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Supplement
to the Prospectus, dated October 28, 1998
for
Institutional Select(TM) S&P 500 Fund
Institutional Select(TM) Large-Cap Value Index Fund
Institutional Select(TM) Small-Cap Value Index Fund
The "Initial Minimum Investments" section of this Prospectus on page 12 has been
modified to state that:
Client accounts of Investment Managers are not required to make a minimum
initial purchase, maintain a minimum balance or meet a minimum amount for
subsequent purchases. All other investment requirements described in this
Prospectus, including initial minimum investment amounts for Investment Managers
and minimums for investors not buying through Investment Managers, have not
changed.
In addition, the following information is added to "Investment Objectives,
Policies & Rules" on page 9 of this prospectus:
One issue with the potential to disrupt fund operations and affect performance
is the inability of some computers to recognize the year 2000. The Investment
Advisor is taking steps to enable its systems to handle this issue. The
Investment Advisor also is seeking assurances that its service providers and
business partners are taking similar steps as well. However, it is impossible to
know in advance exactly how this issue will affect fund administration, fund
performance or securities markets in general.
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STATEMENT OF ADDITIONAL INFORMATION
SCHWAB CAPITAL TRUST
INSTITUTIONAL SELECT(TM) S&P 500 FUND
INSTITUTIONAL SELECT LARGE-CAP VALUE INDEX FUND
INSTITUTIONAL SELECT SMALL-CAP VALUE INDEX FUND
OCTOBER 28, 1998
AS AMENDED MARCH 1, 1999
This Statement of Additional Information (SAI) is not a prospectus. It should be
read in conjunction with the Prospectus dated October 28, 1998 (as amended from
time to time) for the Institutional Select S&P 500 Fund, Institutional Select
Large-Cap Value Index Fund and Institutional Select Small-Cap Value Index Fund
(the Funds).
To obtain a copy of the Prospectus, please contact Charles Schwab & Co., Inc.
(Schwab) at 1-800-435-4000, 24 hours a day, or 101 Montgomery Street, San
Francisco, California 94104. TDD users may contact Schwab at 1-800-345-2550, 24
hours a day.
SCHWABFUNDS(R)
1-800-435-4000
TABLE OF CONTENTS
Page
INVESTMENT SECURITIES AND RISKS................................................2
INVESTMENT RESTRICTIONS ......................................................10
ORGANIZATION AND MANAGEMENT OF THE TRUST .....................................11
MANAGEMENT OF THE FUND........................................................17
PORTFOLIO TRANSACTIONS AND TURNOVER...........................................17
TAXES.........................................................................18
SHARE PRICE CALCULATION.......................................................21
HOW THE FUNDS REFLECT PERFORMANCE.............................................21
THE INDEXES AND INDEXING STRATEGIES...........................................22
PURCHASE AND REDEMPTION OF SHARES.............................................23
OTHER INFORMATION.............................................................24
FINANCIAL INFORMATION.........................................................24
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INVESTMENT SECURITIES AND RISKS
ASSET-BACKED SECURITIES are securities that are backed by the loans or account
receivables of an entity, such as a bank or credit card company. These
securities are obligations that the issuer intends to repay using the assets
backing them (once collected). Therefore, repayment may depend largely on the
cash flows generated by the assets backing the securities. Sometimes the credit
support for these securities is limited to the underlying assets, but, in other
cases, may be provided by a third party via a letter of credit or insurance
guarantee.
CONVERTIBLE SECURITIES. Convertible securities are securities that are
exchangeable for a specific number of another form of security at a specified
price. Bonds and preferred stocks may be convertible. Convertible bonds
typically pay a lower interest rate than nonconvertible bonds of the same
quality and maturity, because the convertible feature allows them to be
exchanged for a specific number of shares of the company's common stock at a
predetermined price. This structure allows the holder of the convertible bond 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.
CREDIT AND LIQUIDITY SUPPORTS may be employed by issuers to reduce the credit
risk of their securities. Credit supports include letters of credit, insurance
and guarantees. Liquidity supports include puts and demand features. These
arrangements move the credit risk of an investment from the issuer of the
security to the support provider.
DEBT SECURITIES are obligations, issued by various entities, including
governments and corporations, in order to raise money. They are basically
"IOUs," but are commonly referred to as bonds. Bonds normally require the issuer
to pay a fixed, variable or floating rate of interest on the amount of money
borrowed (the "principal") until it is paid back (at "maturity"). Upon maturity,
the principal must be repaid.
