketing Portfolio shares. Such
performance information may include data from Lipper Analytical Services, Inc.,
Morningstar Inc., other industry publications, business periodicals, rating
services and market indices. See "Appendix: Prior Performance of Investment
Adviser," and "Prior Performance" in the Statement of Additional Information.
Further information about the performance of the Portfolios will be contained in
the Trust's Annual Reports to Shareholders, which may be obtained without charge
by calling (800) 551-8643.
Description of Shares. The Portfolios are series of Nicholas-Applegate Mutual
Funds, a diversified, open-end management investment company. The Trust was
organized in December 1992 as a Delaware business trust. The Trust is authorized
to issue an unlimited number of shares of each Portfolio. Shares of a Portfolio,
when issued, are fully paid, nonassessable, fully transferable and redeemable at
the option of the holder. Shares of a Portfolio are also redeemable at the
option of the Trust under certain circumstances. There are no conversion,
preemptive or other subscription rights. In the event of liquidation, each share
of a Portfolio is entitled to its portion of all of the Portfolio's assets after
all debts and expenses of the Portfolio have been paid. Pursuant to the Trust's
Declaration of Trust, the Board of Trustees of the Trust may authorize the
creation of additional series, and classes within series, with such preferences,
privileges, limitations and voting and dividend rights as the Board may
determine.
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Investors of the Portfolios are entitled to one vote for each full share held
and fractional votes for fractional shares held, and will vote by series except
as otherwise required by law or when the Board of Trustees of the Trust
determines that a matter to be voted upon affects only the interests of
investors of a particular series. Shares of the Trust do not have cumulative
voting rights for the election of Trustees. The Trust does not intend to hold
annual meetings of its investors unless otherwise required by law. The Trust
will not be required to hold meetings of investors unless the election of
Trustees or any other matter is required to be acted on by investors under the
Investment Company Act. Investors have certain rights, including the right to
call a meeting upon the request of 10% of the outstanding shares of a Portfolio,
for the purpose of voting on the removal of one or more Trustees.
Master Trust. The Funds are series of Nicholas-Applegate Investment Trust, an
open-end management investment company organized as a Delaware business trust in
December 1992. The trustees and officers of the Master Trust are described in
the Statement of Additional Information. Whenever a Portfolio is requested to
vote on matters pertaining to the corresponding Fund or the Master Trust in its
capacity as a shareholder of such Fund, the Trust will hold a meeting of its
investors and will cast its vote as instructed by such investors or, in the case
of a matter pertaining exclusively to the corresponding Fund, as instructed
particularly by investors of the Portfolio and other series of the Trust which
invest in the Fund. The Trust will vote shares for which it has received no
voting instructions in the same proportion as the shares for which it does
receive voting instructions.
Additional Information. This Prospectus, including the Statement of Additional
Information which has been incorporated by reference herein, does not contain
all the information set forth in the Registration Statement filed by the Trust
with the Securities and Exchange Commission under the Securities Act of 1933, as
amended. The Master Trust has also filed a Registration Statement with the
Commission. Copies of the Trust's and Master Trust's Registration Statement may
be obtained at a reasonable charge from the Commission or may be examined,
without charge, at the office of the Commission in Washington, D.C.
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APPENDIX
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INVESTMENT POLICIES, STRATEGIES AND RISKS
The investment policies and strategies of the Portfolios (as implemented through
their investment in corresponding Funds) encompass the following securities,
techniques and risk considerations.
Short-Term Investments. Each of the Funds may invest in short-term investments
to maintain liquidity for redemptions or during periods when, in the opinion of
the Investment Adviser, attractive investments are temporarily unavailable.
Under normal circumstances, no more than 10% of a Fund's total assets will be
retained in cash and cash equivalents. However, each Fund may invest without
restriction in short-term investments for temporary defensive purposes, such as
when the securities markets or economic conditions are expected to enter a
period of decline. Short-term investments in which the Funds may invest include
U.S. Treasury bills or other U.S. Government or Government agency or
instrumentality obligations; certificates of deposit; bankers' acceptances; time
deposits; high quality commercial paper and other short-term high grade
corporate obligations; shares of money market mutual funds; or repurchase
agreements with respect to such securities. The High Yield Bond Fund may also
invest in high quality preferred stocks for such purposes. These instruments are
described below. The Funds will only invest in short-term investments which, in
the opinion of the Investment Adviser present minimal credit and interest rate
risk.
U.S. Government Obligations. Securities issued or guaranteed by the U.S.
Government or its agencies and instrumentalities in which each of the Funds may
invest include U.S. Treasury securities, which differ only in their interest
rates, maturities and times of issuance. Treasury bills have initial maturities
of one year or less; Treasury notes have initial maturities of one to ten years;
and Treasury bonds generally have initial maturities of more than ten years.
Some obligations issued or guaranteed by U.S. Government agencies and
instrumentalities, for example, Government National Mortgage Association
("GNMA") pass-through certificates, are supported by the full faith and credit
of the U.S. Treasury; others, such as those of the Federal Home Loan Banks, by
the right of the issuer to borrow money from the Treasury; others, such as those
issued by the Federal National Mortgage Association, by the discretionary
authority of the U.S. Government to purchase certain obligations of the agency
or instrumentality; and others, such as those issued by the Student Loan
Marketing Association, only by the credit of the agency or instrumentality.
While the U.S. Government provides financial support to U.S.
Government-sponsored agencies and instrumentalities, no assurance can be given
that it will always do so, since it is not so obligated by law. The Funds will
invest in securities issued or guaranteed by U.S. Government agencies and
instrumentalities only when the Investment Adviser is satisfied that the credit
risk with respect to the issuer is minimal.
Certificates of Deposit, Time Deposits and Bankers' Acceptances. Each of the
Funds may invest in certificates of deposit, time deposits and bankers'
acceptances issued by domestic banks, domestic branches of foreign banks, and
savings and loan corporations, and in similar instruments issued by foreign
banks, foreign branches of domestic banks, and foreign branches of foreign
banks, each of which at the date of investment has capital, surplus and
undivided profits as of the date of its most recent published financial
statements in excess of $100 million, or less than $100 million if the principal
amount of such bank obligations is insured by the Federal Deposit Insurance
Corporation. Certificates of deposit are certificates evidencing the obligation
of a bank to repay funds deposited with it for a specified period of
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time. Time deposits are non-negotiable deposits maintained in a banking
institution for a specified period of time at a stated interest rate. Bankers'
acceptances are credit instruments evidencing the obligation of a bank to pay a
draft drawn on it by a customer; these instruments reflect the obligation both
of the bank and of the drawer to pay the face amount of the instrument upon
maturity.
Commercial Paper. Each of the Funds may invest in commercial paper of domestic
entities which is rated (or guaranteed by a corporation the commercial paper of
which is rated) in the two highest rating categories by at least two nationally
recognized statistical rating organizations ("NRSROs"), including "P-1" or "P-2"
by Moody's or "A-1" or "A-2" by S&P, or, if rated by only one NRSRO, in such
NRSRO's two highest grades, or, if not rated, is issued by an entity which the
Investment Adviser, acting pursuant to guidelines established by the Master
Trust's Board of Trustees, has determined to be of minimal credit risk and
comparable quality. The High Yield Fund may also invest in such commercial paper
issued by foreign entities. Commercial paper consists of short-term, unsecured
promissory notes issued to finance short-term credit needs.
Zero Coupon Securities. Each of the Funds may invest up to 50% of its net assets
in "zero coupon" securities issued or guaranteed by the U.S. and foreign
governments and their agencies and instrumentalities. For example, U.S. zero
coupon securities may be issued by the U.S. Treasury or by a U.S. Government
agency, authority or instrumentality (such as the Student Loan Marketing
Association or the Resolution Funding Corporation). Zero coupon securities are
sold at a substantial discount from face value and redeemed at face value at
their maturity date without interim cash payments of interest and principal.
