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STATEMENT OF ADDITIONAL INFORMATION
SCHWAB CAPITAL TRUST
101 Montgomery Street, San Francisco, CA 94104
AUGUST 3, 1997
AS AMENDED DECEMBER 1, 1997
This Statement of Additional Information is not a prospectus. It should
be read in conjunction with the joint Prospectus dated May 19, 1997 (as amended
from time to time) for the Select Shares of Schwab International Index Fund(R)
(the "International Index Fund"), Schwab Small-Cap Index Fund(R) (the "Small-Cap
Index Fund") and Schwab S&P 500 Fund (the "S&P 500 Fund"); the joint Prospectus
dated May 19, 1997 (as amended from time to time) for all classes of the
International Index Fund, the Small-Cap Index Fund and the S&P 500 Fund, the
Prospectus dated February 28, 1997 for Schwab Analytics(TM) Fund (the "Analytics
Fund"); the joint Prospectus dated February 28, 1997 as amended July 14, 1997
(as amended from time to time) for Schwab Asset Director(R)-High Growth Fund
(the "High Growth Fund"), Schwab Asset Director-Balanced Growth Fund (the
"Balanced Growth Fund") and Schwab Asset Director-Conservative Growth Fund (the
"Conservative Growth Fund" and jointly, the "Asset Director Funds"); and the
joint Prospectus dated August 3, 1997 (as amended from time to time) for Schwab
OneSource Portfolios-International, Schwab OneSource Portfolios-Growth
Allocation (the "Growth Allocation"), Schwab OneSource Portfolios-Balanced
Allocation (the "Balanced Allocation") and Schwab OneSource Portfolios-Small
Company ("Small Company Fund" and jointly, the "OneSource Portfolios"), eleven
separately managed investment portfolios (collectively the "Funds") of Schwab
Capital Trust (the "Trust").
Prior to May 19, 1997 the International Index Fund and the Small-Cap
Index Fund were not offered in multiple classes of shares. The existing shares
of these funds are redesignated as Investor Shares. Prior to May 19, 1997, the
S&P 500 Fund was only offered in two classes (Investor Shares and e.Shares). The
other Funds of the Trust are not offered in multiple classes of shares.
To obtain a copy of any of these Prospectuses, please contact Charles
Schwab & Co., Inc. ("Schwab") at 800-2 NO-LOAD, 24 hours a day, or 101
Montgomery Street, San Francisco, California 94104. TDD users may contact Schwab
at 800-345-2550, 24 hours a day. These Prospectuses are also available
electronically by using our World Wide Web address: http://www.schwab.com/funds.
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SCHWABFUNDS(R)
800-2 NO-LOAD
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVES.........................................................3
INVESTMENT SECURITIES.........................................................4
INVESTMENT RESTRICTIONS......................................................27
MANAGEMENT OF THE TRUST......................................................32
PORTFOLIO TRANSACTIONS AND TURNOVER..........................................42
TAXES........................................................................45
SHARE PRICE CALCULATION......................................................48
HOW THE FUNDS REFLECT PERFORMANCE............................................49
THE BENEFITS OF INTERNATIONAL INVESTING......................................51
INDEXING AND ASSET ALLOCATION --THE SCHWAB
INDEX FUNDS AND THE SCHWAB ASSET ALLOCATION FUNDS.......................52
GENERAL INFORMATION..........................................................57
PURCHASE AND REDEMPTION OF SHARES............................................58
OTHER INFORMATION............................................................59
FINANCIAL STATEMENTS........................................................F-1
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INVESTMENT OBJECTIVES
INTERNATIONAL INDEX FUND-INVESTOR SHARES
INTERNATIONAL INDEX FUND-SELECT SHARES
The investment objective of the International Index Fund is to attempt
to track the price and dividend performance (total return) of the Schwab
International Index(R) (the "International Index"), an index created to
represent the performance of common stocks and other equity securities issued by
large publicly traded companies from countries around the world with major
developed securities markets, excluding the United States.
SMALL-CAP INDEX FUND INVESTOR-SHARES
SMALL-CAP INDEX FUND SELECT-SHARES
The investment objective of the Small-Cap Index Fund is to attempt to
track the price and dividend performance (total return) of the Schwab Small-Cap
Index(R) (the "Small-Cap Index"), an index created to represent the performance
of common stocks of the second 1,000 largest United States companies, ranked by
market capitalization (share price times the number of shares outstanding).
HIGH GROWTH FUND
The investment objective of the High Growth Fund is to provide high
capital growth with less volatility than an all-stock portfolio. This Fund
provides the greatest exposure to various stock categories, including domestic
large and small company stocks and international stocks.
BALANCED GROWTH FUND
The investment objective of the Balanced Growth Fund is to provide
maximum total return, including both capital growth and income. This Fund
represents a more balanced approach to stocks and bonds.
CONSERVATIVE GROWTH FUND
The investment objective of the Conservative Growth Fund is to provide
income and more growth potential than an all-bond portfolio. This Fund's stock
component is designed to help offset inflation.
Each Asset Director(R) Fund may seek to achieve its investment
objective by investing directly in portfolio securities or by investing
indirectly in underlying affiliated mutual funds ("underlying Schwab Funds"), as
described herein.
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S&P 500 FUND-INVESTOR SHARES
S&P 500 FUND-e.SHARES(TM)
S&P 500 FUND SELECT SHARES(TM)
The Fund's investment objective is to track the price and dividend
performance (total return) of common stocks of U. S. companies, as represented
by Standard & Poor's 500 Composite Stock Price Index (the "S&P 500(R)").
ANALYTICS FUND(TM)
The investment objective of the Analytics Fund is to achieve long-term
capital growth.
SCHWAB ONESOURCE PORTFOLIOS-INTERNATIONAL AND SMALL COMPANY FUND
Schwab OneSource Portfolios-International and the Small Company Fund
are mutual funds that seek long-term capital appreciation. To achieve their
goals, the Investment Manager, Charles Schwab Investment Management, Inc.
("CSIM"), will attempt to identify and select a diversified portfolio of equity
funds which present the greatest capital growth potential ("underlying fund(s)")
based on an analysis of many factors, including the underlying funds' investment
objective, the history of portfolio manager(s), total return, volatility and
expenses.
SCHWAB ONESOURCE PORTFOLIOS-GROWTH ALLOCATION AND BALANCED ALLOCATION
The Funds are asset allocation funds that provide easy access to
actively managed portfolios of funds from well-known families. The investment
objective of the Growth Allocation is to provide you with capital growth with
less volatility than a portfolio comprised entirely of stock funds. Of course, a
portfolio with lower volatility also has lower growth potential than a portfolio
comprised entirely of stock funds. The investment objective of the Balanced
Allocation is to provide you with capital growth and income with less volatility
than the Growth Allocation.
The investment objectives stated above for each of the Funds, along
with certain investment restrictions adopted by the Funds, are fundamental and
cannot be changed without approval by holders of a majority of the Funds'
outstanding voting shares, as defined in the Investment Company Act of 1940, as
amended (the "1940 Act").
INVESTMENT SECURITIES
FOREIGN INVESTMENTS
The International Index Fund and Asset Director(R) Funds expect to
invest in stocks of foreign issuers. The International Index Fund will invest
primarily in such stocks. The Schwab OneSource Portfolios-International expects
to invest primarily in other investment companies which invest in stocks of
foreign issuers, and may invest directly in domestic and foreign securities. The
Growth Allocation and the Balanced Allocation may invest in other investment
companies which invest in stocks of foreign issuers,
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and may invest directly in domestic and foreign securities. We expect that many
of the underlying funds may invest up to 100% of their assets in foreign
securities. Investing in foreign issuers involves certain special
considerations, including those set forth below, which are typically not
associated with investing in U.S. issuers. Since investments in the securities
of foreign issuers are usually made and held in foreign currencies, and since
the International Index Fund, Asset Director(R) Funds, OneSource Portfolios and
underlying funds may hold cash in foreign currencies, they may be affected
favorably or unfavorably by changes in currency rates and in exchange control
regulations, and may incur costs in connection with conversions between various
currencies. The rate of exchange between the U.S. dollar and other currencies is
determined by the forces of supply and demand in the foreign exchange market as
well as by political and economic factors.
Since foreign companies are not subject to uniform accounting, auditing
and financial reporting standards, practices and requirements comparable to
those applicable to U.S. companies, there may be less publicly available
information about a foreign company than about a U.S. company. Securities of
foreign companies have less volume, are less liquid and are more volatile than
securities of U.S. companies. Fixed commissions on foreign securities exchanges
are generally higher than negotiated commissions on U.S. exchanges, although the
International Index Fund, Asset Director Funds, and OneSource Portfolios
endeavor to achieve the most favorable net results on their portfolio
transactions. There is generally less government supervision and regulation of
foreign securities exchanges, brokers, dealers and listed companies than in the
United States, thus increasing the risk of delayed settlements of portfolio
transactions or loss of certificates for portfolio securities.
Foreign markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
been unable to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. Such delays in settlement could result
in temporary periods when a portion of the assets of the International Index
Fund, Asset Director Funds, OneSource Portfolios and underlying funds is
uninvested and no return is earned thereon. The inability to make intended
security purchases due to settlement problems could cause the International
Index Fund, Asset Director Funds, OneSource Portfolios and underlying funds to
miss attractive investment opportunities. Losses to the International Index
Fund, Asset Director Funds, OneSource Portfolios and underlying funds arising
out of the inability to fulfill a contract to sell such securities could result
in potential liability to the International Index Fund, Asset Director Funds,
OneSource Portfolios and underlying funds.
In addition, with respect to those countries in which the International
Index Fund, Asset Director Funds, OneSource Portfolios and underlying funds may
invest or other countries which may have a significant impact on the companies
in which the International Index Fund, Asset Director Funds, OneSource
Portfolios and underlying funds may invest, there is the possibility of
expropriation or confiscatory taxation, political or social instability,
diplomatic developments, change of government or war which could affect the
International Index Fund's, Asset Director Funds', OneSource Portfolios' and
underlying funds' investments. Moreover, individual foreign economies may differ
favorably or unfavorably from the U.S. economy in such respects as growth of
gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position.
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Each of the Asset Director(R) Funds may invest up to 5% of its net
assets in companies located in developing countries. Schwab OneSource
Portfolios-International may invest directly, or indirectly through underlying
funds which invest primarily in companies located in developing countries.
Growth Allocation, Balanced Allocation and the Small Company Fund may invest up
to 10% of their total net assets directly, or indirectly through underlying
funds which invest primarily in companies located in developing countries.
Compared to the United States and other developed countries, developing
countries may have relatively unstable governments, economies based on only a
few industries and securities markets that trade a small number of securities.
Prices on these exchanges tend to be volatile, and securities in these countries
have historically offered greater potential for gain (as well as loss) than
securities of companies located in developed countries.
Hong Kong. In addition to the risks discussed above, it is
unforeseeable what risk, if any, may exist to the International Index Fund's,
Asset Director Funds', OneSource Portfolios' and underlying funds' investments
as a result of the recent incorporation of the British Crown Colony of Hong Kong
into the People's Republic of China. Shareholders should note that the risks
discussed above may increase depending on political and economic developments.
DEPOSITARY RECEIPTS
Each of the Asset Director Funds, Growth Allocation and Balanced
Allocation may invest in American Depositary Receipts, European Depositary
Receipts, Global Depositary Receipts, Global Depositary Shares ("ADRs," "EDRs,"
"GDRs" and "GDSs," respectively), or other similar global instruments which are
receipts representing ownership of shares of a foreign-based issuer held in
trust by a bank or similar financial institution. The Asset Director Funds',
Growth Allocation's, Balanced Allocation's and the Small Company Fund's direct
investments in these instruments currently will not exceed 10% of each Fund's
net assets, but underlying funds may invest in ADRs, EDRs, GDRs, GDSs or other
similar global instruments. These are designed for U.S. and European securities
markets as alternatives to purchasing underlying securities in their
corresponding national markets and currencies. ADRs, EDRs, GDRs and GDSs can be
sponsored or unsponsored. Sponsored ADRs, EDRs, GDRs and GDSs are certificates
in which a bank or financial institution participates with a custodian. Issuers
of unsponsored ADRs, EDRs, GDRs and GDSs are not contractually obligated to
disclose material information in the United States. Therefore, there may not be
a correlation between such information and the market value of the unsponsored
ADRs, EDRs, GDRs or GDSs.
OPTIONS ON SECURITIES
Writing Covered Options. The Funds may write (sell) covered call and
put options on any securities in which they may invest. The Funds may purchase
and write such options on securities that are listed on domestic or foreign
securities exchanges or traded in the over-the-counter market. All call options
written by the Funds are covered, which means that the Funds will own the
securities subject to the option so long as the option is outstanding. The
purpose of writing covered call options is to realize greater income than would
be realized on portfolio securities transactions alone. However, in writing
covered call options for additional income, the Funds may forego the opportunity
to profit from an increase in the market price of the underlying security.
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All put options the Funds write will be covered, which means that each
of the Funds will have deposited with its custodian cash, U.S. Government
securities or other high-grade debt securities (i.e., securities rated in one of
the top three categories by Moody's Investor Service ("Moody's") or Standard &
Poor's ("S&P") or, if unrated, determined by the Funds' Investment Manager to be
of comparable credit quality) with a value at least equal to the exercise price
of the put option. The purpose of writing such options is to generate additional
income for the Funds. However, in return for the option premium, the Funds
accept the risk that they may be required to purchase the underlying securities
at a price in excess of the securities market value at the time of purchase.
The Funds may terminate their obligations under a written call or put
option by purchasing an option identical to the one it has written. Such
purchases are referred to as "closing purchase transactions."
Purchasing Options. The Funds may purchase put and call options on any
securities in which they may invest or options on any securities index based on
securities in which they may invest. The Funds may also enter into closing sale
transactions in order to realize gains or minimize losses on options they have
purchased.
The writer of an option may have no control over when the underlying
securities must be sold, in the case of a call option, or purchased, in the case
of a put option, since, with regard to certain options, the writer may be
assigned an exercise notice at any time prior to the termination of the
obligation. Whether or not an option expires unexercised, the writer retains the
amount of the premium. This amount may, in the case of a covered call option, be
offset by a decline in the market value of the underlying security during the
option period. If a call option is exercised, the writer experiences a profit or
loss from the sale of the underlying security. If a put option is exercised, the
writer must fulfill its obligation to purchase the underlying security at the
exercise price, which will usually exceed the then market value of the
underlying security.
The purchase of a call option would entitle the Funds, in return for
the premium paid, to purchase specified securities at a specified price during
the option period. The Funds would ordinarily realize a gain if, during the
option period, the value of such securities exceeded the sum of the exercise
price, the premium paid and transaction costs; otherwise the Funds would realize
either no gain or a loss on the purchase of the call option.
Risks Associated With Options Transactions. There is no assurance that
a liquid secondary market on a domestic or foreign options exchange will exist
for any particular exchange-traded option or at any particular time. If the
Funds are unable to effect a closing purchase transaction with respect to
covered options they have written, the Funds will not be able to sell the
underlying securities or dispose of assets held in a segregated account until
the options expire or are exercised. Similarly, if the Funds are unable to
effect a closing sale transaction with respect to options they have purchased,
they would have to exercise the options in order to realize any profit and will
incur transaction costs upon the purchase or sale of underlying securities.
Reasons for the absence of a liquid secondary market on an exchange
include the following: (i) there may be insufficient trading interest in certain
options; (ii) an exchange may impose restrictions on
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opening transactions or closing transactions or both; (iii) trading halts,
suspensions or other restrictions may be imposed with respect to particular
classes or series of options; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of an exchange or
the Options Clearing Corporation (the "OCC") may not at all times be adequate to
handle current trading volume; or (vi) one or more exchanges could, for economic
or other reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), although
outstanding options on that exchange that had been issued by the OCC as a result
of trades on that exchange would continue to be exercisable in accordance with
their terms.
The Funds may purchase and sell both options that are traded on U.S.
and foreign exchanges and options traded over-the-counter with broker-dealers
who make markets in these options. The ability to terminate over-the-counter
options is more limited than with exchange-traded options and may involve the
risk that broker-dealers participating in such transactions will not fulfill
their obligations. Until such time as the staff of the Securities and Exchange
Commission (the "SEC") changes its position, the Funds will treat purchased
over-the-counter options and all assets used to cover written over-the-counter
options as illiquid securities, except that with respect to options written with
primary dealers in U.S. Government securities pursuant to an agreement requiring
a closing purchase transaction at a formula price, the amount of illiquid
securities may be calculated with reference to a formula the staff of the SEC
approves. Each of the Funds will write or purchase an option only when the
market value of that option, when aggregated with the market value of all other
options transactions made on behalf of the Fund, does not exceed 5% of the
Fund's net assets.
The underlying funds may also write (sell) covered call and put options
and purchase put and call options. The nature of the conditions and risks
associated with such transactions by the underlying funds are similar to those
described for the Funds.
FOREIGN CURRENCY TRANSACTIONS
Forward Foreign Currency Exchange Contracts. The International Index
Fund, Asset Director(R) Funds and OneSource Portfolios may enter into forward
foreign currency exchange contracts in several circumstances. The International
Index Fund, Asset Director Funds and OneSource Portfolios may engage in foreign
currency exchange transactions to protect against uncertainty in the level of
future exchange rates. The International Index Fund, Asset Director Funds and
OneSource Portfolios expect to engage in foreign currency exchange transactions
in connection with the purchase and sale of portfolio securities (so-called
"transaction hedging") and to protect the value of specific portfolio positions
("position hedging"). The underlying funds may also engage in transaction and
position hedging.
For transaction hedging purposes, the International Index Fund, Asset
Director Funds, OneSource Portfolios and underlying funds enter into foreign
currency transactions with respect to specific receivables or payables of the
funds arising in connection with the purchase or sale of portfolio securities.
By transaction hedging, the International Index Fund, Asset Director Funds and
OneSource Portfolios will attempt to protect against a possible loss resulting
from an adverse change in the relationship between (i) the U.S. dollar and the
applicable foreign currency during the period between the date on which the
security is purchased or sold and (ii) the transaction's settlement date. When
engaging in position hedging, the
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International Index Fund, Asset Director(R) Funds, OneSource Portfolios and
underlying funds enter into foreign currency exchange transactions to protect
against a decline in the values of the foreign currencies in which portfolio
securities are denominated (or against an increase in the value of currency for
securities which the International Index Fund, Asset Director Funds, OneSource
Portfolios and underlying funds expect to purchase).