Debt securities experience price changes when interest rates change. As a rule,
when interest rates rise, bond prices decline or "fall", and when interest rates
fall bond prices rise. Typically, longer-maturity bonds react to interest rate
changes more severely than shorter-term bonds (all else being equal) but
generally offer a greater rate of interest. Debt securities also are subject to
the risk that their issuer will fail to meet its obligation to pay interest
and/or principal, and their prices also may be affected by the credit quality of
their issuer. Investment-grade debt securities are medium- and high-quality
securities, although some still possess varying degrees of speculative
characteristics and risk.
FUTURES AND OPTIONS. The following sections pertain to futures and options
transactions: Futures Contracts, Options, Options on Futures Contracts, Hedging
Strategies With Futures and Risks Involved in Futures and Options Transactions.
Futures Contracts. A futures contract is generally an agreement between two
parties to buy and sell particular financial instruments for an agreed-upon
price during a designated period. 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, the parties may agree to deliver the final cash settlement price.
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When interest rates are falling or prices of securities are rising, each Fund,
through the purchase of futures contracts, may attempt to secure better rates or
prices than might be available in the market when it effects anticipated
purchases. When interest rates are rising or securities prices are falling, each
Fund may seek, through the sale of futures contracts, to offset a decline in the
value of its current portfolio securities.
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 fulfilled through offsetting transactions, which may result in a
profit or a loss. 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.
While each Fund's futures contracts will usually be liquidated in this manner, a
Fund may instead make or take delivery of the underlying securities or currency
whenever it appears economically advantageous for it to do so. A clearing
corporation associated with the exchange on which futures are traded guarantees
that, if still open, the sale or purchase will be performed on the settlement
date.
The Funds may purchase and sell various kinds of futures contracts. The futures
contracts may be based on various securities (such as U.S. Government
securities), securities indices 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 are not permitted to engage in speculative futures trading. A Fund may
incur brokerage fees when it purchases or sells futures contracts.
Options. Each Fund may purchase put and call options on any securities in which
it may invest and options on any securities index based on securities in which
it may invest. Each Fund also may enter into closing sale transactions in order
to realize gains or minimize losses on options it has purchased.
For certain options, the writer may be assigned an exercise notice at any time
prior to the termination of the obligation. Therefore, the writer may have no
control over when the underlying securities must be sold, in the case of call
options, or purchased, in the case of put options. 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.
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Each Fund may write (sell) covered call and put options on any securities in
which it may invest and 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 Fund 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.
All put options the Funds write will be covered, which means that each Fund will
have deposited with its custodian cash, U.S. Government securities or other
high-grade debt securities with a value at least equal to the exercise price of
the put option. High-grade securities are 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 Investment Advisor to be of comparable
credit quality. 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 it may be required to purchase the underlying securities at
a price in excess of the securities market value at the time of purchase.
Each Fund may terminate its 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."
The Funds may purchase 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.
The Funds currently treat purchased over-the-counter options and all assets used
to cover written over-the-counter options as illiquid securities, except for
options written with primary dealers in U.S. Government securities pursuant to
an agreement requiring a closing purchase transaction at a formula price.
Options on Futures Contracts. The purchase of put and call options on futures
contracts will give each Fund 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, each Fund obtains the benefit of the futures position if
prices move in a favorable direction but limit its 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 a Fund's assets. By writing a call
option on a futures contract, a Fund becomes 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 a Fund in writing options on futures
is potentially unlimited and may exceed the amount of the premium received. Each
Fund will incur transaction costs in connection with the writing of options on
futures.
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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. A Fund's
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 or rate of return on portfolio securities or securities that a
Fund owns or proposes to acquire. Such futures contracts may include contracts
for the future delivery of securities held by a Fund or securities with
characteristics similar to those of a Fund's portfolio securities. If, in the
opinion of the Investment Advisor, there is a sufficient degree of correlation
between price trends for a Fund's portfolio securities and futures contracts
based on other financial instruments, securities indices or other indices, a
Fund may enter into such futures contracts as part of its hedging strategy.
Although, under some circumstances, prices of securities in a Fund's portfolio
may be more or less volatile than prices of such futures contracts, the
Investment Advisor will attempt to estimate the extent of this difference in
volatility based on historical patterns. The Investment Advisor will attempt to
compensate for it by having a Fund enter into a greater or lesser number of
futures contracts or by attempting to achieve only a particular hedge against
price changes affecting a Fund's 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 a Fund's portfolio securities will be substantially offset by a decline in
the value of the futures position.
On other occasions, a Fund may take "long" positions by purchasing such futures
contracts. This may be done when a Fund anticipates the subsequent purchase of
particular securities when it has the necessary cash but expects 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.
