PRINCIPAL SPECIAL MARKETS FUND, INC.
International Securities Portfolio
Mortgage-Backed Securities Portfolio
The Principal Financial Group(R)
Des Moines, Iowa 50392-0200
1-800-521-1502
Principal Special Markets Fund, Inc. (the "Fund") is a no-load, open-end
management investment company, currently consisting of two series
("Portfolios"), each of which is classified as a diversified investment company.
Each Portfolio is designed to meet the investment needs of institutions,
corporations and high net worth individuals desiring professional investment
management for the type of securities in which each Portfolio invests. The
investment objective of each Portfolio is as follows:
International Securities Portfolio: Long-term growth of capital by investing in
a portfolio of securities of companies domiciled in any of the nations of the
world.
Mortgage-Backed Securities Portfolio: A total investment return consisting of
current income and capital appreciation while maintaining liquidity and safety
of principal. The Portfolio seeks to achieve its objective through the purchase
of mortgage-backed securities and other obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities. Portfolio shares
are not guaranteed by the United States Government.
This Prospectus concisely states information that an investor ought to know
before investing. It should be read and retained for future reference.
Additional information about the Fund has been filed with the Securities and
Exchange Commission, including a document called a Statement of Additional
Information dated May 1, 1996 which is incorporated by reference herein. The
Statement of Additional Information can be obtained free of charge by writing or
telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines,
Iowa 50306-0423. Telephone 1-800-521-1502.
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.
The date of this Prospectus is May 1, 1996.
TABLE OF CONTENTS
Page
Summary................................................................. 3
Financial Highlights.................................................... 5
Investment Objectives, Policies and Restrictions........................ 5
Certain Investment Policies and Restrictions............................ 8
Risk Factors............................................................ 9
Manager and Investment Sub-Advisor ..................................... 9
Duties Performed by the Manager and Sub-Advisor......................... 10
Managers' Comments...................................................... 10
Determination of Net Asset Value ....................................... 12
Performance Calculation ................................................ 12
Shareholder Rights ............................. 12
Distribution of Income Dividends and Realized Capital Gains ............ 13
Tax Treatment, Dividends and Distributions ............................. 13
How to Invest .......................................................... 14
Offering Price of Shares ............................................... 15
Minimum Investment Requirement.......................................... 15
Open Account System..................................................... 15
Redemption of Shares.................................................... 16
Periodic Withdrawal Plan................................................ 17
Additional Information.................................................. 17
This Prospectus does not constitute an offer to sell, or a solicitation of
an offer to buy, the securities of any Portfolio in any jurisdiction in which
such sale, offer to sell, or solicitation may not be lawfully made. No dealer,
salesperson, or 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 in this Prospectus, and, if given or made,
such other information or representations must not be relied upon as having been
authorized by Principal Special Markets Fund, Inc. or its Manager or
Sub-Advisor.
SUMMARY
The following summarized information should be read in conjunction with the
detailed information appearing elsewhere in the Prospectus.
What benefits are offered investors?
Professional Investment Management: Experienced securities analysts provide each
Portfolio with professional investment management.
Diversification: Each Portfolio will diversify by investing in securities issued
by a number of issuers. Diversification reduces investment risk.
Economies of Scale: Pooling individual shareholder's investments in either of
the Portfolios creates administrative efficiencies and in certain circumstances
saves on brokerage commissions through the purchase of larger blocks of
securities.
Liquidity: Upon request each Portfolio will redeem its shares and promptly pay
the investor the current net asset value next determined of the shares redeemed.
See "Redemption of Shares."
Dividends: Each Portfolio will normally declare a dividend payable from
investment income in accordance with its distribution policy. See "Distribution
of Income Dividends and Realized Capital Gains."
Convenient Investment and Recordkeeping Services: Shareholders will receive a
statement of account each time there is activity in their account.
No Sales Charge: Each Portfolio offers its shares at net asset value, without a
sales charge.
What are the Portfolio investment objectives?
The investment objective of the International Securities Portfolio is to seek
long-term growth of capital by investing in a portfolio of securities of
companies domiciled in any of the nations of the world.
The investment objective of the Mortgage-Backed Securities Portfolio is to
generate a total investment return consisting of current income and capital
appreciation while maintaining liquidity and safety of principal. The Portfolio
seeks to achieve its objective through the purchase of mortgage-backed
securities and other obligations issued or guaranteed by the United States
Government or its agencies or instrumentalities. Portfolio shares are not
guaranteed by the United States Government.
There can be no assurance that the investment objectives will be realized. See
"Investment Objectives, Policies and Restrictions."
What are the risk factors?
Because each Portfolio has a different investment objective, each Portfolio is
subject to different financial and market risks. Financial risk refers to the
earnings stability and overall financial soundness of an issuer of an equity
security and to the ability of an issuer of a debt security to pay interest and
principal when due. Market risk refers to the degree to which the price of a
security will react to changes in securities markets in general and, with
particular reference to debt securities, to changes in the overall level of
interest rates. See "Risk Factors", and "Investment Objectives, Policies and
Restrictions."
What minimum amount may be invested?
The minimum initial purchase in the Fund is $1.0 million. The minimum initial
purchase of $1.0 million may be invested over a three month period. Investments
in both Portfolios by an investor, investor's spouse and dependent children, or
a trustee may be combined to meet this minimum. There is no minimum for
subsequent investments. Each Portfolio may involuntarily redeem all shares in an
account which, after a redemption, has a value of less than $5,000 and mail the
proceeds of such redemption to the shareholder at the address of record. See
"Minimum Investment Requirement."
How may investments be withdrawn?
Withdrawals, which are also known as redemptions, may be made by mail or by
telephone if telephone transaction services apply to the account. Upon proper
authorization certain redemptions may be processed through a selected dealer.
Redemptions may also be made through a Periodic Withdrawal Plan. Withdrawals are
made at net asset value without charge. See "Redemption of Shares."
Who manages each Portfolio?
Princor Management Corporation, a corporation organized in 1969 by Principal
Mutual Life Insurance Company, is the Manager for each of the Portfolios. It is
also the dividend disbursing and transfer agent. See "Manager." Invista Capital
Management, Inc. ("Invista"), an indirect wholly-owned subsidiary of Principal
Mutual Life Insurance Company and an affiliate of the Manager, has executed an
agreement with the Manager to assume the obligations of the Manager to provide
investment advisory services for each Portfolio.
What fees and expenses apply to ownership of shares?
The following table depicts fees and expenses applicable to the purchase and
ownership of shares of each Portfolio.
Shareholder Transaction Expenses
Maximum Sales Load Imposed
on Purchases
Portfolio (as a percentage of offering price) Redemption Fee
International Securities Portfolio None None*
Mortgage-Backed Securities Portfolio None None*
Annual Portfolio Operating Expenses
(as a percentage of average net assets)
Management 12b-1 Other Total Operating
Portfolio Fee Fee Expenses** Expenses
International Securities Portfolio .90% None None .90%
Mortgage-Backed Securities Portfolio .45% None None .45%
* A wire charge of up to $6.00 will be deducted for all wire transfers.
**In addition to brokerage and extraordinary expenses, a Portfolio will pay only
taxes and interest expenses, which it is anticipated will be minimal or
nonexistent under normal circumstances.
The purpose of the above table is to assist the investor in understanding the
various expenses that an investor in each Portfolio will bear directly or
indirectly. The fee payable by the International Securities Portfolio is higher
than that paid by most funds to their advisors, but it is not higher than the
fees paid by many funds with similar investment objectives and policies and does
cover substantially all expenses of the Portfolio, unlike many other funds. See
"How to Invest" and "Duties Performed by the Manager and Sub-Advisor."
Examples
You would pay the following expenses on a $1,000 investment, assuming (1) 5%
annual return and (2) redemption at the end of each time period:
Period (in years)
Fund 1 3 5 10
----
International Securities Portfolio $9 $29 $50 $111
Mortgage-Backed Securities Portfolio $5 $14 $25 $57
The Examples are based on each Portfolio's Annual Operating Expenses described
above. The Examples should not be considered a representation of past or future
expenses; actual expenses may be greater or less than those shown.
FINANCIAL HIGHLIGHTS
The following financial highlights have been derived from financial statements
which have been audited by Ernst & Young LLP, independent auditors, whose report
thereon has been incorporated by reference herein. The financial highlights
should be read in conjunction with the financial statements, related notes and
other financial information for each portfolio incorporated by reference herein.
The financial statements may be obtained by shareholders, without charge, by
telephoning 1-800-451-5447.
<TABLE>
<CAPTION>
Principal Special Markets Fund
International Securities
Portfolio
Year Year Period
Ended Ended Ended
Dec. 31, Dec. 31, Dec. 31,
1995 1994 1993(a)
<S> <C> <C> <C>
Net Asset Value at Beginning of Period.......................... $11.29 $12.87 $10.01
Income from Investment Operations:
Net Investment Income...................................... .19 .13 .07
Net Realized and Unrealized Gains (Losses) on
Investments and Foreign Currency......................... 1.11 (.95) 2.91
.........................Total from Investment Operations 1.30 (.82) 2.98
Less Distributions:
Dividends (from net investment income)..................... (.10) (.12) (.10)
Excess distribution of net investment income .............. (.07) (.13) --
--..............................................
Distributions (from capital gains)......................... (.72) (.51) (.02)
......................................Total Distributions (.89) (.76) (.12)
Net Asset Value at End of Period................................ $11.70 $11.29 $12.87
Total Return.................................................... 12.02% (6.45)% 29.95%(c)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands)................... $17,251 $15,542 $16,838
Ratio of Expenses to Average Net Assets.................... .90% .90% .90%(b)
Ratio of Net Investment Income to Average Net Assets....... 1.79% .94% 1.21%(b)
Portfolio Turnover Rate......................................... 46.0% 37.0% 6.9%(b)
</TABLE>
<TABLE>
<CAPTION>
Principal Special Markets Fund
Mortgage-Backed Securities
Portfolio
Year Year Period
Ended Ended Ended
Dec. 31, Dec. 31, Dec. 31,
1995 1994 1993(a)
<S> <C> <C> <C>
Net Asset Value at Beginning of Period.......................... $ 9.11 $10.10 $10.01
Income from Investment Operations:
Net Investment Income...................................... .65 .63 .34
Net Realized and Unrealized Gains (Losses) on
Investments and Foreign Currency......................... 1.06 (.99) .09
Total from Investment Operations 1.71 (.36) .43
Less Distributions:
Dividends (from net investment income)..................... (.65) (.63) (.34)
Excess distribution of net investment income .............. -- -- --
Distributions (from capital gains)......................... -- -- --
Total Distributions (.65) (.63) (.34)
Net Asset Value at End of Period................................ $10.17 $ 9.11 $10.10
Total Return.................................................... 19.26% (3.60)% 4.47%(c)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands)................... $14,523 $14,714 $24,309
Ratio of Expenses to Average Net Assets.................... .45% .45% .45%(b)
Ratio of Net Investment Income to Average Net Assets....... 6.66% 6.56% 5.23%(b)
Portfolio Turnover Rate......................................... 9.9% 41.8% 9.6%(b)
<FN>
(a) Period from May 7, 1993, date shares first offered to the public, through
December 31, 1993. Net investment income, aggregating $.01 per share for
the International Securities Portfolio and $.01 per share for the
Mortgage-Backed Securities Portfolio for the period from the initial
purchase of shares on April 26, 1993 through May 6, 1993, was recognized,
none of which was distributed from the International Securities Portfolio
and all of which was distributed from the Mortgage-Backed Securities
Portfolio to the sole shareholder, Principal Mutual Life Insurance Company,
during the period. Additionally, the Mortgage-Backed Securities Portfolio
incurred unrealized gains on investments of $.01 per share during the
initial interim period. This represented activities of each portfolio prior
to the initial offering.
(b) Computed on an annualized basis.
(c) Total return amounts have not been annualized.
</FN>
</TABLE>
INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
The investment objectives and policies of the Portfolios are described below.
There can be no assurance that the objectives will be realized.
International Securities Portfolio
The investment objective is to seek long-term growth of capital through
investment in a portfolio of securities of companies domiciled in any of the
nations of the world. In choosing investments, which will consist primarily of
equity securities of foreign corporations, Invista intends to pay particular
attention to long-term earnings prospects and the relationship of then-current
prices to such prospects. Short-term trading is not generally intended, but
occasional investments may be made for the purpose of seeking short-term or
medium-term gain. The Portfolio expects its investment objective to be met over
long periods which may include several market cycles. For a description of
certain investment risks and tax implications associated with foreign
securities, see "Risk Factors," and "Tax Treatment, Dividends and
Distributions."
The Portfolio will seek to be fully invested under normal conditions in the
following equity securities: common stocks; preferred stocks and debt securities
that are convertible into common stock, that carry rights or warrants to
purchase common stock or that carry rights to participate in earnings; rights or
warrants to subscribe to or purchase any of the foregoing securities; and
sponsored and unsponsored American Depository Receipts (ADRs) based on any of
the foregoing securities. Unsponsored ADRs are not created by the issuer of the
underlying security, may be subject to fees imposed by the issuing bank that, in
the case of sponsored ADRs, would be paid by the issuer of a sponsored ADR and
may involve additional risks such as reduced availability of information about
the issuer of the underlying security.
The Portfolio intends that its investments normally will be allocated among
various countries. Although there is no limitation on the percentage of assets
that may be invested in any one country or denominated in any one currency, the
Portfolio intends under normal market conditions to have at least 65% of its
assets invested in securities issued by corporations of at least three countries
other than the United States. Investments may be made anywhere in the world, but
it is expected that primary consideration will be given to investing in the
securities issued by corporations of Western Europe, North America and
Australasia (Australia, Japan and Far East Asia) that have developed or
developing economies. Changes in investments may be made as prospects change for
particular countries, industries or companies.
The Fund may invest in the securities of other investment companies but may not
invest more than 10% of its assets in securities of other investment companies,
invest more than 5% of its total assets in the securities of any one investment
company, or acquire more than 3% of the outstanding voting securities of any one
investment company except in connection with a merger, consolidation or plan of
reorganization. The Fund's Manager will waive its management fee on the Fund's
assets invested in securities of other open-end investment companies. The Fund
will generally invest only in those investment companies that have investment
policies requiring investment in securities comparable in quality to those in
which the Fund invests.
When in the opinion of Invista current market or economic conditions warrant,
the Portfolio may for temporary defensive purposes place all or a portion of its
assets in cash, on which the Portfolio would earn no income, cash equivalents,
bank certificates of deposit, bankers acceptances, repurchase agreements,
commercial paper, commercial paper master notes which are floating rate debt
instruments without a fixed maturity, government securities, and preferred stock
and investment grade debt securities, whether or not convertible into or
carrying rights for common stock. These securities may be issued by domestic or
foreign corporations, governments or governmental agencies, instrumentalities or
political subdivisions and may be denominated in United States dollars or some
other currency. When investing for temporary defensive purposes, the Portfolio
is not investing so as to achieve its investment objective. The Portfolio may
also maintain reasonable amounts in cash or short-term debt securities (rated by
a nationally recognized statistical rating organization in one of the two
highest rating categories for short-term debt obligations) for daily cash
management purposes or pending selection of particular long-term investments.
Mortgage-Backed Securities Portfolio
The investment objective is to generate a total investment return consisting of
current income and capital appreciation while maintaining liquidity and safety
of principal.
The Portfolio will invest in mortgage-backed securities and other obligations
issued or guaranteed by the United States Government or by its agencies or
instrumentalities ("U.S. Government Securities") and in repurchase agreements
collateralized by such obligations. Under normal market conditions, the
Portfolio intends to invest at least 65% of its assets in mortgage-backed
securities. The U.S. Government Securities in which the Portfolio intends to
invest include Government National Mortgage Association ("GNMA") Certificates of
the modified pass-through type, Federal National Mortgage Association ("FNMA")
Obligations, Federal Home Loan Mortgage Corporation ("FHLMC") Certificates and
Student Loan Marketing Association ("SLMA") Certificates and collateralized
mortgage obligations issued by private issuers for which the underlying
mortgage-backed securities serving as collateral are guaranteed by the U.S.