When engaging in position and/or transaction hedging, the International
Index Fund, Asset Director Funds, OneSource Portfolios and underlying funds may
purchase or sell foreign currencies on a spot (or cash) basis at the prevailing
spot rate and also may enter into contracts to purchase or sell foreign
currencies at a future date ("forward contracts") and purchase and sell foreign
currency futures contracts ("futures contracts"). International Index Fund,
Asset Director Funds, OneSource Portfolios and underlying funds also may
purchase exchange-listed and over-the-counter call and put options on futures
contracts and on foreign currencies. A put option on a futures contract gives
the International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds the right to assume a short position in the futures contract
until expiration of the option. A put option on currency gives the International
Index Fund, Asset Director Funds, OneSource Portfolios and underlying funds the
right to sell a currency at an exercise price until the expiration of the
option. A call option on a futures contract gives the International Index Fund,
Asset Director Funds, OneSource Portfolios and underlying funds the right to
assume a long position in the futures contract until the expiration of the
option. A call option on currency gives the International Index Fund, Asset
Director Funds, OneSource Portfolios and underlying funds the right to purchase
a currency at the exercise price until the expiration of the option.
Hedging transactions involve costs and may result in losses, and the
ability of the International Index Fund, Asset Director Funds, OneSource
Portfolios and underlying funds to engage in hedging transactions may be limited
by tax considerations. Transaction and position hedging do not eliminate
fluctuations in the underlying prices of the securities that the Funds or the
underlying funds own or expect to purchase or sell. They simply establish a rate
of exchange that may be achieved at some future point in time. Additionally,
although these techniques tend to minimize the risk of loss due to decline in
the value of the hedged currency, they tend to limit any potential gain that
might result from an increase in the value of such currency.
Although the contracts are not presently are regulated by the Commodity
Futures Trading Commission (the "CFTC"), the CFTC may in the future assert
authority to regulate these contracts. In such event, the ability of the
International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds to utilize forward foreign currency exchange contracts may be
restricted.
Each of the Asset Director Funds will enter into a forward foreign
currency exchange contract only when the market value of such contract, when
aggregated with the market value of all other such contracts held by the Fund,
does not exceed 5% of the Fund's net assets.
The International Index Fund, Asset Director Funds and OneSource
Portfolios generally will not enter into a forward contract with a term of
greater than one year.
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While the International Index Fund, Asset Director(R) Funds and
OneSource Portfolios will, and underlying funds may, enter into forward
contracts to reduce currency exchange rate risks, transactions in such contracts
involve certain other risks. Thus, while the International Index Fund, Asset
Director Funds, OneSource Portfolios and underlying funds may benefit from such
transactions, unanticipated changes in currency prices may result in a poorer
overall performance for the International Index Fund, Asset Director Funds,
OneSource Portfolios and underlying funds than if they had not engaged in any
such transactions. Moreover, there may be imperfect correlation between the
International Index Fund's, Asset Director Funds', OneSource Portfolios' and
underlying funds' portfolio holdings of securities denominated in a particular
currency and forward contracts into which the International Index Fund, Asset
Director Funds, OneSource Portfolios and underlying funds enter. Such imperfect
correlation may cause the International Index Fund, Asset Director Funds,
OneSource Portfolios and underlying funds to sustain losses, which will prevent
the International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds from achieving a complete hedge or expose the International
Index Fund, Asset Director Funds, OneSource Portfolios and underlying funds to
risk of foreign exchange loss.
Writing and Purchasing Currency Call and Put Options. The International
Index Fund, Asset Director Funds, OneSource Portfolios and underlying funds may
write covered put and call options and purchase put and call options on foreign
currencies for the purpose of protecting against declines in the dollar value of
portfolio securities and against increases in the dollar cost of securities to
be acquired. A call option written by the International Index Fund, Asset
Director Funds, OneSource Portfolios and underlying funds obligates the
International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds to sell specified currency to the holder of the option at a
specified price at any time before the expiration date. A put option written by
the International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds would obligate the International Index Fund, Asset Director
Funds, OneSource Portfolios and underlying funds to purchase specified currency
from the option holder at a specified time before the expiration date. The
writing of currency options involves a risk that the International Index Fund,
Asset Director Funds, OneSource Portfolios and underlying funds will, upon
exercise of the option, be required to sell currency subject to a call at a
price that is less than the currency's market value or be required to purchase
currency subject to a put at a price that exceeds the currency's market value.
The International Index Fund, Asset Director Funds and OneSource
Portfolios may terminate their obligations under a call or put option by
purchasing an option identical to the one it has written. Such purchases are
referred to as "closing purchase transactions." The International Index Fund,
Asset Director Funds and OneSource Portfolios would also be able to enter into
closing sale transactions in order to realize gains or minimize losses on
options purchased by the International Index Fund, Asset Director Funds and
OneSource Portfolios.
The purchase of a call option would entitle the International Index
Fund, Asset Director Funds, OneSource Portfolios and underlying funds to
purchase specified currency at a specified price during the option period in
return for the premium paid. The International Index Fund, Asset Director Funds,
OneSource Portfolios and underlying funds ordinarily would realize a gain or a
loss on the purchase of the call option.
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The purchase of a put option would entitle the International Index
Fund, Asset Director Funds(R), OneSource Portfolios and underlying funds to sell
specific currency at a specified price during the option period in exchange for
the premium paid. The purchase of protective puts is designed merely to offset
or hedge against a decline in the dollar value of the International Index
Fund's, Asset Director Funds', OneSource Portfolios' and underlying funds'
portfolio securities due to currency exchange rate fluctuations. The
International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds ordinarily would realize a gain, if, during the option period,
the value of the underlying currency were to decrease below the exercise price
sufficiently to more than cover the premium and transaction costs; otherwise the
International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds would realize either no gain or a loss on the purchase of the
put option. Gains and losses on the purchase of protective put options would
tend to be offset by countervailing changes in the value of the underlying
currency.
Special Risks Associated With Options on Foreign Currency. An
exchange-traded option position may be closed out only on an options exchange
that provides a secondary market for an option of the same series. Although the
International Index Fund, Asset Director Funds and OneSource Portfolios
generally will 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 may exist. In such
event, it might not be possible to effect closing transactions in particular
options, with the result that the International Index Fund, Asset Director
Funds, OneSource Portfolios and underlying funds would have to exercise their
options in order to realize any profit and would incur transaction costs upon
the sale of underlying securities pursuant to the exercise of put options. If
the International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds, as covered call option writers, are unable to effect a closing
purchase transaction in a secondary market, they will not be able to sell the
underlying currency (or security denominated in that currency) until the option
expires or they deliver the underlying currency upon exercise.
There is no assurance that higher than anticipated trading activity or
other unforeseen events might not, at times, render certain of the facilities of
the OCC inadequate. This could result in an exchange instituting special
procedures that may interfere with the timely execution of customers' orders.
The International Index Fund, Asset Director Funds and OneSource
Portfolios will purchase and write over-the-counter options only to the extent
consistent with their limitations on investments in illiquid securities, as
described in the Prospectuses. Trading in over-the-counter options is subject to
the risk that the other party will be unable or unwilling to close-out
purchasing and writing activities.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Funds may purchase and sell various kinds of futures contracts and
options on futures contracts. The futures contracts may be based on various
securities (such as U.S. Government securities), securities indices, foreign
currencies and other financial instruments and indices. All futures contracts
entered into by the Funds are traded on U.S. exchanges or boards of trade that
the CFTC licenses and regulates on foreign exchanges. The Funds and the
underlying funds are not permitted to engage in speculative futures trading.
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Futures Contracts. A futures contract generally may be described as an
agreement between two parties to buy and sell particular financial instruments
for an agreed upon price during a designated month (or to deliver the final cash
settlement price, in the case of a contract relating to an index or otherwise
not calling for physical delivery at the end of trading in the contract).
When interest rates are rising or securities prices are falling, the
Funds and the underlying funds may seek, through the sale of futures contracts,
to offset a decline in the value of their current portfolio securities. When
rates are falling or prices are rising, the Funds and the underlying funds,
through the purchase of futures contracts, may attempt to secure better rates or
prices than might later be available in the market when they effect anticipated
purchases. Similarly, the International Index Fund, Asset Director(R) Funds,
OneSource Portfolios and the underlying funds may sell futures contracts on a
specified currency to protect against a decline in the value of that currency
and their portfolio securities that are denominated in that currency. The
International Index Fund, Asset Director Funds, OneSource Portfolios and the
underlying funds may purchase futures contracts on a foreign currency to fix the
price in U.S. dollars of a security denominated in that currency that the
International Index Fund, Asset Director Funds, OneSource Portfolios and
underlying funds have acquired or expect to acquire.
Although futures contracts, by their terms, generally call for the
actual delivery or acquisition of underlying securities or the cash value of the
index, in most cases the contractual obligation is fulfilled before the date of
the contract without having to make or take such delivery. The contractual
obligation is offset by buying (or selling, as the case may be) on a commodities
exchange an identical futures contract calling for delivery in the same month.
Such a transaction, which is effected through a member of an exchange, cancels
the obligation to make or take delivery of the securities or the cash value of
the index underlying the contractual obligations. The Funds and the underlying
funds may incur brokerage fees when they purchase or sell futures contracts.
Positions taken in the futures markets are not normally held to
maturity but are instead liquidated through offsetting transactions, which may
result in a profit or a loss. While the Funds' and the underlying funds' futures
contracts on securities or currency will usually be liquidated in this manner,
the Funds and the underlying funds may instead make or take delivery of the
underlying securities or currency whenever it appears economically advantageous
for them to do so. A clearing corporation associated with the exchange on which
futures on securities or currencies are traded guarantees that, if still open,
the sale or purchase will be performed on the settlement date.
Options on Futures Contracts. The acquisition of put and call options
on futures contracts will give the Funds and the underlying funds the right (but
not the obligation), for a specified price, to sell or to purchase,
respectively, the underlying futures contract at any time during the option
period. As the purchaser of an option on a futures contract, the Funds and the
underlying funds obtain the benefit of the futures position if prices move in a
favorable direction but limit their risk of loss in the event of an unfavorable
price movement to the loss of the premium and transaction costs.
The writing of a call option on a futures contract generates a premium
that may partially offset a decline in the value of the Funds' and the
underlying funds' assets. By writing a call option, the Funds and
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the underlying funds become obligated, in exchange for the premium, to sell a
futures contract that may have a value lower than the exercise price. Thus, the
loss incurred by the Funds and the underlying funds in writing options on
futures is potentially unlimited and may exceed the amount of the premium
received. The Funds and the underlying funds will incur transaction costs in
connection with the writing of options on futures.
The holder or writer of an option on a futures contract may terminate
its position by selling or purchasing an offsetting option on the same series.
There is no guarantee that these closing transactions can be effected. The
Funds' and the underlying funds' ability to establish and close out positions on
these options will be subject to the development and maintenance of a liquid
market.
Hedging Strategies With Futures. Hedging by use of futures contracts
seeks to establish more certainty than would otherwise be possible with respect
to the effective price, rate of return or currency exchange rate on portfolio
securities or securities that the Funds own or propose to acquire. Such futures
contracts may include contracts for the future delivery of securities held by
the Funds or securities with characteristics similar to those of the Funds'
portfolio securities. Similarly, the International Index Fund, Asset Director(R)
Funds, and OneSource Portfolios sell futures contracts on currency in which
their portfolio securities are denominated or in one currency to hedge against
fluctuations in the value of securities denominated in a different currency if
there is an established historical pattern of correlation between the two
currencies. If, in the opinion of the Investment Manager, there is a sufficient
degree of correlation between price trends for the Funds' portfolio securities
and futures contracts based on other financial instruments, securities indices
or other indices, the Funds may also enter into such futures contracts as part
of their hedging strategy. Although, under some circumstances, prices of
securities in the Funds' portfolio may be more or less volatile than prices of
such futures contracts, the Investment Manager will attempt to estimate the
extent of this difference in volatility based on historical patterns. The
Investment Manager will attempt to compensate for it by having the Funds enter
into a greater or lesser number of futures contracts or by attempting to achieve
only a particular hedge against price changes affecting the Funds' portfolio
securities. When hedging of this character is successful, any depreciation in
the value of the portfolio securities will be substantially offset by
appreciation in the value of the futures position. On the other hand, any
unanticipated appreciation in the value of the Funds' portfolio securities will
be substantially offset by a decline in the value of the futures position.
On other occasions, the Funds may take "long" positions by purchasing
such futures contracts. This would be done, for example, when the Funds
anticipate the subsequent purchase of particular securities when they have the
necessary cash but expect the prices or currency exchange rates available on the
intended date of purchase in the applicable market to be less favorable than
prices that are currently available.
The underlying funds may engage in similar hedging transactions using
futures contracts, which would operate in a similar manner and entail similar
risks to the underlying funds.
When buying or selling futures contracts, a Fund and an underlying fund
must deposit an amount of cash, cash equivalents or liquid, high-quality debt
instruments with its broker equal to a fraction of the contract amount. This
amount is known as "initial margin" and is in the nature of a performance bond
or
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good faith deposit on the contract, which will be returned to the Fund and
underlying fund upon termination of the futures contract, assuming all
contractual obligations have been satisfied. Subsequent payments to and from the
broker, known as "variation margin," will be made at least daily as the price of
the futures contract fluctuates and the Fund's and the underlying funds'
position in the contract becomes more or less valuable. This process is known as
"marking-to-market."
Regulations of the Commodities Futures Trading Commission ("CFTC")
applicable to the Funds and the underlying funds generally require that all of
their futures transactions constitute "bona fide" hedging transactions. As a
result, a Fund and an underlying fund will normally sell futures contracts to
protect against a decrease in the price of securities it owns but intends to
sell or purchase futures contracts to protect against an increase in the price
of securities it intends to purchase. In addition, the Funds and the underlying
funds may purchase and sell futures contracts and options as a substitute for a
comparable market position in the underlying securities. Futures transactions
need not constitute "bona fide" hedging under CFTC regulations if the aggregate
initial margin and premiums required to establish such positions do not exceed
5% of each Fund's and each underlying fund's net assets.
Risks Involved in Futures and Options Transactions. Futures and options
transactions involve risks, which in some strategies can be substantial due to
the low margin deposits required and the extremely high degree of leverage
involved in futures and options trading. However, to the extent the Funds'
futures and options practices are limited to hedging purposes, the Investment
Manager does not believe that the Funds are subject to the degree of risk
frequently associated with futures and options transactions. To the extent the
Funds and the underlying funds engage in the use of futures and options on
futures other than for hedging purposes, the Funds and the underlying funds may
be subject to additional risk.
The primary risks associated with the use of futures and options
include: imperfect correlation between the change in market value of the
securities held by a Fund and the prices of the futures or options, possible
lack of a liquid secondary market for futures or options, and the resulting
inability to close such positions prior to their maturity dates. To minimize
these risks, the Funds will invest only in those contracts whose behavior is
expected to resemble that of a Fund's underlying securities. The risk that a
Fund will be unable to close out a futures position will be minimized by
entering into such transactions on a national exchange with an active and liquid
secondary market.
Three principal areas of risk are present when futures and options
contracts are used even in a hedging context. First, there may not always be a
liquid secondary market for a futures or option contract at the time a Fund or
an underlying fund seeks to "close out" its position. If a Fund or an underlying
fund is unable to "close out" a futures or option position and prices move
adversely, the Fund or an underlying fund would have to continue to make daily
cash payments to maintain its required margin, and if the Fund or an underlying
fund has insufficient cash to meet this requirement, it may have to sell
portfolio securities at a disadvantageous time. In addition, the Fund or an
underlying fund might be required to deliver the securities underlying futures
or options contracts it holds. Each Fund will seek to and the underlying funds
may seek to reduce the risk that it will be unable to "close out" contracts by
entering into only futures or options contracts that are traded on national
exchanges and for which there appears to be a liquid secondary market.
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It is also possible that changes in the prices of futures or options
contracts might correlate imperfectly, or not at all, with changes in the market
values of the securities being hedged. This situation could result from price
distortions in the futures or options markets due to, among other things, active
trading by speculators and use of offsetting "closing" transactions by other
investors seeking to avoid meeting additional margin deposit requirements. In
the event of significant market distortions, it is possible that a Fund or an
underlying fund could lose money on futures or options contracts and experience
appreciation in the value of its portfolio securities, or vice versa.
Finally, adverse market movements could cause a Fund or an underlying
fund to lose up to its full investment in an options contract and/or to
experience substantial losses on an investment in a futures contract. However,
barring such significant market distortions, a similar result could be expected
were the Fund or an underlying fund to invest directly in the securities being
hedged. There is also the risk of loss by a Fund or an underlying fund of margin
deposits in the event of bankruptcy of a broker with whom the Fund or an
underlying fund has an open position in a futures contract or option.
The value of all futures contracts on stocks and stock indices and
options contracts is not to exceed 10% of the Small-Cap Index Fund's and the
International Index Fund's total assets. The S&P 500 Fund may enter into futures
contracts and options on futures contracts provided that aggregate deposits
required do not exceed 5% of the Fund's total assets. In addition, certain
provisions of the Internal Revenue Code of 1986, as amended, (the "Code"), may
limit each Fund's use of futures contracts and options.
The extent to which each Fund may purchase and sell futures, options,
equity index participations and index participation contracts may be limited by
each Fund's intention to meet Code requirements for qualification as a regulated
investment company. See "Taxes in this Statement of Additional Information (SAI)
for more information." An underlying fund's investment in such instruments may
similarly be restricted by Code requirements.
OTHER INVESTMENTS
SWAPS. Each of the Asset Director(R) Funds may enter into swaps on
various securities (such as U.S. Government securities), securities indices,
interest rates, prepayment rates, foreign currencies or other financial
instruments or indices in order to protect the value of the Asset Director Funds
from interest rate fluctuations and to hedge against fluctuations in the
floating rate market in which the Asset Director Funds' investments are traded,
for both hedging and non-hedging purposes. While swaps are different from
futures contracts (and options on futures contracts) in that swap contracts are
individually negotiated with specific counterparties, the Asset Director Funds
will use swap contracts for purposes similar to the purposes for which they use
options, futures and options on futures. Those uses of swap contracts (i.e.,
risk management and hedging) present the Funds with risks and opportunities
similar to those associated with options contracts, futures contracts and
options on futures. See "Futures Contracts and Options on Futures Contracts" in
this SAI for more information.