When buying or selling futures contracts, a 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 good faith deposit on the
contract, which will be returned to the 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
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
a Fund generally requires that all of its futures transactions constitute "bona
fide" hedging transactions. As a result, a 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, a Fund 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 a 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 a Fund's futures
and options practices are limited to hedging purposes, the Investment Advisor
does not believe that the Fund is subject to the degree of risk frequently
associated with futures and options transactions. To the extent a Fund engages
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in the use of futures and options on futures other than for hedging purposes,
the Fund 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 Fund
will invest only in those contracts whose behavior is expected to resemble that
of a Fund's underlying securities. The Funds will attempt to minimize the risks
of being unable to close out futures positions by entering into these
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 seeks to
"close out" its position. If a Fund is unable to "close out" a futures or option
position and prices move adversely, the Fund would have to continue to make
daily cash payments to maintain its required margin. If the Fund had
insufficient cash to meet this requirement, it might have to sell portfolio
securities at a disadvantageous time. In addition, the Fund might be required to
deliver the securities underlying futures or options contracts it holds. Or, in
the case of covered options that a Fund has written, the Fund would be unable to
sell the underlying securities or dispose of assets held in a segregated account
until the options expire or are exercised. Similarly, if a Fund is unable to
effect a closing sale transaction with respect to options it has purchased, it
would have to exercise the options in order to realize any profit and will incur
transaction costs upon the purchase and subsequent sale of the underlying
securities.
Each Fund will 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.
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 opening and/or closing transactions;
(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; and (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.
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 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 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
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such significant market distortions, a similar result could be expected were a
Fund to invest directly in the securities being hedged. There is also the risk
of loss by a Fund of margin deposits in the event of bankruptcy of a broker with
whom the Fund has an open position in a futures contract or option.
Restrictions. Each Fund may enter into futures contracts and options on futures
contracts provided that aggregate deposits required do not exceed 5% of its
total assets. In addition, certain provisions of the Internal Revenue Code of
1986, as amended (the "Code"), may limit the Fund's use of futures contracts and
options.
Index participations and index participation contracts provide the equivalent of
a position in the securities comprising an index, with each security's
representation equaling its index weighting. Moreover, their holders are
entitled to payments equal to the dividends paid by the underlying index
securities. Generally, the value of an index participation or index
participation contract will rise and fall along with the value of the related
index. A Fund will invest in equity index participations and index participation
contracts only if a liquid market for them appears to exist.
The extent to which each Fund may purchase and sell futures, options, equity
index participations and index participation contracts may be limited by a
Fund's intention to meet Code requirements for qualification as a regulated
investment company. Read the "Taxes" section in this SAI for more information.
ILLIQUID SECURITIES. Investments that cannot be sold or disposed of in the
normal course of business at their approximate value will be considered
illiquid. The Investment Advisor determines the liquidity of a Fund's
investments under the supervision and direction of the Board of Trustees.
Investments currently considered illiquid are repurchase agreements not maturing
within seven days and some restricted securities.
LENDING AND DIRECT DEBT. Direct debt instruments represent ownership interests
in the debt of a company, government or other entity. Lending of securities is a
common practice in the securities industry. Each Fund will engage in security
lending arrangements with the primary objective of increasing a Fund's income
through investment of the cash collateral in short-term, interest-bearing
obligations but will do so only to the extent that a Fund will not lose the tax
treatment available to regulated investment companies. A Fund will be entitled
to all dividends or interest on any of its loaned securities. Loans of
securities involve a risk that the borrower may fail to return the securities or
provide additional collateral. The 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,
letters of credit, 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 Funds may at any time call the loan and
obtain the return of the securities loaned; (iii) the Funds 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 a Fund.
MORTGAGE-BACKED SECURITIES represent an interest in an underlying pool of
mortgages. Issuers of these securities include agencies and instrumentalities of
the U.S. Government, such as the Federal Home Loan Mortgage Corporation and the
Federal National Mortgage Association, and private entities, such as banks. The
income paid on mortgage-backed securities depends upon the income received from
the underlying pool of mortgages. These securities are subject to interest rate
risk, like other debt securities, in addition to prepayment risk.
Mortgage-backed securities include collateralized mortgage obligations,
mortgage-backed bonds and stripped mortgage-backed securities.
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MONEY MARKET SECURITIES are high-quality, short-term securities that may be
issued by entities such as the U.S. Government, corporations and financial
institutions (like banks).
PRECIOUS METAL-RELATED INVESTMENTS. 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. The Funds 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 Advisor considers that at least 50% of the company's assets, revenues
or profits are derived from the precious metal industry.
The Funds 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 Funds as set forth in the "Futures
Contracts and Options on Futures Contracts" section of the SAI.
PREFERRED STOCK. The Funds may invest in preferred stock. 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.