This discount is amortized over the life of the security and such amortization
will constitute the income earned on the security for both accounting and tax
purposes. Because of these features, such securities may be subject to greater
volatility as a result of changes in prevailing interest rates than interest
paying investments in which the Fund may invest. Because income on such
securities is accrued on a current basis, even though the Funds do not receive
the income currently in cash, the Funds may have to sell other portfolio
investments to obtain cash needed by the related Portfolios to make income
distributions.
The Funds may also invest in zero coupon corporate securities, which are similar
to U.S. Government zero coupon securities but are issued by companies. They have
an additional risk that the issuing company may fail to pay interest or repay
principal on the obligations.
Variable Rate Demand Securities. Each of the Funds may purchase floating and
variable rate demand notes and bonds, which are obligations ordinarily having
stated maturities in excess of one year, but which permit the holder to demand
payment of principal at any time, or at specified intervals not exceeding one
year, in each case upon not more than 30 days' notice. Variable rate demand
notes include master demand notes, which are obligations that permit a Fund to
invest fluctuating amounts, which may change daily without penalty. The interest
rates on these notes are adjusted at designated intervals or whenever there are
changes in the market rates of interest on which the interest rates are based.
The issuer of such obligations normally has a corresponding right, after a given
period, to prepay in its discretion the outstanding principal amount of the
obligations plus accrued interest upon a specified number of days' notice to the
holders of such obligations. Because these obligations are direct lending
arrangements between the lender and borrower, it is not contemplated that such
instruments generally will be traded, and there generally is no established
secondary market for these obligations, although they are redeemable at face
value. Such obligations frequently are not rated by credit rating agencies and a
Fund may invest in obligations which are not so rated
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only if the Investment Adviser determines that at the time of investment the
obligations are of comparable quality to the other obligations in which the Fund
may invest. The Investment Adviser will monitor the creditworthiness of the
issuers of such obligations and their earning power and cash flow, and will also
consider situations in which all holders of such notes would redeem at the same
time. Investment by a Fund in floating or variable rate demand obligations as to
which it cannot exercise the demand feature on not more than seven days' notice
will be subject to the Fund's limit on illiquid securities of 15% of net assets
if there is no secondary market available for these obligations.
Corporate Debt Securities. Each of the Funds may invest in non-convertible
corporate debt obligations of varying maturities (such as debentures, bonds and
notes) over a cross-section of industries. The value of a debt security changes
as interest rates fluctuate, with longer-term securities fluctuating more widely
in response to changes in interest rates than those of shorter-term securities.
A decline in interest rates usually produces an increase in the value of debt
securities, while an increase in interest rates generally reduces their value.
The Funds may also invest in loans and other direct debt instruments, which are
interests in amounts owed to another party by a company, government, or other
borrower. These investments may be interests in, or assignments of, a loan and
may be acquired from banks or brokers that have made the loan or are members of
a lending syndicate. No more than 5% of a Fund's net assets will be invested in
direct debt instruments of the same borrower. In addition, such instruments are
subject to the Funds' limitations on investments in illiquid securities. Such
instruments have additional risks beyond conventional debt securities, because
they may entail less legal protection for the Fund or there may be a requirement
that the Fund supply additional cash to a borrower on demand.
Convertible Securities and Warrants. Each of the Funds may invest in debt and
equity securities which may be exchanged for, converted into, or exercised to
acquire a predetermined number of shares of the issuer's common stock at the
option of the holder during a specified time period (such as convertible
preferred stocks, convertible debentures and warrants). Convertible securities
generally pay interest or dividends and provide for participation in the
appreciation of the underlying common stock but at a lower level of risk because
the yield is higher and the security is senior to common stock. Convertible
securities may also include warrants which give the holder the right to purchase
at any time during a specified period a predetermined number of shares of common
stock at a fixed price but which do not pay a fixed dividend. Investments in
warrants involve certain risks, including the possible lack of a liquid market
for resale, potential price fluctuations as a result of speculation or other
factors, and the 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 a Fund's entire investment therein. As a
matter of operating policy, neither Fund will invest more than 5% of its net
assets in warrants.
The value of a convertible security is a function of its "investment value"
(determined by its yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and its
"conversion value" (the security's worth, at market value, if converted into the
underlying common stock). The credit standing of the issuer and other factors
may also affect the investment value of a convertible security. The conversion
value of a convertible security is determined by the market price of the
underlying common stock. If the conversion value is low relative to the
investment value, the price of the
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convertible security is governed principally by its investment value. To the
extent the market price of the underlying common stock approaches or exceeds the
conversion price, the price of the convertible security will be increasingly
influenced by its conversion value.
Like other debt securities, the market value of convertible debt securities
tends to vary inversely with the level of interest rates. The value of the
security declines as interest rates increase and increases as interest rates
decline. Although under normal market conditions longer term debt securities
have greater yields than do shorter term debt securities of similar quality,
they are subject to greater price fluctuations. Fluctuations in the value of a
Fund's investments will be reflected in its and the corresponding Portfolio's
net asset value per share. A convertible security may be subject to redemption
at the option of the issuer at a price established in the instrument governing
the convertible security. If a convertible security held by a Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock or sell it to a third
party.
Junk Bond Considerations. Each of the Funds may invest without limitation in
debt securities rated below "Baa" by Moody's, below "BBB" by S&P or below
investment grade by other recognized rating agencies, or in unrated securities
determined by the Investment Adviser to be of comparable quality if the
Investment Adviser believes that the financial condition of the issuer or the
protection afforded to the particular securities is stronger than would
otherwise be indicated by such low ratings or the lack thereof. Securities rated
below "Baa" or "BBB" or equivalent ratings, commonly referred to as "junk
bonds," are subject to greater risk of loss of income and principal than higher
rated bonds and are considered to be predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal, which may in any case
decline during sustained periods of deteriorating economic conditions or rising
interest rates. Junk bonds are also generally considered to be subject to
greater market risk in times of deteriorating economic conditions and to wider
market and yield fluctuations than higher-rated securities. Junk bonds may also
be more susceptible to real or perceived adverse economic and competitive
industry conditions than investment grade securities. The market for such
securities may be thinner and less active than that for higher-rated securities,
which can adversely affect the prices at which these securities can be sold. To
the extent that there is no established secondary market for lower-rated
securities, a Fund may experience difficulty in valuing such securities and, in
turn, its assets. In addition, adverse publicity and investor perceptions about
junk bonds, whether or not based on fundamental analysis, may tend to decrease
the market value and liquidity of such securities.
Legislation has been and could be adopted limiting the use, or tax and other
advantages, of junk bonds which could adversely affect their value. Under the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989, for
example, federally insured savings and loan associations were required to divest
their investments in non-investment grade corporate debt securities by July 1,
1994. Such legislation could have a material adverse effect on the market for,
and prices of, such securities.
The Investment Adviser will try to reduce the risk inherent in the Funds'
investment in such securities through credit analysis, diversification and
attention to current developments and trends in interest rates and economic
conditions. However, there can be no assurance that losses will not occur. Since
the risk of default is higher for lower-rated bonds, the Investment Adviser's
research and credit analysis are a correspondingly important aspect of its
program for managing the Funds' investments in such debt securities. The
Investment Adviser will attempt to identify those issuers of high-yielding
securities whose financial condition is adequate to meet future obligations, or
has improved or is expected to improve in the future.
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The Funds may purchase securities bearing the lowest ratings issued by Moody's,
S&P or another rating agency, or determined by the Investment Adviser to be of
comparable quality. Debt securities with such ratings are in payment default,
the issuer of such securities may be in bankruptcy, and the securities may be
regarded as having extremely poor prospects of attaining higher ratings.