The Asset Director Funds may enter into these transactions to manage
their exposure to changing interest rates and other market factors. Some
transactions may reduce each Asset Director Fund's exposure to market
fluctuations while others may tend to increase market exposure.
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The use of swaps involves investment techniques and risks different
from and potentially greater than those associated with ordinary fund securities
transactions. If the Investment Manager is incorrect in its expectations of
market values, interest rates or currency exchange rates, the investment
performance of the Asset Director Funds would be less favorable than it would
have been if this investment technique were not used. The Asset Director Funds
will only invest up to 5% of each Fund's net assets in swaps.
PREFERRED STOCK. The Funds may invest in preferred stock, although
Balanced Allocation's and Growth Allocation's direct investments in preferred
stock will not exceed 10% of each Fund's net assets. Preferred stock has
priority over common stock as to income and generally as to assets of an issuer;
however, income is usually limited to a definitive percentage regardless of the
issuer's earnings. Preferred stock usually has limited voting rights. The Asset
Director(R) Funds will invest up to 5% of each Fund's net assets in preferred
stock.
CONVERTIBLE SECURITIES. Each of the Asset Director Funds may invest up
to 5% of its net assets in securities that are convertible into common stock,
including convertible bonds that are investment grade, convertible preferred
stocks, and warrants. The S&P 500 Fund will not purchase convertible securities
directly. It may, however, hold convertible securities to the extent that such
holdings are incident to the Fund's ownership of common stocks.
Convertible bonds are issued with lower coupons than nonconvertible
bonds of the same quality and maturity, but they give holders the option to
exchange their bonds for a specific number of shares of the company's common
stock at a predetermined price. This structure allows the convertible bond
holder to participate in share price movements in the company's common stock.
The actual return on a convertible bond may exceed its stated yield if the
company's common stock appreciates in value and the option to convert to common
shares becomes more valuable.
Convertible preferred stocks are nonvoting equity securities that pay a
fixed dividend. These securities have a convertible feature similar to
convertible bonds; however, they do not have a maturity date. Due to their
fixed-income features, convertible issues typically are more sensitive to
interest rate changes than the underlying common stock. In the event of
liquidation, bondholders would have claims on company assets senior to those of
stockholders; preferred stockholders would have claims senior to those of common
stockholders.
Warrants. The Funds or underlying funds may invest in warrants, which
are options to purchase equity securities at specific prices valid for a
specific period of time. The prices do not necessarily move parallel to the
prices of the underlying securities. Warrants have no voting rights, receive no
dividends and have no rights with respect to the assets of the issuer. If a
warrant is not exercised within the specified time period, it will become
worthless and a Fund or an underlying fund will lose the purchase price and the
right to purchase the underlying security.
REAL ESTATE-RELATED INVESTMENTS. The Asset Director Funds, and the
Balanced Allocation and Growth Allocation may invest no more than 10% of each
Fund's respective net assets in real estate-related investments. Real
estate-related instruments include real estate investment trusts, commercial and
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residential mortgage-backed securities and real estate financings. Real
estate-related instruments are sensitive to factors such as changes in real
estate values and property taxes, interest rates, cash flow of underlying real
estate assets, overbuilding, and the management skill and creditworthiness of
the issuer. Real estate-related instruments may also be affected by tax and
regulatory requirements, such as those relating to the environment.
PRECIOUS METAL-RELATED INVESTMENTS . The Asset Director(R) Funds,
Growth Allocation and Balanced Allocation may invest no more than 10% of each
Fund's respective net assets in precious metal-related investments. The Asset
Director Funds, S&P 500 Fund, Analytics Fund(TM), Growth Allocation and Balanced
Allocation may invest in common stocks of domestic companies principally engaged
in precious metal-related activities, which include companies principally
engaged in the extraction, processing, distribution or marketing of precious
metals if at the time of investment the Investment Manager considers that at
least 50% of the company's assets, revenues or profits are derived from the
precious metal industry. The Asset Director Funds, Growth Allocation and
Balanced Allocation may also invest in securities of foreign companies
principally engaged in the precious metals industry. For further disclosure on
foreign securities, see "Foreign Investments" in this Statement of Additional
Information.
The Asset Director Funds, S&P 500 Fund, Analytics Fund, Growth
Allocation and Balanced Allocation also may invest in futures on precious
metals, such as gold futures, and options thereon. Such investments are subject
to the investment limitations on investments in futures and options for the
Asset Director Funds, S&P 500 Fund, Analytics Fund, Growth Allocation and
Balanced Allocation as set forth in "Futures Contracts and Options on Futures
Contracts" in this Statement of Additional Information.
Prices of precious metals can be expected to respond to changes in
rates of inflation and to perceptions of economic and political instability.
Historically, the prices of precious metals and of securities of companies
engaged in the precious metal-related activities have been subject to extreme
fluctuations, as a result of, among other reasons, wider economic or political
instability.
U.S. GOVERNMENT SECURITIES. The Funds may purchase U.S. Government
securities. Direct obligations of the U.S. Government are supported by the full
faith and credit of the U.S. Treasury. While obligations of certain U.S.
Government agencies and instrumentalities are similarly backed, those of others,
such as the Federal National Mortgage Association and the Student Loan Marketing
Association, are only supported by the right of the issuer to borrow from the
U.S. Treasury, the discretionary authority of the U.S. Government to purchase
the agency's obligations or the credit of the issuing agency or instrumentality.
There can be no assurance that the U.S. Government would provide financial
support to U.S. Government sponsored agencies or instrumentalities if it were
not obligated to do so by law. A Fund will invest in U.S. Government securities
not backed by the full faith and credit of the U.S. Treasury only when the
Investment Manager is satisfied that the credit risk with respect to their
issuer is minimal.
GOVERNMENT "MORTGAGE BACKED" SECURITIES. Government "mortgage-backed"
(or government guaranteed mortgage-related) securities are among the U.S.
Government securities in which the Funds may invest. Mortgages backing the
securities purchased by the Funds include, among others, conventional 30-year
fixed rate mortgages, graduated payment mortgages, 15-year mortgages and
adjustable rate mortgages. All of these mortgages can be used to create
pass-through securities. A pass-through security is
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formed when mortgages are pooled together and undivided interests in the pool or
pools are sold. The cash flow from the mortgages is passed through to the
holders of the securities in the form of periodic payments of interest,
principal and prepayments (net of a service fee). Prepayments occur when the
holder of an individual mortgage prepays the remaining principal before the
mortgage's scheduled maturity date. As a result of the pass-through of
prepayments of principal on the underlying securities, mortgage-backed
securities are often subject to more rapid prepayment of principal than their
stated maturity indicates. Because the prepayment characteristics of the
underlying mortgages vary, it is not possible to predict accurately the realized
yield or average life of a particular issue of pass-through certificates.
Prepayment rates are important because of their effect on the yield and price of
the securities. Accelerated prepayments adversely impact yields for
pass-throughs purchased at a premium (i.e., a price in excess of principal
amount) and may involve additional risk of loss of principal because the premium
may not have been fully amortized at the time the obligation is repaid. The
opposite is true for pass-throughs purchased at a discount. The Funds may
purchase mortgage-related securities at a premium or at a discount. The
government, to the extent described below, guarantees principal and interest
payments on the mortgage-related securities. Such guarantees do not extend to
the value or yield of the mortgage-related securities themselves or of a Fund's
shares.
GNMA Certificates. Certificates of the Government National Mortgage
Association ("GNMA") are mortgage securities which evidence an undivided
interest in a pool or pools of mortgages. GNMA Certificates that the Funds may
purchase are the "modified pass-through" type, which entitle the holder to
receive timely payment of all interest and principal payments due on the
mortgage pool, net of fees paid to the "issuer" and GNMA, regardless of whether
or not the mortgagor actually makes the payment.
The National Housing Act authorized GNMA to guarantee the timely
payment of principal and interest on securities backed by a pool of mortgages
insured by the Federal Housing Administration ("FHA") or guaranteed by the
Veterans Administration ("VA"). The GNMA guarantee is backed by the full faith
and credit of the U.S. Government. GNMA is also empowered to borrow without
limitation from the U.S. Treasury if necessary to make any payments required
under its guarantee.
The average life of a GNMA Certificate is likely to be substantially
shorter than the original maturity of the mortgages underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosures will usually
result in the return of the greater part of principal investment long before the
maturity of the mortgages in the pool. Foreclosures impose no risk to principal
investment because of the GNMA guarantee, except to the extent that a Fund has
purchased the certificates above par in the secondary market.
FHLMC Securities. The Federal Home Loan Mortgage Corporation ("FHLMC")
was created in 1970 to promote development of a nationwide secondary market in
conventional residential mortgages. The FHLMC issues two types of mortgage
pass-through securities ("FHLMC Certificates"): mortgage participation
certificates ("PCs") and guaranteed mortgage certificates ("GMCs"). PCs resemble
GNMA Certificates in that each PC represents a pro rata share of all interest
and principal payments made and owed on the underlying pool. The FHLMC
guarantees timely monthly payment of interest on PCs and the ultimate payment of
principal.
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GMCs also represent a pro rata interest in a pool of mortgages.
However, these instruments pay interest semi-annually and return principal once
a year in guaranteed minimum payments. The expected average life of these
securities is approximately 10 years. The FHLMC guarantee is not backed by the
full faith and credit of the U.S. Government.
FNMA Securities. The Federal National Mortgage Association ("FNMA") was
established in 1938 to create a secondary market in mortgages the FHA insures.
FNMA issues guaranteed mortgage pass-through certificates ("FNMA Certificates").
FNMA Certificates resemble GNMA Certificates in that each FNMA Certificate
represents a pro rata share of all interest and principal payments made and owed
on the underlying pool. FNMA guarantees timely payment of interest and principal
on FNMA Certificates. The FNMA guarantee is not backed by the full faith and
credit of the U.S. Government.
OTHER ASSET-BACKED SECURITIES. The Asset Director(R) Funds may invest a
portion of their assets in debt obligations known as "Asset-Backed Securities"
that are rated in one of the four highest rating categories by a nationally
recognized statistical rating organization ("NRSRO") (e.g., S&P or Moody's) or,
if not so rated, deemed to be of equivalent quality by the Investment Manager
pursuant to guidelines adopted by the Board of Trustees. Growth Allocation,
Balanced Allocation and the Small Company Fund do not currently intend to invest
directly in Asset-Backed Securities, but they may invest in them indirectly
through underlying funds. The credit quality of most Asset-Backed Securities
depends primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated from the
credit risk of the originator (or any other affiliated entities) and the amount
and quality of any credit support provided to the securities. The rate of
principal payments on Asset-Backed Securities generally depends on the rate of
principal payments received on the underlying assets, which in turn may be
affected by a variety of economic and other factors. As a result, the yield on
any Asset-Backed Security is difficult to predict with precision, and actual
yield to maturity may be more or less than the anticipated yield to maturity.
Asset-Backed Securities may be classified as "Pass-Through Certificates" or
"Collateralized Obligations."
"Pass-Through Certificates" are asset-backed securities that represent
undivided fractional ownership interests in the underlying pool of assets.
Pass-Through Certificates usually provide for payments of principal and interest
received to be passed through to their holders, usually after deduction for
certain costs and expenses incurred in administering the pool. Because
Pass-Through Certificates represent ownership interests in the underlying
assets, the holders thereof bear directly the risk of any defaults by the
obligors on the underlying assets not covered by any credit support.
Asset-Backed Securities issued in the form of debt instruments, also
known as Collateralized Obligations, are generally issued as the debt of a
special purpose entity organized solely for the purpose of owning such assets
and issuing such debt. The assets collateralizing such Asset-Backed Securities
are pledged to a trustee or custodian for the benefit of the holders thereof.
Such issuers generally hold no assets other than those underlying the
Asset-Backed Securities and any credit support provided. As a result, although
payments on such Asset-Backed Securities are obligations of the issuers, in the
event of default on the underlying assets not covered by any credit support, the
issuing entities are unlikely to have sufficient assets to satisfy their
obligations on the related Asset-Backed Securities.
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CORPORATE BONDS. Each Asset Director(R) Fund may invest in corporate
bonds rated in one of the four highest categories by a NRSRO. Corporate Bonds
are issued in the form of debt instruments by a private corporation and are
different in character from bonds issued by a government agency or municipality.
Typical distinguishing features include: (1) they are taxable; (2) they have a
par value of $1,000; (3) they have a term maturity (which means they come due
all at once) and are paid for out of a sinking fund accumulated for that purpose
and they may be callable; and (4) they are often traded on major exchanges, with
prices published in the newspapers.
METHODS OF ALLOCATING CASH FLOWS. While many Asset-Backed Securities
are issued with only one class of security, many others are issued in more than
one class, each with different payment terms. Multiple class Asset-Backed
Securities are issued for two main reasons. First, multiple classes may be used
as a method of providing credit support. This is typically accomplished by
creating one or more classes with a right to payments on the Asset-Backed
Security that is subordinate to that of the remaining class or classes. Second,
multiple classes may permit the issuance of securities with payment terms,
interest rates or other characteristics that differ both from those of each
other and from those of the underlying assets. Examples include "multi-tranche
CMOs" (collateralized mortgage obligations) with serial maturities such that all
principal payments received on the mortgages underlying the securities are first
paid to the class with the earliest stated maturity, and then sequentially to
the class with the next stated maturity, "Strips" (Asset-Backed Securities that
entitle the holder to disproportionate interests with respect to the allocation
of interest and principal of the assets backing the security) and securities
with a class or classes having characteristics that mimic the characteristics of
non-Asset-Backed Securities, such as floating interest rates (i.e., interest
rates that adjust as a specified benchmark changes) or scheduled amortization of
principal.
TYPES OF CREDIT SUPPORT. Asset-Backed Securities are often backed by a
pool of assets representing the obligations of a number of different parties. To
lessen the effect of failures by obligors on these underlying assets to make
payments, such securities may contain elements of credit support. Such credit
support falls into two classes: liquidity protection and protection against
ultimate default on the underlying assets. Liquidity protection refers to the
provision of advances, generally by the entity administering the pool of assets,
to ensure that scheduled payments on the underlying pool are made timely.
Protection against ultimate default ensures payment on at least a portion of the
assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained from third parties, through
various means of structuring the transaction, or through a combination of such
approaches. Examples of Asset-Backed Securities with credit support that arise
out of the structure of the transaction include "senior-subordinated securities"
(multiple class Asset-Backed Securities with certain classes subordinate to
other classes as to the payment of principal thereon, so that defaults on the
underlying assets are borne first by the holders of the subordinated class) and
Asset-Backed Securities that have "reserve funds" (cash or investments,
sometimes funded from a portion of the initial payments on the underlying
assets, are held in reserve against future losses) or that have been
"overcollateralized" (the scheduled payments on, or the principal amount of, the
underlying assets substantially exceed that required to make payment on the
Asset-Backed Securities and pay any servicing or other fees). The degree of
credit support provided on each issue is generally based on historical
information respecting the level of credit risk associated with such payments.
Delinquency or loss in excess of that anticipated could adversely affect the
return on an investment in an Asset-Backed Security.
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CREDIT CARD RECEIVABLE SECURITIES. The Asset Director(R) Funds may
invest directly, and the Growth Allocation and Balanced Allocation may invest
indirectly through underlying funds, in Asset-Backed Securities backed by
receivables from revolving credit card agreements ("Credit Card Receivable
Securities"). Most of the Credit Card Receivable Securities issued publicly to
date have been Pass-Through Certificates. In order to lengthen the maturity of
Credit Card Receivable Securities, most such securities provide for a fixed
period during which only interest payments on the underlying accounts are passed
through to the security holder and principal payments received on such accounts
are used to fund the transfer of additional credit card charges made on an
account to the pool of assets supporting the related Credit Card Receivable
Securities. The initial fixed period may usually be shortened upon the
occurrence of specified events that signal a potential deterioration in the
quality of the assets backing the security, such as the imposition of a cap on
interest rates. The ability of the issuer to extend the life of an issue of
Credit Card Receivable Securities thus depends upon the continued generation of
additional principal amounts in the underlying accounts during the initial
period and the non-occurrence of specified events. Competitive and general
economic factors could adversely affect the rate at which new receivables are
created in an account and conveyed to an issuer, shortening the expected
weighted average life of the related Credit Card Receivable Security, and
reducing its yield. An acceleration in cardholders' payment rates or any other
event that shortens the period during which additional credit card charges on an
account may be transferred to the pool of assets supporting the related Credit
Card Receivable Security could have a similar effect on the weighted average
life and yield.
Credit card holders are entitled to the protection of a number of state
and federal consumer credit laws, many of which give such holders the right to
set off certain amounts against balances owed on the credit card, thereby
reducing amounts paid on accounts. In addition, unlike most other Asset-Backed
Securities, accounts are unsecured obligations of the cardholder.
CERTIFICATES OF DEPOSIT AND BANKER'S ACCEPTANCES. The Funds may invest
in certificates of deposit, which are certificates issued against funds
deposited in a banking institution for a specified period of time at a specified
interest rate. Banker's acceptances are credit instruments evidencing a bank's
obligation to pay a draft drawn on it by a customer. These instruments reflect
the obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity. Each Fund will invest only in certificates of deposit
and banker's acceptances of banks that have capital, surplus and undivided
profits in excess of $100 million.
COMMERCIAL PAPER. The Funds may invest in Commercial Paper, which
consists of short-term, unsecured promissory notes issued to finance short-term
credit needs. The Funds will invest only in commercial paper that at the time of
purchase is rated Prime-1 or Prime-2 by Moody's, A-1 or A-2 by S&P, Duff 2 or
higher by Duff & Phelps, Inc. ("Duff"), or F2 or higher by Fitch Investors
Services, Inc. ("Fitch") or if unrated by Moody's, S&P, Duff or Fitch, is
determined by the Investment Manager, using guidelines approved by the Board of
Trustees, to be at least equal in quality to one or more of the above ratings.