REAL ESTATE-RELATED INVESTMENTS. Real estate-related instruments include real
estate investment trusts, commercial and residential mortgage-backed securities
and real estate financing. 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 also may be affected by certain tax and regulatory requirements,
such as those relating to the environment.
REPURCHASE AGREEMENTS. 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 Investment Company Act of 1940, as amended (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 Fund is 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 Fund 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 Fund invests with the value marked-to-market daily to maintain 100%
coverage. A default by the seller might cause the Fund to experience a loss or
delay in the liquidation of the collateral securing the repurchase agreement.
The Fund might also incur disposition costs in liquidating the collateral. The
Fund will make payment for such securities only upon physical delivery or
evidence of book entry transfer to the account of its custodian bank.
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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.
RESTRICTED SECURITIES. Restricted securities are securities that are subject to
legal restrictions on their sale. Restricted securities may be considered to be
liquid if a liquid institutional or other market exists for these securities. In
making this determination, the Investment Advisor, 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 a Fund invests in restricted securities that are deemed liquid, the
general level of illiquidity in the Fund's portfolios may be increased if
qualified institutional buyers become uninterested in purchasing these
securities.
SECURITIES OF OTHER INVESTMENT COMPANIES. Each Fund may buy shares of other
investment companies, including those managed by its Investment Advisor. Because
other investment companies employ investment advisors and other service
providers, investments by a Fund may cause shareholders to pay duplicative fees.
STRIPPED SECURITIES are securities whose income and principal components are
detached and sold separately from each other. While the risks associated with
stripped securities are similar to other securities, stripped securities are
typically subject to greater changes in value. U.S. Treasury securities that
have been stripped by a Federal Reserve Bank are obligations of the U.S.
Treasury.
U.S. GOVERNMENT SECURITIES are debt securities issued by the U.S. Treasury or
issued or guaranteed by the U.S. Government or any of its agencies or
instrumentalities. U.S. Treasury securities are backed by the full faith and
credit of the United States. Not all U.S. Government securities are backed by
the full faith and credit of the United States. Some U.S. Government securities
are supported by a line of credit the issuing entity has with the U.S. Treasury.
Others are supported solely by the credit of the issuing agency or
instrumentality. Of course U.S. Government securities are among the safest
securities, but they are still subject to interest rate changes which may affect
their yields.
WARRANTS. The 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 will lose the
purchase price and the right to purchase the underlying security.
YEAR 2000 presents uncertainties and possible risks to the smooth operations of
the funds and the provision of services to shareholders. Many computer programs
use only two digits to identify a specific year and therefore may not accurately
recognize the upcoming change in the next century. If not corrected, many
computer applications could fail or create erroneous results by or at year 2000.
Due to the funds' and their service providers' dependence on computer technology
to operate, the nature and impact of year 2000 processing failures on the funds
could be material. The funds' investment advisor is taking steps to minimize the
risks of year 2000 for the funds, including obtaining assurances from the funds'
service providers that they are analyzing their systems, testing them for
potential problems and remediating them to the extent possible. There can be no
assurance that these steps will be sufficient to
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avoid any adverse impact on the funds, however, minimizing year 2000 risk for
the funds is a priority of the investment advisor.
Because each fund intends to track an index rather than focus on the
fundamentals of the underlying issuers, the investment advisor generally will
not take into account the extent to which an issuer has prepared or is preparing
for the year 2000 problem when managing a fund's portfolio. It is possible that
a fund's portfolio and performance may be materially affected by an issuer's
year 2000 related problems.
INVESTMENT RESTRICTIONS
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).
Each Fund may not:
1) Purchase securities of any issuer, except as consistent with the
maintenance of its status as a diversified company under the 1940
Act;
2) Concentrate investments in a particular industry or group of
industries, except as permitted under the 1940 Act, or the rules
or regulations thereunder; and
3) (i) Purchase or sell commodities, commodities contracts, futures
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, except as permitted by
the 1940 Act, or the rules or regulations thereunder.
THE FOLLOWING DESCRIPTIONS OF THE 1940 ACT MAY ASSIST INVESTORS IN UNDERSTANDING
THE ABOVE POLICIES AND RESTRICTIONS.
Diversification. 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
securities of other registered investment companies) if, as a result, more than
5% 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 a Fund.
Concentration. The 1940 Act currently defines concentration as investing 25% or
more of a Fund's total assets in an industry or group of industries, with
certain exceptions.
Borrowing. The 1940 Act presently restricts a Fund from borrowing (including
pledging, mortgaging or hypothecating assets) in excess of 33 1/3% of its total
assets (not including temporary borrowings not in excess of 5% of its total
assets).
Lending. Under the 1940 Act, a Fund may only make loans if expressly permitted
by its investment policies.
NON-FUNDAMENTAL INVESTMENT POLICIES.