Non-rated securities will also be considered for investment when the Investment
Adviser believes that the financial condition of the issuers of such securities,
or the protection afforded by the terms of the securities themselves, limit the
risk to a Fund to a degree comparable to that of rated securities which are
consistent with the Fund's investment objective and policies. See "Appendix:
Corporate Bond Ratings" for a description of credit ratings.
Credit ratings evaluate the safety of principal and interest payments of
securities, not their market value. The rating of an issuer is also heavily
weighted by past developments and does not necessarily reflect probable future
conditions. There is frequently a lag between the time a rating is assigned and
the time it is updated. As credit rating agencies may fail to timely change
credit ratings of securities to reflect subsequent events, the Investment
Adviser will also monitor issuers of such securities to determine if such
issuers will have sufficient cash flow and profits to meet required principal
and interest payments and to assure their liquidity. If the rating of a debt
security held by a Fund is downgraded, the Investment Adviser will determine
whether it is in the best interests of the Fund to continue to hold such
security in its investment portfolio.
Synthetic Convertible Securities. Each of the Funds may invest in "synthetic"
convertible securities, which are derivative positions composed of two or more
different securities whose investment characteristics, taken together, resemble
those of convertible securities. For example, a Fund may purchase a
non-convertible debt security and a warrant or option, which enables the Fund to
have a convertible-like position with respect to a company, group of companies
or stock index. Synthetic convertible securities are typically offered by
financial institutions and investment banks in private placement transactions.
Upon conversion, the Fund generally receives an amount in cash equal to the
difference between the conversion price and the then current value of the
underlying security. Unlike a true convertible security, a synthetic convertible
comprises two or more separate securities, each with its own market value.
Therefore, the market value of a synthetic convertible is the sum of the values
of its fixed-income component and its convertible component. For this reason,
the values of a synthetic convertible and a true convertible security may
respond differently to market fluctuations. A Fund will not invest more than 15%
of its net assets in such synthetic securities and other illiquid securities.
See "Illiquid Securities" below.
Eurodollar and Yankee Dollar Instruments. Each of the Funds may invest in
Eurodollar and Yankee Dollar instruments. Eurodollar instruments are bonds that
pay interest and principal in U.S. dollars held in banks outside the United
States, primarily in Europe. Eurodollar instruments are usually issued on behalf
of multinational companies and foreign governments by large underwriting groups
composed of banks and issuing houses from many countries. Yankee dollar
instruments are U.S. dollar denominated bonds issued in the U.S. by foreign
banks and corporations. These investments involve risks that are different from
investments in securities issued by U.S. issuers. See "Foreign Investment
Considerations."
Depository Receipts. Each of the Funds may invest in American Depository
Receipts ("ADRs"), which are receipts issued by an American bank or trust
company evidencing ownership of underlying securities issued by a foreign
issuer. ADRs, in registered form, are designed for use in U.S. securities
markets. The Funds may also invest in European and Global Depository
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Receipts ("EDRs" and "GDRs"), which, in bearer form, are designed for use in
European and foreign securities markets, and in other instruments representing
securities of foreign companies. Such depository receipts may be sponsored by
the foreign issuer or may be unsponsored. Unsponsored depository receipts are
organized independently and without the cooperation of the foreign issuer of the
underlying securities; as a result, available information regarding the issuer
may not be as current as for sponsored depository receipts, and the prices of
unsponsored depository receipts may be more volatile than if they were sponsored
by the issuers of the underlying securities.
Index and Currency-Linked Securities. Each of the Funds may invest in
"index-linked" or "commodity-linked" notes, which are debt securities of
companies that call for interest payments and/or payment at maturity in
different terms than the typical note where the borrower agrees to make fixed
interest payments and to pay a fixed sum at maturity. Principal and/or interest
payments on an index-linked note depend on the performance of one or more market
indices, such as the S&P 500 Index or a weighted index of commodity futures such
as crude oil, gasoline and natural gas. The Funds may also invest in "equity
linked" and "currency-linked" debt securities. At maturity, the principal amount
of an equity-linked debt security is exchanged for common stock of the issuer or
is payable in an amount based on the issuer's common stock price at the time of
maturity. Currency-linked debt securities are short-term or intermediate term
instruments having a value at maturity, and/or an interest rate, determined by
reference to one or more foreign currencies. Payment of principal or periodic
interest may be calculated as a multiple of the movement of one currency against
another currency, or against an index.
Index and currency-linked securities are derivative instruments which may entail
substantial risks. Such instruments may be subject to significant price
volatility. The company issuing the instrument may fail to pay the amount due on
maturity. The underlying investment or security may not perform as expected by
the Investment Adviser. Markets, underlying securities and indexes may move in a
direction that was not anticipated by the Investment Adviser. Performance of the
derivatives may be influenced by interest rate and other market changes in the
U.S. and abroad. Certain derivative instruments may be illiquid. See "Illiquid
Securities" below.
Mortgage-Backed Securities. Each of the Funds may invest in U.S. mortgage-backed
securities. Mortgage-backed securities represent direct or indirect
participations in or obligations collateralized by and payable from mortgage
loans secured by real property. Each mortgage pool underlying mortgage-backed
securities will consist of mortgage loans evidenced by promissory notes secured
by first mortgages or first deeds of trust or other similar security instruments
creating a first lien on real property. An investment in mortgage-backed
securities includes certain risks. Mortgage-backed securities are often subject
to more rapid repayment than their stated maturity dates would indicate as a
result of the pass-through or prepayments of principal on the underlying loans,
which may increase the volatility of such investments relative to similarily
related debt securities. During periods of declining interest rates, prepayment
of loans underlying mortgage-backed securities can be expected to accelerate and
thus impair a Fund's ability to reinvest the returns of principal at comparable
yields. During periods of rising interest rates, reduced prepayment rates may
extend the average life of mortgage-backed securities and increase a Fund's
exposure to rising interest rates. Accordingly, the market values of such
securities will vary with changes in market interest rates generally and in
yield differentials among various kinds of U.S. Government securities and other
mortgage-backed securities.
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The Funds may invest in mortgage pass-through securities, which are fixed or
adjustable rate mortgage-backed securities that provide for monthly payments
that are a "pass-through" of the monthly interest and principal payments
(including any prepayments) made by the individual borrowers on the pooled
mortgage loans, net of any fees or other amounts paid to any guarantor,
administrator and/or servicer of the underlying mortgage loans.
The Funds may also invest in complex investments such as collateralized mortgage
obligations ("CMOs") and stripped mortgage-backed securities. Some of these
securities may have a structure that makes their reaction to interest rates and
other factors difficult to predict, making their value highly volatile. These
securities may also be subject to prepayment risk. CMOs are multiple class
mortgage-backed securities which provide an investor with a specified interest
in the cash flow from a pool of underlying mortgages or of other mortgage-backed
securities. CMOs are issued in multiple classes, each with a specified fixed or
adjustable interest rate and a final distribution date. In most cases, payments
of principal are applied to the CMO classes in the order of their respective
stated maturities, so that no principal payments will be made on a CMO class
until all other classes leaving an earlier stated maturity date are paid in
full. Sometimes, however, CMO classes are "parallel pay" (i.e., payments of
principal are made to two or more classes concurrently). Stripped securities are
the separate income or principal components of a debt security. Their risks are
similar to those of other debt securities, although they may be more volatile
and the values of certain types of stripped securities may move in the same
direction as interest rates.
Other Real Estate-Related Instruments. Each of the Funds may invest in real
estate-related instruments such as securities of real estate investment trusts
and real estate financings. Real estate-related instruments are sensitive to
factors such as changes in real estate values and property taxes, interest
rates, cash flow of underlying real estate assets, overbuilding, and the
management skill and creditworthiness of the issuer. Real estate-related
instruments may also be affected by tax and regulatory requirements, such as
those relating to the environment.
