PRINCIPAL SPECIAL MARKETS FUND INC
497, 1998-05-05
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                      PRINCIPAL SPECIAL MARKETS FUND, INC.
                    International Emerging Markets Portfolio
                       International Securities Portfolio
                        International SmallCap Portfolio
                      Mortgage-Backed Securities Portfolio



                        The Principal Financial Group(R)
                           Des Moines, Iowa 50392-0200
                                 1-800-451-5447



Principal  Special  Markets  Fund,  Inc.  (the  "Fund") is a  no-load,  open-end
management   investment   company,   currently   consisting   of   four   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  Emerging  Markets  Portfolio:  Long-term  growth  of  capital  by
investing   primarily  in  equity  securities  of  issuers  in  emerging  market
countries.

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.

International  SmallCap  Portfolio:  Long-term  growth of capital  by  investing
primarily in equity securities of non-United States companies with comparatively
smaller market capitalizations.

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, 1998, 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 1-800-451-5447.






         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, 1998.


                                TABLE OF CONTENTS



                                                                 Page

     Summary....................................................   3

     Financial Highlights.......................................   5

     Investment Objectives, Policies and Restrictions...........   7

   
     Certain Investment Policies and Restrictions...............  11
    

     Risk Factors...............................................  12

     Manager and Investment Sub-Advisor ........................  12

     Duties Performed by the Manager and Sub-Advisor............  13

     Managers' Comments.........................................  14

     Determination of Net Asset Value ..........................  17

     Performance Calculation ...................................  17

     Shareholder Rights.........................................  17

     Distribution of Income Dividends and Realized Capital Gains  18

   
     Tax Treatment, Dividends and Distributions ................  18
    

     How to Invest .............................................  19

     Offering Price of Shares ..................................  20

     Minimum Investment Requirement.............................  20

     Open Account System........................................  20

     Redemption of Shares.......................................  21

     Periodic Withdrawal Plan...................................  22

   
     Additional Information.....................................  22
    


     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 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 Emerging Markets Portfolio is
to seek long-term growth of capital by investing  primarily in equity securities
of issuers in emerging market countries.

     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 International SmallCap Portfolio is to seek
long-term growth of capital by investing in a portfolio of equity  securities of
non-United States companies with comparatively smaller market capitalizations.

     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 any of the  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?

     Principal  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.

<TABLE>
<CAPTION>
                        Shareholder Transaction Expenses

                                                Maximum Sales Load Imposed
                                                       on Purchases                     
           Portfolio                         (as a percentage of offering price)     Redemption Fee

<S>                                                         <C>                          <C>    
   International Emerging Markets Portfolio                 None                         None
   International Securities Portfolio                       None                         None
   International SmallCap Portfolio                         None                         None
   Mortgage-Backed Securities Portfolio                     None                         None
</TABLE>

<TABLE>
<CAPTION>
                       Annual Portfolio Operating Expenses
                     (as a percentage of average net assets)

                                                 Management          12b-1            Other                  Total Operating
                 Portfolio                          Fee               Fee           Expenses*                    Expenses

<S>                                                 <C>              <C>              <C>                         <C>  
   International Emerging Markets Portfolio         1.15%            None             None                        1.15%
   International Securities Portfolio                .90%            None             None                         .90%
   International SmallCap Portfolio                 1.00%            None             None                        1.00%
   Mortgage-Backed Securities Portfolio              .45%            None             None                         .45%
</TABLE>

   * 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 Emerging Markets, International
Securities and  International  SmallCap  Portfolios are higher than that paid by
most funds to their  advisors,  but not higher  than the fees paid by many funds
with similar investment objectives and policies and does cover substantially all
expenses of the  Portfolios,  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:

<TABLE>
<CAPTION>
                                                                               Period (in years)
                        Portfolio                              1               3               5             10

<S>                                                           <C>             <C>             <C>            <C> 
        International Emerging Markets Portfolio              $12             $37             N/A             N/A
        International Securities Portfolio                     $9             $29             $50            $111
        International SmallCap Portfolio                      $10             $32             N/A             N/A
        Mortgage-Backed Securities Portfolio                   $5             $14             $25             $57
</TABLE>

       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.


                    International Emerging Markets Portfolio


                                                             Period
                                                              Ended
                                                          December 31,
                                                             1997(a)

Net Asset Value at Beginning of Period...................     $9.94

Income from Investment Operations:
   Net Investment Income.................................       .01
   Net Realized and Unrealized Gains (Losses)
      on Investments.....................................       .21

                         Total from Investment Operations       .22

Less Distributions:
   Dividends (from net investment income)................      (.02)
   Distributions (from capital gains)....................       --


                                      Total Distributions      (.02)


Net Asset Value at End of Period.........................    $10.14



Total Return.............................................      1.40%(b)

Ratios/Supplemental Data:
   Net Assets, End of Period (in thousands)..............   $32,488
   Ratio of Expenses to Average Net Assets...............    1.15%(c)
   Ratio of Net Investment Income to Average
      Net Assets.........................................     .91%(c)
   Portfolio Turnover Rate...............................    12.3%(c)
   Average Commission Rate Paid(d).......................   $.0029


<TABLE>
<CAPTION>
                       International Securities Portfolio


                                                              Year          Year            Year            Year          Period
                                                              Ended         Ended           Ended           Ended          Ended
                                                          December 31,  December 31,    December 31,    December 31,   December 31,
                                                              1997          1996            1995            1994          1993(e)


<S>                                                        <C>            <C>            <C>             <C>             <C>   
Net Asset Value at Beginning of Period...................    $13.67         $11.70         $11.29          $12.87          $10.01