The following investment policies and restrictions are non-fundamental and may
be changed by the Trust's Board of Trustees. Each Fund may not:
10
<PAGE> 12
1) Purchase securities of any issuer, if as a result, more than 15%
of its net assets would be invested in illiquid securities,
including repurchase agreements with maturities in excess of 7
days.
2) Invest for the purpose of exercising control or management of
another issuer.
3) Purchase securities of other investment companies, except as
permitted by the 1940 Act, including any exemptive relief granted
by the SEC.
4) Sell securities short unless it owns the security or the right to
obtain the security or equivalent securities (transactions in
futures contracts and options are not considered selling
securities short).
5) Purchase securities on margin, except such short-term credits as
may be necessary for the clearance of purchases and sales of
securities and provided that margin payments in connection with
futures contracts and options on futures shall not constitute
purchasing securities on margin.
6) Borrow money for temporary or emergency purposes except that a
Fund may (i) borrow money from banks and (ii) engage in reverse
repurchase agreements with any party; provided that (i) and (ii)
in combination do not exceed 33 1/3% of its total assets (any
borrowings that come to exceed this amount will be reduced to the
extent necessary to comply with the limitation within three
business days) and the Fund will not purchase securities while
borrowings represent more than 5% of its total assets.
7) Concentrate investments in a particular industry or group of
industries, as concentration is defined under the Investment
Company Act of 1940 or the rules or regulations thereunder, as
such statute, rules or regulations may be amended from time to
time except to the extent the investments of its index are
concentrated.
8) Lend any security or make any other loan if, as a result, more
than 33 1/3% of its total assets would be lent to other parties
(this restriction does not apply to purchases of securities or
repurchase agreements).
Policies and limitations that state a maximum percentage of assets that may be
invested in a security or other asset, or that set forth a quality standard
shall be measured immediately after and as a result of a Fund's acquisition of
such security or asset, unless otherwise noted. Except with respect to
non-fundamental limitations (1) illiquid securities and (6) borrowing, any
subsequent change in net assets or other circumstances will not be considered
when determining whether the investment complies with a Fund's investment
policies and limitations.
ORGANIZATION AND MANAGEMENT OF THE TRUST
Each Fund is a series of Schwab Capital Trust (the Trust), an open-end
investment management company organized as a Massachusetts business trust on May
7, 1993. The Trust is authorized to issue and unlimited number of shares of
beneficial interests in one or more series or classes of series (funds and/or
classes of funds). Currently, Schwab Capital Trust offers the following series:
S&P 500 Fund, Schwab International Index Fund(R), Schwab Small-Cap Index
Fund(R), Schwab Analytics Fund(R), Schwab MarketTrack(TM): All
11
<PAGE> 13
Equity Portfolio, Growth Portfolio, Balanced Portfolio and Conservative
Portfolio, Schwab MarketManager(TM): Balanced Portfolio, Growth Portfolio,
International Portfolio and SmallCap Portfolio.
The Trust generally is not required to hold shareholder meetings. However,
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 a 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 of the Trust 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.
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
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<PAGE> 14
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. There is a remote possibility that a
Fund could become liable for a misstatement in the Prospectus or SAI about
another Fund.
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 SAI
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.
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 Advisor, 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, Co-Chief Executive Officer and
July 29, 1937 Director, The Charles Schwab Corporation;
Chairman, Chief Executive Officer and
Director, Charles Schwab Holdings, Inc.;
Chairman and Director, Charles Schwab &
Co., Inc., Charles Schwab Investment
Management, Inc., The Charles Schwab
Trust Company, and Schwab Retirement
Plan Services, Inc.; 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>
- -----------------------------
* This Trustee is an "interested person" of the Trust.
13
<PAGE> 15
<TABLE>
<S> <C> <C>
STEVEN L. SCHEID* President and Chief Financial Officer, The Charles Schwab
June 28, 1953 Trustee Corporation; Enterprise President - Financial
Products and Services, Charles Schwab &
Co., Inc.; Chief Executive Officer,
Chief Financial Officer and Director,
Charles Schwab Investment Management,
Inc. From 1994 to 1996, Mr. Scheid was
Executive Vice President of Finance for
First Interstate Bancorp and was
Principal Financial Officer from 1995 to
1996. Prior to 1994, Mr. Scheid was
Chief Financial Officer, First
Interstate Bank of Texas.
DONALD F. DORWARD Trustee Executive Vice President and Managing Director,
September 23, 1931 Grey Advertising. From 1990 to 1996, Mr.
Dorward was President and Chief Executive
Officer, Dorward & Associates. Dorward &
Associates is an advertising and
marketing/consulting firm.
