MORGAN GRENFELL INVESTMENT TRUST
No-Load Open-End Funds
Institutional Shares
885 Third Avenue
New York, New York 10022
STATEMENT OF ADDITIONAL INFORMATION
January 16, 1997
Morgan Grenfell Investment Trust (the "Trust") is an open-end,
management investment company consisting of eighteen investment portfolios, each
having separate and distinct investment objectives and policies. This Statement
of Additional Information provides supplementary information pertaining to the
following investment portfolios of the Trust (each, a "Fund"):
(Degree) Morgan Grenfell Fixed Income Fund
(Degree) Morgan Grenfell Municipal Bond Fund
(Degree) Morgan Grenfell Short-Term Fixed Income Fund
(Degree) Morgan Grenfell Short-Term Municipal Bond Fund
(Degree) Morgan Grenfell Smaller Companies Fund
(Degree) Morgan Grenfell Microcap Fund
(Degree) Morgan Grenfell Large Cap Growth Fund
This Statement of Additional Information is not a prospectus, and
should be read only in conjunction with the Funds' Institutional Shares
Prospectus dated January 16, 1997, as amended or supplemented from time to time
(the "Prospectus"). A copy of the Prospectus may be obtained without charge from
SEI Financial Services Company, the Trust's Distributor, by calling
1-800-814-3401 or writing to 1 Freedom Valley Drive, Oaks, Pennsylvania
19456-0100
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TABLE OF CONTENTS
Page
Introduction........................................ 3
Additional Information on Fund Investments
and Strategies and Related Risks.................. 4
Investment Restrictions............................. 30
Trustees and Officers............................... 37
Investment Advisory and Other Services.............. 41
Portfolio Transactions ............................. 47
Net Asset Value..................................... 50
Performance Information............................. 51
Taxes............................................... 55
General Information About the Trust................. 64
Additional Information.............................. 68
Financial Statements................................ 69
Appendix A -- Description of Ratings................ A-1
No person has been authorized to give any information or to make any
representations not contained in this Statement of Additional Information or in
the Prospectus in connection with the offering made by the Prospectus and, if
given or made, such information or representations must not be relied upon as
having been authorized by the Trust or its Distributor. The Prospectus does not
constitute an offering by the Trust or by the Distributor in any jurisdiction in
which such offering may not lawfully be made. Shares of the Funds are not
available in certain states. Please call 1-800-814-3401 to determine
availability in your state.
INTRODUCTION
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The Trust is an open-end, management investment company that currently
consists of eighteen separate investment portfolios. This Statement of
Additional Information relates to the following seven separate investment
portfolios of the Trust (the "Funds"):
Morgan Grenfell Smaller Companies Fund
Morgan Grenfell Microcap Fund
Morgan Grenfell Large Cap Growth Fund
(collectively, the "Equity Funds")
Morgan Grenfell Fixed Income Fund
Morgan Grenfell Short-Term Fixed Income Fund
(collectively, the "Fixed Income Funds")
Morgan Grenfell Municipal Bond Fund
Morgan Grenfell Short-Term Municipal Bond Fund
(collectively, the "Municipal Funds")
The Funds are classified as "diversified" within the meaning of the
Investment Company Act of 1940 (the "1940 Act").
Morgan Grenfell Capital Management, Inc. (the "Adviser" or "MGCM")
serves as investment adviser to the Funds. SEI Financial Services Company (the
"Distributor") serves as the Funds' principal underwriter and distributor. SEI
Financial Management Corporation serves as the Funds' administrator.
The information contained in this Statement of Additional Information
generally supplements the information contained in the Prospectus. No investor
should invest in institutional shares of a Fund without first reading the
Prospectus. Capitalized terms used herein and not otherwise defined have the
same meaning ascribed to them in the Prospectus.
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ADDITIONAL INFORMATION ON FUND INVESTMENTS
AND STRATEGIES AND RELATED RISKS
The following supplements the information contained in the Prospectus
concerning the investment objectives and policies of each Fund.
Fixed Income Securities
Variable and Floating Rate Instruments. Debt instruments purchased by a
Fund may be structured to have variable or floating interest rates. These
instruments may include variable amount master demand notes that permit the
indebtedness to vary in addition to providing for periodic adjustments in the
interest rates. The Adviser will consider the earning power, cash flows and
other liquidity ratios of the issuers and guarantors of such instruments and, if
the instrument is subject to a demand feature, will continuously monitor their
financial ability to meet payment on demand. Where necessary to ensure that a
variable or floating rate instrument is equivalent to the quality standards
applicable to a Fund's fixed income investments, the issuer's obligation to pay
the principal of the instrument will be backed by an unconditional bank letter
or line of credit, guarantee or commitment to lend. Any bank providing such a
bank letter, line of credit, guarantee or loan commitment will meet the Fund's
investment quality standards relating to investments in bank obligations. A Fund
will invest in variable and floating rate instruments only when the Adviser
deems the investment to involve minimal credit risk. The Adviser will also
continuously monitor the creditworthiness of issuers of such instruments to
determine whether a Fund should continue to hold the investments.