Income from Investment Operations:
   Net Investment Income.................................       .24            .31            .19             .13             .07
   Net Realized and Unrealized Gains (Losses)
      on Investments.....................................      1.46           2.46           1.11            (.95)           2.91

                         Total from Investment Operations      1.70           2.77           1.30            (.82)           2.98

Less Distributions:
   Dividends (from net investment income)................      (.24)          (.16)          (.10)           (.12)        (.10)
   Excess distribution of net investment income..........      --             (.07)          (.07)           (.13)           --
   Distributions (from capital gains)....................      (.68)          (.57)          (.72)           (.51)        (.02)


                                      Total Distributions      (.92)          (.80)          (.89)           (.76)           (.12)


Net Asset Value at End of Period.........................    $14.45         $13.67         $11.70          $11.29          $12.87



Total Return.............................................     12.55%         24.12%         12.02%          (6.45)%       29.95%(b)

Ratios/Supplemental Data:
   Net Assets, End of Period (in thousands)..............   $37,684        $28,161        $17,251         $15,542        $16,838
   Ratio of Expenses to Average Net Assets...............        .90%         .90%           .90%            .90%          .90%(c)
   Ratio of Net Investment Income to Average
      Net Assets.........................................       1.73%        1.90%          1.79%            .94%         1.21%(c)
   Portfolio Turnover Rate...............................       30.8%        25.5%          46.0%           37.0%          6.9%(c)
   Average Commission Rate Paid(d).......................     $.0187       $.0187            --              --            --
</TABLE>

                        International SmallCap Portfolio


                                                             Period
                                                              Ended
                                                          December 31,
                                                             1997(a)

Net Asset Value at Beginning of Period...................     $9.86

Income from Investment Operations:
   Net Investment Income.................................       .01
   Net Realized and Unrealized Gains (Losses)
      on Investments.....................................       .12

                         Total from Investment Operations       .13

Less Distributions:
   Dividends (from net investment income)................      (.02)
   Distributions (from capital gains)....................       --


                                      Total Distributions      (.02)


Net Asset Value at End of Period.........................     $9.97



Total Return.............................................      1.59%(b)

Ratios/Supplemental Data:
   Net Assets, End of Period (in thousands)..............   $31,968
   Ratio of Expenses to Average Net Assets...............    1.00%(c)
   Ratio of Net Investment Income to Average
      Net Assets.........................................     .91%(c)
   Portfolio Turnover Rate...............................    30.3%(c)
   Average Commission Rate Paid(d).......................   $.0111
<TABLE>
<CAPTION>
                      Mortgage-Backed Securities Portfolio


                                                              Year          Year            Year            Year          Period
                                                              Ended         Ended           Ended           Ended          Ended
                                                          December 31,  December 31,    December 31,    December 31,   December 31,
                                                              1997          1996            1995            1994          1993(e)


<S>                                                       <C>             <C>           <C>              <C>             <C>   
Net Asset Value at Beginning of Period...................   $  9.93         $10.17        $  9.11          $10.10          $10.01

Income from Investment Operations:
   Net Investment Income.................................       .64            .64            .65             .63             .34
   Net Realized and Unrealized Gains (Losses)
      on Investments.....................................       .34           (.24)          1.06            (.99)            .09

                         Total from Investment Operations       .98            .40           1.71            (.36)            .43
Less Distributions:
   Dividends (from net investment income)................      (.64)          (.64)          (.65)           (.63)        (.34)


Net Asset Value at End of Period.........................    $10.27        $  9.93         $10.17         $  9.11          $10.10



Total Return.............................................     10.18%          4.20%         19.26%          (3.60)%        4.47%(b)

Ratios/Supplemental Data:
   Net Assets, End of Period (in thousands)..............   $13,796        $14,968        $14,253         $14,714        $24,309
   Ratio of Expenses to Average Net Assets...............        .45%         .45%           .45%            .45%          .45%(c)
   Ratio of Net Investment Income to Average
      Net Assets.........................................       6.37%        6.51%          6.66%           6.56%         5.23%(c)
   Portfolio Turnover Rate(d)............................      15.5%        28.7%           9.9%           41.8%          9.6%(c)
</TABLE>

(a)  Period from  November  26, 1997,  date shares first  offered to the public,
     through  December 31, 1997. Net  investment  income,  aggregating  $.02 per
     share for the  International  Emerging Markets Portfolio and $.01 per share
     for the  International  SmallCap  Portfolio for the period from the initial
     purchase of shares on November  17, 1997 through  November  25,  1997,  was
     recognized,  none  of  which  was  distributed  to  the  sole  shareholder,
     Principal  Mutual Life  Insurance  Company.  Additionally,  the  portfolios
     incurred  unrealized  losses on  investments of ($.08) per share and ($.15)
     per  share  respectively,   during  the  interim  period.  This  represents
     activities of each portfolio prior to the initial offering.

(b)  Total return amounts have not been annualized.

(c)  Computed on an annualized basis.

(d)  The  International  Portfolios  identified the cost of commissions  paid on
     purchases and sales charged to each  portfolio in the local currency in the
     respective  country  involved.  The value of the  commissions is translated
     into  U.S.  dollars  at  approximate  rates  when  acquired  or sold.  This
     translation  can give the  appearance  that the  International  Portfolios'
     average commissions are substantially different from the other funds.

(e)  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
     intitial  interim  period.  This  represented  activities of each portfolio
     prior to the initial offering.

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.

     The  International  Emerging Markets  Portfolio,  International  Securities
Portfolio and  International  SmallCap  Portfolio  (together the  "International
Portfolios")  each 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.