ROBERT G. HOLMES Trustee Chairman, Chief Executive Officer and Director,
May 15, 1931 Semloh Financial, Inc. Semloh Financial is an
international financial services and investment
advisory firm.
DONALD R. STEPHENS Trustee Managing Partner, D.R. Stephens & Co.
June 28, 1938 (investment banking). Prior to 1995, Mr.
Stephens was Chairman and Chief
Executive Officer of North American
Trust (a real estate investment trust).
MICHAEL W. WILSEY Trustee Chairman, Chief Executive Officer and Director,
August 18, 1943 Wilsey Bennett, Inc. (truck and air
transportation, real estate investment and
management, and investments).
TAI-CHIN TUNG Treasurer and Vice President - Finance, Charles Schwab & Co.,
March 7, 1951 Principal Inc.; Controller, Charles Schwab Investment
Financial Officer 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,
</TABLE>
- -----------------------------
* This Trustee is an "interested person" of the Trust.
14
<PAGE> 16
<TABLE>
<S> <C> <C>
Capital Research and Management Co.
WILLIAM J. KLIPP* Executive Vice Executive Vice President, SchwabFunds(R),
December 9, 1955 President, Chief Charles Schwab & Co., Inc.; President and Chief
Operating Officer Operating Officer, Charles Schwab Investment
and Trustee Management, Inc.
STEPHEN B. WARD Senior Vice President Senior Vice President and Chief Investment
April 5, 1955 and Chief Investment Officer, Charles Schwab Investment Management,
Officer Inc.
FRANCES COLE Secretary Senior Vice President, Chief Counsel and
September 9, 1955 Assistant Corporate Secretary, Charles Schwab
Investment Management, Inc.
</TABLE>
Each of the above-referenced Officers and/or Trustees also serves in the same
capacity as described for the Trust, Schwab Capital Trust, Schwab Investments
and Schwab Annuity Portfolios. The address of each individual listed above is
101 Montgomery Street, San Francisco, CA 94104.
COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
Pension or
Retirement Estimated
Benefits Accrued Annual Benefits Total
Aggregate as Part of Fund upon Retirement Compensation
Name of Person, Compensation Expenses from the from the Fund from the Fund
Position from the Trust Fund Complex(2) Complex(2) Complex(2)
- -------- -------------- --------------- ---------- ----------
<S> <C> <C> <C> <C>
Charles R. Schwab, 0 N/A N/A 0
Chairman and Trustee
Steven L. Scheid, 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, $18,800 N/A N/A $92,000
Trustee
Robert G. Holmes, $18,800 N/A N/A $92,000
</TABLE>
- -----------------------------
* This Trustee is an "interested person" of the Trust.
15
<PAGE> 17
COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
Pension or
Retirement Estimated
Benefits Accrued Annual Benefits Total
Aggregate as Part of Fund upon Retirement Compensation
Name of Person, Compensation Expenses from the from the Fund from the Fund
Position from the Trust Fund Complex(2) Complex(2) Complex(2)
- -------- -------------- --------------- ---------- ----------
<S> <C> <C> <C> <C>
Trustee
Donald R. Stephens, $18,800 N/A N/A $92,000
Trustee
Michael W. Wilsey, $18,800 N/A N/A $92,000
Trustee
</TABLE>
(1) Figures are for the Trust's fiscal year ended October 31, 1998.
(2) "Fund Complex" comprises all 35 funds of the Trust, The Charles Schwab
Family of Funds, Schwab Investments and Schwab Annuity Portfolios.
DEFERRED COMPENSATION PLAN. Pursuant to exemptive relief from the SEC, the Trust
may enter into deferred fee arrangements (the "Fee Deferral Plan" or the "Plan")
with Trustees who are not "interested persons" of any of the Funds (the
"Independent Trustees").
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 Schwab Fund or SchwabFunds(R) selected by
the participating Trustee (the "Selected Schwab Fund 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 from the SEC, each Fund will purchase and
maintain the Selected Schwab Fund 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
Independent Trustees to purchase the Selected Schwab Fund 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.
16
<PAGE> 18
MANAGEMENT OF THE FUND
INVESTMENT ADVISOR. The Investment Advisor, a wholly owned subsidiary of The
Charles Schwab Corporation, serves as the Funds' investment advisor and
administrator pursuant to an Investment Advisory and Administration Agreement
(the "Advisory Agreement") between it and the Trust. The Investment Advisor is
registered as an investment advisor under the Investment Advisers Act of 1940,
as amended, and currently provides investment management services to the
SchwabFunds Family, a family of 35 mutual funds with over $73 billion in assets
as of October 1, 1998. The Investment Advisor is an affiliate of: Schwab, the
Trust's distributor, and its shareholder services and transfer agent. The
Advisory Agreement will continue in effect for one year terms subject to annual
approval by: (1) the 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 also must be approved by a majority of the 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.