Government or its agencies or instrumentalities. GNMA is a wholly-owned
corporate instrumentality of the United States whose securities and guarantees
are backed by the full faith and credit of the United States. FNMA, a federally
chartered and privately-owned corporation, FHLMC, a federal corporation, and
SLMA, a government sponsored stockholder-owned organization, are
instrumentalities of the United States. The securities and guarantees of FNMA,
FHLMC and SLMA are backed by the credit of the issuing organization but are not
backed, directly or indirectly, by the full faith and credit of the United
States. Although the Secretary of the Treasury of the United States has
discretionary authority to lend FNMA up to $2.25 billion outstanding at any
time, neither the United States nor any agency thereof is obligated to finance
the operations of FNMA, FHLMC or SLMA or to assist them in any other manner. The
Portfolio may maintain reasonable amounts of cash or short-term debt securities
for daily cash management purposes or pending selection of particular long-term
investments.
GNMA Certificates are mortgage-backed securities representing an interest in a
pool of mortgage loans. Such loans are made by lenders such as mortgage bankers,
insurance companies, commercial banks and savings and loan associations. Then,
they are either insured by the Federal Housing Administration (FHA) or they are
guaranteed by the Veterans Administration (VA) or Farmers Home Administration
(FmHA). The lender or other prospective issuer creates a specific pool of such
mortgages, which it submits for approval to GNMA, a United States Government
corporation within the Department of Housing and Urban Development. After
approval, a GNMA Certificate is typically offered by the issuer to investors
through securities dealers.
GNMA Certificates differ from bonds in that the principal is scheduled to be
paid back by the borrower on a monthly basis over the life of the loan rather
than returned in a lump sum at maturity. Modified pass-through GNMA Certificates
entitle the holder to receive all interest and principal payments owed on the
mortgages in the pool whether or not the mortgagor has made such payment. The
timely payment of interest and principal is guaranteed by the full faith and
credit of the United States Government.
Although the payment of interest and principal is guaranteed, the guarantee does
not extend to the value of a GNMA Certificate or the value of the shares of the
Portfolio. The market value of a GNMA Certificate typically will fluctuate to
reflect changes in prevailing interest rates. It falls when rates increase (as
does the market value of other debt securities) and it rises when rates decline
(but it may not rise on a comparable basis with other debt securities because of
its prepayment feature), and, therefore, may be more or less than the face
amount of the GNMA Certificate, which reflects the aggregate principal amount of
the underlying mortgages. As a result the net asset value of shares will
fluctuate as interest rates change.
Mortgagors may pay off their mortgages at any time. Prepayments of the
mortgages can affect the market value of the GNMA Certificate and the return
ultimately received. Prepayments, like scheduled payments of principal, are
reinvested by the Portfolio at prevailing interest rates which may be less than
the rate on the GNMA Certificate. Prepayments are likely to increase as the
interest rate for new mortgages moves lower than the rate on the GNMA
Certificate. Moreover, if the GNMA Certificate had been purchased at a premium
above principal because its rate exceeded prevailing rates, the premium is not
guaranteed and a decline in value to par may result in a loss of the premium
especially in the event of prepayment.
The FNMA and FHLMC securities in which the Portfolio invests are very similar to
GNMA certificates as described above but are not guaranteed by the full faith
and credit of the United States but rather by the agency itself. FNMA and FHLMC
securities are rated Aaa by Moody's and AAA by Standard & Poor's. These ratings
reflect the status of FNMA and FHLMC as federal agencies as well as the
important role each plays in financing purchases of homes in the U.S.
Student Loan Marketing Association is a government sponsored stockholder-owned
organization whose goal is to provide liquidity to financial and educational
institutions. SLMA provides liquidity by purchasing student loans, which are
principally government guaranteed loans issued under the Federal Guaranteed
Student Loan Program and the Health Education Assistance Loan Program. SLMA
securities are not guaranteed by the U.S. Government but are obligations solely
of the agency. SLMA senior debt issues in which the Fund invests are rated AAA
by Standard & Poor's and Aaa by Moody's.
There are other obligations issued or guaranteed by the United States Government
(such as U.S. Treasury securities) or by its agencies or instrumentalities that
are either supported by the full faith and credit of the U.S. Treasury or the
credit of a particular agency or instrumentality. Included in the latter
category are Federal Home Loan Bank and Farm Credit Banks. Obligations not
guaranteed by the United States Government are highly rated because they are
issued by indirect branches of government. Such obligations are issued as needs
arise by an agency and are traded regularly in denominations similar to those in
which government obligations are traded.
The Portfolio may enter into contracts with dealers in securities whereby the
Portfolio agrees to purchase or sell an agreed-upon principal amount of the
securities at a specified price on a certain date. The Portfolio may enter into
similar purchase agreements with issuers of securities other than Principal
Mutual Life Insurance Company. The Portfolio may also purchase optional delivery
standby commitments which give the Portfolio the right to sell particular
securities at a specified price on a specified date. Failure of the other party
to such a contract or commitment to abide by the terms thereof could result in a
loss to the Portfolio. When the Portfolio enters into a forward commitment
contract to purchase securities, it assumes the rights and risks of an owner of
the securities, including the risk of price and yield fluctuation. The Portfolio
accrues no interest until the securities are delivered, and although payment for
and delivery of the securities will occur at a later date, it records the
purchase price as a liability and segregates portfolio assets having a value
equal to the purchase price. The availability of liquid assets for this purpose
and the effect of asset segregation on the Portfolio's ability to meet its
current obligations, to honor requests for redemption and to have its investment
portfolio managed properly will limit the extent to which the Portfolio may
engage in forward commitment agreements. Except as may be imposed by these
factors, there is no limit on the percent of the Portfolio's total assets that
may be committed to transactions in such agreements. The Portfolio intends to be
active in the forward commitment market when the return from holding forward
positions appears to be greater than the return from holding the actual
securities. The Portfolio will enter into forward commitment contracts to
purchase securities for the purpose of acquiring those securities and not for
the purpose of investment leverage or to speculate on interest rate changes, but
as delivery dates approach, a determination will be made whether to take
delivery of a specific forward position, or sell that position and purchase
another forward position. Because of this strategy, it is anticipated that its
annual portfolio turnover rate should generally exceed 100% and may be as much
as 600% or more, although this rate should not be construed as a limiting
factor. The Portfolio intends, however, to limit turnover so that realized
short-term gains on securities held for less than three months do not exceed 30%
of gross income in order to qualify as a "regulated investment company" under
the Internal Revenue Code. See "Tax Treatment, Dividends and Distributions." The
effect of a high turnover rate would be to incur more transaction expenses than
would be incurred at a lower turnover rate, and there is no assurance that the
additional transactions that cause the higher turnover rate would result in
gains for the Portfolio or in sufficient gains to offset the increased
transaction expenses.
CERTAIN INVESTMENT POLICIES AND RESTRICTIONS
Following is a discussion of certain investment practices that each Portfolio
may use in an effort to achieve its investment objective.
Each Portfolio may enter into repurchase agreements with, and may lend its
portfolio securities to, unaffiliated broker-dealers and other unaffiliated
qualified financial institutions. These transactions must be fully
collateralized at all times, but involve some credit risk if the other party
should default on its obligations, and the Portfolio is delayed or prevented
from recovering on the collateral. See the Statement of Additional Information
for further information regarding the credit risks associated with repurchase
agreements and the standards adopted by the Board of Directors to deal with
those risks. Neither Portfolio intends either (i) to enter into repurchase
agreements that mature in more than seven days if any such investment, together
with any other illiquid securities held by the Portfolio, would amount to more
than 15% of its total assets or (ii) to lend securities in excess of 33% of its
total assets.
From time to time, a Portfolio may enter into forward commitment agreements
which call for it to purchase or sell a security on a future date and at a price
fixed at the time the Portfolio enters into the agreement. Each Portfolio may
acquire rights to sell its investments to other parties, either on demand or at
specific intervals. The International Securities Portfolio may invest in
warrants up to 5% of its assets, of which not more than 2% may be invested in
warrants that are not listed on the New York, American or Toronto Stock
Exchanges or the Chicago Board Options Exchange.
As a matter of fundamental policy, each Portfolio may borrow money (a) for
temporary or emergency purposes in an amount not to exceed 5% of the value of
the Portfolio's total assets at the time of the borrowing and (b) for any
purpose from banks in an amount not to exceed one-third of the Portfolio's total
assets (including the amount borrowed) less all liabilities and indebtedness
other than borrowings deemed to be senior securities and while any such
borrowing exceeds 5% of the Funds' total assets, no additional purchases of
investment securities will be made.
Each Portfolio may purchase covered spread options, which would give the
Portfolio the right to sell a security that it owns at a fixed dollar spread or
yield spread in relationship to another security that the Portfolio does not
own, but which is used as a benchmark. Each Portfolio may also purchase and sell
covered financial futures contracts, options on financial futures contracts and
options on securities and securities indices, but will not invest more than 5%
of its assets in initial margin and premiums on financial futures contracts and
options thereon. Each Portfolio may write options on securities and securities
indices to generate additional revenue and for hedging purposes and may enter
into transactions in financial futures contracts and options on those contracts
for hedging purposes. The use of futures contracts and options involves certain
risks, including their failure as hedges when the price movements of the
securities underlying the futures and options do not follow the price movements
of the portfolio securities subject to the hedge; the inability to control
losses by closing a position when a liquid secondary market does not exist; and
the ability of Invista to predict correctly the direction of stock prices,
interest rates and other market and economic factors. Additional information
about risks is included in the Statement of Additional Information.
The International Securities Portfolio may enter into forward currency
contracts, currency futures contracts and options thereon and options on
currencies for hedging and other non-speculative purposes. A forward currency
contract involves a privately negotiated obligation to purchase or sell a
specific currency at a future date at a price set at the time of the contract.
The Portfolio will not enter into a transaction to hedge currency exposure to an
extent greater in effect than the aggregate market value of the securities held
or to be purchased by the Portfolio that are denominated or generally quoted in
or currently convertible into the currency. When the Portfolio enters into a
contract to buy or sell a foreign currency, it generally will hold an amount of
that currency, liquid securities denominated in that currency or a forward
contract for such securities equal to the Portfolio's obligation, or it will
segregate liquid high grade debt obligations equal to the amount of the
Portfolio's obligations. The use of currency contracts involves many of the same
risks as transactions in futures contracts and options as well as the risk of
government action through exchange controls or otherwise that would restrict the
ability of the Portfolio to deliver or receive currency.
Each Portfolio may from time to time execute transactions for portfolio
securities with, and pay related brokerage commissions to, Principal Financial
Securities, Inc. a broker-dealer that is an affiliate of the Distributor,
Manager and Sub-Advisor for each of the Portfolios.
The Statement of Additional Information includes additional information
concerning the investment policies and restrictions applicable to the
Portfolios. Certain investment policies and restrictions are designated in this
Prospectus or in the Statement of Additional Information as fundamental and may
not be changed as to any Portfolio without approval by the holders of the lesser
of: (i) 67% of the shares of that Portfolio represented at a meeting at which
more than 50% of the outstanding shares of the Portfolio are represented or (ii)
more than 50% of the outstanding shares of the Portfolio. The investment
objectives of the Portfolios and all other investment policies and restrictions
described in this Prospectus and the Statement of Additional Information are not
fundamental and may be changed by the Board of Directors without shareholder
approval. A change of an investment objective may result in a Portfolio having
an investment objective different from the objective which a shareholder
considered appropriate at the time of investment in the Portfolio. Shareholders
must be given 30 days prior written notice before the investment objectives of
the Portfolios may be changed at the discretion of the Board of Directors.
RISK FACTORS
An investment in the International Securities Portfolio involves the financial
and market risks that are inherent in any investment in securities. These risks
include changes in the financial condition of issuers, in economic conditions
generally and in the conditions in securities markets. They also include the
extent to which the prices of securities will react to those changes. Investment
in foreign securities presents certain risks which may affect net asset value.
These risks include, but are not limited to, those resulting from fluctuations
in currency exchange rates, revaluation of currencies, the imposition of foreign
taxes, the withholding of taxes on dividends at the source, future political and
economic developments including war, expropriations, nationalization, the
possible imposition of currency exchange controls and other foreign governmental
laws or restrictions, reduced availability of public information concerning
issuers, and the fact that foreign issuers are not generally subject to uniform
accounting, auditing and financial reporting standards or to other regulatory
practices and requirements comparable to those applicable to domestic issuers.
Moreover, securities of many foreign issuers may be less liquid and their prices
more volatile than those of comparable domestic issuers. In addition,
transactions in foreign securities may be subject to higher costs, and the time
for settlement of transactions in foreign securities may be longer than the
settlement period for domestic issuers. Investment in foreign securities may
also result in higher custodial costs and the costs associated with currency
conversions.
An investment in the Mortgage-Backed Securities Portfolio involves market risks
associated with movements in interest rates. The market value of investments
will fluctuate in response to changes in interest rates and other factors.
During periods of falling interest rates, the values of outstanding long-term
fixed-income securities generally rise. Conversely, during periods of rising
interest rates, the values of such securities generally decline. Changes by
recognized rating agencies in their ratings of any fixed-income security and in
the ability of an issuer to make payments of interest and principal may also
affect the value of these investments. Changes in the value of portfolio
securities will affect the net asset value but will not affect cash income
derived from the securities unless a change results from a failure of an issuer
to pay interest or principal when due.
MANAGER AND INVESTMENT SUB-ADVISOR
The Manager for the Funds is Princor Management Corporation (the "Manager"), an
indirectly wholly-owned subsidiary of Principal Mutual Life Insurance Company, a
mutual life insurance company organized in 1879 under the laws of the State of
Iowa. The address of the Manager is The Principal Financial Group, Des Moines,
Iowa 50392. The Manager was organized on January 10, 1969, and since that time
has managed various mutual funds sponsored by Principal Mutual Life Insurance
Company. As of December 31, 1995 the Manager served as investment advisor for
such funds with assets totaling approximately $2.8 billion.
The Manager has executed an agreement with Invista Capital Management, Inc.
("Invista") under which Invista has agreed to assume the obligations of the
Manager to provide investment advisory services for each Portfolio and to
reimburse the Manager for the other costs it incurs under the Management
Agreement. Invista, an indirectly wholly-owned subsidiary of Principal Mutual
Life Insurance Company and an affiliate of the Manager, was founded in 1985 and
manages investments for institutional investors, including Principal Mutual
Life. Assets under management at December 31, 1995 were approximately $15.7
billion. Invista's address is 1500 Hub Tower, 699 Walnut, Des Moines, Iowa
50309.
<TABLE>
<CAPTION>
Invista has assigned certain individuals the primary responsibility for the
day-to-day management of each Fund's portfolio. The persons primarily
responsible for the day-to-day management of each Fund are identified in the
table below:
Primarily
Fund Responsible Since Person Primarily Responsible
<S> <C> <C>
Mortgage-Backed Securities May, 1993 Martin J. Schafer (BBA degree, University of Iowa). Vice
Portfolio (Fund's inception) President, Invista Capital Management Company since 1992.
Director - Securities Trading, Principal Mutual Life
Insurance Company 1992; Prior thereto, Associate Director.
International Securities April, 1994 Scott D. Opsal, CFA (MBA degree, University of
Portfolio Minnesota). Vice President, Invista Capital Management,
Inc. since 1987.
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DUTIES PERFORMED BY THE MANAGER AND SUB-ADVISOR
Under Maryland law, the business and affairs of the Fund are managed under the
direction of its Board of Directors. The investment services and certain other
services referred to under the heading "Cost of Manager's Services" in the
Statement of Additional Information are furnished to each Portfolio under the
terms of a Management Agreement between the Fund and the Manager and a
sub-advisory agreement between the Manager and Invista. Invista advises each
Portfolio on investment policies and on the composition of each Portfolio. In
this connection, Invista furnishes to the Board of Directors a recommended
investment program consistent with each Portfolio's investment objective and
policies. Invista is authorized, within the scope of the approved investment
program, to determine which securities are to be bought or sold, and in what
amounts.
The compensation being paid by each of the Mortgage-Backed Portfolio and the
International Securities Portfolio for investment management and administrative
services is equal on an annual basis to .45% and .90%, respectively, of the
average daily value of its net assets. The fee payable by the International
Securities Portfolio is higher than that paid by most funds to their advisors,
but it is not higher than the fees paid by many funds with similar investment
objectives and policies and does cover substantially all expenses of the
Portfolio, unlike many other funds. The only expenses paid by each Portfolio are
brokerage commissions on portfolio transactions, taxes, interest (if any) and
extraordinary expenses.