     Each Portfolio 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 Manager  will waive its  management  fee on the
portfolio's   assets  invested  in  securities  of  other  open-end   investment
companies.  The  Portfolio  will  generally  invest  only  in  those  investment
companies  that have  investment  policies  requiring  investment  in securities
comparable in quality to those in which the Portfolio invests.

     When in the  opinion  of  Invista  current  market or  economic  conditions
warrant, the Portfolios each 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.

International Emerging Markets Portfolio

     The investment objective of the International Emerging Markets Portfolio is
long-term  growth of capital.  The Portfolio  seeks to achieve this objective by
investing   primarily  in  equity  securities  of  issuers  in  emerging  market
countries. As used in this Prospectus,  the term "emerging market country" means
any country which, in the opinion of Invista,  is generally  considered to be an
emerging  country  by  the  international  financial  community,  including  the
International  Bank for  Reconstruction  and Development (more commonly known as
the World Bank) and the  International  Financial  Corporation.  These countries
generally  include every nation in the world except the United  States,  Canada,
Japan,  Australia,  New  Zealand  and most  nations  located in Western  Europe.
Currently,  investing in many emerging  countries is not feasible or may involve
unacceptable  political  risks.  The Portfolio  focuses on those emerging market
countries  in which it believes the  economies  are  developing  strongly and in
which the markets are becoming more sophisticated.

     Investments in emerging market  countries  involve  special risks.  Certain
emerging market  countries have  historically  experienced,  and may continue to
experience,  high  rates  of  inflation,  high  interest  rates,  exchange  rate
fluctuations, large amounts of debt, balance of payments and trade difficulties,
and extreme  poverty and  unemployment.  In  addition,  there are certain  risks
associated with investments in foreign securities (see "Risk Factors").

     Under normal  conditions at least 65% of the Portfolio's  total assets will
be invested in emerging market country equity securities.  The Portfolio invests
in securities of (1) issuers with their principal place of business or principal
office in emerging  market  countries,  or (2)  issuers for which the  principal
securities  trading  market  is an  emerging  market  country,  or (3)  issuers,
regardless  of where the  security  is traded,  that derive 50% or more of their
total  revenue  from  either  goods or  services  produced  in  emerging  market
countries or sales made in emerging market countries.

     A small portion of the Portfolio  assets may also be invested in closed end
country  specific   investment   companies  and  sovereign  debt  of  developing
countries.  Closed end  investment  companies  provide a way to gain exposure to
countries  where the  mechanics of trading  securities  are not cost  effective.
Investment in sovereign  debt may have the potential for returns that are higher
than returns on stocks within the country.

International Securities Portfolio

     The investment  objective of the International  Securities  Portfolio 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 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.

International SmallCap Portfolio

     The  investment  objective  of  the  International  SmallCap  Portfolio  is
long-term  growth  of  capital.  The  strategy  of this  Portfolio  is to invest
primarily in equity securities of non-United States companies with comparatively
smaller market  capitalizations.  Under normal market conditions,  the Portfolio
invests at least 65% of its assets in  securities  of  companies  having a total
market capitalization of $1 billion or less.

     The Portfolio diversifies its investments geographically. 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. For a description of certain
investment risks associated with foreign securities, see "Risk Factors."

Mortgage-Backed Securities Portfolio

     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  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 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.  The  Portfolios  do not  intend  (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 Portfolios each 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 Portfolios 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   Portfolios  each  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. A
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 a 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.

     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 an  International  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.

     Securities of many foreign issuers may be less liquid and their prices more
volatile than those of comparable  domestic issuers.  In particular,  securities
markets in emerging market countries are known to experience long delays between
the trade and  settlement  dates of securities  purchased and sold,  potentially
resulting  in a lack  of  liquidity  and  greater  volatility  in the  price  of
securities on those markets.  In addition,  investments in smaller companies may
present greater  opportunities  for capital  appreciation,  but may also involve
greater  risks than large,  mature  issuers.  Such  companies  may have  limited
product  lines  and  financial  resources.  Their  securities  may trade in more
limited volume than larger companies and may therefore experience  significantly
more price volatility and less liquidity than securities of larger companies. As
a result of these factors,  the Board of Directors of the Fund has adopted Daily
Pricing and Valuation  Procedures for the Portfolios  which sets forth the steps
to be followed by the Manager and  Sub-Advisor to establish a reliable market or
fair value if a reliable  market value is not  available  through  normal market
quotations.  Oversight of this process is provided by the Executive Committee of
the Board of Directors.

      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  Principal  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, 1997 the Manager had assets
under management of approximately $5.3 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  31,1997 were  approximately  $25.8
billion.  Invista's  address is 1800 Hub Tower,  699 Walnut,  Des  Moines,  Iowa
50309.

     Invista has assigned certain individuals the primary responsibility for the
day-to-day  management of each portfolio.  The persons primarily responsible for
the day-to-day management of each Portfolio are identified in the table below:

<TABLE>
<CAPTION>
                                          Primarily
               Fund                    Responsible Since                                  Person Primarily Responsible
<S>                                   <C>                                 <C>                                            
International Emerging Markets        November, 1997                      Kurtis D. Spieler, CFA (MBA degree, Drake University).
Portfolio                             (Portfolio's inception)             Vice President, Invista Capital Management, Inc. since
                                                                          1995; Investment Officer, 94-95. Prior Thereto, Investment
                                                                          Manager, Principal Mutual Life Insurance Company.

International Securities              April, 1994                         Scott D. Opsal, CFA (MBA degree, University of
Portfolio                                                                 Minnesota). Executive Vice President and Chief Investment
                                                                          Officer,  Invista Capital Management, Inc. since 1997. 
                                                                          Vice President, 1986-1997.