The Investment Advisor and Schwab have guaranteed that, through at least
December 31, 2005, the total fund operating expenses of S&P 500 Fund, Large-Cap
Value Fund and Small-Cap Value Fund will not exceed 0.15%, 0.25% and 0.32%,
respectively, of each Fund's average daily net assets.
DISTRIBUTOR. Pursuant to a Distribution Agreement, Schwab is the principal
underwriter for shares of the Funds and is the Trust's agent for the purpose of
the continuous offering of the Funds' shares. The Funds pay 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.
CUSTODIAN AND FUND ACCOUNTANT. PNC Bank, National Association, 200 Stevens
Drive, Suite 440, Lester, Pennsylvania 19113 and SEI Fund Resources, One Freedom
Valley Drive, Oaks, PA 19456, respectively, serve as Custodian and Fund
Accountant for the Funds.
PORTFOLIO TRANSACTIONS AND TURNOVER
PORTFOLIO TRANSACTIONS. In effecting securities transactions for the Funds, the
Investment Advisor seeks to obtain best price and execution. Subject to the
supervision of the Board of Trustees, the Investment Advisor 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 Advisor
will, among other things, monitor the performance of brokers effecting
transactions for the Funds to determine the effect, if any, that 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 Advisor
also may place orders directly with market makers or with third market brokers,
Instinet or brokers on an agency basis. Placing orders with
17
<PAGE> 19
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 Advisor 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 also may be used by the Investment Advisor when
providing advisory services to other investment advisory clients, including
mutual funds.
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 Advisor 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 Fund 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.
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 a 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.
From time to time, a Fund may compare its portfolio turnover rate with that of
other mutual funds as reported by independent sources.
The Funds have 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.
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, the Funds expect 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, 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
18
<PAGE> 20
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; and (2) diversify its holdings so that at the end of each quarter of
its taxable year (i) at least 50% of the market value of a 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 a 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 a 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 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, the 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.
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 a
Fund's 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 a Fund 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 Fund. However, if a shareholder
receives a long-term capital gain distribution with respect to a Fund's 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 a Fund designates 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 Fund were a regular
corporation. If a shareholder is not subject to income tax, generally the
shareholder will not be taxed on amounts distributed by a Fund.
19
<PAGE> 21
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.
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 a Fund
and its shareholders.
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 advisors regarding the consequences
of investing in a Fund.
AFTER TAX RETURN. Taxes can erode the returns a shareholder earns from a mutual
fund investment and are an important, and often overlooked, factor when
evaluating a mutual fund's performance. The Investment Advisor of the Funds may
use specific investment policies in an attempt to minimize realized capital gain
distributions only to the extent they do not have a material effect on a Fund's
ability to track the performance of its index. Certain of these policies include
selling the highest tax cost securities first and trading only round-lots or
large blocks of securities. In order to minimize capital gain distributions,
while achieving a Fund's investment objective, the Investment Advisor focuses on
individual tax lots in deciding when and how to manage the realization of net
capital gains. By deferring the realization of capital gains, where possible,
until an investor sells shares, those unrealized gains can accumulate in a Fund,
helping to build the value of a shareholder's investment. In addition,
shareholders are given greater control over the timing of the recognition of
such gains and the impact on their tax situations. The Investment Advisor
constantly monitors, analyzes and evaluates each portfolio as well as market
conditions to manage necessary trading activity and to determine when there are
opportunities to harvest capital losses, which can then be used to offset
realized capital gains. There can be no assurance that the Investment Advisor
will succeed in avoiding realized net capital gains.
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SHARE PRICE CALCULATION
Each Fund's net asset value per share (NAV) is determined each Business Day
after the close of trading on the New York Stock Exchange (NYSE), generally as
of 4:00 p.m. Eastern time. The NYSE may change its holiday closing schedule at
anytime, but, currently, the NYSE is scheduled to close on the following
holidays: New Year's Day, Dr. Martin Luther King Jr.'s Day (observed),
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Shares purchased normally begin to earn
dividends on the next business day with the following exceptions: Columbus Day
and Veterans Day.
Each Fund values its 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. 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 guidelines adopted
by the Board of Trustees. Securities may be valued on the basis of prices
provided by pricing services when such prices are believed to reflect fair
market value. The Investment Advisor assigns fair values to a Fund's other
investments in good faith under Board of Trustees guidelines. The Board of
Trustees regularly reviews these values.