The Manager and Invista may purchase at their own expense statistical and other
information or services from outside sources, including Principal Mutual Life
Insurance Company. An Investment Service Agreement between the Fund, the
Manager, and Principal Mutual Life Insurance Company provides that Principal
Mutual Life Insurance Company will furnish certain personnel, services and
facilities required by the Manager and Invista in connection with the
performance of their services for each Portfolio and that the Manager will
reimburse Principal Mutual Life Insurance Company for its costs incurred in this
regard. The Manager serves as dividend disbursing agent and transfer agent for
each Portfolio.
MANAGERS' COMMENTS
Princor Management Corporation and Invista, the adviser and sub-advisor to the
Fund, are staffed with investment professionals who manage each portfolio.
Comments by these individuals in the following paragraphs summarize in capsule
form the general strategy and recent results of each Portfolio throughout the
fiscal year ended December 31, 1995. The accompanying charts display results for
the life of the Fund through December 31, 1995. Average Annual Total Return
figures provided for each fund in the graphs below reflect all expenses of the
Fund and assume all distributions are reinvested at net asset value. Past
performance is not predictive of future performance. Returns and net asset
values fluctuate. Shares are redeemable at current net asset value, which may be
more or less than original cost.
International Securities Portfolio
International equities provided positive returns for 1995 of just over 10%.
Europe was the star performing region for 1995, rising over 20% compared with a
small gain from Japan and losses in Southeast Asia and Latin America. The
International Securities Portfolio outperformed the average fund for the year on
the basis of large exposures to undervalued European markets which performed
well, and underweightings in Japan and Latin America which did poorly.
Europe was the strongest international region in the world for 1995, up over
20%. Japan was essentially flat, and emerging markets lost 7% paced by Latin
America's 15% drop. The International Securities Portfolio was significantly
overweighted in the top five performing countries in the world and underweighted
in the poorest performers. These weightings were based on relative valuations
with the heaviest overweightings found in the countries carrying the lowest
valuation parameters. The Fund also benefited from being overweighted in
industrial cyclical and consumer durable sectors which experienced earnings and
market value gains resulting from continued economic expansion in Europe.
Emerging markets performed poorly in 1995, and the Fund's small exposure to this
market sector allowed it to avoid the negative returns suffered by emerging
market investors. Finally, we estimate the International Securities Portfolio
experienced a positive 4.4% impact from currencies, while Morgan Stanley Capital
International EAFE's (Europe, Australia and Far East) yearly total was a
positive 1.5%.
Principal Special Markets Fund, Inc.
International Securities Portfolio *
Fund Morgan Stanley Lipper
Total EAFE International
Year Ended December 31 Return Index Index
1,000,000 1,000,000 1,000,000
1993 1,299,450 1,081,100 1,225,000
1994 1,215,602 1,165,101 1,216,303
1995 1,361,697 1,295,826 1,330,757
Total Returns *
As of December 31, 1995
1 Year Since Inception Date 5/7/93 10 Year
12.02% 12.35% --
Important Notes:
Lipper International Fund Average: this average consists of mutual funds which
invest in securities whose primary trading markets are outside the United
States. The one year average currently contains 254 funds.
Morgan Stanley Capital International EAFE (Europe, Australia and Far East )
Index: an unmanaged index consisting of stocks of 4,552 companies traded in
twenty major world stock markets.
Mortgage-Backed Securities Portfolio
The U.S. Federal Reserve Board's long-term goal of low inflation and steady
growth appears closer to reality with each passing year. The dismal performance
of 1994 was due to the Fed's actions to slow economic growth and potential
inflation. In 1995, the dramatic turnaround was the result of the markets
recognizing that inflation was well contained at the peak of this economic
cycle. In fact, the most powerful ingredient in calculating inflation--labor
costs--has been deflating. With wage increases holding steady and benefit
packages being trimmed, corporate America has forced workers to work smarter and
harder resulting in increased productivity. This provides products with lower
unit labor costs. We look for the Fed to continue their vigilant fight against
inflation. While ultimately this should be beneficial to all fixed-income
investors, the road to solid returns may be rocky from time to time.
This Fund's success reflects our preference for slightly longer duration assets
than our competitors. We try to keep our duration between 4.5 and 6 years. The
duration as of December 31, 1995, was 4.59 years. Duration measures the
sensitivity of the value of the mortgage-backed securities to changes in
interest rates. In general, if interest rates change one percentage point, the
value will change in the opposite direction by a percentage which equals the
duration.
Principal Special Markets Fund, Inc.
Mortgage-Backed Securities Portfolio *
Lehman Brothers Lipper U.S.
Year Ended Fund Mortgage Mortgage Fund
December 31, Value Index Average
1,000,000 1,000,000 1,000,000
1993 1,044,651 1,032,308 1,033,900
1994 1,006,746 1,015,723 990,786
1995 1,200,601 1,186,333 1,151,591
Total Returns *
As of December 31, 1995
1 Year Since Inception Date 5/7/93 10 Year
19.26% 7.14% --
Important Notes:
Lehman Brothers Mortgage Index: an unmanaged index of 15- and 30 year fixed rate
securities backed by mortgage pools of the Government National Mortgage
Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and Federal
National Mortgage Association (FNMA).
Lipper U.S. Mortgage Fund Average: this average consists of mutual funds
investing at least 65% of their assets in mortgages/securities issued or
guaranteed as to principal and interest by the U.S. Government and certain
federal agencies. The one year average currently contains 58 mutual funds.
NOTE: Mutual fund data from Lipper Analytical Services, Inc.
DETERMINATION OF NET ASSET VALUE
The net asset value of each Portfolio is determined daily, Monday through
Friday, as of the close of trading on the New York Stock Exchange except on days
on which changes in the value of the portfolio securities will not materially
affect the current net asset value of the redeemable securities, on days during
which a Portfolio receives no order for the purchase or sale of its redeemable
securities and no tender of such a security for redemption, and on customary
national business holidays. The net asset value per share of each Portfolio is
determined by dividing the value of the Portfolios' securities plus all other
assets, less all liabilities, by the number of Portfolio shares outstanding.
Securities for which market quotations are readily available are valued using
those quotations. Other securities are valued by using market quotations, prices
provided by market makers or estimates of market values obtained from yield data
and other factors relating to instruments or securities with similar
characteristics in accordance with procedures established in good faith by the
Board of Directors. Securities with remaining maturities of 60 days or less are
valued at amortized cost. Other assets are valued at fair value as determined in
good faith through procedures established by the Board of Directors of the Fund.
Trading of foreign securities is substantially completed each day at various
times prior to the close of the New York Stock Exchange. The values of such
securities used in computing net asset value per share are usually determined as
of such times. Occasionally, events which affect the values of such securities
and foreign currency exchange rates may occur between the times at which they
are generally determined and the close of the New York Stock Exchange and would
therefore not be reflected in the computation of the net asset value. If events
materially affecting the value of such securities occur during such period, then
these securities will be valued at their fair value as determined in good faith
by the Manager or Invista under procedures established and regularly reviewed by
the Board of Directors. To the extent the International Securities Portfolio
invests in foreign securities listed on foreign exchanges which trade on days on
which the Portfolio does not determine its net asset value, for example
Saturdays and other customary national U.S. holidays, the net asset value could
be significantly affected on days when shareholders have no access to the
Portfolio.
PERFORMANCE CALCULATION
From time to time, the Fund may publish advertisements containing information
(including graphs, charts, tables and examples) about the performance of one or
more of its Portfolios. The yield and total return figures described below will
vary depending upon market conditions, the composition of portfolios and
operating expenses. These factors and possible differences in the methods used
in calculating yield and total return should be considered when comparing
performance figures for the Portfolios to performance figures published for
other investment vehicles. Any performance data quoted for a Portfolio
represents only historical performance and is not intended to indicate future
performance. For further information on how the Fund calculates yield and total
return figures for its Portfolios, see the Statement of Additional Information.
The Mortgage-Backed Securities Portfolio may advertise its yield and average
annual and cumulative total return. The International Securities Portfolio may
advertise its average annual and cumulative total return. Yield is determined by
annualizing a Portfolio's net investment income per share for a specific,
historical 30-day period and dividing the result by the ending net asset value
of the Portfolio for the same period. Average annual total return for each
Portfolio is computed by calculating the average annual compounded rate of
return over the stated period that would equate an initial $1,000 investment to
the ending redeemable value assuming the reinvestment of all dividends and
capital gains distributions at net asset value. Cumulative total return is
computed by dividing the ending redeemable value by the initial investment on
the basis of the same assumptions. Each Portfolio may also quote rankings,
yields or returns as published by independent statistical services or
publishers, and information regarding the performance of certain market indices.
SHAREHOLDER RIGHTS
Each share is entitled to one vote either in person or by proxy at all
shareholder meetings. This includes the right to vote on the election of
directors, selection of independent accountants and other matters submitted to
meetings of shareholders. Shares of each Portfolio generally vote in the
aggregate without regard to series, except where otherwise required by the
Investment Company Act of 1940 in which case any matter being voted upon must be
approved by each Portfolio affected by the matter being voted upon. Matters
required by the Investment Company Act of 1940 to be voted upon by each affected
Portfolio include changes to the Management Agreement, a subadvisory agreement
and fundamental investment policies and restrictions. Each share of a Portfolio
has equal rights with every other share of that Portfolio as to dividends,
earnings, voting, assets and redemption. Shares are fully paid and
non-assessable, have no preemptive or conversion rights, and are freely
transferable. Shares may be issued as full or fractional shares, and each
fractional share has proportionately the same rights, including voting, as are
provided for a full share. Shareholders of the Fund may remove any director with
or without cause by the vote of a majority of the votes entitled to be cast at a
meeting of shareholders. Shareholders will be assisted with shareholder
communication in connection with such matter, and the Fund will hold a meeting
of shareholders for such purpose when requested to do so in writing by the
holders of 10% or more of the outstanding shares of the Fund.
The articles of incorporation of the Fund provide that the Board of Directors
may increase or decrease the aggregate number of shares which the Fund has
authority to issue and may create additional series of shares at any time
without a shareholder vote.
The Fund intends to hold meetings of shareholders only when required by law and
at such other times as may be deemed appropriate by the Board of Directors. The
Fund will hold annual meetings of shareholders only when the election of
directors by shareholders is required under the Investment Company Act of 1940
and special meetings of shareholders when the approval by shareholders of such
matters as investment advisory agreements and distribution agreements is
required under that Act.
Shareholder inquiries should be directed to the Fund at The Principal Financial
Group, Des Moines, Iowa 50392.
NON-CUMULATIVE VOTING: The shares have non-cumulative voting rights which means
that the holders of more than 50% of the shares voting for the election of
directors can elect 100% of the directors if they choose to do so, and in such
event, the holders of the remaining shares voting for the election of directors
will not be able to elect any directors.
As of March 21, 1996, Principal Mutual Life Insurance Company and its
subsidiaries and affiliates owned the following number and percentage of the
outstanding shares of each Portfolio of the Fund:
Percentage of
Number of Outstanding Shares
Portfolio Shares Owned Owned
International Securities Portfolio 1,186,538 79.25%
Mortgage-Backed Securities Portfolio 1,193,984 82.87%
DISTRIBUTION OF INCOME DIVIDENDS AND REALIZED CAPITAL GAINS
Any dividends from the net income of the International Securities Portfolio
normally will be distributed to shareholders annually and any dividends from the
net income of the Mortgage-Backed Securities Portfolio will normally be
distributed monthly. Distributions from the International Securities Portfolio
will be made on the last business day of December to shareholders of record on
the preceding business day. Distributions from the Mortgage-Backed Securities
Portfolio will normally be declared daily and payable on the first business day
of each month to shareholders of record at the close of business on the last
business day of the preceding month. A shareholder who redeems the entire
balance of an account during the month will receive the dividends declared
through the date of the redemption. Net realized capital gains for each of the
Portfolios, if any, will be distributed annually, generally the last business
day of December to shareholders of record on the preceding business day. In the
application, the shareholder authorizes income dividends and capital gains
distributions to be invested in additional shares at net asset value as of the
payment date, but the shareholder at any time on ten days written notice to the
Fund and without charge may have future dividends (or dividends and capital
gains distributions) paid in cash. Any dividends or distributions paid shortly
after a purchase of shares by an investor will have the effect of reducing the
per share net asset value by the amount of the dividends or distributions. These
dividends or distributions are subject to taxation like other dividends and
distributions, even though they are in effect a return of capital.
TAX-TREATMENT, DIVIDENDS AND DISTRIBUTIONS
It is the policy of each Portfolio to distribute substantially all net
investment income and net realized gains. Through such distributions, and by
satisfying certain other requirements, the Fund intends to qualify each
Portfolio for the tax treatment accorded to regulated investment companies under
the applicable provisions of the Internal Revenue Code. This means that in each
year in which a Portfolio so qualifies, it will be exempt from federal income
tax upon the amounts so distributed to investors. The Tax Reform Act of 1986
imposed an excise tax on mutual funds which fail to distribute net investment
income and capital gains by the end of the calendar year in accordance with the
provisions of the Act. The Fund intends to comply with the Act's requirements
and to avoid this excise tax.
When at the close of a fiscal year, more than 50% of the value of the
International Securities Portfolio's total assets are invested in securities of
foreign corporations, the Fund may elect pursuant to Section 853 of the Internal
Revenue Code to permit Portfolio shareholders to take a credit (or a deduction)
for foreign income taxes paid by the Fund. In that case, Portfolio shareholders
should include in gross income for federal income tax purposes both cash
dividends received from the Fund and the amount which the Fund advises is their
pro rata portion of foreign income taxes paid with respect to, or withheld from,
dividends and interest paid to the Fund from its foreign investments. Portfolio
shareholders would then be entitled to subtract from their federal income taxes
the amount of such taxes withheld, or else treat such foreign taxes as a
deduction from gross income, if that should be more advantageous. As in the case
of individuals receiving income directly from foreign sources, the
above-described tax credit for tax deduction is subject to certain limitations.
Under the federal income tax law, dividends paid from investment income and from
realized short-term capital gains, if any, are generally taxable at ordinary
income rates whether received in cash or additional shares.
Dividends from the International Securities Portfolio and the Mortgage-Backed
Securities Portfolio are not expected to qualify for the 70% dividends received
deduction for corporations. Dividends and capital gains are taxable in the year
in which distributed, whether received in cash or reinvested in additional
shares. Dividends declared with a record date in December and paid in January
will be deemed to have been distributed to shareholders in December. The Fund
will inform shareholders of the amount and nature of their income dividends and
capital gains distributions. Dividends from net income and distributions of
capital gains may also be subject to state and local taxation.
The Fund is required by law to withhold 31% of dividends paid to investors who
do not furnish their correct taxpayer identification number, which, in the case
of most individuals is their social security number. If, at the time the account
is established the investor does not have a taxpayer identification number but
certifies that one has been applied for, such withholding will be delayed but
will commence 60 days after the date of such certification if within such time
the investor has not provided such number to the Fund.
Shareholders should consult their own tax advisors as to the federal, state and
local tax consequences of ownership of shares of a Portfolio in their particular
circumstances.
HOW TO INVEST
Investments by check - An account with either Portfolio may be established by
submitting a completed application and check made payable to Princor Financial
Services Corporation (the "Distributor") to the Distributor or other dealers
which it selects. An application is attached to this Prospectus. All
applications are subject to acceptance by the Fund and the Distributor. If an
application and check are properly submitted to the Distributor, the shares will
be issued at the net asset value next determined after the check has been
converted into Federal Funds, ordinarily within one business day following
receipt of the check.
Investments By Wire - Shares may also be purchased by wiring Federal Funds
directly to Norwest Bank Iowa, N.A., on a day on which the New York Stock
Exchange, Norwest Bank Iowa, N.A., and, in the case of an initial purchase,
Princor Financial Services Corporation are open for business. It is possible the
shareholder's bank will charge a fee for transmitting funds by wire. FOR AN
INITIAL PURCHASE, FIRST OBTAIN AN ACCOUNT NUMBER BY TELEPHONING THE DISTRIBUTOR
TOLL FREE 1-800-521-1502. Princor Financial Services Corporation requests the
following information:
1. Name in which the account will be registered
2. Address and Telephone Number
3. Tax Identification Number
4. Dividend distribution election
5. Amount being wired and wiring bank
6. Name of Princor Financial Services Corporation registered representative,
if any.
7. Portfolio for which shares are being purchased.
Princor Financial Services Corporation will assign an account number immediately
upon receipt of the above information. After an account number is assigned, the
purchaser should instruct the bank to wire transfer Federal Funds to: Norwest
Bank Iowa, N.A., Des Moines, Iowa, ABA No. 073000228, for credit to: Princor
Financial Services Corporation, Account Number 073-330; for further credit to:
Purchaser's Name and Account Number.