International SmallCap                November, 1997                      Darren K. Sleister, CFA (MBA degree, University of
Portfolio                             (Portfolio's inception)             Iowa). Investment Officer, Invista Capital Management,
                                                                          Inc. since 1995; Prior thereto, Security Analyst.

Mortgage-Backed Securities            May, 1993                           Martin J. Schafer (BBA degree, University of Iowa). Vice
Portfolio                             (Portfolio's inception)             President, Invista Capital Management, Inc.  since 1992.
                                                                          Director - Securities Trading, Principal Mutual Life 
                                                                          Insurance Company 1992; Prior thereto, Associate Director.
</TABLE>

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 Management Fees are computed at the following annual rates:

<TABLE>
<CAPTION>
                                                                        Fees Computed On                 Fees as a Percent of
                  Portfolio                                       Net Asset Value of Portfolio         Average Daily Net Assets
<S>                                                                    <C>                                     <C>  
     International Emerging Markets Portfolio                          First $250 million                      1.15%
                                                                       Next $250 million                       1.05%
                                                                       Over $500 million                       0.95%

     International Securities Portfolio                                Entire Portfolio                        0.90%

     International SmallCap Portfolio                                  First $250 million                      1.00%
                                                                       Next $250 million                       0.90%
                                                                       Over $500 million                       0.80%

     Mortgage-Backed Securities Portfolio                              Entire Portfolio                        0.45%
</TABLE>

     The fee payable by the  International  Portfolios are 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

     Principal  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, 1997.  The  accompanying  charts
display  results for the life of the Fund through  December  31,  1997.  Average
Annual Total  Return  figures  provided  for each  portfolio 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 Emerging Markets Portfolio

Historical  records  indicate that fourth  quarter 1997 emerging  market returns
represented  the weakest  period of  performance in this asset class in the last
decade.   Asian  markets   continued  to  underperform  with  various  countries
experiencing currency devaluation.  The difference in the fourth quarter was the
impact of the Asian problems on the rest of the emerging markets universe. Latin
America,  Eastern Europe, and Africa joined in the sell-off as investors avoided
`risky' assets.

In general,  equity market  returns are driven by interest rates and earnings or
cash flow growth. As a result of the loss of confidence in Asia,  interest rates
rose in virtually  every Asian market as  governments  tried to stabilize  their
currency. Many emerging countries outside of Asia, including Brazil,  Argentina,
Chile,  and South Africa,  also increased  their interest rates in an attempt to
avoid  currency  speculation.  In addition to the interest rate  increase,  many
economists  are now  predicting  recessions  throughout  Asia and a slowdown  in
growth from other emerging  countries.  Thus,  emerging  markets were hit by the
double impact of increased interest rates and low earnings growth.

The  Portfolio's  inception  in late  November  allowed  it to miss  most of the
dramatic capitulations occurring in the second half of 1997. The 1.40% return is
respectable  considering  most of the emerging indices  registered  double digit
declines in the fourth quarter.

The Portfolio is  diversified by region with Latin America  constituting  40% of
the fund,  EMEA  (Eastern  Europe,  Middle  East,  Africa) 35% and Asia 25%. The
Portfolio's  managers continue to focus primarily on companies in Latin America,
Eastern  Europe and the Middle  East due to the strong  government  response  to
problems and the  stronger  economic  fundamentals.  The  Portfolio  sold out of
several  leveraged  companies  in Latin  America  and  remains  focused  on cash
generative  businesses.  Managers  are cautious in Asia,  primarily  playing net
exporters with strong balance  sheets but  continually  monitoring the situation
for value  opportunities.  Risk management entails limitations on country (20%),
industry (25%), and company exposure (5%).

            Comparison of Change in Value of $1.0 Million Investment
                in the International Emerging Markets Portfolio,
                MSCI EMF and Lipper Emerging Markets Fund Average



International Emerging Markets Portfolio




                                               MSCI       Lipper Emerging
                                              EMF ID          Markets
Year Ended December 31, 1997        IEP        INDEX         Fund Avg.     
                                 1,000,000    1,000,000     1,000,000
                                 1,014,000    1,021,800     1,015,300      

Note:  Past performance is not predictive of future performance.

- -------------------------------------------------
        International Emerging Markets Portfolio
                 Total Returns
            As of December 31, 1997
             1 Year       5 Year      10 Year
             1.40%*         --          --


* - Since Inception Date 11/26/97
- -------------------------------------------------


International Securities Portfolio

The  International  Securities  Portfolio's  return of  12.55% in 1997  compared
favorably  with the return  generated by the EAFE index of 1.78%.  The Portfolio
benefited from its  overweight  position in Europe.  European  markets were very
strong in 1997 and with all markets up for the year and only two markets, Norway
and Austria,  up less than 10%. The  environment for equities in Europe was very
positive in 1997;  inflation  remained low,  interest rates were low and falling
and economic  growth began to pick up. The strong U.S. dollar was another factor
boosting the performance of European  equities because of its positive effect on
the profitability of exporters based in Europe.

While almost everything was going right in Europe,  almost everything went wrong
in Asia.  The  currency  crisis that  started in  Thailand in the third  quarter
spread to other Asian  countries  employing a currency  peg system in the months
that followed.  The currency depreciation that these countries experienced had a
significant  negative  ripple  effect on the  profitability  of their  corporate
sector and on near-term  economic  growth  prospects.  Stock market  performance
reflected those problems,  with five markets (Thailand,  South Korea, Indonesia,
Malaysia, Philippines) all down more than 60%. Hong Kong and Singapore were down
30% or less.  The  Portfolio  benefited  from its  underweight  position in Asia
relative  to the EAFE  index.  A large  portion  of the  Asian  exposure  in the
Portfolio  in  1997  resided  in  Hong  Kong,   another  positive  for  relative
performance.