Asset-Backed Securities. Each of the Funds may invest in U.S. asset-backed
securities, which represent participations in, or are secured by and payable
from, assets such as motor vehicle installment sale contracts, installment loan
contracts, leases of various types of real and personal property, receivables
from revolving credit (credit card) agreements and other categories of
receivables. Asset-backed securities may also be collateralized by a portfolio
of U.S. Government securities, but are not direct obligations of the U.S.
Government, its agencies or instrumentalities. Payments or distributions of
principal and interest on asset-backed securities may be guaranteed up to
certain amounts and for a certain time period by a letter of credit or a pool
insurance policy issued by a financial institution, or other credit enhancements
may be present; however, privately issued obligations collateralized by a
portfolio of privately issued asset-backed securities do not involve any
government-related guaranty or insurance.
Asset-backed securities can be structured in several ways, the most common of
which has been a "pass-through" model. A certificate representing a fractional
undivided beneficial interest in a trust or corporation created solely for the
purpose of holding the trust's assets is issued to the asset-backed security
holder. The certificate entitles the holder to receive a percentage of the
interest and principal payments on the terms and according to the schedule
established by the trust instrument. A servicing agent collects amounts due on
the underlying assets for the account of the trust, which distributes such
amounts to the security holders. As an alternative structure, the issuer of
asset-backed securities effectively transforms an asset-backed pool into
obligations comprised of several different maturities. Instead of holding an
undivided interest
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in trust assets, the purchaser of the asset-backed security holds a bond
collateralized by the underlying assets. The bonds are serviced by cash flows
from the underlying assets, a specified fraction of all cash received (less a
fixed servicing fee) being allocated first to pay interest and then to reduce
principal.
Asset-backed securities present certain risks similar to and in addition to
those presented by mortgage-backed securities. Asset-backed securities generally
do not have the benefit of a security interest in collateral that is comparable
to mortgage assets and there is the possibility that, in some cases, recoveries
on repossessed collateral may not be available to support payments on these
securities. Asset-backed securities, however, are not generally subject to the
risks associated with prepayments of principal on the underlying loans.
Equity Securities. Each of the Funds may invest in equity securities, including
common stocks, preferred stocks, convertible securities and warrants. Common
stocks, the most familiar type of equity securities, represent an equity
(ownership) interest in a corporation. Preferred stocks also represent an
ownership interest in a corporation, but pay dividends which have a preference
over dividends paid to the common shareholders of the corporation and have a
preference over common stock upon liquidation of the corporation. See
"Convertible Securities and Warrants" for a description of convertible
securities and warrants.
The Funds may invest in equity securities of companies of any size. These may
include equity securities of growth companies, cyclical companies, companies
with smaller market capitalizations (i.e., $500 million or less at the time of
purchase) or companies believed to be undergoing a basic change in operations or
markets which could result in a significant improvement in earnings. Although
equity securities have a history of long-term growth in value, their prices
fluctuate based on changes in the issuer's financial condition and prospects and
on overall market and economic conditions. Small companies and new companies
often have limited product lines, markets or financial resources, and may be
dependent upon one or few key persons for management. The securities of such
companies may be subject to more volatile market movements than securities of
larger, more established companies, both because the securities typically are
traded in lower volume and because the issuers typically are more subject to
changes in earnings and prospects. To the extent of such investments, a
Portfolio's net asset value can be expected to experience above-average
fluctuations, as above-average risk is assumed by the corresponding Fund in
investing in such growth companies in seeking higher than average growth in
capital.
Eurodollar Convertible Securities. Each of the Funds may invest in Eurodollar
convertible securities, which are fixed income securities of a U.S. issuer or a
foreign issuer that are issued outside the United States and are convertible
into or exchangeable for equity securities of the same or a different issuer.
Interest and dividends on Eurodollar securities are payable in U.S. dollars
outside of the United States. The Funds may invest without limitation in
Eurodollar convertible securities that are convertible into or exchangeable for
foreign equity securities listed, or represented by ADRs listed, on the New York
Stock Exchange or the American Stock Exchange or convertible into or
exchangeable for publicly traded common stock of U.S. companies. The Funds may
also invest up to 15% of its total assets invested in convertible securities,
taken at market value, in Eurodollar convertible securities that are convertible
into or exchangeable for foreign equity securities which are not listed, or
represented by ADRs listed, on such exchanges.
Foreign Investment Considerations. There are special risks associated with the
Funds' investments in securities of foreign companies and governments, which add
to the usual risks inherent in domestic investments. Such special risks include
fluctuations in foreign exchange
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rates, political or economic instability in the country of issue, and the
possible imposition of exchange controls or other laws or restrictions. In
addition, securities prices in foreign markets are generally subject to
different economic, financial, political and social factors than are the prices
of securities in United States markets. With respect to some foreign countries
there may be the possibility of expropriation or confiscatory taxation,
limitations on liquidity of securities or political or economic developments
which could affect the foreign investments of a Fund. Moreover, securities of
foreign issuers generally will not be registered with the Securities and
Exchange Commission and such issuers generally will not be subject to the
Commission's reporting requirements. Accordingly, there is likely to be less
publicly available information concerning certain of the foreign issuers of
securities held by a Fund than is available concerning U.S. companies. Foreign
companies are also generally not subject to uniform accounting, auditing and
financial reporting standards or to practices and requirements comparable to
those applicable to U.S. companies. There may also be less government
supervision and regulation of foreign broker-dealers, financial institutions and
listed companies than exists in the United States. The Fund will not invest in
securities denominated in a foreign currency unless, at the time of investment,
such currency is considered by the Investment Adviser to be fully exchangeable
into United States dollars without legal restriction. See "Investment
Objectives, Policies and Risks--Foreign Investments" in the Statement of
Additional Information.
Special Considerations Regarding Emerging Markets Investments. Investments by
the Funds in securities issued by the governments of emerging or developing
countries, and of companies within those countries, involve greater risks than
other foreign investments. Investments in emerging or developing markets involve
exposure to economic and legal structures that are generally less diverse and
mature (and in some cases the absence of developed legal structures governing
private and foreign investments and private property), and to political systems
which can be expected to have less stability, than those of more developed
countries. The risks of investment in such countries may include matters such as
relatively unstable governments, higher degrees of government involvement in the
economy, the absence until recently of capital market structures or
market-oriented economies, economies based on only a few industries, securities
markets which trade only a small number of securities, restrictions on foreign
investment in stocks, and significant foreign currency devaluations and
fluctuations.
Emerging markets can be substantially more volatile than both U.S. and more
developed foreign markets. Such volatility may be exacerbated by illiquidity.
The average daily trading volume in all of the emerging markets combined is a
small fraction of the average daily volume of the U.S. market. Small trading
volumes may result in a Fund being forced to purchase securities at
substantially higher prices than the current market, or to sell securities at
much lower prices than the current market.
Over-the-Counter Securities. Securities owned by the Funds may be traded in the
over-the-counter market or on a regional securities exchange and may not be
traded every day or in the volume typical of securities trading on a national
securities exchange. As a result, disposition by the Funds of portfolio
securities to meet redemptions by shareholders or otherwise may require the
Funds to sell these securities at a discount from market prices, to sell during
periods when such disposition is not desirable, or to make many small sales over
a lengthy period of time.
Short Sales. The Investment Adviser believes that its growth equity management
approach, in addition to identifying equity securities the earnings and prices
of which it expects to grow at a rate above that of the S&P 500, also identifies
securities the prices of which can be expected to
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decline. Therefore, each Fund is authorized to make short sales of securities it
owns or has the right to acquire at no added cost through conversion or exchange
of other securities it owns (referred to as short sales "against the box") and
to make short sales of securities which it does not own or have the right to
acquire. A short sale that is not made "against the box" is a transaction in
which a Fund sells a security it does not own in anticipation of a decline in
market price. When a Fund makes a short sale, the proceeds it receives are
retained by the broker until the Fund replaces the borrowed security. In order
to deliver the security to the buyer, the Fund must arrange through a broker to
borrow the security and, in so doing, the Fund becomes obligated to replace the
security borrowed at its market price at the time of replacement, whatever that
price may be.