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OTHER INVESTMENT POLICIES
Securities that are acquired by the International Index Fund, Asset
Director(R) Funds, and OneSource Portfolios outside the United States and that
are publicly traded in the United States on a foreign securities exchange or in
a foreign securities market, are not considered by the Funds to be illiquid
assets provided that: (i) the Funds acquire and hold the securities with the
intention of reselling the securities in the foreign trading market, (ii) the
Funds reasonably believe they can dispose of the securities readily in the
foreign trading market or for cash in the United States, or (iii) foreign market
and current market quotations are readily available. Investments may be in
securities of foreign issuers, whether located in developed or undeveloped
countries. Investments in foreign securities where delivery takes place outside
the United States will have to be made in compliance with any applicable U.S.
and foreign currency restrictions and tax laws (including laws imposing
withholding taxes on any dividend or interest income) and laws limiting the
amount and types of foreign investments. Changes of government administrations
or economic or monetary policies in the United States or abroad, or changed
circumstances regarding convertibility or exchange rates, could result in
investment losses for the Funds. Investments in foreign securities may also
subject the Funds to losses due to nationalization, expropriation or differing
accounting practices and treatments. Moreover, investors should recognize that
foreign securities are often traded with less frequency and volume, and
therefore may have greater price volatility than many U.S. securities.
Notwithstanding that the Funds generally intend to acquire the securities of
foreign issuers where there are public trading markets, the Funds' investments
in the securities of foreign issuers may tend to increase the risks with respect
to the liquidity of the Funds' portfolio and the Funds' ability to meet a large
number of shareholder redemption requests should there be economic or political
turmoil in a country in which the Funds have a substantial portion of their
assets invested or should relations between the United States and foreign
countries deteriorate markedly. Furthermore, the reporting and disclosure
requirements applicable to foreign issuers may differ from those applicable to
domestic issuers, and there may be difficulties in obtaining or enforcing
judgments against foreign issuers.
Loans of Portfolio Securities. The Funds or underlying funds may loan
securities to qualified broker-dealers or other institutional investors
provided: (i) the loan is secured continuously by collateral consisting of U.S.
Government securities, cash or cash equivalents maintained on a daily
marked-to-market basis in an amount at least equal to the current market value
of the securities loaned; (ii) the Fund or underlying fund may at any time call
the loan and obtain the return of the securities loaned; (iii) the Fund or
underlying fund will receive any interest or dividends paid on the loaned
securities; and (iv) the aggregate market value of securities loaned will not at
any time exceed one-third of the total assets of the Fund or underlying fund.
The lending of securities is a common practice in the securities
industry. The Funds will engage in security lending arrangements with the
primary objective of increasing the Funds' income through investment of the cash
collateral in short-term, interest-bearing obligations but will do so only to
the extent that the Funds will not lose the tax treatment available to regulated
investment companies. The Funds will be entitled to all dividends or interest on
any loaned securities. Loans of securities involve a risk that the borrower may
fail to return the securities or provide additional collateral.
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<PAGE> 23
Repurchase Transactions. Repurchase agreements are instruments under
which a buyer acquires ownership of a security from a seller who agrees to
repurchase the security at a mutually agreed upon time and price (which price is
higher than the purchase price), thereby determining the yield during the
buyer's holding period. Under the 1940 Act, a repurchase agreement is deemed to
be a Fund's loan of money to the seller, collateralized by the underlying
security. The interest rate is effective for the period of time in which the
Funds are invested in the agreement and is not related to the coupon rate on the
underlying security. Any repurchase agreements a Fund enters into will involve
the Fund as the buyer and banks or broker-dealers as sellers (repurchase
agreements with broker-dealers will be limited to obligations of the U.S.
Government or its agencies or instrumentalities). The period of these repurchase
agreements will be usually short--from overnight to one week--and at no time
will the Funds invest in repurchase agreements for more than one year. However,
securities subject to repurchase agreements may have maturity dates in excess of
one year from the effective date of the repurchase agreements. The transaction
requires the initial collateralization of the seller's obligation with
securities having a market value, including accrued interest, equal to at least
102% of the dollar amount the Funds invest with the value marked-to-market daily
to maintain 100% coverage. A default by the seller might cause the Funds to
experience a loss or delay in the liquidation of the collateral securing the
repurchase agreement. The Funds might also incur disposition costs in
liquidating the collateral. The Funds will make payment for such securities only
upon physical delivery or evidence of book entry transfer to the account of its
custodian bank. The Funds may not enter into a repurchase agreement of more than
seven days duration if, as a result, the market value of the Funds' net assets,
together with investments in other securities deemed to be not readily
marketable, would be invested in excess of the Funds' policy on investments in
illiquid securities.
In the event of a bankruptcy or other default of a repurchase
agreement's seller, a Fund might incur expenses in enforcing its rights, and
could experience losses, including a decline in the value of the underlying
securities and loss of income. Each Fund will not invest more than 10% of its
net assets at the time of purchase in repurchase agreements maturing in more
than seven days and other illiquid securities.
Illiquid Securities. Each Fund, except the OneSource Portfolios,
reserves the right to invest up to 10% of its net assets in illiquid securities.
Each of the OneSource Portfolios reserves the right to invest up to 15% of its
net assets in illiquid securities. Generally, an "illiquid security" is any
security that cannot be disposed of promptly and in the ordinary course of
business at approximately the amount at which the Funds have valued the
instrument. Subject to this limitation, the Funds may invest in restricted
securities when such investment is consistent with the Funds' investment
objectives, and such securities may be considered to be liquid to the extent the
Funds' Investment Manager determines that there is a liquid institutional or
other market for such securities. In determining whether a restricted security
is properly considered a liquid security, the Funds' Investment Manager, under
the direction of the Board of Trustees, will take into account the following
factors: (i) the frequency of trades and quotes for the security; (ii) the
number of dealers willing to purchase or sell the security and the number of
potential purchasers; (iii) dealer undertakings to make a market in the
security; and (iv) the nature of the security and marketplace trades (e.g., the
time needed to dispose of the security, the method of soliciting offers and the
mechanics of transfer). To the extent the Funds invest in restricted securities
that are deemed liquid, the general level of illiquidity in the Funds'
portfolios may be increased if qualified institutional buyers become
uninterested in purchasing these securities contracts.
When-Issued and Delayed Delivery Securities. The Funds may hold
securities on a "when-issued" or "delayed delivery" basis. When-issued or
delayed delivery securities are securities purchased for future delivery at a
stated price and yield. Generally, a Fund will not pay for securities until the
Fund receives
23
<PAGE> 24
them. Securities purchased on a when-issued or delayed delivery
basis are recorded as assets. During the period between the agreement date and
the settlement date, the value of such securities may change as the prices of
securities in the stock market increase or decrease, or as interest rates
change. Default by the other party to the agreement may result in a loss to a
Fund.
INVESTMENT IN UNDERLYING SCHWAB FUNDS
The Asset Director Funds may invest in underlying SchwabFunds(R). The
investment objectives and investment policies, limitations, techniques and
associated risks of certain SchwabFunds are described in the Asset Director
Funds'Prospectus or in this SAI. The investment policies, limitations,
techniques and associated risks of each SchwabFund is fully described in its
prospectus and SAI. These are available by contacting Schwab at 1-800-NO-LOAD,
24 hours a day, or by writing to a fund at 101 Montgomery Street, San
Francisco, CA 94104 or electronically at Schwab's World Wide Website at
http://www.schwab.com/funds. TDD users please contact Schwab at 1-800-345-2550.
In addition to utilizing the investment securities, techniques and
policies and exposing themselves to similar limitations and risks as described
in this SAI, the other underlying SchwabFunds may also invest in restricted
securities, collateralized mortgage obligations, municipal securities and index
options.
Each Fund reserves the right to invest all of the assets allocated to
a particular class in one or more newly created SchwabFund, that would expose
the Fund and its shareholders to the risks described below. Some of the
SchwabFunds in which the Asset Director Funds may invest are noted below.
Schwab Total Bond Market Index Fund seeks current income by tracking
the performance of the Lehman Brothers Aggregate Bond Index, a broad-based
index covering bonds with maturities over 1 year. Investments in this
SchwabFund expose a Fund to bond market risks that are described in this SAI
and in the prospectus.
The Schwab S&P 500 Fund seeks to track the price and dividend
performance (total return) of common stocks of U. S. companies, as represented
by the S&P 500 Index(R), by investing in substantially all of the 500 common
stocks composing the S&P 500 Index. Investments in this SchwabFund expose a Fund
to stock risk. The Schwab S&P 500 Fund may also invest in short-term debt
securities with attendant risks described above regarding investment in debt
securities.
The International Index Fund attempts to track the price and dividend
performance (total return) of the Schwab International Index(R), an index
created by Schwab to represent the performance of common stocks and other equity
securities including preferred stocks, rights and warrants issued by large,
publicly traded companies from countries around the world with major developed
securities markets, excluding the U.S. To the extent a Fund invests in this
SchwabFund, which normally invests 80% of its assets in stocks which comprise
the Schwab International Index, the Fund will be exposed to international stock
risk, which is described above. The International Index Fund may also engage in
foreign currency hedging, which involves certain costs that may result in losses
to that SchwabFund, and although tending to minimize risk of certain losses also
tends to limit certain potential gains.
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<PAGE> 25
The Small-Cap Index Fund attempts to track the price and dividend
performance (total return) of the Schwab Small-Cap Index(R), an index created by
Schwab to represent the performance of common stocks of the second 1,000 largest
U.S. corporations (excluding investment companies). To the extent a Fund invests
in the Small-Cap Index Fund, which normally invests 80% of its assets in stocks
which comprise the Schwab Small-Cap Index, the Fund will be exposed to risks of
small company stocks.
Each of the Schwab Index Funds engages in index or passive investing,
and also seeks to minimize capital gain distributions by offsetting capital
gains and capital losses and lowering portfolio turnover. These investment
policies are intended to minimize the adverse federal income tax consequences of
portfolio trading, but may increase the differences between the Schwab Index
Funds' performance and the relevant index's performance. Each Schwab Index Fund
may also purchase other investment securities or engage in securities techniques
(normally up to 20% of its total assets) that are similar to the Asset
Director(R) Funds' and will entail similar risks.
UNDERLYING FUND INVESTMENT TECHNIQUES
The underlying funds for the OneSource Portfolios may also engage in
foreign currency transactions with respect to foreign securities investments;
invest in restricted securities; sell securities short; borrow money for
investment purposes (i.e., leverage their portfolio); write (sell) or purchase
call or put options on securities or on stock indices; concentrate their assets
in one industry; invest in master demand notes; invest in domestic equity
securities; and enter into futures contracts and options on futures contracts.
The underlying funds for the Asset Director Funds may also engage in foreign
currency transactions with respect to foreign securities investments, borrow
money and invest in futures and options. The risks associated with these
investments are discussed below.
To the extent that the underlying funds also invest or engage in swaps,
preferred stock, convertible securities, real estate-related investments,
precious metal related investments, U.S. Government securities, government
"mortgage-backed" securities, asset-backed securities, certificates of deposit
and bankers' acceptances, commercial paper, repurchase transactions, and
when-issued and delayed delivery securities, the underlying funds would be
subject to risks associated with such investments similar to those risks
discussed above regarding such investments by the Funds.
Short Sales. An underlying fund may sell securities short. In a short
sale, the underlying fund sells stock which it does not own, making delivery
with securities "borrowed" from a broker. The underlying fund is then obligated
to replace the security borrowed by purchasing it at the market price at the
time of replacement. This price may or may not be less than the price at which
the security was sold by the underlying fund. Until the security is replaced,
the underlying fund is required to pay the lender any dividends or interest that
accrue during the period of the loan. In order to borrow the security, the
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<PAGE> 26
underlying fund may also have to pay a premium, which would increase the cost of
the security sold. The broker will retain the proceeds of the short sale to the
extent necessary to meet margin requirements until the short position is closed
out.
The underlying fund must also deposit in a segregated account an amount
of cash or U.S. Government securities equal to the difference between (a) the
market value of the securities sold short at the time they were sold short and
(b) the value of the collateral deposited with the broker in connection with the
short sale (not including the proceeds from the short sale). While the short
position is open, the underlying fund must maintain daily the segregated account
at such a level that (i) the amount deposited in it plus the amount deposited
with the broker as collateral equals the current market value of the securities
sold short and (ii) the amount deposited in it plus the amount deposited with
the broker as collateral is not less than the market value of the securities at
the time they were sold short. Depending upon market conditions, up to 80% of
the value of an underlying fund's net assets may be deposited as collateral for
the obligation to replace securities borrowed to effect short sales and
allocated to a segregated account in connection with short sales. The underlying
fund will incur a loss as a result of the short sale if the price of the
security increases between the date of the short sale and the date on which the
underlying fund replaces the borrowed security. The underlying fund will realize
a gain if the security declines in price between those dates. The amount of any
gain will be decreased and the amount of any loss increased by the amount of any
premium dividends or interest the underlying fund may be required to pay in
connection with a short sale.
A short sale is "against the box" if at all times when the short
position is open the underlying fund owns an equal or greater amount of the
securities or securities convertible into, or exchangeable without further
consideration for, securities of the same issue as the securities sold short.
Such a transaction defers a gain or loss for Federal income tax purposes. The
procedures described above regarding deposits in a segregated account are not
required to be followed for short sales "against the box."
Leverage Through Borrowing. An underlying fund may borrow up to 25% of
the value of its net assets on an unsecured basis from banks to increase its
holdings of portfolio securities. Under the 1940 Act, the underlying fund is
required to maintain continuous asset coverage of 300% with respect to such
borrowings and to sell (within three days) sufficient portfolio holdings to
restore such coverage if it should decline to less than 300% due to market
fluctuations or otherwise, even if it is disadvantageous to do so from an
investment standpoint. Leveraging will exaggerate the effect of any increase or
decrease in the value of portfolio securities on the underlying fund's net asset
value. Money borrowed will also be subject to interest costs (which may include
commitment fees and/or the cost of maintaining minimum average balances), which
may or may not exceed the interest and option premiums received from the
securities purchased with borrowed underlying funds.
Derivatives. An underlying fund may invest in the following instruments
that are known commonly as derivatives. Generally, a derivative is a financial
arrangement, the value of which is based on or "received" from a traditional
security, asset or market index.
Hedging. An underlying fund may employ many of the investment
techniques described herein not only for investment purposes which may be
considered speculative, but also for hedging purposes. For
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<PAGE> 27
example, an underlying fund may purchase or sell put and call options on common
stocks to hedge against movement in individual common stock prices, or purchase
and sell stock index futures and related options to hedge against marketwide
movements in common stock prices. Although such hedging techniques generally
tend to minimize the risk of loss that is hedged against, they may also limit
commensurably the potential gain that might have resulted had the hedging
transaction not occurred. Also, the desired protection generally resulting from
hedging transactions may not always be achieved.
Master Demand Notes. Although the Funds will not do so, underlying
funds (particularly money market mutual funds) may invest up to 100% of their
assets in master demand notes. Master demand notes are unsecured obligations of
U.S. corporations redeemable upon notice that permit investment by an underlying
fund of fluctuating amounts at varying rates of interest pursuant to direct
arrangements between the fund and the issuing corporation. Because they are
direct arrangements between the underlying fund and the issuing corporation,
there is no secondary market for the notes. However, they are redeemable at face
value, plus accrued interest, at any time.
Domestic Equity Securities. The underlying funds, particularly global
underlying funds, also may be able to purchase equity securities of U.S.
companies. Equity securities are ownership interests in the net worth of a
corporation and include common stocks, convertible securities and warrants.
Common stock prices can be volatile in the short term. Market conditions or
other company, political and economic news can often cause large changes in a
stock's price. Such investments entail market risk, i.e., the risk of being
invested in stocks when the market goes down, resulting in stock prices
declining over short or even long periods.
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS FOR INTERNATIONAL INDEX FUND,
SMALL-CAP INDEX FUND, HIGH GROWTH FUND, BALANCED GROWTH FUND,
CONSERVATIVE GROWTH FUND, SCHWAB S&P 500 FUND, ANALYTICS FUND(TM),
ONESOURCE PORTFOLIOS-INTERNATIONAL
Except as otherwise noted, the restrictions below are fundamental and
cannot be changed without approval of the holders of a majority of the
outstanding voting securities (as defined in the 1940 Act). With respect to the
Analytics Fund and the Schwab OneSource Portfolios-International, investment
restriction numbers 3, 4, 6 and 7 are non-fundamental and may be changed by the
Trust's Board of Trustees. Each of the Funds listed above may not:
1) As to 75% of its assets, purchase securities of any issuer (other
than obligations of, or guaranteed by, the U.S. Government, its agencies or
instrumentalities or investments in other registered investment companies) if,
as a result, more than 5% of the value of its total assets would be invested in
the securities of such issuer.
2) Purchase securities (other than securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities) if, as a result of such
purchase, 25% or more of the value of its total assets would be invested in any
industry (except that the International Index Fund and Small-Cap Index Fund may
purchase securities under such circumstances only to the extent that the
International Index or Small-Cap
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<PAGE> 28
Index, respectively, is also so concentrated and that the S&P 500 Fund and
Analytics Fund may purchase securities under such circumstances only to the
extent that the S&P 500 is also so concentrated, and except that the Schwab
OneSource Portfolios-International will invest 25% or more of its total assets
in other investment companies).
3) Invest more than 10% of its net assets in illiquid securities,
including repurchase agreements with maturities in excess of seven days (except
that the Schwab OneSource Portfolios-International may not invest more than 15%
of its net assets in illiquid securities).
4) Purchase or retain securities of an issuer if any of the officers,
Trustees or Directors of the Trust or the Investment Manager individually own
beneficially more than 1/2 of 1% of the securities of such issuer and together
beneficially own more than 5% of the securities of such issuer.
5) Purchase or sell commodities, commodity contracts or real estate,
including interests in real estate limited partnerships, provided that each Fund
may (i) purchase securities of companies that deal in real estate or interests
therein, (ii) purchase or sell futures contracts, options contracts, equity
index participations and index participation contracts, and (iii) for the Asset
Director(R) Funds, S&P 500 Fund, and Analytics Fund(TM), purchase securities of
companies that deal in precious metals or interests therein.
6) Invest for the purpose of exercising control or management of
another issuer.
7) Purchase securities of other investment companies, except as
permitted by the 1940 Act, including any exemptive relief granted by the SEC.
8) Lend money to any person, except that each Fund may (i) purchase a
portion of an issue of short-term debt securities or similar obligations
(including repurchase agreements) that are distributed publicly or customarily
purchased by institutional investors, and (ii) lend its portfolio securities.