HOW THE FUNDS REFLECT PERFORMANCE
STANDARDIZED TOTAL RETURN. Average annual total return is determined by
calculating the 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. It
is reported for periods of 1, 5, 10 years or since commencement of operations
for periods not falling on those intervals. In computing average annual total
return, a Fund assumes the reinvestment of all distributions at net asset value
on applicable reinvestment dates.
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 a Fund may be calculated by taking
the Fund's standardized or non-standardized total return and subtracting
applicable federal taxes from the portions of the 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.
A 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 commencement of
operations to its fiscal year end.
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THE INDEXES AND INDEXING STRATEGIES
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 and S&P 500 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. A Fund 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 a Fund's 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 Fund may report
or advertise tracking error.
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.
THE S&P 500/BARRA VALUE INDEX is a widely recognized index comprised of 343
large-cap value common stocks selected by BARRA, Inc. and Standard & Poor's, as
of June 30, 1998. The total value of the Index (as measured by the combined
market capitalization of the companies included in the Index) is approximately
one-half of the total value of the S&P 500 Index. The securities of the
companies with the highest book-to-price ratios may be included in the Index.
BARRA, Inc. and Standard & Poor's rebalance the Index at least semiannually.
THE S&P SMALLCAP 600/BARRA VALUE INDEX is a widely recognized index comprised of
373 small-cap value common stocks selected by BARRA, Inc. and Standard & Poor's,
as of June 30, 1998. The total value of the Index (as measured by the combined
market capitalization of the companies included in the Index) is approximately
one-half of the total value of the S&P SmallCap 600 Index. The securities of
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companies with the highest book-to-price ratios may be included in the Index.
BARRA, Inc. and Standard & Poor's rebalance the Index at least semiannually.
The Funds are not sponsored, endorsed, sold or promoted by S&P. S&P makes no
representation or warranty, express or implied, to the shareholders of the Funds
or any member of the public regarding the advisability of investing in
securities generally or in the Funds particularly or the ability of the Funds to
track general stock market performance. S&P's only relationship to the Funds is
the licensing of certain trademarks and trade names of S&P and of the S&P 500(R)
Index, which is determined, composed and calculated by S&P without regard to the
Funds. S&P has no obligation to take the needs of the Funds or their
shareholders into consideration in determining, composing or calculating the S&P
500 Index. S&P is not responsible for and has not participated in the
determination of the prices and amount of each Fund's shares or in the
determination or calculation of the equation by which each Fund's shares are to
be converted into cash. S&P has no obligation or liability in connection with
the administration, marketing or trading of each Fund's shares.
S&P does not guarantee the accuracy and/or the completeness of the S&P 500 Index
or any data included therein, and S&P shall have no liability for any errors,
omissions or interruptions therein. S&P makes no warranty, express or implied,
as to results to be obtained by the Funds, their shareholders or any other
person or entity from the use of the S&P 500 Index or any data therein. S&P
makes no express or implied warranties and expressly disclaims all warranties or
merchantability or fitness for a particular purpose or use with respect to the
S&P 500 Index or any data included therein. Without limiting any of the
foregoing, in no event shall S&P have any liability for any special, punitive,
indirect or consequential damages (including lost profits), even if notified of
the possibility of such damages.
PURCHASE AND REDEMPTION OF SHARES
We designed the Funds for long-term investors. You should not use the Funds to
speculate on short-term market movements. Doing so can disrupt our investment
strategy and operations. It also raises costs for other Fund investors. As a
result, we may refuse any purchase or buy exchange order that we deem to be
disruptive to a Fund or its investments.
Each Fund has set minimum initial and subsequent investment requirements. These
minimum investment requirements may be changed at any time and may not be
applicable to certain types of investors. The Trust may waive the minimums for
purchases by Trustees and officers.
Each Fund has 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. This election is irrevocable without the SEC's prior approval.
Redemption requests in excess of applicable limits (as summarized below) may be
paid, in whole or in part, in investment securities or in cash, as the 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 Funds. If
redemption proceeds are paid in investment securities, such securities will be
valued as set forth in the "Share Price Calculation" section of the SAI. A
redeeming shareholder would normally incur brokerage expenses if he or she were
to convert the securities to cash.
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OTHER INFORMATION
The Prospectus and SAI 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 Prospectus. Certain
portions of the Registration Statement have been omitted from the Prospectus and
SAI 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 Prospectus or SAI 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 the contract or other document filed
as an exhibit to the Registration Statement. Each such statement is qualified in
all respects by such reference.
FINANCIAL INFORMATION
The Funds' independent accountant audits and reports on the annual financial
statements of each series of the Trust and review certain regulatory reports and
each Fund's federal income tax return. It also performs other professional
accounting, auditing, tax and advisory services when the Trust engages it to do
so.
THIS SAI 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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