Short sales by a Fund that are not made "against the box" create opportunities
to increase the Fund's return but, at the same time, involve special risk
considerations and may be considered a speculative technique. Since a Fund in
effect profits from a decline in the price of the securities sold short without
the need to invest the full purchase price of the securities on the date of the
short sale, the Fund's net asset value per share, and that of the corresponding
Portfolio, will tend to increase more when the securities it has sold short
decrease in value, and to decrease more when the securities it has sold short
increase in value, than would otherwise be the case if it had not engaged in
such short sales. Short sales theoretically involve unlimited loss potential, as
the market price of securities sold short may continuously increase, although
the Fund may mitigate such losses by replacing the securities sold short before
the market price has increased significantly. Under adverse market conditions a
Fund might have difficulty purchasing securities to meet its short sale delivery
obligations, and might have to sell portfolio securities to raise the capital
necessary to meet its short sale obligations at a time when fundamental
investment considerations would not favor such sales. The value of securities of
any issuer in which a Fund maintains a short position which is "not against the
box" may not exceed the lesser of 2% of the value of the Fund's net assets or 2%
of the securities of such class of the issuer.
If a Fund makes a short sale "against the box", the Fund would not immediately
deliver the securities sold and would not receive the proceeds from the sale.
The seller is said to have a short position in the securities sold until it
delivers the securities sold, at which time it receives the proceeds of the
sale. A Fund's decision to make a short sale "against the box" may be a
technique to hedge against market risks when the Investment Adviser believes
that the price of a security may decline, causing a decline in the value of a
security owned by the Fund or a security convertible into or exchangeable for
such security. In such case, any future losses in the Fund's long position would
be reduced by a gain in the short position.
In the view of the Commission, a short sale involves the creation of a "senior
security" as such term is defined in the Investment Company Act, unless the sale
is "against the box" and the securities sold are placed in a segregated account
(not with the broker), or unless the Fund's obligation to deliver the securities
sold short is "covered" by placing in a segregated account (not with the broker)
cash or U.S. Government securities in an amount equal to the difference between
the market value of the securities sold short at the time of the short sale and
any cash or U.S. Government securities required to be deposited as collateral
with a broker in connection with the sale (not including the proceeds from the
short sale), which difference is adjusted daily for changes in the value of the
securities sold short. The total value of the cash and U.S. Government
securities deposited with the broker and otherwise segregated may not at any
time be less than the market value of the securities sold short at the time of
the short sale. Each Fund will comply with these requirements. In addition, as a
matter of policy, the Master Trust's Board of Trustees has determined that a
Fund will not
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make short sales of securities or maintain a short position if to do so could
create liabilities or require collateral deposits and segregation of assets
aggregating more than 25% of the Fund's total assets, taken at market value.
A Fund's ability to enter into short sales transactions is limited by the
requirements of the Internal Revenue Code with respect to the corresponding
Portfolio's qualification as a regulated investment company. See "Dividends,
Distributions and Taxes" in the Statement of Additional Information.
When-Issued Securities and Firm Commitment Agreements. The Funds may purchase
securities on a delayed delivery or "when-issued" basis and enter into firm
commitment agreements (transactions in which the payment obligation and interest
rate are fixed at the time of the transaction but the settlement is delayed).
Delivery and payment for these securities typically occur 15 to 45 days after
the commitment to purchase. No interest accrues to the purchaser during the
period before delivery. There is a risk in these transactions that the value of
the securities at settlement may be more or less than the agreed upon price, or
that the party with which a Fund enters into such a transaction may not perform
its commitment. The Funds will normally enter into these transactions with the
intention of actually receiving or delivering the securities. The Funds may sell
the securities before the settlement date.
To the extent a Fund engages in any of these transactions it will do so for the
purpose of acquiring securities for its portfolio consistent with its investment
objective and policies and not for the purpose of investment leverage. The Funds
will segregate liquid assets such as cash, U.S. Government securities and other
liquid high quality debt securities in an amount sufficient to meet their
payment obligations with respect to these transactions. A Fund may not purchase
when-issued securities or enter into firm commitments if, as a result, more than
15% of the Fund's net assets would be segregated to cover such contracts.
"Roll" Transactions. The Funds may enter into "roll" transactions, which are the
sale of GNMA certificates and other securities together with a commitment to
purchase similar, but not identical, securities at a later date from the same
party. During the roll period, a Fund forgoes principal and interest paid on the
securities. The Fund is compensated by the difference between the current sales
price and the forward price for the future purchase, as well as by the interest
earned on the cash proceeds of the initial sale. Like when-issued securities or
firm commitment agreements, roll transactions involve the risk that the market
value of the securities sold by the Fund may decline below the price at which
the Fund is committed to purchase similar securities. Additionally, in the event
the buyer of securities under a roll transaction files for bankruptcy or becomes
insolvent, the Fund's use of the proceeds of the transaction may be restricted
pending a determination by the other party, or its trustee or receiver, whether
to enforce the Fund's obligation to repurchase the securities.
The Funds will engage in roll transactions for the purpose of acquiring
securities for their portfolios consistent with their investment objectives and
policies and not for investment leverage. Nonetheless, roll transactions are
speculative techniques and are considered borrowings by the Funds for purposes
of the percentage limitations applicable to borrowings. See "Borrowings" below.
Each Fund will establish a segregated account with its Custodian in which it
will maintain cash, U.S. Government securities and other liquid debt and equity
securities in an amount sufficient to meet its payment obligations with respect
to these transactions. A Fund will not enter into roll transactions if, as a
result, more than 15% of the Fund's net assets would be segregated to cover such
contracts.
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Foreign Exchange Contracts. Since each Fund may invest in securities denominated
in currencies other than the U.S. dollar, changes in foreign currency exchange
rates will affect the values of its portfolio securities and the unrealized
appreciation or depreciation of its investments. The rate of exchange between
the U.S. dollar and other currencies is determined by forces of supply and
demand in the foreign exchange markets. These forces are affected by the
international balance of payments and other economic and financial conditions,
government intervention, speculation and other factors.
A Fund may enter into derivative positions such as foreign exchange forward
contracts or currency futures or options contracts for the purchase or sale of
foreign currency to "lock in" the U.S. dollar price of the securities
denominated in a foreign currency or the U.S. dollar equivalent of interest to
be paid on such securities, or to hedge against the possibility that the
currency of a foreign country in which the Fund has investments may suffer a
decline against the U.S. dollar. 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, a Fund may 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, a Fund might sell a particular currency on either a spot (cash)
basis at the rate then prevailing in the currency exchange market or on a
forward basis by entering into a forward contract to purchase or sell currency,
to hedge against an anticipated decline in the U.S. dollar value of securities
it intends or has contracted to sell. This method of attempting to hedge the
value of a Fund's portfolio securities against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices of the
securities. The Funds are not obligated to engage in any such currency hedging
operations, and there can be no assurance as to the success of any hedging
operations which a Fund may implement. Although the strategy of engaging in
foreign currency transactions could reduce the risk of loss due to a decline in
the value of the hedged currency, it could also limit the potential gain from an
increase in the value of the currency.
Options. Each Fund may purchase exchange-listed and over-the-counter covered
"put" and "call" options with respect to debt securities and currencies which
are otherwise eligible for purchase by such Fund, and broadly-based indexes.