9) Borrow money or issue senior securities, except that each Fund may
borrow from banks as a temporary measure to satisfy redemption requests or for
extraordinary or emergency purposes and then only in an amount not to exceed
one-third of the value of its total assets (including the amount borrowed),
provided that each Fund will not purchase securities while borrowings represent
more than 5% of its total assets.
10) Pledge, mortgage or hypothecate any of its assets, except that, to
secure allowable borrowings, each Fund may do so with respect to no more than
one-third of the value of its total assets.
11) Underwrite securities issued by others, except to the extent it may
be deemed to be an underwriter, under the federal securities laws, in connection
with the disposition of securities from its investment portfolio.
In order to permit the sale of shares of each Fund in certain
jurisdictions, each Fund may make commitments more restrictive than the
fundamental operating restrictions described above. Should it do so and later
determine that any such commitment is no longer in the best interests of the
Fund and its shareholders, it will revoke the commitment(s) by terminating sales
of its shares in the jurisdiction(s) involved.
NON-FUNDAMENTAL RESTRICTIONS FOR INTERNATIONAL INDEX FUND,
SMALL-CAP INDEX FUND, HIGH GROWTH FUND, BALANCED GROWTH FUND,
CONSERVATIVE GROWTH FUND, SCHWAB S&P 500 FUND, ANALYTICS FUND AND
ONESOURCE PORTFOLIOS INTERNATIONAL
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<PAGE> 29
The following restrictions are non-fundamental and may be changed by
the Trust's Board of Trustees. Each of the Funds, with the exception of Growth
Allocation, Balanced Allocation and the Small Company Fund, may not:
1) Purchase more than 10% of any class of securities of any issuer if,
as a result of such purchase, it would own more than 10% of such issuer's
outstanding voting securities.
2) Invest more than 5% of its net assets in warrants, valued at the
lower of cost or market, and no more than 40% of this 5% may be invested in
warrants that are not listed on the New York Stock Exchange or the American
Stock Exchange, provided, however, that for purposes of this restriction,
warrants acquired by a Fund in units or attached to other securities are deemed
to be without value.
3) Purchase puts, calls, straddles, spreads or any combination thereof
if by reason of such purchase the value of its aggregate investment in such
securities would exceed 5% of the Fund's net assets.
4) Make short sales, except for short sales against the box.
5) Purchase or sell interests in oil, gas or other mineral development
programs or leases, although it may invest in companies that own or invest in
such interests or leases.
6) Purchase securities on margin, except such short-term credits as may
be necessary for the clearance of purchases and sales of securities.
Investments in Other Mutual Funds. The Schwab OneSource
Portfolios-International intends to purchase shares of underlying funds in
compliance with the requirements of Section 12(d)(1)(F) of the 1940 Act. Under
that provision, the Fund is prohibited from purchasing the securities of an
underlying fund if, as a result, the Fund together with its affiliates would own
more than 3% of the total outstanding securities of that underlying fund. In
addition, the Fund is required to seek voting instructions from its shareholders
regarding underlying fund proxies, and to vote such proxies in accordance with
the instructions received or to vote such proxies in the same proportion as the
vote of all other holders of the underlying fund securities.
The definition of "securities" in the first non-fundamental restriction
does not include cash and cash items (including receivables), government
securities and the securities of other investment companies.
FUNDAMENTAL INVESTMENT RESTRICTIONS FOR GROWTH ALLOCATION,
BALANCED ALLOCATION AND THE SMALL COMPANY FUND
The restrictions numbered 1, 2 and 3 immediately below are fundamental
and cannot be changed without approval of the holders of a majority of the
outstanding voting securities (as defined in the 1940 Act). For more detailed
information, see "1940 Act Restrictions" and "Other Investment Policies"
discussed below. The Growth Allocation, Balanced Allocation and the Small
Company Fund:
1) May purchase securities of any issuer only when consistent with the
maintenance of its status as a diversified company under the 1940 Act.
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<PAGE> 30
2) May not concentrate investments in a particular industry or group of
industries as concentration is defined under the 1940 Act, or the rules or
regulations thereunder.
3) May (i) purchase or sell commodities, commodities contracts, or real
estate, (ii) lend or borrow money, (iii) issue senior securities, (iv)
underwrite securities, or (v) pledge, mortgage or hypothecate any of its assets,
only if permitted by the 1940 Act or the rules or regulations thereunder.
The Growth Allocation's, Balanced Allocation's and the Small Company
Fund's fundamental investment policies have been adopted to avoid wherever
possible the necessity of shareholder meetings otherwise required under the 1940
Act. This recognizes the need to react quickly to changes in the law or new
investment opportunities in the securities markets and the cost and time
involved in obtaining shareholder approvals for diversely held investment
companies. However, the Growth Allocation, Balanced Allocation and the Small
Company Fund have also adopted non-fundamental investment policies, set forth
below, which are more restrictive than their fundamental investment policies.
The Growth Allocation's, Balanced Allocation's and the Small Company Fund's
non-fundamental investment policies may be changed by a vote of the Board of
Trustees. Any changes in either the Growth Allocation's, Balanced Allocation's
or the Small Company Fund's non-fundamental investment policies will be
communicated to the Fund's shareholders prior to the effectiveness of the
changes.
1940 ACT RESTRICTIONS. Under the 1940 Act and the rules, regulations
and interpretations thereunder, a "diversified company," as to 75% of its total
assets, may not purchase securities of any issuer (other than obligations of, or
guaranteed by, the U.S. Government or its agencies, or instrumentalities or
investments in other registered investment companies) if, as a result, more than
5% of the value of its total assets would be invested in the securities of such
issuer or more than 10% of the issuer's voting securities would be held by the
fund. "Concentration" is generally interpreted under the 1940 Act as investing
25% or more of total assets in an industry or group of industries. The 1940 Act
limits the ability of investment companies to borrow and lend money and to
underwrite securities. The 1940 Act currently prohibits an open-end fund from
issuing senior securities, as defined in the 1940 Act, except under very limited
circumstances.
OTHER INVESTMENT POLICIES FOR GROWTH ALLOCATION, BALANCED ALLOCATION
AND THE SMALL COMPANY FUND
The following investment policies and restrictions are non-fundamental
and may be changed by the Trust's Board of Trustees. The Growth Allocation,
Balanced Allocation and the Small Company Fund may not:
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<PAGE> 31
1) Invest more than 15% of its net assets in illiquid securities,
including repurchase agreements with maturities in excess of 7 days.
2) Purchase or retain securities of an issuer if any of the officers,
Trustees or Directors of the Trust or the Investment Manager individually own
beneficially more than 1/2 of 1% of the securities of such issuer and together
beneficially own more than 5% of the securities of such issuer.
3) Invest for the purpose of exercising control or management of
another issuer.
4) Purchase securities of other investment companies, except as
permitted by the 1940 Act, including any exemptive relief granted by the SEC.
5) Purchase more than 10% of any class of securities of any issuer if,
as a result of such purchase, it would own more than 10% of such issuer's
outstanding voting securities.
6) Invest more than 5% of its net assets in warrants, valued at the
lower of cost or market, and no more than 40% of this 5% may be invested in
warrants that are not listed on the New York Stock Exchange or the American
Stock Exchange, provided, however, that for purposes of this restriction,
warrants acquired by a Fund in units or attached to other securities are deemed
to be without value.
7) Purchase puts, calls, straddles, spreads or any combination thereof,
if by reason of such purchase the value of its aggregate investment in such
securities would exceed 5% of the Fund's net assets.
8) Make short sales, except for short sales against the box.
9) Purchase or sell interests in oil, gas or other mineral development
programs or leases, although it may invest in companies that own or invest in
such interests or leases.
10) Purchase securities on margin, except such short-term credits as
may be necessary for the clearance of purchases and sales of securities.
The definition of "securities" in the fifth non-fundamental restriction
does not include cash and cash items (including receivables), government
securities and the securities of other investment companies.
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MANAGEMENT OF THE TRUST
OFFICERS AND TRUSTEES. The officers and Trustees of the Trust, their
principal occupations over the past five years and their affiliations, if any,
with The Charles Schwab Corporation, Schwab and the Investment Manager, are as
follows:
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ --------- --------------------
<S> <C> <C>
CHARLES R. SCHWAB* Chairman and Trustee Chairman, Chief Executive Officer and
July 29, 1937 Director, The Charles Schwab Corporation;
Chairman and Director, Charles Schwab &
Co., Inc. and Charles Schwab Investment
Management, Inc.; Chairman and Director,
The Charles Schwab Trust Company; Chairman
and Director (current board positions), and
Chairman (officer position) until December
1995, Mayer & Schweitzer, Inc. (a
securities brokerage subsidiary of The
Charles Schwab Corporation); Director, The
Gap, Inc. (a clothing retailer),
Transamerica Corporation (a financial
services organization), AirTouch
Communications (a telecommunications
company) and Siebel Systems (a software
company).
</TABLE>
- ---------------------------
*Mr. Schwab is an "interested person" of the Trust.
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<PAGE> 33
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ --------- --------------------
<S> <C> <C>
TIMOTHY F. McCARTHY** President and Trustee Executive Vice President and President -
September 19, 1951 Financial Products and International Group,
Charles Schwab & Co., Inc.; Executive Vice
President-President, Financial Products and
International Group, The Charles Schwab
Corporation; Chief Executive Officer,
Charles Schwab Investment Management, Inc.;
Vice Chairman and Chief Operating Officer,
Charles Schwab Limited; Director, Mayer &
Schweitzer. From 1994 to 1995, Mr. McCarthy
was Chief Executive Officer, Jardine
Fleming Unit Trusts Ltd.; Executive
Director, Jardine Fleming Holdings Ltd.;
Chairman, Jardine Fleming Taiwan Securities
Ltd.; and Director of JF India and Fleming
Flagship, Europe. Prior to 1994, he was
President of Fidelity Investments Advisor
Group, a division of Fidelity Investments
in Boston.
DONALD F. DORWARD Trustee Executive Vice President and Managing
September 23, 1931 Director, Grey Advertising. From 1990 to
1996, Mr. Dorward was President and Chief
Executive Officer, Dorward & Associates.
Dorward and Associates is an advertising
and marketing/consulting firm.
ROBERT G. HOLMES Trustee Chairman, Chief Executive Officer and
May 15, 1931 Director, Semloh Financial, Inc. Semloh
Financial is an international financial
services and investment advisory firm.
</TABLE>
- ---------------------------
**Mr. McCarthy is an "interested person" of the Trust.
33
<PAGE> 34
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ --------- --------------------
<S> <C> <C>
DONALD R. STEPHENS Trustee Managing Partner, D.R. Stephens & Co.
June 28, 1938 (investment banking). From 1985 to 1995,
Mr. Stephens was Chairman and Chief
Executive Officer of North American Trust
(a real estate investment trust). Prior to
1992, Mr. Stephens was Chairman and Chief
Executive Officer of the Bank of San
Francisco.
MICHAEL W. WILSEY Trustee Chairman, Chief Executive Officer and
August 18, 1943 Director, Wilsey Bennett, Inc. (truck and
air transportation, real estate investment
and management, and investments).
TAI-CHIN TUNG Treasurer and Principal Vice President - Finance, Charles Schwab &
March 7, 1951 Financial Officer Co., Inc.; Controller, Charles Schwab
Investment Management, Inc. From 1994 to
1996, Ms. Tung was Controller for Robertson
Stephens Investment Management, Inc. From
1993 to 1994, she was Vice President of
Fund Accounting, Capital Research and
Management Co. Prior to 1993, Ms. Tung was
Senior Vice President of the Sierra Funds
and Chief Operating Officer of Great
Western Financial Securities.
WILLIAM J. KLIPP* Executive Vice President, Executive Vice President-SchwabFunds(R),
December 9, 1955 Chief Operating Officer Charles Schwab & Co., Inc.; President and
and Trustee Chief Operating Officer, Charles Schwab
Investment Management, Inc. Prior to 1993,
Mr. Klipp was Treasurer of Charles Schwab &
Co., Inc. and Mayer & Schweitzer, Inc.
</TABLE>
- ---------------------------
*Mr. Klipp is an "interested person" of the Trust.
34
<PAGE> 35
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ --------- --------------------
<S> <C> <C>
STEPHEN B. WARD Senior Vice President Senior Vice President and Chief Investment
April 5, 1955 and Chief Investment Officer, Charles Schwab Investment
Officer Management, Inc.
FRANCES COLE Secretary Vice President, Chief Counsel, Chief
September 9, 1955 Compliance Officer and Assistant Corporate
Secretary, Charles Schwab Investment
Management, Inc.
DAVID H. LUI Assistant Secretary Vice President and Senior Counsel - Charles
October 14, 1960 Schwab Investment Management, Inc. From
1991 to 1992, he was Assistant Secretary
and Assistant Corporate Counsel for the
Franklin Group of Mutual Funds.
CHRISTINA M. PERRINO Assistant Secretary Vice President and Senior Counsel - Charles
June 16, 1961 Schwab Investment Management, Inc. Prior to
1994, she was Counsel and Assistant
Secretary for North American Security Life
Insurance Company and Secretary for North
American Funds.
KAREN L. SEAMAN Assistant Secretary Corporate Counsel - Charles Schwab
February 27, 1968 Investment Management, Inc. From October,
1994 to July 1996, Ms. Seaman was Attorney
for Franklin Resources, Inc. Prior to 1994,
Ms. Seaman was an attorney for The Benham
Group.
</TABLE>
Each of the above-referenced Officers and/or Trustees also serves in
the same capacity as described for the Trust, Schwab Investments, The Charles
Schwab Family of Funds and Schwab Annuity Portfolios. The address of each
individual listed above is 101 Montgomery Street, San Francisco, California
94104.
35
<PAGE> 36
COMPENSATION TABLE 1
<TABLE>
<CAPTION>
Pension or Retirement Estimated Annual
Aggregate Benefits Accrued as Benefits upon Total Compensation
Compensation from Part of Fund Expenses Retirement from the from the Fund
Name of Person, Position the Trust from the Fund Complex 2 Fund Complex 2 Complex 2
- ------------------------ --------- ---------------------- ------------- --------
<S> <C> <C> <C> <C>
Charles R. Schwab, 0 N/A N/A 0
Chairman and Trustee
Timothy F. McCarthy, 0 N/A N/A 0
President and Trustee
William J. Klipp, 0 N/A N/A 0
Executive Vice
President, Chief Operating
Officer and Trustee
Donald F. Dorward, 16,150 N/A N/A 81,100
Trustee
Robert G. Holmes, 16,150 N/A N/A 81,100
Trustee
Donald R. Stephens, 16,150 N/A N/A 81,100
Trustee
Michael W. Wilsey, 16,150 N/A N/A 81,100
Trustee
</TABLE>
1 Figures are for the Trust's fiscal year ended October 31, 1996.
2 "Fund Complex" comprises all 30 funds of the Trust, The Charles Schwab
Family of Funds, Schwab Investments and Schwab Annuity Portfolios.
DEFERRED COMPENSATION PLAN
Pursuant to exemptive relief received by the Trust from the SEC, the
Trust may enter into deferred fee arrangements (the "Fee Deferral Plan" or the
"Plan") with the Trust's Trustees who are not "interested persons" of any of the
Funds of the Trust (the "Independent Trustees" or the "Trustees").
36
<PAGE> 37
As of the date of this SAI, none of the Independent Trustees has
elected to participate in the Fee Deferral Plan. In the event an Independent
Trustee does elect to participate in the Plan, the Plan would operate as
described below.
Under the Plan, deferred Trustee's fees will be credited to a book
reserve account established by the Trust (the "Deferred Fee Account") as of the
date such fees would have been paid to such Trustee. The value of the Deferred
Fee Account as of any date will be equal to the value the Account would have had
as of that date if the amounts credited to the Account had been invested and
reinvested in the securities of the SchwabFund or SchwabFunds(R) selected by the
participating Trustee (the "Selected SchwabFund Securities"). SchwabFunds
include the series or classes of beneficial interest of the Trust, The Charles
Schwab Family of Funds and Schwab Investments.
Pursuant to the exemptive relief granted to the Trust, each Fund will
purchase and maintain the Selected SchwabFund Securities in an amount equal to
the deemed investments in that Fund of the Deferred Fee Accounts of the
Independent Trustees. The exemptive relief granted to the Trust permits the
Funds and the Trustees to purchase the Selected SchwabFund Securities, which
transactions would otherwise be limited or prohibited by the investment policies
and/or restrictions of the Funds. See "Investment Restrictions in this SAI for
more information."
INVESTMENT MANAGER
The Investment Manager, a wholly owned subsidiary of The Charles Schwab
Corporation, serves as the Funds' investment adviser and administrator pursuant
to an Investment Advisory and Administration Agreement (the "Advisory
Agreement") between it and the Trust. The Investment Manager is registered as an
investment adviser under the Investment Advisers Act of 1940, as amended, and
currently provides investment management services to the SchwabFunds Family(R),
a family of 27 mutual funds with over $50 billion in assets as of July 15, 1997.
The Investment Manager is an affiliate of: Schwab; the Trust's distributor; the
shareholder services; and the transfer agent. The Advisory Agreement will
continue in effect until May 30, 1998 with respect to each of the Funds and
thereafter will continue for one year terms subject to annual approval by: (1)
the Trust's Board of Trustees or (2) a vote of a majority (as defined in the
1940 Act) of the outstanding voting securities of a Fund. In either event, the
continuance must also be approved by a majority of the Trust's Board of Trustees
who are not parties to the Agreement or interested persons (as defined in the
1940 Act) of any such party by vote cast in person at a meeting called for the
purpose of voting on such approval. The Advisory Agreement may be terminated at
any time upon 60 days' notice by either party, or by a majority vote of the
outstanding shares of a Fund, and will terminate automatically upon assignment.
International Index Fund. For its advisory and administrative services
to the International Index Fund, the Investment Manager is entitled to receive a
graduated annual fee, payable monthly, of 0.70% of the Fund's average daily net
assets not in excess of $300 million and 0.60% of such assets over $300 million.
The Investment Manager and Schwab have guaranteed that, through at
least February 29, 2000, the total fund operating expenses allocable to the
Investor Shares and Select Shares for the International
37
<PAGE> 38
Index Fund will not exceed 0.58% and 0.47%, respectively, of the average daily
net assets of each class of shares.