The Portfolio remains underweighted in the Japanese market, which was down 23.7%
in 1997, another reason the Portfolio  outperformed.  Valuations  continue to be
high in  Japan  and the  outlook  for  economic  growth  is not good  given  the
continued weakness of the Japanese economy and the subdued growth outlook of its
Asian neighbors.

The strong  U.S.  dollar had an equally  negative  effect on the  returns of the
account and the EAFE Index, reducing both by 10.5%.

 Comparison of Change in Value of $1.0 Million Investment in the International
     Securities Portfolio, EAFE Index and Lipper International Fund Average

                                 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    1,058,800     1,225,000    
                       1994    1,215,602    1,141,175     1,216,303    
                       1995    1,361,697    1,269,100     1,330,757    
                       1996    1,690,200    1,345,881     1,487,520    
                       1997    1,902,357    1,369,838     1,568,441    

Note:  Past performance is not predictive of future performance.

- ---------------------------------------------------------
          International Securities Portfolio
                  Total Returns 
              As of December 31, 1997

1 Year          Since Inception Date 5/7/93      10 Year
   12.55%                 14.83%                    --
- ---------------------------------------------------------


International SmallCap Portfolio

The fourth quarter of 1997 proved to be a challenging period to hold equities in
the international arena. The International  SmallCap Portfolio clearly benefited
from a low exposure to the Asian  region and a high level of European  holdings.
Most  of Asia  registered  double-digit  losses  in  dollar  terms.  While  this
portfolio's  managers  were correct in their  assessment  of Asia,  the negative
impact the  crisis  would  exert on  non-Asian  companies  with  indirect  Asian
involvement was not anticipated.  The Portfolio missed most of the equity market
capitulation that occurred during the last half of 1997.  However, by the end of
year most of the  markets  had begun to level off.  Inception  of the  Portfolio
occurred  in late  November,  returning  1.59% to  investors  in a little over a
month's time. This return was respectable considering the severe impact Asia had
on the rest of the world's markets.

As the investment  philosophy of the Portfolio requires long term forecasts of a
company's  value as a business,  the managers  feel  conditions  in Asia are too
unsettled at this time to make such forecasts. Thus, the Portfolio's holdings in
the region have been limited.  The impact the Southeast  Asian economies has had
on Europe has driven the price of European  companies to unjustified  valuations
and the Portfolio  will continue to hold on to many European  companies as their
valuations are now quite attractive.  The Portfolio  managers continue to search
for  undervalued  European  small caps that are  believed  to  benefit  from the
changing  economic  conditions  in Europe as the European  Economic and Monetary
Union ("EMU") continues to progress.

            Comparison of Change in Value of $1.0 Million Investment
                    in the International SmallCap Portfolio,
            MSCI EAFE Index and Lipper International SmallCap Fund Average


                                                 Lipper
                                   MSCI       International
Year Ended                        EAFE ND       SmallCap 
December 31, 1997     ICP          INDEX        Fund Avg.   
                   1,000,000     1,000,000      1,000,000
                   1,015,900     1,008,700        985,500   


Note:  Past performance is not predictive of future performance.

- ------------------------------------------
    International SmallCap Portfolio
             Total Returns
       As of December 31, 1997
   1 Year    5 Year       10 Year
    1.59%*     --           --

* - Since Inception Date 11/26/97
- ------------------------------------------
Important Notes:

Lipper  Emerging  Markets Fund  Average:  This  average  consists of funds which
invest at least 65% of their total assets in emerging market equity  securities,
where  "emerging  market"  is  defined  by a  country's  GNP per capita or other
economic measures. The one-year average currently contains 130 funds.

Morgan Stanley Capital  International  EMF (Emerging  Markets Free) Index:  This
average is  capitalization  weighted and  consists of stocks from 26  countries.
These countries include:  Argentina,  Brazil, Chile, China Free, Columbia, Czech
Republic,  Greece, Hungary, India, Indonesia Free, Israel, Jordan, Korea at 50%,
Malaysia Free, Mexico Free, Pakistan,  Peru, Philippines Free, Poland, Portugal,
South Africa, Sri Lanka, Taiwan at 50%, Thailand Free, Turkey and Venezuela.

Lipper  International  Small Cap Funds Average:  This average  consists of funds
which invest at least 65% of their  assets in equity  securities  of  non-United
States  companies with market  capitalizations  less than U.S. $1 billion at the
time of purchase. The one-year average currently contains 29 funds.

Morgan  Stanley  Capital  International  EAFE  (Europe,  Australia and Far East)
Index:  This average  reflects an arithmetic,  market value weighted  average of
performance of more than 900 securities  which are listed on the stock exchanges
of the following countries:  Australia,  Austria, Belgium, Denmark, Netherlands,
New Zealand, Norway,  Singapore/Malaysia,  Spain, Sweden,  Switzerland,  and the
United Kingdom.

Lipper  International Fund Average:  This average consists of funds which invest
in securities  primarily  traded in markets  outside of the United  States.  The
one-year average currently contains 421 funds.

Note: Mutual fund data from Lipper Analytical Services, Inc.

Mortgage-Backed Securities Portfolio

Interest  rates fell for most of 1997,  which led to a very  strong year for the
Mortgage-Backed Securities Portfolio. The Portfolio outperformed both the Lehman
Brothers MBS Index as well as the Lipper U.S.  Mortgage Fund Average  mostly due
to its slightly longer duration.