Such options will be purchased for hedging purposes, subject to the following
restrictions: the aggregate premiums on call options purchased by a Fund may not
exceed 5% of the market value of net assets of the Fund as of the date the call
options are purchased, and the aggregate premiums on put options may not exceed
5% of the market value of the net assets of the Fund as of the date such options
are purchased. In addition, a Fund will not purchase or sell options if,
immediately thereafter, more than 25% of its net assets would be hedged. A "put"
gives a holder the right, in return for the premium paid, to require the writer
of the put to purchase from the holder a security at a specified price. A "call"
gives a holder the right, in return for the premium paid, to require the writer
of the call to sell a security to the holder at a specified price.
Put and call options are derivative securities traded on United States and
foreign exchanges, including the American Stock Exchange, Chicago Board Options
Exchange, Philadelphia Stock Exchange, Pacific Stock Exchange and New York Stock
Exchange. Additionally, the Funds may purchase options not traded on a
securities exchange, which may bear a greater risk of nonperformance than
options traded on a securities exchange. Options not traded on an exchange are
considered dealer options and generally lack the liquidity of an exchange traded
option. Accordingly, dealer options may be subject to the Funds' restriction on
investment in
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illiquid securities, as described below. Dealer options may also involve the
risk that the securities dealers participating in such transactions will fail to
meet their obligations under the terms of the option.
Each Fund may also write listed and over-the-counter covered options on up to
25% of the value of its net assets. Call options written by a Fund give the
holder the right to buy the underlying securities from the Fund at a stated
exercise price; put options written by a Fund give the holder the right to sell
the underlying security to the Fund. A call option is covered if the Fund owns
the security underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration upon conversion or
exchange of securities currently held by the Fund. A put option is covered if
the Fund maintains cash or cash equivalents equal to the exercise price in a
segregated amount with its Custodian. If an option written by the Fund expires
unexercised, the Fund realizes a gain equal to the premium received at the time
the option was written. If an option purchased by the Fund expires unexercised,
the Fund realizes a capital loss equal to the premium paid.
Prior to the earlier of exercise or expiration, an option written by a Fund may
be closed out by an offsetting purchase or sale of an option of the same series.
The Fund will realize a gain from a closing purchase transaction if the cost of
the closing transaction is less than the premium received from writing the
option; if it is more, the Fund will realize a capital loss. If the premium
received from a closing sale transaction is more than the premium paid to
purchase the option, the Fund will realize a gain; if it is less, the Fund will
realize a loss.
Futures Contracts. Each Fund may purchase and sell futures contracts as a hedge
against changes in interest rates and market prices and currency fluctuations.
Each Fund may also purchase and sell related options on futures contracts. A
financial or currency futures contract obligates the seller of the contract to
deliver and the purchaser of the contract to take delivery of the type of
financial instrument or currency called for in the contract at a specified
future time (the settlement date) for a specified price. Although the terms of a
contract call for actual delivery or acceptance of the financial instrument or
currency, the contracts normally will be closed out before the delivery date
without delivery or acceptance taking place. Futures options possess many of the
same characteristics as options on securities and indices. 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 of a call
option, the holder acquires a long position in the futures contract and the
writer is assigned the opposite short position. In the case of a put option, the
opposite is true. A futures option may be closed out before exercise or
expiration by an offsetting purchase or sale of a futures option of the same
series.
Financial and currency futures contracts are derivative instruments traded on
United States commodities and futures exchanges, including the Chicago
Mercantile Exchange, the New York Futures Exchange, the Kansas City Board of
Trade, the Chicago Board of Trade and the International Monetary Market, as well
as commodity and securities exchanges located outside the United States,
including the London International Financial Futures Exchange, the Singapore
International Monetary Exchange, the Sydney Futures Exchange Limited and the
Tokyo Stock Exchange.
The Funds will not engage in transactions in futures contracts for speculation,
but only as a hedge against the risk of unexpected changes in interest rates or
other matters. As a general rule, a Fund will not purchase or sell futures if,
immediately thereafter, more than 25% of its net assets would be hedged. In
addition, neither Fund may purchase or sell futures or related options if,
immediately thereafter, the sum of the amount of margin deposits on the Fund's
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existing futures positions and premiums paid for such options would exceed 5% of
the market value of the Fund's net assets. In instances involving 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 Fund's Custodian or with a broker to collateralize the position
and thereby insure that the use of such futures is unleveraged. See "Investment
Objectives, Policies and Risks--Futures Contracts and Related Options" in the
Statement of Additional Information.
Interest Rate and Currency Swaps. For hedging purposes, each Fund may enter into
interest rate and currency swap transactions and purchase or sell interest rate
and currency caps and floors. An interest rate or currency swap involves an
agreement between a Fund and another party to exchange payments calculated as if
they were interest on a specified ("notional") principal amount (e.g., an
exchange of floating rate payments by one party for fixed rate payments by the
other). An interest rate cap or floor entitles the purchaser, in exchange for a
premium, to receive payments of interest on a notional principal amount from the
seller of the cap or floor, to the extent that a specified reference rate
exceeds or falls below a predetermined level.
A Fund usually enters into such transactions on a "net" basis, with the Fund
receiving or paying, as the case may be, only the net amount of the two payment
streams. The net amount of the excess, if any, of a Fund's obligations over its
entitlements with respect to each swap is accrued on a daily basis, and an
amount of cash or high-quality liquid securities having an aggregate net asset
value at least equal to the accrued excess is maintained in a segregated account
by the Master Trust's custodian. If a Fund enters into a swap on other than a
net basis, or sells caps or floors, the Fund maintains a segregated account in
the full amount accrued on a daily basis of the Fund's obligations with respect
to the transaction. Such segregated accounts are maintained in accordance with
applicable regulations of the Commission.
A Fund will not enter into any of these derivative transactions unless the
unsecured senior debt or the claims paying ability of the other party to the
transaction is rated at least "high quality" at the time of purchase by at least
one of the established rating agencies (e.g., AAA or AA by S&P). The swap market
has grown substantially in recent years, with a large number of banks and
investment banking firms acting both as principals and agents utilizing standard
swap documentation, and the Investment Adviser has determined that the swap
market has become relatively liquid. Swap transactions do not involve the
delivery of securities or other underlying assets or principal, and the risk of
loss with respect to such transactions is limited to the net amount of payments
that the Fund is contractually obligated to make or receive. Caps and floors are
more recent innovations for which standardized documentation has not yet been
developed; accordingly, they are less liquid than swaps, and caps and floors
purchased by a Fund are considered to be illiquid assets.
Special Hedging Considerations. Special risks are associated with the use of
options, futures contracts and swap transactions as hedging techniques. There
can be no guarantee of a correlation between price movements in the hedging
vehicle and in the portfolio securities being hedged. A lack of correlation
could result in a loss on both the hedged securities in a Fund and the hedging
vehicle, so that the Fund's return might have been better had hedging not been
attempted. In addition, a decision as to whether, when and how to use options,
futures or swaps involves the exercise of skill and judgment which are different
from those needed to select portfolio securities, and even a well-conceived
transaction may be unsuccessful to some degree because of market behavior,
currency fluctuations or interest rate trends. If the Investment Adviser is
incorrect in its forecasts regarding interest rate trends,
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currency fluctuations or other relevant factors, a Fund may be in a worse
position than if the Fund had not engaged in options, futures or swap
transactions. The loss incurred by a Fund in writing options on futures and
entering into futures and swap transactions is potentially unlimited. The
Investment Adviser is experienced in the use of options, futures and swap
transactions as an investment technique.
In the event of a default by the other party to an over-the-counter option
transaction or a futures or swap transaction, a Fund might incur a loss. In
addition, there can be no assurance that a liquid market will exist at a time
when a Fund seeks to close out an option position or futures or swap contract.