For the fiscal years ended October 31, 1996, 1995 and 1994, the
International Index Fund paid investment advisory fees of $886,000, $665,000 and
$474,000, respectively (fees were reduced by $675,000, $415,000 and $388,000,
respectively).
Small-Cap Index Fund. For its advisory and administrative services to
the Small-Cap Index Fund, the Investment Manager is entitled to receive a
graduated annual fee, payable monthly, of 0.50% of the Fund's average daily net
assets not in excess of $300 million and 0.45% of such assets over $300 million.
The Investment Manager and Schwab have guaranteed that, through at
least February 29, 2000, the total fund operating expenses allocable to the
Investor Shares and Select Shares for the Small-Cap Index Fund will not exceed
0.49% and 0.38%, respectively, the average daily net assets of each class of
shares.
For the fiscal years ended October 31, 1996 and 1995, and for the
fiscal period from December 3, 1993 (commencement of operations) to October 31,
1994, the Small-Cap Index Fund paid investment advisory fees of $520,000,
$332,000 and $152,000, respectively (fees were reduced by $347,000, $115,000 and
$107,000, respectively).
Asset Director(R) Funds. For its advisory and administrative services
to the Asset Director Funds, the Investment Manager is entitled to receive a
graduated annual fee, payable monthly, of 0.74% of each Fund's average daily net
assets not in excess of $1 billion, 0.69% of the next $1 billion and 0.64% of
such net assets over $2 billion.
The Investment Manager and Schwab have guaranteed that, through at
least February 28, 1998, the total fund operating expenses for each Asset
Director Fund will not exceed 0.89% of the Fund's average daily net assets.
For the fiscal period of November 20, 1995 (commencement of operations)
to October 31, 1996, the High Growth Fund, the Balanced Growth Fund, and the
Conservative Growth Fund paid investment advisory fees of $337,000 $219,000, and
$26,000, respectively (fees were reduced by $296,000, $242,000 and $118,000
respectively).
S&P 500 Fund. For its advisory and administrative services to the S&P
500 Fund, the Investment Manager is entitled to receive a graduated annual fee,
payable monthly, of 0.36% of the Fund's average daily net assets not in excess
of $1 billion, 0.33% of the next $1 billion and 0.31% of such net assets over $2
billion.
The Investment Manager and Schwab have guaranteed that, through at
least February 29, 2000, the total operating expenses allocable to the Investor
Shares, the e.Shares(TM) and the Select Shares(TM) will not exceed 0.35%, 0.28%
and 0.19% respectively, of the average daily net assets of each class of shares.
38
<PAGE> 39
For the fiscal period of May 1, 1996 (commencement of operations) to
October 31, 1996, the S&P 500 Fund paid investment advisory fees of $128,000
(fees were reduced by $223,000).
Analytics Fund(TM). For its advisory and administrative services to the
Analytics Fund, the Investment Manager is entitled to receive a graduated annual
fee, payable monthly, of 0.74% of the Fund's average daily net assets not in
excess of $1 billion, 0.69% of the next $1 billion and 0.64% of such net assets
over $2 billion.
The Investment Manager and Schwab have guaranteed that, through at
least February 28, 1998, the total fund operating expenses for the Analytics
Fund will not exceed 0.75% of its average daily net assets.
For the fiscal period of July 1, 1996 (commencement of operations) to
October 31, 1996, the Analytics Fund paid investment advisory fees of $66,000
(fees were reduced by $151,000).
Schwab OneSource Portfolios-International. For its advisory and
administrative services to the Schwab OneSource Portfolios-International, the
Investment Manager is entitled to receive a graduated annual fee, payable
monthly, of 0.74% of the Fund's average daily net assets not in excess of $1
billion, 0.69% of the next $1 billion and 0.64% of net assets over $2 billion.
The Investment Manager and Schwab have guaranteed that, through at
least February 28, 1999, the total fund operating expenses for the Schwab
OneSource Portfolios-International will not exceed 0.50% of its average daily
net assets.
For the fiscal period of October 16, 1996 (commencement of operations)
to October 31, 1996, the Schwab OneSource Portfolios-International paid
investment advisory fees of $0 (fees were reduced by $17,000).
Growth Allocation and Balanced Allocation. For its advisory and
administrative services to the Growth Allocation and Balanced Allocation, the
Investment Manager is entitled to receive a graduated annual fee, payable
monthly, of 0.74% of the first $1 billion of each Fund's average daily net
assets, 0.69% of the next $1 billion, and 0.64% of net assets over $2 billion.
The Investment Manager and Schwab have guaranteed that, through at
least February 28, 1999, the fund selection and investment management fees for
Growth Allocation and Balanced Allocation will not exceed 0.50% of its average
daily net assets.
Small Company Fund. For its advisory and administrative services to the
Small Company Fund, the Investment Manager is entitled to receive a graduated
annual fee, payable monthly, of 0.74% of the first $1 billion of the Fund's
average daily net assets, 0.69% of the next $1 billion, and 0.64% of net assets
over $2 billion.
39
<PAGE> 40
The Investment Manager and Schwab have guaranteed that, through at
least February 28, 1999, the fund selection and investment management fees for
the Small Company Fund will not exceed 0.50% of its average daily net assets.
Schwab currently receives remuneration from fund companies
participating in its Mutual Fund OneSource(R) service equal to 0.25% to 0.35%
per annum of assets invested in the OneSource Portfolios. The Investment Manager
and Schwab provide investment management and other services to all of Schwab's
proprietary funds and receive compensation from them. In light of this
remuneration and compensation, Schwab guarantees, through at least December 31,
2001, to waive its Transfer Agent and Shareholder Service fees for OneSource
Portfolios International, Growth Allocation, Balanced Allocation and the Small
Company Fund. These fees normally total 0.25% for each Fund. After December 31,
2001, the guarantee may be terminated, modified or continued.
Additional Information. From time to time, each Fund may compare its
total operating expense ratio to the total operating expense ratio of other
mutual funds or mutual fund averages with similar investment objectives as
reported by Lipper Analytical Service, Inc., Morningstar, Inc. or other
independent sources of such information ("independent sources").
SUB-ADVISER
With respect to the Analytics Fund(TM), the Investment Manager has
entered into an investment sub-advisory agreement (the "Sub-Advisory Agreement")
with Symphony Asset Management, Inc. (the "Sub-Adviser" or "Symphony") pursuant
to which Symphony Asset Management, Inc. will act as the Fund's sub-adviser. The
Sub-Adviser is registered as an investment adviser under the Investment Advisers
Act of 1940 and currently manages directly and indirectly approximately $700
million in institutional and private account assets.
The Sub-Adviser makes investment decisions for the Analytics Fund's
non-cash investments and uses quantitative techniques and proprietary real-time
databases and software models to continually identify and rank stocks that
exhibit a favorable combination of attributes that have historically been
associated with aggregate total returns greater than that of the S&P 500. Once
rankings are determined, statistical methodologies will be used to construct a
portfolio of the most attractive stocks in terms of potential long-term capital
growth.
For the Sub-Adviser's services relating to the Analytics Fund(TM), the
Investment Manager pays the Sub-Adviser an annual investment sub-advisory fee,
payable monthly, of 0.20% of the Fund's average daily net assets not in excess
of $300 million, 0.15% of the next $500 million and 0.10% of such assets over
$800 million.
As of February 28, 1997, Symphony no longer served as sub-adviser to
the Asset Director(R) Funds. Instead, the Investment Manager became responsible
for providing all investment advisory services to the Asset Director Funds.
40
<PAGE> 41
As of May 1, 1995 and June 30, 1995, Dimensional Fund Advisors Inc.
("Dimensional") no longer served as the sub-adviser to the Small-Cap Index Fund
and International Index Fund, respectively. As of the same dates, the Investment
Manager became responsible for providing all investment advisory services to the
Funds.
Expenses. Under the Sub-Advisory Agreement between Dimensional and the
Investment Manager, the Investment Manager paid Dimensional the following
amounts for the fiscal periods indicated below.
International Index Fund: for the fiscal years ended October 31, 1996,
1995 and 1994, Dimensional was paid $0, $143,000 and $185,000 respectively.
Small-Cap Index Fund: for the fiscal year ended October 31, 1996, 1995
and for the fiscal period from December 3, 1993 (commencement of operations) to
October 31, 1994, Dimensional was paid $0, $36,000 and $51,000, respectively.
Asset Director Funds for the fiscal period from November 20, 1995
(commencement of operations) to October 31, 1996 paid Symphony $120,156.
DISTRIBUTOR
Pursuant to a Distribution Agreement, Schwab is the principal
underwriter for shares of the Trust and is the Trust's agent for the purpose of
the continuous offering of the Funds' shares. Each Fund pays the cost of the
prospectuses and shareholder reports to be prepared and delivered to existing
shareholders. Schwab pays such costs when the described materials are used in
connection with the offering of shares to prospective investors and for
supplementary sales literature and advertising. Schwab receives no fee under the
Distribution Agreement. Terms of continuation, termination and assignment under
the Distribution Agreement are identical to those described above with respect
to the Advisory Agreement.
CONSULTANT
The Investment Adviser has hired and pays Symphony as a consultant for
the Asset Director(R) Funds. Symphony provides the Tactical Asset Allocation
Model described below under "Indexing and Asset Allocation -- the Schwab Index
Funds and the Schwab Asset Allocation Funds."
CUSTODIAN AND FUND ACCOUNTANT
Morgan Stanley Trust Company, 1 Pierrepont Plaza, Brooklyn, New York
11201, and Federated Services Company, 1001 Liberty Avenue, Pittsburgh,
Pennsylvania 15222, serve as Custodian and Fund Accountant for the International
Index Fund, Small-Cap Index Fund, Asset Director Funds, Schwab OneSource
Portfolios-International, Growth Allocation, Balanced Allocation and the Small
Company Fund.
PNC Bank, National Association, at the Airport Business Center, 200
Stevens Drive, Suite 440, Lester, Pennsylvania 19113, serves as Custodian for
the S&P 500 Fund and Analytics Fund(TM). PFPC Inc.,
41
<PAGE> 42
at 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as Fund Accountant
for the S&P 500 Fund and Analytics Fund.
ACCOUNTANTS AND REPORTS TO SHAREHOLDERS
The Trust's independent accountants, Price Waterhouse LLP, audit and
report on the annual financial statements of each series of the Trust and review
certain regulatory reports and each Fund's federal income tax return. Price
Waterhouse LLP also performs other professional accounting, auditing, tax and
advisory services when the Trust engages it to do so. Shareholders will be sent
audited annual and unaudited semi-annual financial statements. The address of
Price Waterhouse LLP is 555 California Street, San Francisco, California 94104.
LEGAL COUNSEL
Ropes & Gray, One Franklin Square, 1301 K Street, N.W., Suite 800 East,
Washington, D.C. 20005, is counsel to the Trust.
PORTFOLIO TRANSACTIONS AND TURNOVER
PORTFOLIO TRANSACTIONS
In effecting securities transactions for the Funds, the Investment
Manager and the Sub-Adviser seek to obtain best price and execution. Subject to
the supervision of the Board of Trustees, the Investment Manager and the
Sub-Adviser will generally select brokers and dealers for the Funds primarily on
the basis of the quality and reliability of brokerage services, including
execution capability and financial responsibility. In assessing these criteria,
the Investment Manager and the Sub-Adviser will, among other things, monitor the
performance of brokers effecting transactions for the Funds to determine the
effect, if any, the Funds' transactions through those brokers have on the market
prices of the stocks involved. This may be of particular importance for the
Funds' investments in relatively smaller companies whose stocks are not as
actively traded as those of their larger counterparts. The Funds will seek to
buy and sell securities in a manner that causes the least possible fluctuation
in the prices of those stocks in view of the size of the transactions.
In an attempt to obtain best execution for the Funds, the Investment
Manager and the Sub-Adviser may also place orders directly with market makers or
with third market brokers, Instinet or brokers on an agency basis. Placing
orders with third market brokers or through Instinet may enable the Funds to
trade directly with other institutional holders on a net basis. At times, this
may allow the Funds to trade larger blocks than would be possible trading
through a single market maker.
When the execution and price offered by two or more broker-dealers are
comparable, the Investment Manager and the Sub-Adviser may, in its discretion,
in agency transactions (and not principal transactions) utilize the services of
broker-dealers that provide it with investment information and other research
resources. Such resources may also be used by the Investment Manager and the
Sub-Adviser when providing advisory services to other investment advisory
clients, including mutual funds.
42
<PAGE> 43
In determining when and to what extent to use Schwab or any other
affiliated broker-dealer as its broker for executing orders for the Funds on
securities exchanges, the Investment Manager and the Sub-Adviser will consider
(if relevant) whether the compensation to be paid Schwab or any other affiliated
broker-dealer will be (i) fair and reasonable, (ii) at least as favorable to the
Funds as commissions that would be charged by other qualified brokers having
comparable execution capabilities and (iii) at least as favorable as commissions
contemporaneously charged by Schwab or any other affiliated broker-dealer on
comparable transactions for its most favored unaffiliated customers. The Funds
do not consider it practicable or in the best interests of their shareholders to
solicit competitive bids for commission rates on each transaction. However, the
Board of Trustees, including a majority of the Trustees who are not "interested
persons" of Schwab or any other affiliated broker-dealer within the meaning of
the 1940 Act, (i) has prescribed procedures designed to provide that the Funds
do not pay commissions that do not meet the standards described above, (ii)
reviews those procedures annually to determine whether they remain adequate and
(iii) considers quarterly whether or not the commissions charged by Schwab or
any other affiliated broker-dealer have met the standards.
Brokerage services Schwab provides to the Funds are also subject to
Rule 11a2-2(T) under the Securities Exchange Act of 1934, as amended. Rule
11a2-2(T) permits the Funds to use Schwab as a broker provided certain
conditions are met. Among these requirements are that members of the exchange
not associated with Schwab perform the floor brokerage element of portfolio
transactions (that is, execution on the exchange floor or through use of
exchange facilities) that the orders to such members be transmitted from off the
exchange floor and that neither Schwab nor an associated person of Schwab
participates in the execution of the transaction after the order has been so
transmitted. In connection with transactions in which Schwab acts as broker for
the Funds, Schwab, while not permitted to perform floor brokerage (which is
undertaken by members Schwab selects who are not associated with that firm),
still continues to bear principal responsibility for determining important
elements of overall execution such as timing and order size, and also clears and
settles such transactions. Schwab pays the fees charged by those persons
performing the described floor brokerage elements. Schwab will not trade
directly with the Funds in any transactions in which Schwab or an affiliate acts
as principal.
Brokerage Commissions. For the fiscal years ended October 31, 1996,
1995 and 1994, the International Index Fund paid brokerage commissions of
$101,230, $54,718 and $86,127, respectively. For the fiscal years ended October
31, 1996 and 1995, and for the fiscal period from December 3, 1993 (commencement
of operations) to October 31, 1994, the Small-Cap Index Fund paid brokerage
commissions of $181,679, $142,785 and $165,997, respectively. For the fiscal
period November 20, 1995 (commencement of operations) to October 31, 1996, the
High Growth Fund, the Balanced Growth Fund and the Conservative Growth Fund paid
brokerage commissions of $92,248, $48,733, $10,741 respectively. For the fiscal
period May 1, 1996 (commencement of operations) to October 31, 1996, the S&P 500
Fund paid brokerage commissions of $119,350. For the fiscal period July 1, 1996
(commencement of operations) to October 31, 1996, the Analytics Fund(TM) paid
brokerage commissions of $90,932. For the fiscal period October 16, 1996
(commencement of operations) to October 31, 1996, the OneSource Portfolios
International paid brokerage commissions of $0.
43
<PAGE> 44
PORTFOLIO TURNOVER
For reporting purposes, each Fund's turnover rate is calculated by
dividing the value of purchases or sales of portfolio securities for the fiscal
year, whichever is less, by the monthly average value of portfolio securities
the Fund owned during the fiscal year. When making the calculation, all
securities whose maturities at the time of acquisition were one year or less
("short-term securities") are excluded.
A 100% portfolio turnover rate would occur, for example, if all
portfolio securities (aside from short-term securities) were sold and either
repurchased or replaced once during the fiscal year. The Funds expect that their
portfolio turnover rate will not exceed 100% in any given year, a turnover rate
lower than that of most non-index mutual funds. In the case of the Asset
Director(R) Funds, the portfolio turnover rate applies to the Funds' stock and
bond categories.
The International Index Fund's portfolio turnover rate for the fiscal
years ended October 31, 1996 and 1995 was 6% and 0%, respectively. The Small-Cap
Index Fund's portfolio turnover rate for the fiscal years ended October 31, 1996
and 1995 was 23% and 24% respectively.
The High Growth Fund, Balanced Growth Fund (equity portion) and
Conservative Growth Fund's (equity portion) portfolio turnover rates for the
period from November 20, 1995 (commencement of operations) to October 31, 1996
were 46%, 44%, and 64%, respectively. The portfolio turnover rate for the bond
portion of both the Balanced Growth Fund and the Conservative Growth Fund for
this same period was 0%.
The S&P 500 Fund's portfolio turnover rate for the period May 1, 1996
(commencement of operations) to October 31, 1996 was 1.0%.
The Analytics Fund's(TM) portfolio turnover rate for the period from
July 1, 1996 (commencement of operations) to October 31, 1996 was 33%.
The Schwab OneSource Portfolios-International portfolio turnover rate
for the period from October 16, 1996 (commencement of operations) to October 31,
1996 was 0.0% and 53% for the period from November 1 to February 28, 1997.
Balanced Allocation and Growth Allocation's portfolio turnover rate for the
period November 18, 1996 (commencement of operations) to February 28, 1997 was
61% and 67%, respectively.
The Small Company Fund anticipates that its annual portfolio turnover
rate will not exceed 100%, however, there is no limit on the Fund's portfolio
turnover rate.
From time to time, each Fund may compare its portfolio turnover rate
with that of other mutual funds as reported by independent sources.
44
<PAGE> 45
TAXES
It is each Fund's policy to qualify for taxation as a "regulated
investment company" by meeting the requirements of Subchapter M of the Code. By
following this policy, each Fund expects to eliminate or reduce to a nominal
amount the federal income tax to which it is subject.