To make subsequent purchases by wire, the investor should instruct the bank to
wire transfer Federal Funds to: Norwest Bank Iowa, N.A., Des Moines, Iowa, ABA
No. 073000228, for credit to: Princor Management Corporation, Account No.
3000499968, for further credit to: Investor's name and fund account number. It
is the shareholder's responsibility to advise Princor Financial Services
Corporation when a subsequent purchase has been wired so that proper credit can
be given.
Payment of Federal Funds normally must be received by Norwest Bank before 3:00
p.m. Central Time for an order to be accepted on that day. If payment is
received after that time, the order will not be accepted until the next business
day. Wire transfers may take two hours or more to complete. Investors may make
special arrangements to transmit orders for Portfolio shares to the Distributor
prior to 3:00 p.m. (Central Time) on a day when the Fund is open for business
with the investor's assurance that payment for such shares will be made by
wiring Federal Funds directly to Norwest Bank Iowa, N.A. prior to 10:00 a.m.
(Central Time) the following regular business day. Such orders will be effected
at the Portfolio's net asset value per share next determined after such purchase
order is received by the Distributor.
Promptly after the initial purchase, INVESTORS SHOULD COMPLETE AN ACCOUNT
APPLICATION and mail to Princor Financial Services Corporation, P.O. Box 10423,
Des Moines, Iowa 50306-0423.
Investments through a Selected Dealer - If the application and settlement funds
are submitted through a selected dealer, the shares will be issued in accordance
with the following: An order accepted by a dealer on any day before the close of
the Exchange and received by the Distributor as principal underwriter before the
close of its business on that day will be executed at the net asset value
computed as of the close of the Exchange on that day. An order accepted by such
dealer after the close of the Exchange and received by the Distributor before
its closing on the following business day will be executed at the net asset
value computed as of the close of the Exchange on such following business day.
Dealers have the responsibility to transmit orders to the Distributor promptly.
After an open account has been established (see "Open Account System"),
purchases will be executed at the price next computed after receipt of the
investor's funds at the main office of the Distributor. Wire purchases through a
selected dealer may involve other procedures established by that dealer.
OFFERING PRICE OF SHARES
The Fund offers shares of each Portfolio continuously through Princor Financial
Services Corporation which is the principal underwriter for the Fund and sells
shares as agent for the Fund. Shares are sold to the public at net asset value,
subject to the minimum investment requirements. In certain circumstances,
Princor Financial Services Corporation will compensate its registered
representatives or a selected dealer with whom it has entered into a selling
agreement for their efforts in distributing shares of the fund. Compensation
will be an ongoing fee in an amount up to 0.10% on an annualized basis of the
average net asset value of shares held in a customer account the establishment
of which is attributable to the efforts of the registered representative or
selected dealer.
MINIMUM INVESTMENT REQUIREMENT
The minimum initial purchase in the Fund is $1.0 million. The minimum initial
purchase of $1.0 million may be invested over a three month period. Investments
in both Portfolios by an investor, the investor's spouse, dependent children or
a trustee may be combined to meet this minimum. There is no minimum for
additional investments. If the total $1.0 million investment is not completed
within the three month period, the shareholder will be given notice of the
additional investment needed to meet the minimum and if not remitted within 30
days, the account will be redeemed.
OPEN ACCOUNT SYSTEM
Share certificates will not ordinarily be issued to shareholders. Shareholders
of each Portfolio will receive a statement of account each time they invest. The
statement will record the current investment and the total number of shares then
owned.
The Fund treats the statement of account as evidence of ownership of shares.
This is known as an open account system. It avoids the trouble and expense of
safeguarding share certificates and the cost of a lost instrument bond if
certificates are lost or destroyed. Certificates, which can be stolen or lost,
are unnecessary except for special purposes such as collateral for a loan. A
shareholder may obtain a certificate at any time for full shares by requesting
it from the Fund in writing. The certificate will be delivered promptly at no
cost. In cases where certificates have been issued, the certificate must be
surrendered in connection with a redemption, transfer or exchange.
The Fund has adopted the policy of requiring signature guarantees in certain
circumstances to safeguard shareholder accounts. A signature guarantee is
necessary under the following circumstances:
1. If a redemption payment is to be made payable to a payee other than the
registered shareholder or joint shareholders, or to Principal Mutual Life
Insurance Company or any of its affiliated companies;
2. To change the ownership of the account;
3. If a redemption payment is to be mailed to an address other than the address
of record or to an address of record that has been changed within the preceding
three months.
4. To add telephone transaction services to an account after the initial
application is processed.
5. To change the designated commercial bank account authorized to accept
redemption proceeds.
A shareholder's signature must be guaranteed by a commercial bank, trust
company, credit union, savings and loan association, national securities
exchange member, or brokerage firm. A signature guaranteed by a notary public is
not acceptable.
Although there currently is no minimum balance, due to the disproportionately
high cost of maintaining small accounts, the Fund reserves the right to redeem
all shares in an account with a value of less than $5,000 and to mail the
proceeds to the shareholder. Involuntary redemptions will not be triggered
solely by market activity. Shareholders will be notified before these
redemptions are to be made and will have thirty days to make an additional
investment to bring their accounts up to the required minimum. The Fund reserves
the right to increase the required minimum.
All orders are subject to acceptance by the Fund and the Distributor. The Fund's
Board of Directors reserves the right to change or waive minimum investment
requirements at any time, which would be applicable to all investors alike.
REDEMPTION OF SHARES
Each Portfolio will redeem its shares upon request. There is no charge for
redemptions. Princor Financial Services usually requires additional
documentation for the sale of shares by a corporation, partnership, agent or
fiduciary, or a surviving joint owner. Contact Princor Financial Services for
details. Shareholders may redeem in one of two ways:
By Mail - If no certificates have been issued, a shareholder simply writes a
letter to the Fund, at Princor Financial Services Corporation, P.O. Box 10423,
Des Moines, Iowa 50306-0423, requesting redemption of any part or all of the
shares owned by specifying either a dollar or share amount. The letter must
provide the account number, shareholder social security number, or tax
identification number and be signed by a registered owner. If certificates have
been issued, they must be properly endorsed and forwarded with the redemption
request. If redemption proceeds are to be sent by wire transfer to a bank
account previously designated as authorized to accept a wire transfer, or if
payment is to be mailed to the address of record, which has not been changed
within the three month period preceding the redemption request, and is made
payable to the registered shareholder or joint shareholders, or to Principal
Mutual Life Insurance Company or any of its affiliated companies, the Fund will
not require a signature guarantee as a part of a proper endorsement; otherwise
the shareholder's signature must be guaranteed by either a commercial bank,
trust company, credit union, savings and loan association, national securities
exchange member, or by a brokerage firm. A signature guaranteed by a notary
public or savings bank is not acceptable.
By Telephone - Shareholders may, by telephone, direct proceeds from redemptions
from the shareholder's account to be sent to the address of record, if such
address has not changed within the three month period preceding the date of the
request, or transferred to a commercial bank account in the United States
previously authorized in writing by the shareholder. The telephone redemption
privilege is available only if telephone transaction services apply to the
account from which shares are redeemed. Telephone transaction services apply to
all accounts, unless the shareholder has specifically declined this service on
the account application or in writing to the Fund. If certificates have been
issued, the telephone redemption privilege will not be allowed on those shares.
Shareholders may exercise the telephone redemption privilege by telephoning
1-800-521-1502. If all telephone lines are busy, shareholders might not be able
to request telephone redemptions and would have to submit written redemption
requests. Redemption proceeds may be sent to the previously designated bank by
check or wire transfer. A wire charge of up to $6.00 will be deducted from the
account from which the redemption is made for all wire transfers. If proceeds
are to be used to settle a securities transaction with a selected dealer,
telephone redemptions may be requested by the shareholder or upon appropriate
authorization from an authorized representative of the dealer, and the proceeds
will be wired to the dealer.
Telephone redemption requests must be received by the Fund by the close of the
New York Stock Exchange on a day when the Fund is open for business to be
effective that day. Requests made after that time or on a day when the Fund is
not open for business will be effective the next business day. Although the Fund
and the transfer agent are not responsible for the authenticity of redemption
requests received by telephone, the right is reserved to refuse telephone
redemptions when in the opinion of the Fund or the transfer agent it seems
prudent to do so. The shareholder bears the risk of loss caused by a fraudulent
telephone redemption request which the Fund reasonably believes to be genuine.
The Fund will employ reasonable procedures to confirm that instructions
communicated by telephone are genuine and if such procedures are not followed,
the Fund may be liable for losses due to unauthorized or fraudulent
transactions. Such procedures include requiring the caller to provide the
shareholder's social security number or tax identification number, date of birth
(if an individual) and current address; mailing written confirmation of the
transaction to the address of record; and recording telephone instructions. In
addition, the Fund directs redemption proceeds made payable to the owner or
owners of the account only to the address of record that has not been changed
within the three month period prior to the date of the telephone request or to a
previously authorized bank account.
General - Redemptions, whether in writing or by telephone or other means, by any
joint owner shall be binding upon all joint owners. The price at which the
shares are redeemed will be the net asset value per share as next determined
after the request is received by the Fund in proper and complete form. The
amount received for shares upon redemption may be more or less than the cost of
such shares depending upon the net asset value at the time of redemption.
Accurate records should be kept for the duration of the account for tax
purposes.
Redemption proceeds will be sent within three business days after receipt of a
request for redemption in proper form. However, the Fund may suspend the right
of redemption during any period when (a) trading on the New York Stock Exchange
is restricted as determined by the Securities and Exchange Commission or such
Exchange is closed for other than weekends and holidays; (b) an emergency
exists, as determined by the Securities and Exchange Commission, as a result of
which (i) disposal by the Fund of securities owned by it is not reasonably
practicable, or (ii) it is not reasonably practicable for the Fund fairly to
determine the value of its net assets; or (c) the Commission by order so permits
for the protection of security holders of the Fund.
The Fund will redeem only Portfolio shares for which it has received good
payment. To avoid the inconvenience of such a delay, shares may be purchased
with a certified check, bank cashier's check or money order.
The Fund reserves the right to modify any of the methods of redemption or to
charge a fee for providing these services upon written notice to shareholders.
PERIODIC WITHDRAWAL PLAN
A shareholder may request that a fixed number of shares ($100 initial minimum
amount) or enough shares to produce a fixed amount of money ($100 initial
minimum payment) be withdrawn from an account monthly, quarterly, semi-annually
or annually. The Fund makes no recommendation as to either the number of shares
or the fixed amount that the investor may withdraw. An investor may initiate a
Periodic Withdrawal Plan by signing an Agreement for Periodic Withdrawal Form
and depositing any share certificates that have been issued or, if no
certificates have been issued and telephone transaction services apply to the
account, by telephoning the Fund.
Cash withdrawals are made out of the proceeds of redemption on the day
designated by the shareholder, so long as the day is a trading day, and will
continue until cancelled. If the designated day is not a trading day, the
redemption will occur on the next trading day occurring during that month. If
the next trading day occurs in the following month, the redemption will occur on
the day prior to the designated day. Withdrawal payments will be sent on or
before the third business day following such redemption. The redemption of
shares to make payments under this Plan will reduce and may eventually exhaust
the account.
Each redemption of shares may result in a gain or loss, which may be reportable
for income tax purposes. An investor should keep an accurate record of any gain
or loss on each withdrawal. Any income dividends or capital gains distributions
on shares held under a Periodic Withdrawal Plan are reinvested in additional
shares at net asset value. Withdrawals may be stopped at any time without
penalty, subject to notice in writing which is received by the Fund.
ADDITIONAL INFORMATION
Organization: The Fund was incorporated in the state of Maryland on January 28,
1993.
Custodian: Bank of New York, 48 Wall Street, New York, New York 10286, is
custodian of the portfolio securities and cash assets of the Mortgage-Backed
Securities Portfolio. The custodian for the International Securities Portfolio
is Chase Manhattan Bank, N.A., Global Security Services, Chase Metro Tech
Center, Brooklyn, New York 11245. The custodians perform no managerial or
policymaking functions for the Fund.
Capitalization: The authorized capital stock of each Portfolio consists of
100,000,000 shares of common stock, $.01 par value.
Financial Statements: Copies of the financial statements of the Fund will be
mailed to each shareholder semi-annually. At the close of each fiscal year, the
Fund's financial statements will be audited by a firm of independent auditors.
The firm of Ernst & Young LLP has been appointed to audit the financial
statements of the Fund.
Registration Statement: This Prospectus omits some information contained in the
Statement of Additional Information (also known as Part B of the Registration
Statement) and Part C of the Registration Statement which the Fund has filed
with the Securities and Exchange Commission. The Fund's Statement of Additional
Information is hereby incorporated by reference into this Prospectus. A copy of
this Statement of Additional Information can be obtained upon request, free of
charge, by writing or telephoning Princor Financial Services Corporation. You
may obtain a copy of Part C of the Registration Statement filed with the
Securities and Exchange Commission, Washington, D.C. from the Commission upon
payment of the prescribed fees.
Principal Underwriter: Princor Financial Services Corporation, P.O. Box 10423,
Des Moines, Iowa 50306-0423, is the principal underwriter for the Fund.
Transfer Agent and Dividend Disbursing Agent: Princor Management Corporation,
The Principal Financial Group, Des Moines, Iowa, 50392-0200, is the transfer
agent and dividend disbursing agent for the Fund.
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PART B
PRINCIPAL SPECIAL MARKETS FUND, INC.
INTERNATIONAL SECURITIES PORTFOLIO
MORTGAGE-BACKED SECURITIES PORTFOLIO
Statement of Additional Information
dated May 1, 1996
This Statement of Additional Information provides information about each
Portfolio in addition to the information that is contained in the Prospectus,
dated May 1, 1996.
This Statement of Additional Information is not a prospectus. It should be read
in conjunction with the Prospectus, a copy of which can be obtained free of
charge by writing or telephoning:
Princor Financial Services Corporation
P.O. Box 10423
Des Moines, Iowa 50306-0423
Telephone: 1-800-521-1502
FV 76B-4
<PAGE>
TABLE OF CONTENTS
Investment Policies and Restrictions .............................. 2
Investments ....................................................... 4
Directors and Officers of the Fund................................. 14
Manager and Sub-Advisor ........................................... 16
Cost of Manager's Services ........................................ 17
Brokerage on Purchases and Sales of Securities .................... 19
Offering Price .................................................... 21
Determination of Net Asset Value .................................. 21
Performance Calculation ........................................... 22
Tax Treatment, Dividends and Distributions ........................ 24
Financial Statements............................................... 25
-1-
<PAGE>
INVESTMENT POLICIES AND RESTRICTIONS
The following information supplements the information provided in the Prospectus
under the caption "Investment Objectives, Policies and Restrictions."
INVESTMENT RESTRICTIONS
In implementing the investment policies of the Portfolios, the Fund is subject
to fundamental and nonfundamental restrictions. Nonfundamental restrictions may
be changed by the Board of Directors without shareholder approval. Fundamental
restrictions may only be changed by a vote of the lesser of (i) 67% or more of
the shares represented at a meeting at which more than 50% of the outstanding
shares are represented or (ii) more than 50% of the outstanding shares. The
required shareholder approval shall be effective with respect to a Portfolio if
a majority of the outstanding voting securities of that Portfolio votes to
approve the matter, notwithstanding that the matter has not been approved by a
majority of the outstanding voting securities of the Fund or of any other
Portfolio affected by the matter.
The investment objective and investment policies and restrictions of each
Portfolio discussed in the Prospectus and the Statement of Additional
Information, except for those investment restrictions identified below under the
caption "Fundamental Restrictions," are not fundamental and may be changed by
the Fund's Board of Directors without shareholder approval. Shareholders must be
given 30 days prior written notice before the investment objectives of the
Portfolios may be amended at the discretion of the Board of Directors.
All percentage limitations apply at the time of acquisition of a security, and
any subsequent change in any applicable percentage resulting from changes in the
values or nature of a Portfolio's assets will not require elimination of the
security from the Portfolio.
Fundamental Restrictions. Each of the following restrictions is fundamental and
may not be changed without shareholder approval. Each Portfolio will not (unless
specifically excepted):
(1) With respect to 75% of its total assets, purchase the securities of
any issuer if the purchase would cause more than 5% of the total
assets of the Portfolio to be invested in the securities of any one
issuer (other than securities issued or guaranteed by the United
States Government or its agencies or instrumentalities) or cause more
than 10% of the outstanding voting securities of any one issuer to be
held by the Portfolio.