The  Portfolio  added to its  results  last year by  identifying  and  selecting
certain undervalued  sectors of mortgage-backed  securities for a portion of the
Portfolio.  These  securities  have now become very popular with Wall Street and
other investors, resulting in the securities increasing in value.

Portfolio  management  believes its current  portfolio to be well positioned for
the period  ahead.  It has a number of  securities  that are  "seasoned"  (e.g.,
original 30 year loans that have been  outstanding  for three years or more) and
therefore valued more highly in the marketplace.  The majority of its securities
are priced below par, so prepayment risk is negligible.  The current strategy of
staying fully  invested in generic MBS  pass-throughs  with a mix of coupons has
served the Portfolio well and this should continue going forward.

            Comparison of Change in Value of $1.0 Million Investment
                       in the Mortgage-Backed Securities
Portfolio, Lehman Brothers Mortgage Index and Lipper U.S. Mortgage Fund Average


                                              Lehman Brothers    Lipper U.S.
                                    Fund          Mortgage      Mortgage Fund
Year Ended 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
                        1996      1,251,002      1,249,802       1,196,158
                        1997      1,378,369      1,368,408       1,298,788

Note:  Past performance is not predictive of future performance.

        --------------------------------------------------------
                 Mortgage-Backed Securities Portfolio        
                       Total Returns  
                   As of December 31, 1997 

        1 Year    Since Inception Date 5/7/93    10 Year        
        10.18%                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 59 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   Portfolios  invest  in  foreign  securities  listed  on  foreign
exchanges which trade on days on which the Portfolios do not determine 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 Portfolios.

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  Portfolios may
advertise  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 April 9,  1998,  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 Emerging Markets Portfolio      6,974,330            81.19%
International Securities Portfolio            1,325,824            43.28%
International SmallCap Portfolio              5,869,848            98.32%
Mortgage-Backed Securities Portfolio          1,364,224            100.00%

DISTRIBUTION OF INCOME DIVIDENDS AND REALIZED CAPITAL GAINS

     Any dividends from the net income of the International  Portfolios normally
will be  distributed  to  shareholders  annually on the 24th of December (or the
preceding  business day if the 24th is not a business  day) to  shareholders  of
record three business days before the payable date.

     Any  dividends  from  the  net  income  of the  Mortgage-Backed  Securities
Portfolio normally will be declared daily. Normal payment of dividends is on the
last business day of each 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,on the 24th of December (or the preceding  business day if
the 24th is not a business day) to  shareholders  of record three  business days
before the payable date. 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.  At any time on ten days written  notice
to the Fund, the  shareholder  may,  without charge,  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 each of the value of
the International 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  International  Portfolio  shareholders  to take a credit  (or a
deduction)   for  foreign   income  taxes  paid  by  the  Fund.  In  that  case,
International  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.  International  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   Portfolios  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  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 registered representative, if any. 
     4. Dividend distribution election 
     5. Amount being wired and wiring bank 
     6. Name of Princor  Financial Services Corporation   
     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 Federal Funds to:  Norwest Bank Iowa,  N.A.,  Des Moines,  Iowa, ABA No.
073000228,  for credit to:  Principal  Management  Corporation,  Account  Number
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 any of the  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.  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  Emerging  Markets
Portfolio,  International  Securities  Portfolio and the International  SmallCap
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:   Principal   Management
Corporation, The Principal Financial Group, Des Moines, Iowa, 50392-0200, is the
transfer agent and dividend disbursing agent for the Fund.





                                     PART B

                      PRINCIPAL SPECIAL MARKETS FUND, INC.
                    INTERNATIONAL EMERGING MARKETS PORTFOLIO
                       INTERNATIONAL SECURITIES PORTFOLIO
                        INTERNATIONAL SMALLCAP PORTFOLIO
                      MORTGAGE-BACKED SECURITIES PORTFOLIO


                       Statement of Additional Information


                                dated May 1, 1998


         This Statement of Additional  Information  provides  information  about
each  Portfolio  in  addition  to  the  information  that  is  contained  in the
Prospectus, dated May 1, 1998.

         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: 1-800-451-5447





FV 76 B-7


                                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

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.  The
International Emerging Markets Portfolio, International Securities Portfolio and
International SmallCap Portfolio will each invest more than 5% of its net assets
in foreign  securities.  Each Portfolio 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.

        Securities  of many foreign  issuers may be less liquid and their prices
more  volatile  than  those  of  comparable  domestic  issuers.  In  particular,
securities  markets in emerging  market  countries are known to experience  long
delays between the trade and settlement dates of securities  purchased and sold,
potentially resulting in a lack of liquidity and greater volatility in the price
of securities on those markets.  In addition,  investments in smaller  companies
may present greater opportunities for capital appreciation, but may also involve
greater  risks than large,  mature  issuers.  Such  companies  may have  limited
product  lines  and  financial  resources.  Their  securities  may trade in more
limited volume than larger companies and may therefore experience  significantly
more price volatility and less liquidity than securities of larger companies. As
a result of these  factors,  the Boards of  Directors  of the Funds have adopted
Daily Pricing and Valuation  Procedures  for the Funds which set forth the steps
to be followed by the Manager and  Sub-Advisor to establish a reliable market or
fair value if a reliable  market value is not  available  through  normal market
quotations.  Oversight of this process is provided by the Executive Committee of
the Boards of Directors.

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

        Each  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 calland 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  security 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 Emerging Markets Portfolio,  International  Securities
Portfolio  and  International  SmallCap  Portfolio  each 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 place any asset,  including equity securities
and non-investment  grade debt, in a segregated account, so long as the asset is
liquid and marked to the market daily.  The amount so segregated  shall be equal
to the amount of the Portfolio's obligation.