In order to qualify as a regulated investment company, each of the
Funds must, among other things, (1) derive at least 90% of its gross income from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of stocks, securities, foreign currencies or other
income (including gains from options, futures or forward contracts) derived with
respect to its business of investing in stocks, securities or currencies; (2)
derive less than 30% of its gross income from gains from the sale or other
disposition of certain assets (including stocks and securities) held for less
than three months; and (3) diversify its holdings so that at the end of each
quarter of its taxable year (i) at least 50% of the market value of the Fund's
total assets is represented by cash or cash items, U.S. Government securities,
securities of other regulated investment companies and other securities limited,
in respect of any one issuer, to a value not greater than 5% of the value of the
Fund's total assets and 10% of the outstanding voting securities of such issuer,
and (ii) not more than 25% of the value of its assets is invested in the
securities of any one issuer (other than U.S. Government securities or
securities of any other regulated investment company) or of two or more issuers
that the Fund controls, within the meaning of the Code, and that are engaged in
the same, similar or related trades or businesses.
These requirements may restrict the degree to which a Fund may engage
in short-term trading and certain hedging transactions and may limit the range
of a Fund's investments. If a Fund qualifies as a regulated investment company,
it will not be subject to federal income tax on the part of its net investment
income and net realized capital gains, if any, which it distributes to
shareholders, provided that the Fund meets certain minimum distribution
requirements. To comply with these requirements, a Fund must distribute at least
(a) 90% of its "investment company taxable income" (as that term is defined in
the Code) and (b) 90% of the excess of its (i) tax-exempt interest income over
(ii) certain deductions attributable to that income (with certain exceptions),
for its taxable year. Each Fund intends to make sufficient distributions to
shareholders to meet these requirements.
The Code imposes a non-deductible excise tax on regulated investment
companies that do not distribute in a calendar year (regardless of whether they
otherwise have a non-calendar taxable year) an amount equal to 98% of their
"ordinary income" (as defined in the Code) for the calendar year plus 98% of
their capital gain net income for the one year period ending on October 31 of
such calendar year. The balance of such income must be distributed during the
next calendar year. For the foregoing purposes, a Fund is treated as having
distributed any amount on which it is subject to income tax for any taxable year
ending in such calendar year. If the distributions during a calendar year were
less than the required amount, the Fund is subject to a non-deductible excise
tax equal to 4% of the deficiency.
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INCOME TAX INFORMATION
Any dividends declared by the Funds in October, November or December to
shareholders of record during those months and paid during the following January
are treated, for tax purposes, as if they were received by each shareholder on
December 31 of the year in which they were declared.
Dividends the Funds pay from net investment income and distributions
from the Funds' net short-term capital gains in excess of any net long-term
capital losses, whether received in cash or reinvested, will generally be
taxable to shareholders as ordinary income. Distributions received from the
Funds designated as long-term capital gains (net of capital losses), whether
received in cash or reinvested, will be taxable as long-term capital gains
without regard to the length of time a shareholder owned shares in the Funds.
However, if a shareholder receives a long-term capital gain distribution with
respect to Funds' shares held for six months or less, any loss on the sale or
exchange of those shares shall, to the extent of the long-term capital gain
distribution, be treated as a long-term capital loss. For corporate investors in
the Funds, dividend distributions the Funds designate to be from dividends
received from qualifying domestic corporations will be eligible for the 70%
corporate dividends-received deduction to the extent they would qualify if the
Funds were regular corporations. If a shareholder is not subject to income tax,
generally the shareholder will not be taxed on amounts distributed by the Funds.
A Fund will be required in certain cases to withhold and remit to the
U.S. Treasury 31% of taxable dividends paid to any shareholder who (1) fails to
provide a correct taxpayer identification number certified under penalty of
perjury; (2) is subject to withholding by the Internal Revenue Service for
failure to properly report all payments of interest or dividends; or (3) fails
to provide a certified statement that he or she is not subject to "backup
withholding." This "backup withholding" is not an additional tax and any amounts
withheld may be credited against the shareholder's ultimate U.S. tax liability.
The foregoing discussion relates only to federal income tax law as
applicable to U.S. citizens or residents. Foreign shareholders (i.e.,
nonresident alien individuals and foreign corporations, partnerships, trusts and
estates) are generally subject to U.S. withholding tax at the rate of 30% (or a
lower tax treaty rate) on distributions derived from net investment income and
short-term capital gains. Distributions to foreign shareholders of long-term
capital gains and any gains from the sale or other disposition of shares of the
Funds are generally not subject to U.S. taxation, unless the recipient is an
individual who meets the Code's definition of "resident alien." Different tax
consequences may result if the foreign shareholder is engaged in a trade or
business within the United States. In addition, the tax consequences to a
foreign shareholder entitled to claim the benefits of a tax treaty may be
different than those described above. Distributions by a Fund also may be
subject to state, local and foreign taxes, and its treatment under applicable
tax laws may differ from the federal income tax treatment.
Income which the International Index Fund, Asset Director(R) Funds, and
OneSource Portfolios receive from sources within various foreign countries may
be subject to foreign income taxes withheld at the source. If a Fund has at
least 50% of its assets invested in foreign securities at the end of its taxable
year, it may elect to pass through to its shareholders the ability to take
either the foreign tax credit or the deduction for foreign titles. It is
expected that the International Index Fund will have more than 50% of the value
of its total assets at the close of its taxable year invested in foreign
securities, and it will make this
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<PAGE> 47
election. Pursuant to this election, U.S. shareholders must include in gross
income, even though not actually received, their respective pro rata share of
foreign taxes, and may either deduct their pro rata share of foreign taxes (but
not for alternative minimum tax purposes) or credit the tax against U.S. income
taxes, subject to certain limitations described in Code section 904 (but not
both). A shareholder who does not itemize deductions may not claim a deduction
for foreign taxes. It is expected that the Asset Director Funds, and OneSource
Portfolios will not have 50% of their assets invested in foreign securities at
the close of their taxable years, and therefore will not be permitted to make
this election and "pass through" to their shareholders. Also, to the extent the
Asset Director(R) Funds, and OneSource Portfolios invest in an underlying fund
that elects to "pass through" foreign taxes, these Funds will not be able to
"pass through" the taxes paid by the underlying fund. Each shareholder's
respective pro rata share of foreign taxes these Funds pay will, therefore, be
netted against their share of the Fund's gross income.
The International Index Fund, Asset Director Funds, and OneSource
Portfolios may invest in a non-U.S. corporation which could be treated as a
passive foreign investment company ("PFIC") or become a PFIC under the Code.
This could result in adverse tax consequences upon the disposition of, or the
receipt of "excess distributions" with respect to, such equity investments. To
the extent the International Index Fund, Asset Director Funds, and OneSource
Portfolios do invest in PFICs, they may elect to treat the PFIC as a "qualified
fund" or mark-to-marked its investments in PFICs annually. In either case, the
Funds may be required to distribute amounts in excess of realized income and
gains. To the extent that the International Index Fund, Asset Director Funds,
and OneSource Portfolios do invest in foreign securities which are determined to
be PFIC securities and are required to pay a tax on such investments, a credit
for this tax would not be allowed to be passed through to the International
Index Fund's, Asset Director Funds', and OneSource Portfolios' shareholders.
Therefore, the payment of this tax would reduce the International Index Fund's,
Asset Director Funds', and OneSource Portfolios' economic return from their PFIC
shares, and excess distributions received with respect to such shares are
treated as ordinary income rather than capital gains.
An underlying fund may invest in non-U.S. corporations which would be
treated as PFICs or become a PFIC. This could result in adverse tax consequences
upon the disposition of, or the receipt of "excess distributions" with respect
to, such equity investments. To the extent an underlying fund does invest in
PFICs, it may elect to treat the PFIC as a "qualified electing fund" or
mark-to-market its investments in PFICs annually. In either case, the underlying
fund may be required to distribute amounts in excess of its realized income and
gains. To the extent that the underlying fund itself is required to pay a tax on
income or gain from investment in PFICs, the payment of this tax would reduce
the Asset Director Funds' and OneSource Portfolios' economic return.
A Fund's transactions in futures contracts, forward contracts, foreign
currency transactions, options and certain other investment and hedging
activities are subject to special tax rules. In a given case, these rules may
accelerate income to a Fund, defer its losses, cause adjustments in the holding
periods of the Fund's assets, convert short-term capital losses into long-term
capital losses or otherwise affect the character of the Fund's income. These
rules could therefore affect the amount, timing and character of distributions
to shareholders. The Funds will endeavor to make any available elections
pertaining to these transactions in a manner believed to be in the best interest
of the Funds and their shareholders.
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<PAGE> 48
The discussion of federal income taxation presented above only
summarizes some of the important federal tax considerations generally affecting
purchasers of Fund shares. No attempt has been made to present a detailed
explanation of the federal income tax treatment of a Fund and its shareholders,
and the discussion is not intended as a substitute for careful tax planning.
Accordingly, prospective investors (particularly those not residing or domiciled
in the United States) should consult their own tax advisers regarding the
consequences of investing in a Fund.
SHARE PRICE CALCULATION
Each Fund's net asset value per share is determined each Business Day
at the close of trading on the New York Stock Exchange, generally as of 4:00
p.m. Eastern time. The net asset value of the International Index Fund is
expressed in U.S. dollars by translating the Fund's assets using the mean price
for the U.S. dollar as quoted by generally recognized, reliable sources.
Currently, the New York Stock Exchange is closed on the following holidays: New
Year's Day (observed), Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day.
The Funds value their portfolio securities daily based on their fair
value. Securities traded on stock exchanges are valued at the last quoted sales
price on the exchange on which such securities are primarily traded, or, lacking
any sales, at the mean between the bid and ask prices. Securities traded in the
over-the-counter market are valued at the last sales price that day, or if no
sales that day, at the mean between the bid and ask prices. In addition,
securities that are primarily traded on foreign exchanges are generally valued
at the preceding closing values of such securities on their respective exchanges
with these values then translated into U.S. dollars at the current exchange
rate. Foreign securities for which the closing values are not readily available
are valued at fair value as determined in good faith pursuant to the Board of
Trustees' guidelines.
Securities for which market quotations are not readily available
(including restricted securities that are subject to limitations on their sale
and illiquid securities) are valued at fair value as determined in good faith
pursuant to the Trust's Board of Trustees' guidelines.
Securities may be valued on the basis of prices provided by pricing
services when such prices are believed to reflect fair market value. In
accordance with the 1940 Act, the underlying funds are valued at their
respective net asset values as determined by those funds. The underlying funds
that are money market funds value their portfolio securities based on the
amortized cost method. The other underlying funds value their portfolio
securities based on market quotes if they are readily available. The Investment
Manager assigns fair values to the Funds' other investments in good faith under
Board of Trustees guidelines. The Board of Trustees regularly reviews these
values.
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<PAGE> 49
HOW THE FUNDS REFLECT PERFORMANCE
STANDARDIZED TOTAL RETURN
Average annual total return for a period is determined by calculating
the actual dollar amount of investment return on a $1,000 investment in a Fund
made at the beginning of the period, then calculating the average annual
compounded rate of return that would produce the same investment return on the
$1,000 over the same period. In computing average annual total return, a Fund
assumes the reinvestment of all distributions at net asset value on applicable
reinvestment dates.
<TABLE>
<CAPTION>
Name of Fund and Date Fund Total Return for the One Year Average Annual Total Return from
Commenced Operations* Period ended October 31, 1996 Commencement of Operations to October 31, 1996
- --------------------- ----------------------------- ----------------------------------------------
<S> <C> <C>
International Index Fund 11.07% 7.54%
(9/09/93)
Small-Cap Index Fund 16.73% 11.56%
(12/03/93)
</TABLE>
* See "Nonstandardized Total Return" below for the aggregate (cumulative) total
return of Funds that have not operated for a full fiscal year as of October 31,
1996. Data is for Investor Shares only.
NONSTANDARDIZED TOTAL RETURN
Nonstandardized total return for a Fund differs from standardized total
return in that it relates to periods other than the period for standardized
total return and/or that it represents aggregate (rather than average) total
return.
In addition, an after-tax total return for each Fund may be calculated
by taking that Fund's standardized or non-standardized total return and
subtracting applicable federal taxes from the portions of each Fund's total
return attributable to capital gain distributions and ordinary income. This
after-tax total return may be compared to that of other mutual funds with
similar investment objectives as reported by independent sources.
Each Fund also may report the percentage of that Fund's standardized or
non-standardized total return which would be paid to taxes annually (at the
applicable federal personal income and capital gains tax rates) before
redemption of Fund shares. This proportion may be compared to that of other
mutual funds with similar investment objectives as reported by independent
sources.
A Fund may also advertise its cumulative total return since inception.
This number is calculated using the same formula that is used for average annual
total return except that, rather than calculating the total return based on a
one-year period, cumulative total return is calculated from inception to the
date specified.
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<PAGE> 50
<TABLE>
<CAPTION>
Name of Fund and Date Fund Cumulative Total Return From Commencement
Commenced Operations* of Operations
- --------------------- -------------
<S> <C>
International Index Fund 1 (9/09/93) 25.71%
Small-Cap Index Fund 1 (12/03/93) 37.57%
High Growth Fund 1 (11/20/95) 13.24%
Balanced Growth Fund 1 (11/20/95) 10.82%
Conservative Growth Fund 1 (11/20/95) 8.18%
S&P 500 Fund Investor Shares 1 (5/01/96) 8.80%
S&P 500 e.Shares 1 (5/01/96) 8.90%
Analytics Fund(TM)1 (7/1/96) 10.10%
OneSource Portfolios-International 2 (10/16/96) 5.99%
Growth Allocation 2 (11/18/96) 3.10%
Balanced Allocation 2 (11/18/96) 2.71%
</TABLE>
* Data is for Investor Shares only.
1 Cumulative (aggregate) total return from commencement of operations to
October 31, 1996
2 Cumulative (aggregate) total return from commencement of operations to
February 28, 1997
YIELD
A Fund's yield refers to the net investment income generated by a
hypothetical investment in the Fund over a specific 30 day period. This net
investment income is then annualized, which means that the net investment income
generated during the 30-day period is assumed to be generated in each 30-day
period over an annual period, and is shown as a percentage of the investment.
EFFECTIVE YIELD
A Fund's effective yield is calculated similarly, but the net
investment income earned by the investment is assumed to be compounded monthly
when annualized. The effective yield will be slightly higher than the yield due
to this compounding effect.
COMPARING THE PERFORMANCE OF THE FUNDS WITH OTHER FUNDS AND INDICES
The performance of the Funds may be compared with the performance of
other mutual funds by comparing the ratings of mutual fund rating services,
various indices of investment performance, U.S. Government obligations, bank
certificates of deposit, the consumer price index and other investments for
which reliable data is available. For example, the International Index Fund and
the Small Cap Index Fund may be compared to the Schwab 1000 Index(R), the Schwab
International Index(R), the Schwab Small-Cap Index(R), and the Standard & Poor's
500 Index(R), and the Small Cap Index Fund(R) may also be compared to Standard &
Poor's Small-Cap 600 Index.
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<PAGE> 51
The Asset Director(R) Funds, OneSource Portfolios-Growth Allocation,
Balanced Allocation and Small Company Fund also may compare their historical
performance figures to the performance of indices similar to their asset
categories and sub-categories, and to the performance of "blended indices"
similar to the Funds' portfolio strategies, such as those indices named in the
Funds' Prospectus under "Market Performance."
The Schwab OneSource Portfolios-International may compare its
historical performance to the performance of indices such as Morgan Stanley
Capital International's EAFE index, its World ex-U.S. index and other indices or
combination of indices.
From time to time, the Funds may include discussions in advertisements
of the income tax savings shareholders may experience as a result of their
policy of limiting portfolio trading in order to reduce capital gains. This
information may be supplemented by presentations of statistical data
illustrating the extent of such income tax savings and the impact of such
savings on the yield and/or total return of the Funds. In addition, such
advertisements may include comparisons of the Funds' performance against that of
investment products that do not employ the Funds' policy of seeking to limit
capital gains.
THE BENEFITS OF INTERNATIONAL INVESTING
INCREASED DIVERSIFICATION CAN LOWER RISK
To some extent, all U.S.-based investments -- stocks, bonds, mutual
funds and CDs -- are affected by the same economic forces. Tax cuts, interest
rate changes and the performance of the U.S. stock market can all influence U.S.
investments. Adding international (or overseas) investments to a U.S.-based
portfolio historically has reduced the portfolio's overall volatility. Although
U.S. and international markets may be interrelated, they do not move in tandem
- -- so losses in one market can be offset by gains in another.
POTENTIALLY HIGHER OVERALL PERFORMANCE
During the 20 years ending December 31, 1996, international equity
markets outperformed the U.S. equity market and most other U.S. securities
investments -- corporate bonds, CDs and U.S. Treasuries. The returns
international markets produced also have kept investors well ahead of inflation.
This historical performance means that investors diversified overseas earned a
higher level of return.
BROADER GROWTH OPPORTUNITIES
Investors who limit their portfolios to U.S. securities are missing
these investment opportunities. According to Morgan Stanley, as of December 31,
1979, the United States made up more than half of the world's stock market, a
value of over $11 trillion. As of December 31, 1996, it represented forty-five
percent.
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<PAGE> 52
INDEXING AND ASSET ALLOCATION - THE SCHWAB INDEX FUNDS AND THE SCHWAB
ASSET ALLOCATION FUNDS
Because the unmanaged performance of a broad-based equity index often
has proven superior to that of many individually selected stock portfolios, a
growing percentage of assets invested in the equity markets are being placed in
"index" portfolios. Institutional investors often devote a substantial
percentage of their assets to indexed strategies.
An index typically tracks the performance of a group of securities
selected to represent a particular market, and most often is used to gauge that
market's performance. The Dow Jones Industrial Average ("DJIA") and S&P 500(R)
are two indices designed to measure the performance of U.S. stocks. When
investment managers invest indexed separate accounts or index fund assets, they
attempt to replicate the performance of the applicable target index by holding
all or a representative sample of the securities included in the index.
An index's performance data assumes the reinvestment of dividends but
does not reflect deductions for administrative and management expenses. The
Funds will be subject to these costs and expenses, while an index does not have
these expenses. In addition, various factors, such as holding a cash balance,
may cause the Funds' performance to be higher or lower than that of an index.
The Funds are intended to make indexed investing easily available to
Schwab customers with the highest level of convenience and economy, thereby
facilitating their ability to participate in the long-term performance of the
U.S. stock market.