(2) Borrow money, except (a) for temporary or emergency purposes in an
amount not to exceed 5% of the value of the Portfolio's total assets
at the time of the borrowing and (b) for any purpose from banks in an
amount not to exceed one-third of the Portfolio's total assets
(including the amount borrowed) less all liabilities and indebtedness
other than borrowings deemed to be senior securities.
(3) Issue any senior securities as defined in the Investment Company Act
of 1940. For purposes of this restriction, purchasing and selling
securities, currency and futures contracts and options and borrowing
money in accordance with restrictions described herein do not involve
the issuance of a senior security.
(4) Act as an underwriter of securities, except to the extent the
Portfolio may be deemed to be an underwriter in connection with the
sale of securities held in its portfolio.
(5) Concentrate its investments in any particular industry or industries,
except that the Portfolio may invest not more than 25% of the value of
its total assets in a single industry. For purposes of this
restriction, foreign government and supranational issuers are not
considered members of any industry.
(6) Invest in real estate, although it may invest in securities which are
secured by real estate and securities of issuers which invest or deal
in real estate.
(7) Invest in commodities or commodity contracts, but it may purchase and
sell currency and financial futures contracts and options on such
contracts.
(8) Make loans, except that the Portfolio may (i) purchase and hold debt
obligations in accordance with its investment objective and policies,
(ii) enter into repurchase agreements, and (iii) lend its portfolio
securities but not in excess of 33% of the value of its total assets.
The deposit of underlying securities and other assets in escrow and
other collateral arrangements in connection with options, currency and
futures transactions are not deemed to be the making of loans.
Nonfundamental Restrictions. Each of the following restrictions is
nonfundamental and may be changed by the Board of Directors without shareholder
approval. Each Portfolio will not (unless specifically excepted):
(1) Invest more than 15% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than seven
days. The value of any options purchased in the over-the-counter
market are included as part of this 15% limitation.
(2) Sell securities short (except where the Portfolio holds or has the
right to obtain at no added cost a long position in the securities
sold that equals or exceeds the securities sold short) or purchase any
securities on margin, except it may obtain such short-term credits as
are necessary for the clearance of transactions. The deposit or
payment of margin in connection with options, currency and futures
transactions is not considered the purchase of securities on margin.
(3) Invest in companies for the purpose of exercising control or
management.
(4) Purchase puts, calls, straddles, spreads or any combination thereof if
by reason thereof the value of its aggregate investment in such
classes of securities will exceed 5% of its total assets. Options will
be used solely for hedging purposes; not for speculation.
(5) Invest more than 5% of its assets in initial margin and premiums on
futures contracts and options on such contracts.
(6) Purchase securities of other investment companies if the purchase
would cause more than 10% of its total assets to be invested in
securities of other investment companies or more than 5% of its total
assets to be invested in the securities of any investment company or
would cause the Portfolio to own more than 3% of the outstanding
voting securities of any investment company. These restrictions do not
apply to purchases in connection with a merger, consolidation, or plan
of reorganization. [For purposes of these restrictions, privately
issued collateralized mortgage obligations will not be treated as
investment company securities if issued by "Exemptive Issuers."
Exemptive Issuers are defined as unmanaged, fixed-asset issuers that
(i) invest primarily in mortgage-backed securities, (ii) do not issue
redeemable securities as defined in section 2(a)(32) of the Investment
Company Act of 1940, (iii) operate under general exemptive orders
exempting them from "all provisions of the Investment Company Act of
1940," and (iv) are not registered or regulated under the Investment
Company Act of 1940 as investment companies.]
(7) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in
escrow and other collateral arrangements in connection with options,
currency and futures transactions are not deemed to be pledges or
other encumbrances.
(8) Purchase warrants in excess of 5% of its total assets, of which 2% may
be invested in warrants that are not listed on the New York, American
or Toronto Stock Exchanges or the Chicago Board Options Exchange. This
restriction does not apply to warrants included in units or attached
to other securities.
(9) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Portfolio may invest in securities
of issuers which invest in or sponsor such programs.
(10) Purchase securities of any issuer having less than three years'
continuous operation (including operations of any predecessors) if
such purchase would cause the value of the Portfolio's investments in
all such issuers to exceed 5% of the value of its total assets.
(11) Purchase or retain in its portfolio securities of any issuer if those
officers or directors of the Fund or its Manager owning beneficially
more than one-half of 1% (0.5%) of the securities of the issuer
together own beneficially more than 5% of such securities.
(12) Invest in arbitrage transactions.
(13) Invest in mineral leases.
(14) Invest in real estate limited partnership interests.
(15) Invest more than 25% of the value of its total assets (i) in the
securities issued by a single foreign government; or (ii) in
securities issued by supranational issuers.
The Manager will waive its management fee on Portfolio assets invested in
securities of other open-end investment companies and will generally invest only
in those open-end investment companies that have investment policies requiring
investment in securities comparable to those in which the Portfolio invests.
INVESTMENTS
The following information further supplements the discussion of the investment
objectives and policies in the Prospectus under the caption "INVESTMENT
OBJECTIVES, POLICIES AND RESTRICTIONS."
In making selections of equity securities, Invista will use an approach
described broadly as fundamental analysis. Fundamental analysis consists of
three steps. First is the continuing study of basic economic factors in an
effort to conclude what the future general economic climate is likely to be over
the next one to two years. Second, given some conviction as to the likely
economic climate, Invista attempts to identify the prospects for the major
industrial, commercial and financial segments of the economy, by looking at such
factors as demand for products, capacity to produce, operating costs, pricing
structure, marketing techniques, adequacy of raw materials and components,
domestic and foreign competition, and research productivity, to ascertain
prospects for each industry for the near and intermediate term. Finally, Invista
determines what the earnings prospects are for individual companies within each
industry by considering the same types of factors described above. Invista
evaluates these earnings prospects in relation to the current price of the
securities of each company.
Although each Portfolio may pursue the investment practices described under the
captions Restricted Securities, Foreign Securities, Spread Transactions, Options
on Securities and Securities Indices, and Futures Contracts and Options on
Futures Contracts, Currency Contracts, Repurchase Agreements, Lending of
Portfolio Securities and When-Issued and Delayed Delivery Securities, none of
the Portfolios currently intends to commit during the present fiscal year more
than 5% of its net assets to any of the practices, with the exception that the
Mortgage-Backed Securities Portfolio may commit more than 5% of its net assets
in When-Issued and Delayed Delivery Securities and the International Securities
Portfolio's investments in foreign securities will exceed 5% of its net assets
and it may commit more than 5% of its assets to Currency Contracts.
Restricted Securities
Each Portfolio is subject to an investment restriction that limits its
investments in illiquid securities to 15% of its net asset value. In computing
the Portfolio's net asset value per share, illiquid securities are valued at
their fair value as determined in good faith by or under the direction of the
Board of Directors.
Each Portfolio may acquire securities that are subject to legal or contractual
restrictions upon resale. Securities subject to such restrictions ("restricted
securities") are frequently treated as illiquid for purposes of the 15%
restriction. Such securities may be sold only in a public offering with respect
to which a registration statement is in effect under the Securities Act of 1933
("1933 Act") or in a transaction which is exempt from the registration
requirements of that act. One such exemption is provided by Rule 144A under the
1933 Act, pursuant to which certain restricted securities may be sold at a
readily ascertainable price. The Board of Directors has adopted procedures to
determine the liquidity of restricted securities qualifying for Rule 144A
treatment, and any such securities so determined to be liquid will be excluded
when applying the Portfolio's limitation on illiquid securities. To the extent
Rule 144A securities held by a Portfolio should become illiquid because of a
lack of interest on the part of qualified institutional investors, the overall
liquidity of the Portfolio could be adversely affected.
When registration of a restricted security is required, a Portfolio may be
obligated to pay all or a part of the registration expenses and a considerable
period may elapse between the time of the decision to sell and the time the
Portfolio may be permitted to sell the security under an effective registration
statement. If during such a period adverse market conditions were to develop,
the Portfolio might obtain a less favorable price than prevailed when it decided
to sell.
Foreign Securities
Investment in foreign securities presents certain risks, including those
resulting from fluctuations in currency exchange rates, revaluation of
currencies, the imposition of foreign taxes, the withholding of taxes on
dividends at the source, future political and economic developments including
war, expropriations, nationalization, the possible imposition of currency
exchange controls and other foreign governmental laws or restrictions, reduced
availability of public information concerning issuers, and the fact that foreign
issuers are not generally subject to uniform accounting, auditing and financial
reporting standards or to other regulatory practices and requirements comparable
to those applicable to domestic issuers. Moreover, securities of many foreign
issuers may be less liquid and their prices more volatile than those of
comparable domestic issuers. In addition, transactions in foreign securities may
be subject to higher costs, and the time for settlement of transactions in
foreign securities may be longer than the settlement period for domestic
issuers. A Portfolio's investment in foreign securities may also result in
higher custodial costs and the costs associated with currency conversions.
Spread Transactions, Options on Securities and Securities Indices, Futures
Contracts and Options on Futures Contracts, and Currency Contracts
Except as specifically indicated otherwise, each Portfolio may engage in the
practices described under this heading to attempt to hedge market value,
interest rate and currency risks and, in certain cases, to enhance its income.
Spread Transactions
A Portfolio may purchase from securities dealers covered spread options. Such
covered spread options are not presently exchange listed or traded. The purchase
of a spread option gives the Portfolio the right to put, or sell, a security
that it owns at a fixed dollar spread or fixed yield spread in relationship to
another security that the Portfolio does not own, but which is used as a
benchmark. The risk to the Portfolio in purchasing covered spread options is the
cost of the premium paid for the spread option and any transaction costs. In
addition, there is no assurance that closing transactions will be available. The
purchase of spread options can be used to protect the Portfolio against adverse
changes in prevailing credit quality spreads, i.e., the yield spread between
high quality and lower quality securities. The security covering the spread
option will be maintained in a segregated account by the Portfolio's custodian.
A security covered by a spread option is not considered to be "pledged" as that
term is used in the Portfolio's policy limiting the pledging or mortgaging of
assets.
Options on Securities and Securities Indices
The Portfolio may write (sell) and purchase call and put options on securities
in which it may invest and on securities indices based on securities in which
the Portfolio may invest. The Portfolio may write call and put options to
generate additional revenue, and may write and purchase call and put options in
seeking to hedge against a decline in the value of securities owned or an
increase in the price of securities which the Portfolio plans to purchase.
Writing Covered Call and Put Options. When a Portfolio writes a call option, it
gives the purchaser of the option, in return for the premium it receives, the
right to buy from the Portfolio the underlying security at a specified price at
any time before the option expires. When a Portfolio writes a put option, it
gives the purchaser of the option, in return for the premium it receives, the
right to sell to the Portfolio the underlying security at a specified price at
any time before the option expires.
The premium received by a Portfolio, when it writes a put or call option,
reflects, among other factors, the current market price of the underlying
security, the relationship of the exercise price to the market price, the time
period until the expiration of the option and interest rates. The premium will
generate additional income for the Portfolio if the option expires unexercised
or is closed out at a profit. By writing a call, a Portfolio limits its
opportunity to profit from any increase in the market value of the underlying
above the exercise price of the option, but it retains the risk of loss if the
price of the security should decline. By writing a put, a Portfolio assumes the
risk that it may have to purchase the underlying security at a price that may be
higher than its market value at time of exercise.
The Portfolios write only covered options and will comply with applicable
regulatory and exchange cover requirements. A Portfolio will own the underlying
security covered by any outstanding call option that it has written or will be
able to acquire such security through the exercise of conversion privileges on
convertible securities or otherwise at no additional cost. With respect to an
outstanding put option that it has written, each Portfolio will deposit and
maintain with its custodian cash, U.S. Government securities or other liquid
securities with a value at least equal to the exercise price of the option.
Once a Portfolio has written an option, it may terminate its obligation, before
the option is exercised, by effecting a closing transaction, which is
accomplished by the Portfolio's purchasing an option of the same series as the
option previously written. The Portfolio will have a gain or loss depending on
whether the premium received when the option was written exceeds the closing
purchase price plus related transaction costs.
Purchasing Call and Put Options. When a Portfolio purchases a call option, it
receives, in return for the premium it pays, the right to buy from the writer of
the option the underlying security at a specified price at any time before the
option expires. The Portfolio may purchase call options in anticipation of an
increase in the market value of securities that it intends ultimately to buy.
During the life of the call option, the Portfolio would be able to buy the
underlying security at the exercise price regardless of any increase in the
market price of the underlying security. In order for a call option to result in
a gain, the market price of the underlying security must rise to a level that
exceeds the sum of the exercise price, the premium paid and transaction costs.
If the option expires unexercised, the Portfolio will lose the premium paid and
any transaction costs incurred.
When a Portfolio purchases a put option, it receives, in return for the premium
it pays, the right to sell to the writer of the option the underlying security
at a specified price at any time before the option expires. The Portfolio may
purchase put options in anticipation of a decline in the market value of the
underlying security. During the life of the put option, the Portfolio would be
able to sell the underlying security at the exercise price regardless of any
decline in the market price of the underlying security. In order for a put
option to result in a gain, the market price of the underlying security must
decline, during the option period, below the exercise price sufficiently to
cover the premium and transaction costs.
Once a Portfolio has purchased an option, it may close out its position by
selling an option of the same series as the option previously purchased. The
Portfolio will have a gain or loss depending on whether the closing sale price
exceeds the initial purchase price plus related transaction costs.
Options on Securities Indices. Each Portfolio may purchase and sell put and call
options on any securities index based on securities in which the Portfolio may
invest. Securities index options are designed to reflect price fluctuations in a
group of securities or segment of the securities market rather than price
fluctuations in a single security. Options on securities indices are similar to
options on securities, except that the exercise of securities index options
requires cash payments and does not involve the actual purchase or sale of
securities. A Portfolio would engage in transactions in put and call options on
securities indices for the same purposes as it would engage in transactions in
options on securities. When a Portfolio writes call options on securities
indices, it will hold in its portfolio underlying securities which, in the
judgment of Invista, correlate closely with the securities index and which have
a value at least equal to the aggregate amount of the securities index options.
Risks Associated with Options Transactions. An options position may be closed
out only on an exchange which provides a secondary market for an option of the
same series. Although a Portfolio will generally purchase or write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market on an exchange will exist for any
particular option, or at any particular time. For some options, no secondary
market on an exchange or elsewhere may exist. If a Portfolio is unable to effect
closing sale transactions in options it has purchased, the Portfolio would have
to exercise its options in order to realize any profit and may incur transaction
costs upon the purchase or sale of underlying securities pursuant thereto. If a
Portfolio is unable to effect a closing purchase transaction for a covered
option that it has written, it will not be able to sell the underlying
securities, or dispose of the assets held in a segregated account, until the
option expires or is exercised. A Portfolio's ability to terminate option
positions established in the over-the-counter market may be more limited than
for exchange-traded options and may also involve the risk that broker-dealers
participating in such transactions might fail to meet their obligations.
A Portfolio's hedging strategy that employs options on a securities index may be
unsuccessful due to imperfect correlation between the securities in the index
and the securities owned by the Portfolio. In addition, if Invista is incorrect
in predicting the direction of stock prices, interest rates and other economic
factors, hedging through the use of options could result in a lower return than
if the Portfolio had not hedged its investments.
Futures Contracts and Options on Futures
Each Portfolio may purchase and sell financial futures contracts and options on
those contracts. Financial futures contracts are commodities contracts based on
financial instruments such as U.S. Treasury bonds or bills or on securities
indices such as the S&P 500 Index. Futures contracts, options on futures
contracts and the commodity exchanges on which they are traded are regulated by
the Commodity Futures Trading Commission ("CFTC"). Through the purchase and sale
of futures contracts and related options, a Portfolio may seek to hedge against
a decline in securities owned by the Portfolio or an increase in the price of
securities which the Portfolio plans to purchase.
Futures Contracts. When a Portfolio sells a futures contract based on a
financial instrument, the Portfolio becomes obligated to deliver that kind of
instrument at a specified future time for a specified price. When a Portfolio
purchases the futures contract, it becomes obligated to take delivery of the
instrument at a specified time and to pay the specified price. In most
instances, these contracts are closed out by entering into an offsetting
transaction before the settlement date, thereby canceling the obligation to make
or take delivery of specific securities. The Portfolio realizes a gain or loss
depending on whether the price of an offsetting purchase plus transaction costs
are less or more than the price of the initial sale or on whether the price of
an offsetting sale is more or less than the price of the initial purchase plus
transaction costs. Although a Portfolio will usually liquidate futures contracts
on financial instruments in this manner, it may instead make or take delivery of
the underlying securities whenever it appears economically advantageous to do
so.