        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.

        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 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 (annualized when reporting
period is less than one year):  International  Emerging  Markets  12.3% (for the
period beginning November 26, 1997 and ending December 31, 1997);  International
Securities  30.8% and 25.5%;  International  SmallCap  Portfolio  30.3% (for the
period   beginning   November   26,  1997  and  ending   December   31,   1997);
Mortgage-Backed Securities 15.5% and 28.7%.

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 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,  38,  Assistant  Counsel.  Counsel,  Principal  Mutual Life
Insurance  Company since 1995.  Attorney,  1994-1995.  Prior thereto,  Attorney,
Dickinson, Mackaman, Tyler & Hogan, P.C..

     Michael W. Cumings, 46, Assistant Counsel.  Counsel,  Principal Mutual Life
Insurance Company.

     @James D.  Davis,  64,  Director.  4940  Center  Court,  Bettendorf,  Iowa.
Attorney. Vice President, Deere and Company, retired.

     Pamela A. Ferguson, 54, Director,  4112 River Oaks Drive, Des Moines, Iowa.
Professor of Mathematics, Grinnell College since 1998. Prior thereto, President,
Grinnell College.

     *&J. Barry  Griswell,  49,  Director and Chairman of the Board.  President,
Principal Mutual Life Insurance Company,  since 1998;  Executive Vice President,
1996-1998, Senior Vice President, 1991-1996. Director and Chairman of the Board,
Principal Management Corporation and Princor Financial Services Corporation.

     *&Stephan L. Jones, 62, Director and President.  Vice President,  Principal
Mutual  Life  Insurance  Company.  Director  and  President,  Princor  Financial
Services Corporation and Principal Management Corporation.

     @&Barbara A. Lukavsky,  57, Director.  3930 Grand Avenue, #304, Des Moines,
Iowa.  President and CEO, Barbican  Enterprises,  Inc. Since 1977. President and
CEO, Lu San ELITE USA, L.C., 1985-1998.

     *Craig  L.  Bassett,  46,  Treasurer.   Treasurer,  Principal  Mutual  Life
Insurance  Company since 1996. Prior thereto,  Associate  Treasurer.  Treasurer,
Princor  Financial  Services  Corporation and Principal  Management  Corporation
since 1996.

     *Michael J. Beer, 37,  Financial  Officer.  Senior Vice President and Chief
Operating  Officer,   Princor  Financial  Services   Corporation  and  Principal
Management  Corporation,  since 1997.  Prior  thereto,  Vice President and Chief
Operating Officer.

     *Arthur S.  Filean,  59, Vice  President  and  Secretary.  Vice  President,
Princor Financial Services  Corporation.  Vice President,  Principal  Management
Corporation, since 1996.

     *Ernest H. Gillum,  42,  Assistant  Secretary.  Assistant  Vice  President,
Registered  Products,  Princor  Financial  Services  Corporation  and  Principal
Management  Corporation,  since 1995.  Prior thereto,  Product  Development  and
Compliance Officer.

     Jane E. Karli,  41, Assistant  Treasurer.  Assistant  Treasurer,  Principal
Mutual  Life  Insurance  Company  since  1998.  Senior  Accounting  and  Custody
Administrator  1994-1998;  Prior  thereto,  Senior  Investment  Cost  Accountant
1993-1994.

     *Michael D. Roughton, 46, Counsel. Counsel, Principal Mutual Life Insurance
Company, since 1994. Prior thereto Assistant Counsel.  Counsel,  Invista Capital
Management,  Inc., Princor Financial Services  Corporation,  Principal Investors
Corporation and Principal Management Corporation.

     @ Member of Audit and Nominating Committee.

     * Affiliated  with the Manager of the Fund or its parent and  considered an
"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 April 9, 1998, 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 Emerging Markets Portfolio     6,974,330        81.19%
International Securities Portfolio           1,325,824        43.28%
International SmallCap Portfolio             5,869,848        98.32%
Mortgage-Backed Securities Portfolio         1,364,224       100.00%
- ------------------------------------------------------------------------------

       As of April 9, 1998,  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 April 9, 1998, the following  shareholders  of the Fund owned 5% or
more of the outstanding shares of any Portfolio of the Fund:


<TABLE>
<CAPTION>
                                                                           Percentage
                      Name                               Address          of Ownership
<S>                                       <C>                                 <C>
International Emerging Markets Portfolio

ConAgra Master Pension Trust              1 Enterprise Drive                  17.66%
                                          Quincy, MA 02171-2126
International Securities Portfolio

Centurion Life Insurance Company          206 8th Street                      16.43%
                                          Des Moines, IA 50309-3805


Miter & Co.                               P.O. Box 2977                        7.78%
                                          Milwaukee, WI 53201-2977

Pigeon & Co.                              P.O. Box 2479                       12.69%
                                          San Antonio, TX 78298-2479

Norwest Financial Pension Trust           206 8th Street                       6.98%
                                          Des Moines, IA 50309-3805
</TABLE>

- --------------------------------------------------------------------------------

MANAGER AND SUB-ADVISOR

       The  Manager  of  each  Portfolio  of the  Fund is  Principal  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, 1997 were  approximately  $25.8
billion.  Invista's  address is 1800 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
Craig L. Bassett       Treasurer               Treasurer (Manager)
Michael J. Beer        Financial Officer       Senior Vice President and Chief
                                                 Operating Officer (Manager)
Arthur S. Filean       Vice President and      Vice President (Manager)
                         Secretary
Ernest H. Gillum       Assistant Secretary     Assistant Vice President -
                                                 Registered Products (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)

COST OF MANAGER'S SERVICES

        The Manager has entered into a Management  Agreement with the Fund which
requires the Manager 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.  Under a Sub-
Advisory  Agreement  between  Invista  and the  Manager,  Invista  performs  all
investment  advisory   responsibilities  of  the  Manger  under  the  Management
Agreement  and receive the full amount of the  compensation  paid by the Fund to
the Manager.