The difference between a fund's total return and the total return of
its benchmark index is referred to as a fund's tracking error. The Schwab Index
Funds may report or advertise tracking error.
INTERNATIONAL INDEX
The International Index is a broad-based stock market index which
contains the common stocks of the 350 largest operating companies (i.e.,
non-investment companies) incorporated outside the United States. To reduce
undue risk, the Index represents equities only from countries that are
considered to have developed markets and economies. By tracking the largest
companies in developed markets, the Index represents the performance of the
"blue chips" of international markets. The Index also is designed to provide a
broad representation of the international market, by limiting each country to no
more than 35% of the total market capitalization of the Index. As the stocks
contained in the Index represent about 35% of the total market capitalization of
international companies, the Index provides a reliable measure of market
performance. The International Index was first made available to the public on
July 29, 1993.
SMALL-CAP INDEX
To be included in the Small-Cap Index, a company must satisfy all of
the following criteria: (1) it must be an "operating company" (i.e., not an
investment company) incorporated in the United States, its territories or
possessions; (2) a liquid market for its common shares must exist on the New
York Stock
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<PAGE> 53
Exchange, American Stock Exchange or the NASDAQ/NMS and (3) its market value
must place it among the second 1,000 such companies as measured by market
capitalization (i.e., from the company with a rank of 1,001 through the company
with a rank of 2,000). Shareholders generally avoid exposure to the smallest
companies, whose shares are often thinly traded and very volatile, because these
stocks are not included in the Index.
A particular stock's weighting in the Small-Cap Index is based on its
relative total market value (i.e., its market price per share times the number
of shares outstanding), divided by the total market capitalization of the
Small-Cap Index. The returns produced by the U.S. stock market during the 25
years ending December 31, 1995 have been exceeded by very few types of
securities investments. Because the unmanaged performance of the U.S. stock
market often has proven superior to that of many individually selected stock
portfolios, a growing percentage of assets invested in the equity markets are
being placed in "index" portfolios. From less than $9 billion in 1980, indexed
institutional holdings have grown to over $280 billion, a figure equal to
approximately one-quarter of all institutional assets. (Source: Callan
Associates Survey, reported in Fall 1990 edition of The Journal of Portfolio
Management.)
Historically, returns in a long-term investment in a group of common
stocks representative of the stock market as a whole, as well as a group of
common stocks representative of small-cap stocks, significantly have exceeded
the returns of U.S. Treasury Bills, CDs, corporate bonds and inflation.
THE S&P 500 INDEX(R)
The S&P 500 is representative of the performance of the U.S. stock
market. The Index consists of 500 stocks chosen for market size, liquidity and
industry group representation. It is a market-value weighted index (stock price
times number of shares outstanding), with each stock's weight in the Index
proportionate to its market value. The S&P 500 does not contain the 500 largest
stocks, as measured by market capitalization. Although many of the stocks in the
Index are among the largest, there also are some relatively small companies in
the Index. Those companies, however, generally are established companies within
their industry group. S&P identifies important industry groups within the U.S.
economy and then allocates a representative sample of stocks with each group to
the S&P 500. There are four major industry sectors within the Index:
Industrials, Utilities, Financial and Transportation.
ASSET ALLOCATION STRATEGIES USING SCHWABFUNDS(R)
Shareholders of SchwabFunds may wish to invest in the SchwabFunds as
components of their personal asset allocation plan. They also may choose to
invest in the Schwab Asset Director(R) Funds, Growth Allocation or Balanced
Allocation, which offer the benefits of asset allocation in a single fund. An
asset allocation program is available through Schwab. This program may help
shareholders select investments, including investments in SchwabFunds, which
match their individual investment needs. The shareholders' personal investment
plan is based on a number of factors, including personal financial situation,
time horizon, investment objectives and goals and risk tolerance.
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<PAGE> 54
ASSET DIRECTOR(R) FUNDS
As stated in the Funds' prospectus, under neutral market conditions,
each Asset Director Fund seeks to meet its investment objective by investing,
either directly or through investments in affiliated underlying mutual funds, in
a different mix of stocks, bonds and cash-equivalents. The Asset Director Funds
invest a portion of their assets in all or a representative sample of the common
stocks in the following stock sub-categories: large company; small company; and
international. As stated in the Funds' prospectus, under normal market
conditions the Investment Manager currently intends to utilize an indexing
approach to investing within each asset sub-category, which provides
shareholders with the potential benefits to be realized from both an asset
allocation strategy and an indexing approach with one investment.
For the Asset Director Funds, the Investment Manager also consults a
Tactical Asset Allocation Model, which measures the relative value of each asset
category and makes recommendations for allocations within the defined ranges.
Tactical Asset Allocation is a value-oriented strategy that seeks the highest
reward for a given level of risk. Expected returns are measured for each asset
category; for stocks, the internal rate of return is measured on forecasted
dividend stream; for bonds, the yield to maturity is evaluated on representative
long corporate bonds; and for cash equivalents yield to maturity is evaluated on
representative money market instruments. Risks and correlations of the asset
categories are measured from long-term return histories. The Funds may also make
other investments that do not fall within the asset categories.
ACCESS TO SCHWAB'S MUTUAL FUND ONESOURCE(R) SERVICE
With Schwab's Mutual Fund OneSource Service ("OneSource"), a
shareholder can invest in over 650 mutual funds from many fund companies,
subject to the following. Schwab's standard transaction fee will be charged on
each redemption of fund shares held for 90 days or less to discourage short-term
trading. Mutual fund shares held for more than 90 days are exempt from the
short-term redemption policy and may be sold without penalty. Up to 15
short-term redemptions of fund shares per calendar year are permitted. If you
exceed this number, you will no longer be able to buy or sell fund shares
without paying a transaction fee. As a courtesy, we will notify you in advance
if your short-term redemptions are nearing the point where all of your future
trades will be subject to transaction fees. Schwab reserves the right to modify
OneSource's terms and conditions at any time. For more information, a
shareholder should call 800-2 NO-LOAD, 24 hours a day.
ONESOURCE PORTFOLIOS--SELECTION AND MANAGEMENT STRATEGY
The OneSource Portfolios are four portfolios of mutual funds that offer
investors easy access to actively managed funds from well-known fund families.
Underlying funds are selected based on their investment objective, practices and
policies, their management and other factors. Selection will also be based on
quantifiable factors such as historic total returns, volatility, expenses and
size. The OneSource Portfolios will include both a "core" component that
represents holdings specific to the Funds' objectives and long term horizons as
well as a "tactical" position that consists of special investment opportunities
that arise due to market conditions.
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<PAGE> 55
SCHWABFUNDS(R)
SchwabFunds offers a variety of series and classes of shares of beneficial
interest to help you with your investment needs.
EQUITY FUNDS
Schwab 1000 Fund(R) - Investor Shares 1
Schwab 1000 Fund - Select Shares(TM)
Schwab International Index Fund(R)- Investor Shares 2
Schwab International Index Fund - Select Shares(TM)
Schwab Small-Cap Index Fund(R) - Investor Shares 2
Schwab Small-Cap Index Fund - Select Shares
Schwab Asset Director(R)-High Growth Fund 2,7
Schwab Asset Director-Balanced Growth Fund 2,7
Schwab Asset Director-Conservative Growth Fund 2,7
Schwab S&P 500 Fund-Investor Shares 2
Schwab S&P 500 Fund-e.Shares(TM)2, 3
Scwhab S&P 500 Fund - Select Shares 2
Schwab Analytics Fund(TM)2
Schwab OneSource Portfolios-International 2,7
Schwab OneSource Portfolios-Growth Allocation 2,7
Schwab OneSource Portfolios-Balanced Allocation 2,7
Schwab OneSource Portfolios - Small Company Fund 2,7
FIXED INCOME FUNDS 1
Schwab Short/Intermediate Government Bond Fund
Schwab California Long-Term Tax-Free Bond Fund 4
Schwab Long-Term Tax-Free Bond Fund
Schwab Long-Term Government Bond Fund
Schwab Short/Intermediate Tax-Free Bond Fund
Schwab California Short/Intermediate Tax-Free Bond Fund 4
MONEY MARKET FUNDS 5
Schwab Money Market Fund
Schwab Government Money Fund
Schwab Municipal Money Fund-Sweep Shares
Schwab U.S. Treasury Money Fund
Schwab Value Advantage Money Fund(R)
Schwab Institutional Advantage Money Fund(R)6
Schwab Retirement Money Fund(R)6
Schwab Municipal Money Fund-Value Advantage Shares(TM)
Schwab California Municipal Money Fund-Sweep Shares
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<PAGE> 56
Schwab California Municipal Money Fund-Value Advantage Shares(TM)
Schwab New York Municipal Money Fund-Sweep Shares
Schwab New York Municipal Money Fund-Value Advantage Shares(TM)
1 The Schwab 1000 Fund and all fixed income funds are separate investment
portfolios of Schwab Investments.
2 The Funds are separate investment portfolios or classes of shares of Schwab
Capital Trust.
3 Available only through SchwabLink(R).
4 Available only to California residents and residents of selected other
states.
5 All listed money market funds are separate investment portfolios of The
Charles Schwab Family of Funds.
6 Designed for institutional investors only.
7 The Asset Director(R) Funds may not invest in these Funds.
OTHER INFORMATION
From time to time, the International Index Fund and Small-Cap Index
Fund may compare the historical performance of the International Index and
Small-Cap Index, respectively, to the historical performance of various other
indices, including the S&P 500, as reported by independent sources.
Each Fund, except for the Analytics Fund(TM) and Schwab OneSource
Portfolios-International, is managed to offset capital gains with capital losses
in order to minimize each Fund's capital gain distributions. This special
feature can make a real difference in an investor's after-tax return, especially
if the investor is in a high tax bracket. In addition, each Fund has adopted a
number of policies that should cause its portfolio turnover rate to be below the
portfolio turnover rate of many other mutual funds. A lower portfolio turnover
rate acts to minimize associated transaction costs as well as the level of
realized capital gains. By avoiding, where possible, distributing capital gains
to shareholders, the Funds help to build the value of a shareholders' shares and
defer payment of capital gains taxes until shares are redeemed. A shareholder's
current tax liability for capital gains should be reduced and the shareholder's
total return increased by these policies.
Each Fund may, from time to time, refer to recent studies that analyze
certain techniques and strategies which either Fund may use. In addition, each
Fund may, from time to time, promote the advantages of investing in a series
that is part of a large, diverse mutual fund complex.
From time to time, each Fund may include discussions in advertisements
of the income tax savings shareholders may experience as a result of that Fund's
policy of limiting portfolio trading in order to reduce capital gains. This
information may be supplemented by presentations of statistical data
illustrating the extent of such income tax savings and the impact of such
savings on the yield and/or total return of each Fund. In addition, such
advertisements may include comparisons of each Fund's performance against that
of investment products that do not employ each Fund's policy of seeking to limit
capital gains.
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GENERAL INFORMATION
The Trust generally is not required to hold shareholder meetings.
However, as provided in its Agreement and Declaration of Trust and Bylaws,
shareholder meetings will be held in connection with the following matters: (1)
election or removal of Trustees if a meeting is requested in writing by a
shareholder or shareholders who beneficially own(s) 10% or more of the Trust's
shares; (2) adoption of any contract for which shareholder approval is required
by the 1940 Act; (3) any termination of the Trust to the extent and as provided
in the Declaration of Trust; (4) any amendment of the Declaration of Trust
(other than amendments changing the name of the Trust or any of its investment
portfolios, supplying any omission, curing any ambiguity or curing, correcting
or supplementing any defective or inconsistent provision thereof); (5)
determining whether a court action, proceeding or claim should or should not be
brought or maintained derivatively or as a class action on behalf of the Trust
or the shareholders, to the same extent as the stockholders of a Massachusetts
business corporation; and (6) such additional matters as may be required by law,
the Declaration of Trust, the Bylaws or any registration of the Trust with the
SEC or any state or as the Board of Trustees may consider desirable. The
shareholders also would vote upon changes to a Fund's fundamental investment
objective, policies or restrictions.
Each Trustee serves until the next meeting of shareholders, if any,
called for the purpose of electing Trustees and until the election and
qualification of his or her successor or until death, resignation, retirement or
removal by a majority vote of the shares entitled to vote (as described below)
or of a majority of the Trustees. In accordance with the 1940 Act, (i) the Trust
will hold a shareholder meeting for the election of Trustees when less than a
majority of the Trustees have been elected by shareholders and (ii) if, as a
result of a vacancy in the Board of Trustees, less than two-thirds of the
Trustees have been elected by the shareholders, that vacancy will be filled by a
vote of the shareholders.
Upon the written request of 10 or more shareholders who have been such
for at least six months and who hold shares constituting at least 1% of the
Trust's outstanding shares stating that they wish to communicate with the other
shareholders for the purpose of obtaining signatures necessary to demand a
meeting to consider removal of one or more Trustees, the Trust has undertaken to
disseminate appropriate materials at the expense of the requesting shareholders.
The Bylaws provide that a majority of shares entitled to vote shall be
a quorum for the transaction of business at a shareholders' meeting, except that
where any provision of law, of the Declaration of Trust or of the Bylaws permits
or requires that (i) holders of any series shall vote as a series, then a
majority of the aggregate number of shares of that series entitled to vote shall
be necessary to constitute a quorum for the transaction of business by that
series, or (ii) holders of any class shall vote as a class, then a majority of
the aggregate number of shares of that class entitled to vote shall be necessary
to constitute a quorum for the transaction of business by that class. Any lesser
number shall be sufficient for adjournments. Any adjourned session or sessions
may be held, within a reasonable time after the date set for the original
meeting, without the necessity of further notice. The Declaration of Trust
specifically authorizes the Board of Trustees to terminate the Trust (or any of
its investment portfolios) by notice to the shareholders without shareholder
approval.
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Under Massachusetts law, shareholders of a Massachusetts business trust
could, under certain circumstances, be held personally liable for the Trust's
obligations. The Declaration of Trust, however, disclaims shareholder liability
for the Trust's acts or obligations and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the Trust or the Trustees. In addition, the Declaration of Trust provides for
indemnification out of the property of an investment portfolio in which a
shareholder owns or owned shares for all losses and expenses of such shareholder
or former shareholder if he or she is held personally liable for the obligations
of the Trust solely by reason of being or having been a shareholder. Moreover,
the Trust will be covered by insurance which the Trustees consider adequate to
cover foreseeable tort claims. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is considered remote, because
it is limited to circumstances in which a disclaimer is inoperative and the
Trust itself is unable to meet its obligations.
For further information, please refer to the registration statement and
exhibits for the Trust on file with the SEC in Washington, D.C. and available
upon payment of a copying fee. The statements in the Prospectus and this
Statement of Additional Information concerning the contents of contracts or
other documents, copies of which are filed as exhibits to the registration
statement, are qualified by reference to such contracts or documents.
PRINCIPAL HOLDERS OF SECURITIES
As of July 7, 1997, two trustees owned approximately 1.6% of the total
outstanding shares of the Conservative Growth Fund. As of this same date, the
officers and Trustees of the Trust, as a group, owned of record or beneficially
less than 1% of the outstanding voting securities of the remaining classes and
series of Schwab Capital Trust.
As of July 7, 1997, The Charles Schwab Trust Company, 101 Montgomery
Street, San Francisco, California, 94104, directly or beneficially owned 21.65%
of the International Index Fund - Select Shares, 14.86% of the Small-Cap Index
Fund - Select Shares, 12.04% of the Balanced Growth Fund, 7.69% of the S&P 500
Fund - Investor Shares, 8.94% of the S&P 500 Fund - Select Shares, and 5.54% of
the S&P 500 Fund - e.Shares. As of this same date, the Morgan Stanley Trust
Company, 1 Pierrepont Plaza, Brooklyn, New York, 11201, directly or beneficially
owned 15.00% of the International Index Fund - Investor Shares and 15.44% of the
Small-Cap Index Fund - Investor Shares.
PURCHASE AND REDEMPTION OF SHARES
Each Fund has set minimum initial investment requirements, as disclosed
in its respective Prospectus. Subsequent investments of $100 or more may be
made. These minimum investment requirements may be changed at any time and are
not applicable to certain types of investors. The Trust may waive the minimums
for purchases by Trustees, Directors, officers or employees of the Sub-Adviser.
The Funds, other than the OneSource Portfolios have made an election
with the SEC to pay in cash all redemptions requested by any shareholder of
record limited in amount during any 90-day period to the lesser of $250,000 or
1% of its net assets at the beginning of such period. The OneSource Portfolios
have not so elected. This election is irrevocable without the SEC's prior
approval. Redemption requests in
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excess of applicable limits (as summarized below) may be paid, in whole or in
part, in investment securities or in cash, as the Trust's Board of Trustees may
deem advisable; however, payment will be made wholly in cash unless the Board of
Trustees believes that economic or market conditions exist that would make such
a practice detrimental to the best interests of the Fund. If redemption proceeds
are paid in investment securities, such securities will be valued as set forth
in the Prospectus of the Fund affected under "Share Price Calculation" for the
International Index Fund, Small- Cap Fund and OneSource Portfolios, and under
"Important Information About Your Investment - How We Determine the Price of
Your Shares" for the Asset Director(R) Funds and Analytics Fund(TM). A redeeming
shareholder would normally incur brokerage expenses if he or she were to convert
the securities to cash.
OTHER INFORMATION
The Prospectuses of the Funds and this Statement of Additional
Information do not contain all the information included in the Registration
Statement filed with the SEC under the Securities Act of 1933, as amended, with
respect to the securities offered by the Prospectuses. Certain portions of the
Registration Statement have been omitted from the Prospectuses and this
Statement of Additional Information pursuant to the rules and regulations of the
SEC. The Registration Statement, including the exhibits filed therewith, may be
examined at the office of the SEC in Washington, D.C.
Statements contained in the Prospectuses or in this Statement of
Additional Information as to the contents of any contract or other document
referred to are not necessarily complete, and, in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement of which the Prospectuses and this Statement of
Additional Information form a part, each such statement being qualified in all
respects by such reference.
THIS STATEMENT OF ADDITIONAL INFORMATION DOES NOT CONSTITUTE AN
OFFERING BY THE TRUST, ANY SERIES THEREOF, OR BY THE DISTRIBUTOR IN ANY
JURISDICTION IN WHICH SUCH OFFERING MAY NOT BE LAWFULLY MADE.
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