A futures contract based on a securities index provides for the purchase or sale
of a group of securities at a specified future time for a specified price. These
contracts do not require actual delivery of securities, but result in a cash
settlement based upon the difference in value of the index between the time the
contract was entered into and the time it is liquidated, which may be at its
expiration or earlier if it is closed out by entering into an offsetting
transaction.
When a futures contract is purchased or sold a brokerage commission is paid, but
unlike the purchase or sale of a security or option, no price or premium is paid
or received. Instead, an amount of cash or U.S. Government securities, which
varies, but is generally about 5% of the contract amount, is deposited by the
Portfolio with its custodian for the benefit of the futures commission merchant
through which the Portfolio engages in the transaction. This amount is known as
"initial margin." It does not involve the borrowing of funds by the Portfolio to
finance the transaction, but instead represents a "good faith" deposit assuring
the performance of both the purchaser and the seller under the futures contract.
It is returned to the Portfolio upon termination of the futures contract, if all
the Portfolio's contractual obligations have been satisfied.
Subsequent payments to and from the broker, known as "variation margin," are
required to be made on a daily basis as the price of the futures contract
fluctuates, making the long or short positions in the futures contract more or
less valuable, a process known as "marking to market." If the position is closed
out by taking an opposite position prior to the settlement date of the futures
contract, a final determination of variation margin is made, additional cash is
required to be paid to or released by the broker, and the Portfolio realizes a
loss or gain.
In using futures contracts, a Portfolio will seek to establish more certainly
than would otherwise be possible the effective price of or rate of return on
portfolio securities or securities that the Portfolio proposes to acquire. A
Portfolio, for example, may sell futures contracts in anticipation of a rise in
interest rates which would cause a decline in the value of its debt investments.
When this kind of hedging is successful, the futures contracts should increase
in value when the Portfolio's debt securities decline in value and thereby keep
the Portfolio's net asset value from declining as much as it otherwise would. A
Portfolio may also sell futures contracts on securities indices in anticipation
of or during a stock market decline in an endeavor to offset a decrease in the
market value of its equity investments. When a Portfolio is not fully invested
and anticipates an increase in the cost of securities it intends to purchase, it
may purchase financial futures contracts. When increases in the prices of
equities are expected, a Portfolio may purchase futures contracts on securities
indices in order to gain rapid market exposure that may partially or entirely
offset increases in the cost of the equity securities it intends to purchase.
Options on Futures. A Portfolio may also purchase and write call and put options
on futures contracts. A call option on a futures contract gives the purchaser
the right, in return for the premium paid, to purchase a futures contract
(assume a long position) at a specified exercise price at any time before the
option expires. A put option gives the purchaser the right, in return for the
premium paid, to sell a futures contract (assume a short position), for a
specified exercise price, at any time before the option expires.
Upon the exercise of a call, the writer of the option is obligated to sell the
futures contract (to deliver a long position to the option holder) at the option
exercise price, which will presumably be lower than the current market price of
the contract in the futures market. Upon exercise of a put, the writer of the
option is obligated to purchase the futures contract (deliver a short position
to the option holder) at the option exercise price, which will presumably be
higher than the current market price of the contract in the futures market.
However, as with the trading of futures, most options are closed out prior to
their expiration by the purchase or sale of an offsetting option at a market
price that will reflect an increase or a decrease from the premium originally
paid.
Options on futures can be used to hedge substantially the same risks as might be
addressed by the direct purchase or sale of the underlying futures contracts.
For example, if a Portfolio anticipated a rise in interest rates and a decline
in the market value of the debt securities in its portfolio, it might purchase
put options or write call options on futures contracts instead of selling
futures contracts.
If a Portfolio purchases an option on a futures contract, it may obtain benefits
similar to those that would result if it held the futures position itself. But
in contrast to a futures transaction, the purchase of an option involves the
payment of a premium in addition to transaction costs. In the event of an
adverse market movement, however, the Portfolio will not be subject to a risk of
loss on the option transaction beyond the price of the premium it paid plus its
transaction costs.
When a Portfolio writes an option on a futures contract, the premium paid by the
purchaser is deposited with the Portfolio's custodian, and the Portfolio must
maintain with its custodian all or a portion of the initial margin requirement
on the underlying futures contract. The Portfolio assumes a risk of adverse
movement in the price of the underlying futures contract comparable to that
involved in holding a futures position. Subsequent payments to and from the
broker, similar to variation margin payments, are made as the premium and the
initial margin requirement are marked to market daily. The premium may partially
offset an unfavorable change in the value of portfolio securities, if the option
is not exercised, or it may reduce the amount of any loss incurred by the
Portfolio if the option is exercised.
Risks Associated with Futures Transactions. There are a number of risks
associated with transactions in futures contracts and related options. A
Portfolio's successful use of futures contracts is subject to Invista's ability
to predict correctly the factors affecting the market values of the Portfolio's
portfolio securities. For example, if a Portfolio was hedged against the
possibility of an increase in interest rates which would adversely affect debt
securities held by the Portfolio and the prices of those debt securities instead
increased, the Portfolio would lose part or all of the benefit of the increased
value of its securities which it hedged because it would have offsetting losses
in its futures positions. Other risks include imperfect correlation between
price movements in the financial instrument or securities index underlying the
futures contract, on the one hand, and the price movements of either the futures
contract itself or the securities held by the Portfolio, on the other hand. If
the prices do not move in the same direction or to the same extent, the
transaction may result in trading losses.
Prior to exercise or expiration, a position in futures may be terminated only by
entering into a closing purchase or sale transaction. This requires a secondary
market on the relevant contract market. The Portfolio will enter into a futures
contract or related option only if there appears to be a liquid secondary
market. There can be no assurance, however, that such a liquid secondary market
will exist for any particular futures contract or related option at any specific
time. Thus, it may not be possible to close out a futures position once it has
been established. Under such circumstances, the Portfolio would continue to be
required to make daily cash payments of variation margin in the event of adverse
price movements. In such situations, if the Portfolio has insufficient cash, it
may be required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. In addition, the
Portfolio may be required to perform under the terms of the futures contracts it
holds. The inability to close out futures positions also could have an adverse
impact on a Portfolio's ability effectively to hedge its portfolio.
Most United States futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. This daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
Limitations on the Use of Futures and Options on Futures. The Fund intends that
each Portfolio will come within an exclusion from the definition of "commodity
pool operator" provided by CFTC regulations by complying with certain
limitations on the use of futures and related options prescribed by those
regulations.
No Portfolio will purchase or sell futures contracts or options thereon if
immediately thereafter the aggregate initial margin and premiums exceed 5% of
the fair market value of the Portfolio's assets, after taking into account
unrealized profits and unrealized losses on any such contracts it has entered
into (except that in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount generally may be excluded in computing the
5%).
The Portfolios will enter into futures contracts and related options
transactions only for bona fide hedging purposes as permitted by the CFTC and
for other appropriate risk management purposes, if any, which the CFTC may deem
appropriate for mutual funds excluded from the regulations governing commodity
pool operators. A Portfolio is not permitted to engage in speculative futures
trading. Invista will determine that the price fluctuations in the futures
contracts and options on futures used for hedging or risk management purposes
for a Portfolio are substantially related to price fluctuations in securities
held by the Portfolio or which it expects to purchase. In pursuing traditional
hedging activities, each Portfolio will sell futures contracts or acquire puts
to protect against a decline in the price of securities that the Portfolio owns,
and each Portfolio will purchase futures contracts or calls on futures contracts
to protect the Portfolio against an increase in the price of securities the
Portfolio intends to purchase before it is in a position to do so.
When a Portfolio purchases a futures contract, or purchases a call option on a
futures contract, it will comply with applicable cover requirements, such as
maintaining an amount of cash, cash equivalents or short-term high grade fixed
income securities in a segregated account with the Portfolio's custodian, so
that the amount so segregated plus the amount of initial margin held for the
account of its broker equals the market value of the futures contract.
A Portfolio will not maintain open short positions in futures contracts, call
options written on futures contracts, and call options written on securities
indices if, in the aggregate, the value of the open positions (marked to market)
exceeds the current market value of that portion of its securities portfolio
being hedged by those futures and options plus or minus the unrealized gain or
loss on those open positions, adjusted for the historical volatility
relationship between that portion of the portfolio and the contracts (i.e., the
Beta volatility factor). To the extent a Portfolio has written call options on
specific securities in that portion of its portfolio, the value of those
securities will be deducted from the current market value of that portion of the
securities portfolio. If this limitation should be exceeded at any time, the
Portfolio will take prompt action to close out the appropriate number of open
short positions to bring its open futures and options positions within this
limitation.
Currency Contracts
The International Securities Portfolio may engage in currency transactions with
securities dealers, financial institutions or other parties that are deemed
credit worthy by Invista to hedge the value of portfolio securities denominated
in particular currencies against fluctuations in relative value. Currency
transactions include forward currency contracts, exchange-listed currency
futures contracts and options thereon and exchange-listed and over-the-counter
options on currencies. A forward currency contract involves a privately
negotiated obligation to purchase or sell (with delivery generally required) a
specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon the parties, at a price set at the time of
the contract.
A Portfolio will engage in currency transactions only for hedging and other
non-speculative purposes, including transaction hedging and position hedging.
Transaction hedging is entering into a currency transaction with respect to
specific assets or liabilities of a Portfolio, which will generally arise in
connection with the purchase or sale of the Portfolio's portfolio securities or
the receipt of income from them. Position hedging is entering into a currency
transaction with respect to portfolio securities positions denominated or
generally quoted in that currency. A Portfolio will not enter into a transaction
to hedge currency exposure to an extent greater, after netting all transactions
intended wholly or partially to offset other transactions, than the aggregate
market value (at the time of entering into the transaction) of the securities
held by the Portfolio that are denominated or generally quoted in or currently
convertible into the currency, other than with respect to proxy hedging as
described below.
A Portfolio may cross-hedge currencies by entering into transactions to purchase
or sell one or more currencies that are expected to increase or decline in value
relative to other currencies to which the Portfolio has or in which the
Portfolio expects to have exposure. To reduce the effect of currency
fluctuations on the value of existing or anticipated holdings of its securities,
a Portfolio may also engage in proxy hedging. Proxy hedging is often used when
the currency to which a Portfolio's holding is exposed is difficult to hedge
generally or difficult to hedge against the dollar. Proxy hedging entails
entering into a forward contract to sell a currency, the changes in the value of
which are generally considered to be linked to a currency or currencies in which
some or all of a Portfolio's securities are or are expected to be denominated,
and to buy dollars. The amount of the contract would not exceed the market value
of the Portfolios's securities denominated in linked currencies.
Except when a Portfolio enters into a forward contract in connection with the
purchase or sale of a security denominated in a foreign currency or for other
non-speculative purposes, which requires no segregation, a currency contract
that obligates the Portfolio to buy or sell a foreign currency will generally
require the Portfolio to hold an amount of that currency or liquid securities
denominated in that currency equal to the Portfolio's obligations or to
segregate liquid high grade debt obligations equal to the amount of the
Portfolio's obligations.
Currency hedging involves some of the same risks and considerations as other
transactions with similar instruments. Currency transactions can result in
losses to a Portfolio if the currency being hedged fluctuates in value to a
degree or in a direction that is not anticipated. Further, the risk exists that
the perceived linkage between various currencies may not be present or may not
be present during the particular time that a Portfolio is engaging in proxy
hedging. Currency transactions are also subject to risks different from those of
other portfolio transactions. Because currency control is of great importance to
the issuing governments and influences economic planning and policy, purchases
and sale of currency and related instruments can be adversely affected by
government exchange controls, limitations or restrictions on repatriation of
currency, and manipulations or exchange restrictions imposed by governments.
These forms of governmental actions can result in losses to a Portfolio if it is
unable to deliver or receive currency or monies in settlement of obligations and
could also cause hedges it has entered into to be rendered useless, resulting in
full currency exposure as well as incurring transaction costs. Currency exchange
rates may also fluctuate based on factors extrinsic to a country's economy.
Buyers and sellers of currency futures contracts are subject to the same risks
that apply to the use of futures contracts generally. Further, settlement of a
currency futures contract for the purchase of most currencies must occur at a
bank based in the issuing nation. Trading options on currency futures contracts
is relative new, and the ability to establish and close out positions on these
options is subject to the maintenance of a liquid market that may not always be
available.
Repurchase Agreements
Each Portfolio may invest in repurchase agreements. No Portfolio will enter into
repurchase agreements that do not mature within seven days if any such
investment, together with other illiquid securities held by the Portfolio, would
amount to more than 15% of its assets. Repurchase agreements will typically
involve the acquisition by the Portfolio of debt securities from a selling
financial institution such as a bank, savings and loan association or
broker-dealer. A repurchase agreement provides that the Portfolio will sell back
to the seller and that the seller will repurchase the underlying securities at a
specified price and at a fixed time in the future. Repurchase agreements may be
viewed as loans by a Portfolio collateralized by the underlying securities
("collateral"). This arrangement results in a fixed rate of return that is not
subject to market fluctuation during the Portfolio's holding period. Although
repurchase agreements involve certain risks not associated with direct
investments in debt securities, each Portfolio follows procedures established by
the Board of Directors which are designed to minimize such risks. These
procedures include entering into repurchase agreements only with large,
well-capitalized and well-established financial institutions, which have been
approved by the Board of Directors and which Invista believes present minimum
credit risks. In addition, the value of the collateral underlying the repurchase
agreement will always be at least equal to the repurchase price, including
accrued interest. In the event of a default or bankruptcy by a selling financial
institution, the affected Portfolio bears a risk of loss. In seeking to
liquidate the collateral, a Portfolio may be delayed in or prevented from
exercising its rights and may incur certain costs. Further to the extent that
proceeds from any sale upon a default of the obligation to repurchase were less
than the repurchase price, the Portfolio could suffer a loss.
Lending of Portfolio Securities
Each Portfolio may lend its portfolio securities. No Portfolio intends to lend
its portfolio securities if as a result the aggregate of such loans made by the
Portfolio would exceed 33% of its total assets. Portfolio securities may be lent
to unaffiliated broker-dealers and other unaffiliated qualified financial
institutions provided that such loans are callable at any time on not more than
five business days' notice and that cash or government securities equal to at
least 100% of the market value of the securities loaned, determined daily, is
deposited by the borrower with the Portfolio and is maintained each business day
in a segregated account. While such securities are on loan, the borrower will
pay the Portfolio any income accruing thereon, and the Portfolio may invest any
cash collateral, thereby earning additional income, or may receive an agreed
upon fee from the borrower. Borrowed securities must be returned when the loan
is terminated. Any gain or loss in the market price of the borrowed securities
which occurs during the term of the loan inures to the Portfolio and its
shareholders. A Portfolio may pay reasonable administrative, custodial and other
fees in connection with such loans and may pay a negotiated portion of the
interest earned on the cash or government securities pledged as collateral to
the borrower or placing broker. The Fund does not vote securities that have been
loaned, but it will call a loan of securities in anticipation of an important
vote.
When-Issued and Delayed Delivery Securities
Each of the Portfolios may from time to time purchase securities on a
when-issued basis and may purchase or sell securities on a delayed delivery
basis. The price of such a transaction is fixed at the time of the commitment,
but delivery and payment take place on a later settlement date, which may be a
month or more after the date of the commitment. No interest accrues to the
purchaser during this period, and the securities are subject to market
fluctuation, which involves the risk for the purchaser that yields available in
the market at the time of delivery may be higher than those obtained in the
transaction. Each Portfolio will only purchase securities on a when-issued or
delayed delivery basis for the purpose of acquiring the securities and not for
the purpose of investment leverage or to speculate on interest rate changes, but
a Portfolio may sell the securities before the settlement date, if such action
is deemed advisable. At the time a Portfolio makes the commitment to purchase
securities on a when-issued or delayed delivery basis, the Fund will record the
transaction and thereafter reflect the value, each day, of the securities in
determining the net asset value of the Portfolio. Each Portfolio will also
establish a segregated account with its custodian bank in which it will maintain
cash or cash equivalents, United States Government securities and other high
grade debt obligations equal in value to the Portfolio's commitments for such
when-issued or delayed delivery securities. The availability of liquid assets
for this purpose and the effect of asset segregation on a Portfolio's ability to
meet its current obligations, to honor requests for redemption and to have its
investment portfolio managed properly will limit the extent to which the
Portfolio may engage in forward commitment agreements. Except as may be imposed
by these factors, there is no limit on the percent of a Portfolio's total assets
that may be committed to transactions in such agreements.