Most futures exchanges and boards of trade limit the amount of fluctuation in
futures contract prices during a single day; once the daily limit has been
reached on a particular contract, no trades may be made that day at a price
beyond that limit. In addition, certain of these instruments are relatively new
and without a significant trading history. As a result, there is no assurance
that an active secondary market will develop or continue to exist. Lack of a
liquid market for any reason may prevent a Fund from liquidating an unfavorable
position and a Fund would remain obligated to meet margin requirements until the
position is closed. See "Investment Objectives, Policies and Risks--Options on
Securities and Securities Indices" and "--Futures Contracts and Related Options"
in the Statement of Additional Information.
A Fund's ability to enter into options, futures contracts and swap transactions
is limited by the requirements of the Internal Revenue Code with respect to the
corresponding Portfolio's qualification as a regulated investment company. See
"Taxes" in the Statement of Additional Information.
Non-Hedging Strategic Transactions (Strategic Income Fund). Each Fund's options,
futures and swap transactions will generally be entered into for hedging
purposes--to protect against possible changes in the market values of securities
held in or to be purchased for the Fund's portfolio resulting from securities
markets, currency or interest rate fluctuations, to protect the Fund's
unrealized gains in the values of its portfolio securities, to facilitate the
sale of such securities for investment purposes, to manage the effective
maturity or duration of the Fund's portfolio, or to establish a position in the
derivatives markets as a temporary substitute for purchase or sale of particular
securities. However, in addition to the hedging transactions referred to above,
the Strategic Income Fund may enter into options, futures and swap transactions
to enhance potential gain in circumstances where hedging is not involved. The
Fund's net loss exposure resulting from transactions entered into for such
purposes will not exceed 5% of the Fund's net assets at any one time and, to the
extent necessary, the Fund will close out transactions in order to comply with
this limitation. Such transactions are subject to the limitations described
above under "Options," "Futures Contracts," and "Interest Rate and Currency
Swaps," and to the same types of risks as described above under "Special Hedging
Considerations."
Closed-End Funds. Closed-end funds in which the Funds may invest are registered
closed-end investment companies with publicly traded shares and which hold
various types of portfolio securities in which the Funds may invest directly.
The extent to which a Fund may invest in closed-end funds is limited by the
Investment Company Act and various state securities or "blue sky" laws.
Accordingly, as a fundamental policy, neither of the Funds will own more than 3%
of the outstanding voting stock of any closed-end investment company, will
invest more than 10% of its total assets in securities issued by closed-end
investment companies nor, together with other investment companies managed by
the Investment Adviser, will own more
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than 10% of any closed-end investment company. Assets of the Funds invested in
closed-end funds are subject to advisory and other fees imposed by the
closed-end fund, as well as to fees imposed by the Funds.
Repurchase Agreements. Each Fund may invest up to 25% of its net assets in
repurchase agreements, in which the Fund purchases securities and the seller
agrees to repurchase them from the Fund at a mutually agreed-upon time and
price. The period of maturity is usually overnight or a few days, although it
may extend over a number of months. The resale price is in excess of the
purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the security. Each Fund's
repurchase agreements will at all times be fully collateralized in an amount at
least equal to 102% of the purchase price, including accrued interest earned on
the underlying securities. The instruments held as collateral are valued daily
and, if the value of the instruments declines, the Fund will require additional
collateral. If the seller defaults and the value of the collateral securing the
repurchase agreement declines, the Fund may incur a loss. If bankruptcy
proceedings are commenced with respect to the seller, realization upon the
collateral by a Fund may be delayed or limited. A Fund will only enter into
repurchase agreements involving securities in which it could otherwise invest
and with selected financial institutions and brokers and dealers which meet
certain creditworthiness and other criteria.
Reverse Repurchase Agreements. Each Fund may enter into reverse repurchase
agreements, which involve the sale of a security by a Fund and its agreement to
repurchase the security (or, in the case of mortgage-backed securities,
substantially similar but not identical securities) at a specified time and
price. A Fund will maintain in a segregated account with the Custodian cash,
U.S. Government securities or other appropriate liquid, high-grade debt
obligations in an amount sufficient to cover its obligations under these
agreements with broker-dealers (no such collateral is required on such
agreements with banks). Under the 1940 Act, these agreements are considered
borrowings by the Funds, and are subject to the percentage limitations on
borrowings described below. The agreements are subject to the same types of
risks as borrowings.
Illiquid Securities. Each Fund may invest up to 15% of its net assets in
securities that at the time of purchase have legal or contractual restrictions
on resale or are otherwise illiquid. Historically, illiquid securities have
included securities subject to contractual or legal restrictions on resale
because they have not been registered under the Securities Act of 1933
("restricted securities"), securities which are otherwise not readily marketable
such as over-the-counter, or dealer traded, options, and repurchase agreements
having a maturity of more than seven days. Mutual funds do not typically hold a
significant amount of restricted or other illiquid securities because of the
potential for delays on resale and uncertainty in valuation. Limitations on
resale may have an adverse effect on the marketability of portfolio securities
and the Fund might not be able to dispose of restricted or other securities
promptly or at reasonable prices and might thereby experience difficulty
satisfying redemptions. The Fund might also have to register such restricted
securities in order to dispose of them, resulting in additional expense and
delay.
In recent years, however, a large institutional market has developed for certain
securities that are not registered under the Securities Act of 1933, including
repurchase agreements, commercial paper, municipal securities and corporate
bonds and notes. Institutional investors depend on an efficient institutional
market in which the unregistered security can be readily resold or on an
issuer's ability to honor a demand for repayment. The fact that there are
contractual or legal restrictions on resale to the general public or to certain
institutions may
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not be indicative of the liquidity of such investments. If such securities are
subject to purchase by institutional buyers in accordance with Rule 144A
promulgated by the Securities and Exchange Commission under the Securities Act
of 1933, the Investment Adviser, pursuant to guidelines adopted by the Master
Trust's Board of Trustees, may determine that such securities are not illiquid
securities notwithstanding their legal or contractual restrictions on resale,
based on factors such as the frequency of trades and quotes for the securities,
the number of dealers and others wishing to purchase and sell the securities,
and the nature of the security and the marketplace trades. In all other cases,
however, securities subject to restrictions on resale will be deemed illiquid.
Investing in restricted securities eligible for resale pursuant to Rule 144A
could have the effect of increasing the level of illiquidity in the Funds to the
extent that qualified institutional buyers become for a time uninterested in
purchasing such securities.
Securities Lending. To increase its income, each Fund may lend its portfolio
securities to financial institutions such as banks and brokers if the loan is
collateralized in accordance with applicable regulatory requirements. The Master
Trust's Board of Trustees has adopted an operating policy that limits the amount
of loans made by a Fund to not more than 30% of the value of the total assets of
the Fund. During the time portfolio securities are on loan, the borrower pays
the Fund an amount equivalent to any dividends or interest paid on such
securities, and the Fund may invest the cash collateral and earn additional
income, or it may receive an agreed-upon amount of interest income from the
borrower who has delivered equivalent collateral or secured a letter of credit.
Such loans involve risks of delay in receiving additional collateral or in
recovering the securities loaned or even loss of rights in the collateral should
the borrower of the securities fail financially. However, such securities
lending will be made only when, in the Investment Adviser's judgment, the income
to be earned from the loans justifies the attendant risks. Loans are subject to
termination at the option of the Fund or the borrower.
Borrowing. Each Fund may borrow money from banks in amounts up to 20% of its
total assets (calculated when the loan is made) for temporary, extraordinary or
emergency purposes or for the clearance of transactions. In addition, the
Strategic Income Fund may borrow from banks to buy securities, so long as its
total borrowings for this and other purposes do not exceed 33 1/3% of the value
of its total assets. Borrowing involves special risk considerations. Since
substantially all of a Fund's assets fluctuate in value, whereas the interest
obligation resulting from a borrowing will be fixed by the terms of the Fund's
agreement with its lender, the asset value per share of the Fund will tend to
increase more when its portfolio securities increase in value, and to decrease
more when its portfolio assets decrease in value, than would otherwise be the
case if the Fund did not borrow funds. In addition, interest costs on borrowings
may fluctuate with changing market rates of interest and may partially offset or
exceed the return earned on borrowed funds (or on the assets that were retained
rather than sold to meet the needs for which funds were borrowed). Under adverse
market conditions, a Fund might have to sell portfolio securities to meet
interest or principal payments at a time when fundamental investment
considerations would not favor such sales. All borrowings by a Fund 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.