        The Management Fees are computed at the following annual rates:

                                Fees Computed             Fees as a Percent
                              One Net Asset Value         of Average Daily
           Portfolio            of Portfolio                 Net Assets
 International Emerging                          
   Markets Portfolio          First $250 million              1.15%
                              Next $250 million               1.05%
                              Over $500 million               0.95%
 International Securities
   Portfolio                  Entire Portfolio                0.90%

 International SmallCap
   Portfolio                  First $250 million              1.00%
                              Next $250 million               0.90%
                              Over $500 million               0.80%
 Mortgage-Backed Securities
     Portfolio                 Entire Portfolio                0.45%

         The net assets of each  portfolio  on December 31, 1997 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, 1997   December 31, 1997
          ---------               -----------------   -----------------
International Emerging Markets     $32,488,046                1.15%
International Securities           $37,684,011                 .90%
International SmallCap             $31,967,661                1.00%
Mortgage Backed Securities         $13,795,530                 .45%
- ----------------------------------------------  ----------------

         Fees  paid  for  investment  management  services  during  the  periods
indicated were as follows:


                                            Management Fees for Fiscal
          Portfolio                           Year Ended December 31
          ---------                           ----------------------
                                   1997                1996          1995
                                   ----                ----          ----
International Emerging Markets   $ 43,775               N/A           N/A
International Securities          311,027            $185,375      $146,209
International SmallCap            37,932                N/A           N/A
Mortgage-Backed Securities        67,721             $ 65,114      $ 61,455

- ---------------------------------------------------------- --------------

         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 8, 1997.  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  Management
Agreement.  The  Management  Agreement  was last  approved by the Funds Board of
Directors on September 8, 1997.

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  Emerging  Markets,  International  Securities  and  International
SmallCap Portfolios to certain brokers during the fiscal year ended December 31,
1997  due to  research  services  provided  by  such  brokers.  These  portfolio
transactions  resulted in  commissions  paid to such  brokers by the Fund in the
amounts of $1,100, $4,841 and $317, respectively.

         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
                                                  -----------------
                                      1997         1996       1995
                                      ----         ----       ----
International Emerging Markets       $99,367        N/A       N/A
International Securities             $78,786      $66,683   $54,987
International SmallCap               $80,568        N/A       N/A
Mortgage-Backed Securities            $ -0-        $ -0-     $ -0-

- ------------------------------------------------------------------------

        Brokerage  commissions paid to affiliates during the year ended December
31, 1997 were as follows:


                    Commissions Paid to Morgan Stanley & Co.

                                                               Percent of Dollar
                                                                   Amount of
                               Total Dollar   As Percent of      Commissionable
                                  Amount    Total Commissions     Transactions
International Emerging Markets   $10,074         10.14%              16.63%
International Securities          $1,394          1.77%              1.99%

     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,  Invista  may  submit  the  orders  to
purchase,  or whenever possible, to sell, to a broker/dealer for execution on an
aggregate or "bunched" basis.  Invista may create several aggregate or "bunched"
orders  relating to a single security at different times during the same day. On
such  occasion,  Invista  will employ a computer  program to randomly  order the
entities whose individual  orders for purchase or sale make up each aggregate or
"bunched"  order.  Securities  purchased  or proceeds of sales  received on each
trading day with  respect to each such  aggregate  or  "bunched"  order shall be
allocated to the various entities whose  individual  orders for purchase or sale
make up the  aggregate or "bunched"  order.  Securities  purchased  for entities
participating  in an  aggregate  or  "bunched"  order will be placed  into those
accounts,  and where  applicable,  other client accounts at a price equal to the
average  of the  prices  achieved  in the course of  filling  the  aggregate  or
"bunched" order.

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,  Martin
Luther King, Jr. Day, Presidents' Day, Good Friday,  Memorial Day,  Independence
Day,  Labor Day,  Thanksgiving  Day, and Christmas  Day. 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, 1997 average annual return
for each of the Portfolios for the periods indicated:

              Portfolio               1-Year         5-Year      10-Year
              ---------               ------         ------      -------
International Emerging Markets       1.40%(1)        N/A            N/A
International Securities            12.55%         14.83%(2)        N/A
International SmallCap Portfolio     1.59%(1)         N/A           N/A
Mortgage-Backed Securities          10.18%          7.14%(2)        N/A

          (1)  Period beginning November 26, 1997 and ending December 31, 1997.

          (2)  Period beginning May 7, 1993 and ending December 31, 1997.

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, 1997
was 6.35%.

        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
5.72% (average six-month CD rate for the month of October,  1997, as reported in
the Federal  Reserve  Bulletin) and an inflation rate of 2.1% (rate of inflation
for the 12-month period ended October 31, 1997 as measured by the Consumer Price
Index) and an income tax bracket of 28% would be $(101).

      ($10,000 x 5.72%) / 2 = $286   Interest for six-month period
                          -     80   Federal income taxes (28%)
                          -    105   Inflation's impact on invested principal 
                                     ($10,000 x 2.1%) / 2
                             ($101)  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   Emerging  Markets  Portfolio,
International   Securities  Portfolio,   International  SmallCap  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.

        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   Emerging  Markets   Portfolio,   International   Securities
Portfolio and International SmallCap Portfolio

        When at the  close  of a fiscal  year  more  than 50% of the  value of a
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,
1997  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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