Portfolio Turnover
Portfolio turnover will normally differ for each Portfolio, may vary from year
to year, as well as within a year, and may be affected by portfolio sales
necessary to meet cash requirements for redemptions of Portfolio shares. The
portfolio turnover rate for a Portfolio is calculated by dividing the lesser of
purchases or sales of its portfolio securities during the fiscal year by the
monthly average of the value of its portfolio securities (excluding from the
computation all securities, including options, with maturities at the time of
acquisition of one year or less).
A high rate of portfolio turnover generally involves correspondingly greater
brokerage commission expenses, which must be borne directly by the Portfolio.
Although the rate of portfolio turnover will not be a limiting factor when it is
deemed appropriate to purchase or sell securities for a Portfolio, each
Portfolio intends to limit turnover so that realized short-term gains on
securities held for less than three months do not exceed 30% of gross income in
order to qualify as a "regulated investment company" under the Internal Revenue
Code. This requirement may in some cases limit the ability of a Portfolio to
effect certain portfolio transactions.
The Mortgage-Backed Securities Portfolio intends to be active in the forward
commitment market when the return from holding forward positions appears to be
greater than the return from holding the actual securities. The Portfolio will
enter into forward commitment contracts to purchase securities for the purpose
of acquiring those securities and not for the purpose of investment leverage or
to speculate on interest rate changes, but as delivery dates approach, a
determination will be made whether to take delivery of a specific forward
position, or sell that position and purchase another forward position. Because
of this strategy, it is anticipated that its annual portfolio turnover rate
should generally exceed 100% and may be as much as 600% or more, although this
rate should not be construed as a limiting factor. The Portfolio intends,
however, to limit turnover so that realized short-term gains in securities held
for less than three months do not exceed 30% of gross income in order to qualify
as a "regulated investment company" under the Internal Revenue Code. See "Tax
Treatment, Dividends and Distribution." The effect of a high turnover rate would
be to incur more transaction expenses than would be incurred at a lower turnover
rate, and there is no assurance that the additional transactions that cause the
higher turnover rate would result in gains for the Portfolio or in sufficient
gains to offset the increased transaction expenses. The annualized portfolio
turnover rates for each portfolio for its most recent and immediately preceding
fiscal year were as follows: International Securities 46.0% and 37.0%;
Mortgage-Backed Securities 9.9% and 41.8%. The portfolio turnover rate was
higher for the Mortgage-Backed Securities portfolio during the preceding fiscal
year due to fund redemption activity.
DIRECTORS AND OFFICERS OF THE FUND
The following listing discloses the principal occupations and other principal
business affiliations of the Fund's Officers and Directors during the past five
years. All Directors and Officers listed here also hold similar positions with
each of the other mutual funds (currently 26 such mutual funds) sponsored by
Principal Mutual Life Insurance Company. All mailing addresses are The Principal
Financial Group, Des Moines, Iowa 50392, unless otherwise indicated.
David J. Brown, 36, Assistant Counsel. Counsel, Principal Mutual Life Insurance
Company since 1995. Prior thereto, Assistant Counsel 1994-1995; Attorney,
Dickinson, Mackaman, Tyler & Hogan 1986- 1994.
Michael W. Cumings, 44, Assistant Counsel. Counsel, Principal Mutual Life
Insurance Company since 1992. Prior thereto, Assistant Counsel.
@James D. Davis, 62, Director. 4940 Center Court, Bettendorf, Iowa. Attorney.
Vice President, Deere and Company, retired.
@Pamela A. Ferguson, 52, Director, P.O. Box 805, Grinnell, Iowa. President and
Professor of Mathematics, Grinnell College since 1991. Prior thereto, Associate
Provost and Dean of the Graduate School, University of Miami.
*J. Barry Griswell, 47, Director and Chairman of the Board. Senior Vice
President, Principal Mutual Life Insurance Company, since 1991. Prior thereto,
Agency Vice President. Director and Chairman of the Board, Princor Management
Corporation, Princor Financial Services Corporation.
*&Stephan L. Jones, 60, Director and President. Vice President, Principal Mutual
Life Insurance Company. Director and President, Princor Financial Services
Corporation and Princor Management Corporation.
@Barbara A. Lukavsky, 55, Director. 3920 Grand Avenue, Des Moines, Iowa.
President, Lu San, Inc.
Craig L. Bassett, 44, Assistant Treasurer. Director - Treasury, since 1996.
Prior thereto, Associate Treasurer, Principal Mutual Life Insurance Company.
Michael J. Beer, 35, Vice President and Financial Officer. Vice President and
Chief Operating Officer, Princor Financial Services Corporation and Princor
Management Corporation, since 1995; Financial Officer, 1991-1995. Prior thereto,
Accounting Manager, Principal Mutual Life Insurance Company.
Arthur S. Filean, 57, Vice President and Secretary. Vice President, Princor
Financial Services Corporation since 1990. Second Vice President, Principal
Mutual Life Insurance Company 1983-1990.
Ernest H. Gillum, 40, Assistant Secretary. Assistant Vice President, Registered
Products, Princor Financial Services Corporation and Princor Management
Corporation, since 1995; Product Development and Compliance Officer, 1991-1995.
Prior thereto, Registered Investments Products Manager, Principal Mutual Life
Insurance Company.
Michael D. Roughton, 44, Counsel. Counsel, Principal Mutual Life Insurance
Company. Counsel, Invista Capital Management, Inc., Princor Financial Services
Corporation, Principal Investors Corporation and Princor Management Corporation.
Jerry G. Wisgerhof, 58, Treasurer. Vice President and Treasurer, Principal
Mutual Life Insurance Company. Treasurer, Princor Financial Services
Corporation. Vice President and Treasurer, Princor Management Corporation.
@ Member of Audit Committee.
* Directors who are "Interested Persons," as defined in the Investment Company
Act of 1940, as amended.
& Member of the Executive Committee. The Executive Committee is elected by the
Board of Directors and may exercise all the powers of the Board of Directors,
with certain exceptions, when the Board is not in session and shall report its
actions to the Board.
The Fund does not pay fees or other remuneration to its directors and officers.
As of March 21, 1996, Principal Mutual Life Insurance Company, a mutual life
insurance company organized in 1879 under the laws of Iowa, its subsidiaries and
affiliates owned of record and beneficially the following number of shares or
percentage of the outstanding shares of each Portfolio:
No. of Shares % of Outstanding
Portfolio Owned Shares
International Securities Portfolio 1,186,538 79.25%
Mortgage-Backed Securities Portfolio 1,193,984 82.87%
As of March 21, 1996, the Officers and Directors of the Fund as a group owned
less than 1% of the outstanding shares of any Portfolio of the Fund.
As of March 21, 1996, the following shareholders of the Fund owned 5% or
more of the outstanding shares of any Portfolio of the Fund:
Percentage
Name Address of Ownership
Mortgage-Backed Securities Portfolio
Calhoun & Co. P.O. Box 75000 17.13%
Detroit MI 48275
International Securities Portfolio
Via-Bradley College of P.O. Box 13606 6.79%
Engineering Foundation Roanoke VA 24035
MANAGER AND SUB-ADVISOR
The Manager of each Portfolio of the Fund is Princor Management
Corporation, a wholly-owned subsidiary of Princor Financial Services Corporation
which is a wholly-owned subsidiary of Principal Holding Company. Principal
Holding Company is a holding company which is a wholly-owned subsidiary of
Principal Mutual Life Insurance Company, a mutual life insurance company
organized in 1879 under the laws of the state of Iowa. The address of the
Manager is The Principal Financial Group, Des Moines, Iowa 50392-0200. The
Manager was organized on January 10, 1969 and since that time has managed
various mutual funds sponsored by Principal Mutual Life Insurance Company.
The Manager has executed an agreement with Invista Capital Management, Inc.
("Invista") under which Invista has agreed to assume the obligations of the
Manager to provide investment advisory services for each Portfolio and to
reimburse the Manager for the other costs it incurs under the Management
Agreement. Invista, an indirectly wholly-owned subsidiary of Principal Mutual
Life Insurance Company and an affiliate of the Manager, was founded in 1985 and
manages investments for institutional investors, including Principal Mutual
Life. Assets under management at December 31, 1995 were approximately $15.7
billion. Invista's address is 1500 Hub Tower, 699 Walnut, Des Moines, Iowa
50309.
Each of the persons affiliated with the Fund who is also an affiliated person of
the Manager or Invista is named below, together with the capacities in which
such person is affiliated with the Fund, Invista and the Manager:
Office Held With Office Held With
Name Each Fund The Manager/Invista
Michael J. Beer Financial Officer Vice President and Financial Officer
(Manager)
Ernest H. Gillum Assistant Secretary Product Development and
Compliance Officer (Manager)
J. Barry Griswell Director and Chairman Director and Chairman of
of the Board the Board (Manager)
Stephan L. Jones Director and Director and President
President (Manager)
Michael D. Roughton Counsel Counsel (Manager; Invista)
Jerry G. Wisgerhof Treasurer Vice President and Treasurer
(Manager)
COST OF MANAGER'S SERVICES
The Manager has entered into a Management Agreement with the Fund pursuant to
which the Manager undertakes to act as investment adviser and manager of each
Portfolio. As compensation for its services and other responsibilities, the
Manager receives a fee computed and accrued daily and payable monthly at an
annual rate of .90% of the average net assets of the International Stock
Portfolio and .45% of the average net assets of the Mortgage-Backed Securities
Portfolio. Under a Sub-Advisory Agreement between Invista and the Manager,
Invista performs all investment advisory responsibilities of the Manager under
the Management Agreement and receives the full amount of the compensation paid
by the Fund to the Manager.
The average net assets of each portfolio on December 31, 1995 and the rate of
the fee for each portfolio for investment management services as provided in the
Management Agreement for the fiscal year then ended were as follows:
Management Fee for
Net Assets as of Fiscal Year Ended
Portfolio December 31, 1995 December 31, 1995
--------- ----------------- -----------------
International Securities $17,251,134 .90%
Mortgage Backed Securities $14,523,048 .45%
Fees paid for investment management services during the periods indicated were
as follows:
Management Fees for Fiscal
Portfolio Year Ended December 31
1995 1994 1993
---- ---- ----
International Securities $146,209 $147,720 $79,588*
Mortgage-Backed Securities $ 61,455 $102,737 $65,608*
* Period from April 26, 1993 (Commencement of Operations) through December 31,
1993.
In addition to investment advisory services, the responsibilities of the Manager
under the Management Agreement include various corporate and administrative
services, including furnishing the services of its officers and employees that
are elected to serve as officers or directors of the Fund; furnishing office
space and all necessary office facilities and equipment for the general
corporate functions of the Fund; furnishing the services of supervisory and
clerical personnel necessary to perform such functions; determining the net
asset value per share for the shares of each Portfolio; acting as and performing
the services of transfer and paying agent (including preparing and distributing
prospectuses, shareholder reports, tax information, notices and proxy
statements, making dividend payments, maintaining shareholder records in an open
account system and processing redemptions, repurchases and remittances to
shareholders); and qualifying Fund shares for sale in various jurisdictions.
In addition, the Manager is responsible for all expenses of each Portfolio
except (i) the management fee paid to it by the Fund, (ii) taxes, including in
case of redeemed shares any initial transfer taxes, (iii) portfolio brokerage
fees and incidental brokerage expenses, (iv) interest and (v) extraordinary
expenses. Since brokerage fees are treated as part of the price paid or received
upon the purchase or sale of securities and since taxes, interest and
extraordinary expenses are expected to be minimal, the management fee should
tend to give shareholders an idea as to the expected level of operating expenses
of the Portfolios in which they invest. This arrangement is different from the
fee structures of most mutual funds where one fee is paid to the investment
adviser for advisory services and many or all other expenses involved with the
operation of the fund are paid directly by the fund.
Under the terms of the Sub-Advisory Agreement with the Manager, Invista has
agreed to reimburse the Manager for all of its costs in performing corporate and
administrative services and to pay all expenses of the Fund that the Manager has
undertaken to pay under the Management Agreement.
The Management Agreement and Sub-Advisory Agreement ("Agreements") were last
approved by the Fund's Board of Directors on September 11, 1995. Both kinds of
agreements provide that each will continue in effect as to any Portfolio from
year to year only so long such continuance is specifically approved at least
annually either by the Board of Directors of the Fund or by a vote of a majority
of the outstanding voting securities of the Fund and in either event by vote of
a majority of the directors of the Fund who are not interested persons of the
Manager, Principal Mutual Life Insurance Company, the Fund and, in the case of
the Sub-Advisory Agreement, Invista cast in person at a meeting called for the
purpose of voting on such approval. Each Agreement may, on sixty days' written
notice, be terminated at any time without the payment of any penalty, by the
Board of Directors of the Fund, by vote of a majority of the outstanding voting
securities of the Fund, as to any Portfolio by the vote of a majority of the
outstanding voting securities of that Portfolio, by the Manager, and in the case
of the Sub-Advisory Agreement by Invista. Each Agreement shall automatically
terminate in the event of its assignment.
The required shareholder approval of any continuance of either Agreement shall
be effective with respect to any Portfolio if a majority of the outstanding
voting securities of that Portfolio votes to approve the continuance,
notwithstanding that the amendment may not have been approved by a majority of
the outstanding voting securities of the Fund or of any other Portfolio affected
by the amendment. If the shareholders of any Portfolio of the Fund fail to
approve the continuance of either Agreement and that failure causes the
Agreement to be invalid with respect to that Portfolio, the Manager and Invista
will continue to act as investment adviser and sub-adviser with respect to that
Portfolio pending the required approval of the Agreement's continuance or of a
new contract or other definitive action, provided that the compensation received
by each of the Manager and Invista, in case of the invalidity of the Management
Agreement, or by Invista, in case of the invalidity of the Sub-Advisory
Agreement, in respect of that Portfolio during such period will be no more than
its actual costs incurred in furnishing services to that Portfolio or the amount
it would have received under the Agreement in respect of that Portfolio,
whichever is less.
The Management Agreement may be amended but such amendment will not be effective
until specifically approved by vote of the holders of a majority of the Fund's
outstanding voting securities and by vote of a majority of the directors of the
Fund who are not interested persons of the Manager, Principal Mutual Life
Insurance Company or the Fund cast in person at a meeting called for the purpose
of voting on such approval. The required shareholder approval of any amendment
to the Management Agreement shall be effective with respect to any Portfolio if
a majority of the outstanding voting securities of that Portfolio votes to
approve the amendment, notwithstanding that the amendment may not have been
approved by a majority of the outstanding voting securities of the Fund or of
any other Portfolio affected by the matter.
The Manager has entered into an Investment Service Agreement with Principal
Mutual Life Insurance Company ("Principal Mutual") whereby Principal Mutual has
agreed to provide on a part-time basis such employees as the parties may agree
are reasonably needed by the Manager and Invista in the performance of
investment advisory services (but not corporate or administrative services)
under the Management Agreement. Principal Mutual also agreed to permit such
employees, in performing services for the Manager and Invista, full access to
statistical and economic data, investment research reports and other
non-confidential materials in the files of its Investment Department. For the
services of Principal Mutual employees, the Manager will reimburse Principal
Mutual for the direct and indirect costs fairly attributable to their services
performed for the Manager, and the Manager will be reimbursed for such costs by
Invista. The Investment Service Agreement contains provisions on continuation
and termination comparable to those described above for the Investment
Management Agreement. The Investment Management Agreement was last approved by
the Funds Board of Directors on September 11, 1995.