If such asset coverage of 300% is not maintained, the Fund will take prompt
action to reduce its borrowings as required by applicable law.
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CORPORATE BOND RATINGS
Description of Moody's Corporate Bond Ratings
Aaa -- Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt edge."
Interest payments are protected by a large or by an exceptionally stable margin
and principal is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa -- Bonds rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A -- Bonds rated A possess many favorable investment attributes and are to be
considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa -- Bonds rated Baa are considered as medium-grade obligations (I.E., they
are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba -- Bonds rated Ba are judged to have speculative elements; their future
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B -- Bonds rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or maintenance of other terms of
the contract over any long period of time may be small.
Caa -- Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca -- Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked short-comings.
C -- Bonds rated C are the lowest-rated class of bonds, and such issues can be
regarded as having extremely poor prospects of ever attaining any real
investment standing.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
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Description of S&P's Corporate Bond Ratings:
AAA -- Debt rated AAA has the highest rating assigned by Standard & Poor's to a
debt obligation. Capacity to pay interest and repay principal is extremely
strong.
AA -- Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher-rated issues only in small degree.
A -- Debt rated A has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB -- Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
BB -- Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B -- Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB- rating.
CCC -- Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial, or economic conditions, it is not likely to have
the capacity to pay interest and repay principal. The CCC rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied B or B- Rating.
CC -- Debt rated CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating.
C -- The Rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC- debt rating. The C rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI -- The rating CI is reserved for income bonds on which no interest is being
paid.
D -- Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating will also be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
The ratings from AA to CCC may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
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PRIOR PERFORMANCE OF INVESTMENT ADVISER
The following table sets forth the Investment Adviser's composite performance
data relating to the historical performance of institutional private accounts
managed by the Investment Adviser, since the dates indicated, that have
investment objectives, policies, strategies and risks substantially similar to
those of the High Yield Bond and Strategic Income Institutional Portfolios. The
data is provided to illustrate the past performance of the Investment Adviser in
managing substantially similar accounts as measured against specified market
indices and does not represent the performance of the High Yield Bond and
Strategic Income Portfolios. Investors should not consider this performance data
as an indication of future performance of the High Yield Bond and Strategic
Income Institutional Portfolios or of the Investment Adviser.
The Investment Adviser's composite performance data shown below were calculated
in accordance with recommended standards of the Association for Investment
Management and Research ("AIMR"*), retroactively applied to all time periods.
All returns presented were calculated on a total return basis and include all
dividends and interest, accrued income and realized and unrealized gains and
losses. All returns reflect the deduction of investment advisory fees, brokerage
commissions and execution costs paid by the Investment Adviser's institutional
private accounts, without provision for federal or state income taxes. Custodial
fees, if any, were not included in the calculation. The Investment Adviser's
composites include all actual, fee-paying, discretionary institutional private
accounts managed by the Investment Adviser that have investment objectives,
policies, strategies and risks substantially similar to those of the High Yield
Bond and Strategic Income Portfolios. Securities transactions are accounted for
on the trade date and accrual accounting is utilized. Cash and equivalents are
included in performance returns. The monthly returns of each of the Investment
Adviser's composites combine the individual accounts' returns (calculated on a
time-weighted rate of return that is revalued whenever cash flows exceed $500)
by asset-weighing each individual account's asset value as of the beginning of
the month. Quarterly and yearly returns are calculated by geometrically linking
the monthly and quarterly returns, respectively. The yearly returns are computed
by geometrically linking the returns of each quarter within the calendar year.
The institutional private accounts that are included in the Investment Adviser's
composites are not subject to the same types of expenses to which the High Yield
Bond and Strategic Income Portfolios are subject nor to the diversification
requirements, specific tax restrictions and investment limitations imposed on
the High Yield Bond and Strategic Income Portfolios by the Investment Company
Act or Subchapter M of the Internal Revenue Code. Consequently, the performance
results for each of the Investment Adviser's composites could have been
adversely affected if the institutional private accounts included in the
composite had been regulated as investment companies under the federal
securities laws.
- --------------
* AIMR is a non-profit membership and education organization with more than
60,000 members worldwide that, among other things, has formulated a set of
performance presentation standards for investment advisers. These AIMR
performance presentation standards are intended to (i) promote full and fair
presentations by investment advisers of their performance results, and (ii)
ensure uniformity in reporting so that performance results of investment
advisers are directly comparable.
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<PAGE>
The investment results of the Investment Advisers composites presented below are
unaudited and are not intended to predict or suggest the returns that might be
experienced by the High Yield Bond or Strategic Income Institutional Portfolios
or an individual investing in such Portfolios. Investors should also be aware
that the use of a methodology different from that used below to calculated
performance could result in different performance data.
<TABLE>
<CAPTION>
Strategic Income Performance
High Yield Bond Performance -------------------------------------------------
-------------------------------------------------------------- Lehman Bros.
Investment Lehman Bros. Merrill Lynch First Boston Investment Mortgage- First Boston
Adviser's High Yield High Yield High Yield Adviser's Backed Securities High Yield
Year Composite Index(1) Master Index(2) Index(3) Composite Index(4) Index(3)
- -------------- ------------- --------------- --------------- ------------- ------------- ----------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
1994(5)....... 1.45% 0.95% 0.88% 0.09%
1995.......... 19.38 19.17 19.89 17.36
1996(5),(6)... 9.36 3.48 2.85 3.77 5.34% 0.35% 3.77%
Last
year(6)...... 12.51 9.68 9.37 9.97
Since
inception(6)... 13.32 10.23 10.10 9.22 5.34* 0.35* 3.77*
</TABLE>
- ----------------
(1) The Lehman Brothers High Yield Index includes all U.S. domestic fixed income
securities having a maximum quality rating of Ba1 by Moody's (including
defaulted issues), a minimum principal amount outstanding of $100 million,
and a remaining term to maturity of at least one year, other than
payment-in-kind securities and Eurobonds. The Index reflects the
reinvestment of income, if any, but does not reflect fees, dealer markups,
or other expenses of investing.
(2) The Merrill Lynch High Yield Master Index includes all publicly placed
nonconvertible, coupon-bearing U.S. domestic debt securities with a
remaining term to maturity of at least one year, with par amounts
outstanding of at least $10 million at the start and close of the
performance measurement period, other than floating rate debt, equipment
trust certificates and Title 11 securities. Issues must be rated as less
than investment grade by Standard & Poor's or Moody's, but not in default.
The index reflects the reinvestment of income, if any, but does not reflect
fees, dealer markups, or other expenses of investing.
(3) The First Boston High Yield Index includes over 180 U.S. domestic issues
with an average maturity range of seven to ten years and with a minimum
issue size of $100 million. The Index reflects the reinvestment of income,
if any, but does not reflect fees, dealer markups, or other expenses of
investing.
(4) The Lehman Brothers Mortgage-Backed Securities Index is composed of all
fixed-rate, securitized mortgage pools of GNMA, FNMA and the FHLMC,
including GNMA Graduated Payment Mortgages, with a principal amount of at
least $50 million. The Index reflects the reinvestment of income, if any,
but does not reflect fees, dealer markups, or other expenses of investing.
(5) Commencement of investment operations is April 1, 1994 for the High Yield
Bond Composite and January 1, 1996 for the Strategic Income Composite.
(6) Through June 30, 1996.
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INSTINCPRO896