BROKERAGE ON PURCHASES AND SALES OF SECURITIES
In distributing brokerage business arising out of the placement of orders for
the purchase and sale of securities for any Portfolio, Invista's objective is to
obtain the best overall terms. In pursuing this objective, Invista considers all
matters it deems relevant, including the breadth of the market in the security,
the price of the security, the financial condition and executing capability of
the broker or dealer and the reasonableness of the commission, if any (for the
specific transaction and on a continuing basis). This may mean in some instances
that Invista will pay a broker commissions that are in excess of the amount of
commission another broker might have charged for executing the same transaction
when Invista believes that such commissions are reasonable in light of (a) the
size and difficulty of transactions (b) the quality of the execution provided
and (c) the level of commissions paid relative to commissions paid by other
institutional investors. (Such factors are viewed both in terms of that
particular transaction and in terms of all transactions that broker executes for
accounts over which Invista exercises investment discretion. Invista may
purchase securities in the over-the-counter market, utilizing the services of
principal market matters, unless better terms can be obtained by purchases
through brokers or dealers, and may purchase securities listed on the New York
Stock Exchange from non-Exchange members in transactions off the Exchange.)
Invista gives consideration in the allocation of business to services performed
by a broker (e.g. the furnishing of statistical data and research generally
consisting of information of the following types: analyses and reports
concerning issuers, industries, economic factors and trends, portfolio strategy
and performance of client accounts). If any such allocation is made, the primary
criteria used will be to obtain the best overall terms for such transactions.
Invista may pay additional commission amounts for research services but
generally does not do so. Such statistical data and research information
received from brokers or dealers may be useful in varying degrees and Invista
may use it in servicing some or all of the accounts it manages. Some statistical
data and research information may not be useful to Invista in managing the
client account, brokerage for which resulted in Invista's receipt of the
statistical data and research information. However, in Invista's opinion, the
value thereof is not determinable and it is not expected that Invista's expenses
will be significantly raised since the receipt of such statistical data and
research information is only supplementary to Invista's own research efforts.
The Manager, or Sub-advisor, allocated portfolio transactions for the
International Securities Portfolio to certain brokers during the fiscal year
ended December 31, 1995 due to research services provided by such brokers. These
portfolio transactions resulted in commissions paid to such brokers by the Fund
in the amount of $536.
Some products and services brokers provide to Invista (such as computer
hardware) may perform an administrative function (e.g. client accounting) as
well as a research function. In such cases, Invista makes a reasonable
allocation of the cost of the product or service according to Invista's use.
Invista pays for the portion of the product or service that consists of research
in commission dollars. Invista pays for the portion that provides it with
administrative or non-research assistance with its own money. Invista's
allocation of such products and services between research and non-research
functions poses a conflict of interest between Invista and its clients.
Annually the officers of Invista call a meeting to determine dollar limits on
business done with brokers who provide useful research information. A list of
products, research and services is kept in Invista's office.
Purchases and sales of debt securities and money market instruments usually will
be principal transactions and will normally be purchased directly from the
issuer or from an underwriter or marketmaker for the securities. Such
transactions are usually conducted on a net basis with a Portfolio paying no
brokerage commissions. Purchases from underwriters will include a commission or
concession paid by the issuer to the underwriter, and the purchases from dealers
serving as marketmakers will include the spread between the bid and asked
prices.
The following table shows the brokerage commissions paid during the periods
indicated. In each year, 100% of the commissions paid by each Fund went to
broker-dealers which provided research, statistical or other factual
information.
Total Brokerage Commissions
Portfolio Paid During Fiscal Year
Ended December 31
1995 1994 1993
---- ---- ----
International Securities $54,987 $47,909 $54,878*
Mortgage-Backed Securities $ -0- $ -0- $ -0-*
* Period from April 26, 1993 (date operations commenced) through December 31,
1993.
Brokerage commissions paid to affiliates during the year ended December
31, 1995 were as follows:
Commissions Paid to Morgan Stanley & Co.
As Percent of Dollar
Total Dollar As Percent of Amount of
Amount Total Commissions Commissionable Transactions
International
Securities Portfolio $2,888 5.25% 5.93%
Morgan Stanley and Co. is affiliated with Morgan Stanley Asset Management, Inc.,
which acts as sub- advisor to two mutual funds included in the Fund Complex.
The Manager acts as investment advisor for other funds sponsored by Principal
Mutual Life Insurance Company. Invista furnishes certain personnel, services and
facilities required by the Manager to assist the Manager in carrying out its
investment advisory responsibilities to such other funds. If, in carrying out
the investment objectives of these entities, occasions arise when purchases or
sales of the same equity securities are to be made for two or more of the
entities at the same time, a computer program will randomly order the
instructions to purchase and, whenever possible, to sell securities. Securities
purchased or proceeds of sales received on each trading day with respect to such
orders shall be allocated to the various entities placing orders on that trading
day by filling each entity's order for that day, in the sequence arrived at by
the random order. If purchases or sales of the same debt securities are to be
made for two or more of the Funds at the same time, the securities will be
purchased or sold proportionately in accordance with the amount of such security
sought to be purchased or sold at that time for each fund.
OFFERING PRICE
Each Portfolio offers its shares continuously through Princor Financial Services
Corporation which is principal underwriter for the Fund and sells shares as
agent for the Fund. Shares are sold at net asset value, without a sales charge.
In certain circumstances, Princor Financial Services Corporation will compensate
its registered representatives or a selected dealer with whom it has entered
into a selling agreement for their efforts in distributing shares held in a
customer account the establishment of which is attributable to the efforts of
the registered representatives or selected dealer.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of each Portfolio is determined daily, Monday
through Friday, as of the close of trading on the New York Stock Exchange,
except on days on which changes in the value of a Portfolio's portfolio
securities will not materially affect the current net asset value of that
Portfolio's redeemable securities, on days during which a Portfolio receives no
order for the purchase or sale of its redeemable securities and no tender of
such a security for redemption, and on customary national business holidays. The
Portfolios treat as customary national business holidays those days on which the
New York Stock Exchange is closed for New Year's Day (January 1), Washington's
Birthday (third Monday in February), Good Friday (variable date between March 20
and April 23, inclusive), Memorial Day (last Monday in May), Independence Day
(July 4), Labor Day (first Monday in September), Thanksgiving Day (fourth
Thursday in November) and Christmas Day (December 25). The net asset value per
share for each Portfolio is determined by dividing the value of securities in
the Portfolio's investment portfolio plus all other assets, less all
liabilities, by the number of Portfolio shares outstanding. Securities for which
market quotations are readily available, including options and futures traded on
an exchange, are valued at market value, which is for exchanged-listed
securities, the closing sale price; for United Kingdom-listed securities, the
market-maker provided price; and for non-listed equity securities, the bid
price. Non-listed corporate debt securities and government securities are
usually valued using an evaluated bid price provided by a pricing service. If
closing prices are unavailable for exchange-listed securities, generally the bid
price, or in the case of debt securities an evaluated bid price, is used to
value such securities. When reliable market quotations are not considered to be
readily available, which may be the case, for example, with respect to certain
debt securities, preferred stocks, foreign securities and over-the-counter
options, the investments are valued by using market quotations, prices provided
by market makers, which may include dealers with which the Portfolio has
executed transactions, or estimates of market values obtained from yield data
and other factors relating to instruments or securities with similar
characteristics in accordance with procedures established in good faith by the
Board of Directors. Securities with remaining maturities of 60 days or less are
valued at amortized cost. Other assets are valued at fair value as determined in
good faith through procedures established by the Board of Directors.
Generally, trading in foreign securities is substantially completed each day at
various times prior to the close of the New York Stock Exchange. The values of
such securities used in computing net asset value per share are usually
determined as of such times. Occasionally, events which affect the values of
such securities and foreign currency exchange rates may occur between the times
at which they are generally determined and the close of the New York Stock
Exchange and would therefore not be reflected in the computation of the net
asset values of the Portfolios. If events materially affecting the value of such
securities occur during such period, then these securities will be valued at
their fair value as determined in good faith by the Manager or Invista under
procedures established and regularly reviewed by the Board of Directors. To the
extent the Portfolio invests in foreign securities listed on foreign exchanges
which trade on days on which the Portfolio does not determine its net asset
value, for example Saturdays and other customary national U.S. holidays, the
Portfolio's net asset value could be significantly affected on days when
shareholders have no access to the Portfolio.
PERFORMANCE CALCULATION
Each Portfolio may from time to time advertise its performance in terms of total
return or yield. The figures used for total return and yield are based on the
historical performance of a Portfolio, show the performance of a hypothetical
investment and are not intended to indicate future performance. Total return and
yield will vary from time to time depending upon market conditions, the
composition of a Portfolio's portfolio and operating expenses. These factors and
possible differences in the methods used in calculating performance figures
should be considered when comparing a Portfolio's performance to the performance
of some other kind of investment.
A Portfolio may also include in its advertisements performance rankings and
other performance-related information published by independent statistical
services or publishers, such as Lipper Analytical Services, Weisenberger
Investment Companies Services, Money Magazine, Forbes, The Wall Street Journal,
Baron's and Changing Times, and comparisons of the performance of a Portfolio to
that of various market indices, such as the S&P 500 Index, Dow Jones Industrials
Index, Morgan Stanley Capital International EAFE (Europe, Australia and Far
East) Index and World Index, Lehman Brothers GNMA Index and the Salomon Brothers
Investment Grade Bond Index.
Total Return
When advertising total return figures, each Portfolio will include its average
annual total return for each of the one, five and ten year periods (or if
shorter, the period during which its registration statement has been in effect)
that end on the last day of the most recent calendar quarter. Average annual
total return is computed by calculating the average annual compounded rate of
return over the stated period that would equate an initial $1,000 investment to
the ending redeemable value assuming the reinvestment of all dividends and
capital gains distributions at net asset value. In its advertising, a Portfolio
may also include average annual total return for some other period or cumulative
total return for a specified period. Cumulative total return is computed by
dividing the difference between the ending redeemable value (assuming the
reinvestment of all dividends and capital gains distributions) and the initial
investment by the initial investment.
The following table shows as of December 31, 1995 average annual return for each
of the Portfolios for the periods indicated:
Portfolio 1-Year 5-Year 10-Year
International Securities 12.02 12.35%(1) N/A
Mortgage-Backed Securities 19.26 7.14%(1) N/A
(1) Period beginning May 7, 1993 and ending December 31, 1995.
Yield
The Mortgage-Backed Securities Portfolio calculates its yield by determining its
net investment income per share for a 30-day (or one month) period, annualizing
that figure (assuming semi-annual compounding) and dividing the result by the
net asset value per share for the last day of the same period. The yield for the
Mortgage-Backed Securities Portfolio as of December 31, 1995 was 6.42%.
A Portfolio may include in its advertisements the compounding effect of
reinvested dividends over an extended period of time as illustrated below.
The Power of Compounding
Shareholders who choose to reinvest their distributions get the advantage of
compounding. Here's what happens to a $10,000 investment with monthly income
reinvested at 6 percent, 8 percent and 10 percent over 20 years.
These figures assume no fluctuation in the value of principal. This chart is for
illustration purposes only and is not intended as an indication of the results a
shareholder may receive as a shareholder of a specific Portfolio. The return and
capital value of an investment in a Portfolio will fluctuate so that the value,
when redeemed, may be worth more or less than the original cost.
Years 6% 8% 10%
0 $10,000 $10,000 $10,000
20 $32,071 $46,610 $67,275
A Portfolio may also include in its advertisements an illustration of the impact
of income taxes and inflation on earnings from bank certificates of deposit
("CD's"). The interest rate on the hypothetical CD will be based upon average CD
rates for a stated period as reported in the Federal Reserve Bulletin. The
illustrated annual rate of inflation will be the core inflation rate as measured
by the Consumer Price Index for the 12-month period ended as of the most recent
month prior to the advertisement's publication. The illustrated income tax rate
may include any federal income tax rate applicable to individuals at the time
the advertisement is published. Any such advertisement will indicate that,
unlike bank CD's, an investment in the Fund is not insured nor is there any
guarantee that the Fund's net asset value or any stated rate of return will
remain constant.
An example of a typical calculation included in such advertisements is as
follows: the after-tax and inflation-adjusted earnings on a bank CD, assuming a
$10,000 investment in a six-month bank CD with an annual interest rate of 5.76%
(average six-month CD rate for the month of October, 1995, as reported in the
Federal Reserve Bulletin) and an inflation rate of 2.8% (rate of inflation for
the 12-month period ended October 31, 1995 as measured by the Consumer Price
Index) and an income tax bracket of 28% would be $(67).
($10,000 x 5.76%) / 2 = $288 Interest for six-month period
- 81 Federal income taxes (28%)
- 140 Inflation's impact on invested principal ($10,000 x 2.8%) / 2
($ 67) After-tax, inflation-adjusted earnings
TAX TREATMENT, DIVIDENDS AND DISTRIBUTIONS
It is the policy of each Portfolio to distribute substantially all net
investment income and net realized gains. Through such distributions, and by
satisfying certain other requirements, the Fund intends to qualify each
portfolio for the tax treatment accorded to regulated investment companies under
the applicable provisions of the Internal Revenue Code. This means that in each
year in which a Portfolio so qualifies, it will be exempt from federal income
tax upon the amount so distributed to investors. The Tax Reform Act of 1986
imposed an excise tax on mutual funds which fail to distribute net investment
income and capital gains by the end of the calendar year in accordance with the
provisions of the Act. Each Portfolio intends to comply with the Act's
requirements and to avoid this excise tax.
Distributions from the International Securities Portfolio and Mortgage-Backed
Securities Portfolio will generally not be eligible for the 70% corporate
dividends received deduction. All taxable dividends and capital gains are
taxable in the year in which distributed, whether received in cash or reinvested
in additional shares. Dividends declared with a record date in December and paid
in January will be deemed to have been distributed to shareholders in December.
Each Portfolio will inform its shareholders of the amount and nature of their
taxable income dividends and capital gain distributions. Dividends from a
Portfolio's net income and distributions of capital gains, if any, may also be
subject to state and local taxation.
As previously discussed, a Portfolio may invest in futures contracts or options
thereon, index options or options traded on qualified exchanges. For federal
income tax purposes, capital gains and losses on futures contracts or options
thereon, index options or options traded on qualified exchanges are generally
treated as 60% long-term and 40% short-term. In addition, a Portfolio must
recognize any unrealized gains and losses on such positions held at the end of
the fiscal year. A Portfolio may elect out of such tax treatment, however, for a
futures or options position that is part of an "identified mixed straddle" such
as a put option purchased with respect to a portfolio security. Gains and losses
on futures and options included in an identified mixed straddle will be
considered 100% short-term and unrealized gain or loss on such positions will
not be realized at year end. The straddle provisions of the Code may require the
deferral of realized losses to the extent that a Portfolio has unrealized gains
in certain offsetting positions at the end of the fiscal year, and may also
require recharacterization of all or a part of losses on certain offsetting
positions from short-term to long-term, as well as adjustment of the holding
periods of straddle positions.
One of the requirements each Portfolio must meet to qualify as a regulated
investment company under federal tax law is that it must derive less than 30% of
its gross income from gains on the sale or other disposition of securities held
for less than three months. Accordingly, each Portfolio will be restricted in
selling securities held or considered under Code rules to have been held for
less than three months and in engaging in certain transactions to obtain or
close positions in options and futures contracts.
Each Portfolio is required by law under certain circumstances to withhold 31% of
dividends paid to investors who do not furnish their correct taxpayer
identification number (in the case of individuals, their social security
number).
Shareholders should consult their own tax advisors as to the federal, state and
local tax consequences of ownership of shares of the Portfolios in their
particular circumstances.
Special Tax Considerations
International Securities Portfolio
When at the close of a fiscal year more than 50% of the value of the
International Securities Portfolio's total assets are invested in securities of
foreign corporations, the Fund may elect pursuant to Section 853 of the Code to
permit its Shareholders to take a credit (or a deduction) for foreign income
taxes paid by the Portfolio. In that case, Shareholders should include in their
report of gross income in their federal income tax returns both cash dividends
received from the Portfolio and also the amount which the Portfolio advises is
their pro rata portion of foreign income taxes paid with respect to, or withheld
from, dividends and interest paid to the Portfolio from its foreign investments.
Shareholders would then be entitled to subtract from their federal income taxes
the amount of such taxes withheld, or treat such foreign taxes as a deduction
from gross income, if that should be more advantageous. As in the case of
individuals receiving income directly from foreign sources, the above-described
tax credit or tax deduction is subject to certain limitations. Shareholders or
prospective shareholders should consult their tax advisors on how these
provisions apply to them.
FINANCIAL STATEMENTS
The financial statements of the Fund for the year ended December 31, 1995
appearing in the Annual Report to shareholders and the report thereon of Ernst &
Young LLP, independent auditors, appearing therein are incorporated by reference
in this Statement of Additional Information. The Annual Report will be furnished
without charge, to investors who request copies of the Statement of Additional
Information.
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