The absence of an active secondary market for certain variable and
floating rate notes could make it difficult to dispose of the instruments, and a
Fund could suffer a loss if the issuer defaults or during periods in which a
Fund is not entitled to exercise its demand rights.
Variable and floating rate instruments held by a Fund will be subject
to the Fund's limitation on investments in illiquid securities when a reliable
trading market for the instruments does not exist and the Fund may not demand
payment of the principal amount of such instruments within seven days.
Yields and Ratings. The yields on certain obligations, including the
money market instruments in which each Fund may invest (such as commercial paper
and bank obligations), are dependent on a variety of factors, including general
money market conditions, conditions in the particular market for the obligation,
the financial condition of the issuer, the size of the offering, the maturity of
the obligation and the ratings of the issue. The ratings of Standard and Poors
Ratings Group ("Standard & Poor's"), Moody's Investor Service, Inc. ("Moody's")
and other recognized rating organizations represent their respective opinions as
to the quality
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of the obligations they undertake to rate. Ratings, however, are general and
are not absolute standards of quality or value. Consequently, obligations with
the same rating, maturity and interest rate may have different market prices.
See Appendix A for a description of the ratings provided by Standard & Poor's,
Moody's and certain other recognized rating organizations.
Subsequent to its purchase by a Fund, a rated security may cease to be
rated or its rating may be reduced below the minimum rating required for
purchase by the Fund. The Board of Trustees or the Adviser, pursuant to
guidelines established by the Board of Trustees, will consider such an event in
determining whether the Fund should continue to hold the security in accordance
with the interests of the Fund and applicable regulations of the Securities and
Exchange Commission (the "Commission"). In no event, however, will a Fund hold
more than 5% of its net assets in fixed income securities that are not
investment grade.
Custodial Receipts. Each of the Fixed Income Funds may acquire U.S.
Government Securities and their unmatured interest coupons that have been
separated ("stripped") by their holder, typically a custodian bank or investment
brokerage firm. Having separated the interest coupons from the underlying
principal of the U.S. Government Securities, the holder will resell the stripped
securities in custodial receipt programs with a number of different names,
including "Treasury Income Growth Receipts" ("TIGRs") and "Certificate of
Accrual on Treasury Securities" ("CATS"). The stripped coupons are sold
separately from the underlying principal, which is usually sold at a deep
discount because the buyer receives only the right to receive a future fixed
payment on the security and does not receive any rights to periodic interest
(cash) payments. The underlying U.S. Treasury bonds and notes themselves are
generally held in book-entry form at a Federal Reserve Bank. Counsel to the
underwriters of these certificates or other evidences of ownership of U.S.
Treasury securities have stated that, in their opinion, purchasers of the
stripped securities most likely will be deemed the beneficial holders of the
underlying U.S. Government Securities for federal tax and securities purposes.
In the case of CATS and TIGRS, the Internal Revenue Service ( the "IRS") has
reached this conclusion for the purpose of applying the tax diversification
requirements applicable to regulated investment companies such as the Funds.
CATS and TIGRS are not considered U.S. Government Securities by the staff of the
Commission. Further, the IRS conclusion noted above is contained only in a
general counsel memorandum, which is an internal document of no precedential
value or binding effect, and a private letter ruling, which also may not be
relied upon by the Funds. The Trust is not aware of any binding legislative,
judicial or administrative authority on this issue.
Preferred Stock
Each of the Equity Funds, subject to its investment objectives, may
purchase preferred stock. Preferred stocks are equity securities, but
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possess certain attributes of debt securities and are generally considered fixed
income securities. Holders of preferred stocks normally have the right to
receive dividends at a fixed rate when and as declared by the issuer's board of
directors, but do not participate in other amounts available for distribution by
the issuing corporation. Dividends on the preferred stock may be cumulative, and
in such cases all cumulative dividends usually must be paid prior to dividend
payments to common stockholders. Because of this preference, preferred stocks
generally entail less risk than common stocks. Upon liquidation, preferred
stocks are entitled to a specified liquidation preference, which is generally
the same as the par or stated value, and are senior in right of payment to
common stocks. However, preferred stocks are equity securities in that they do
not represent a liability of the issuer and therefore do not offer as great a
degree of protection of capital or assurance of continued income as investments
in corporate debt securities. In addition, preferred stocks are subordinated in
right of payment to all debt obligations and creditors of the issuer, and
convertible preferred stocks may be subordinated to other preferred stock of the
same issuer. See "Convertible Securities and Preferred Stocks" in the Prospectus
for a description of certain characteristics of convertible preferred stock.
Warrants
As stated in the Prospectus, each of the Equity Funds may purchase
warrants, which are privileges issued by corporations enabling the owners to
subscribe to and purchase a specified number of shares of the corporation at a
specified price during a specified period of time. The purchase of warrants
involves a risk that a Fund could lose the purchase value of a warrant if the
right to subscribe to additional shares is not exercised prior to the warrant's
expiration. Also, the purchase of warrants involves the risk that the effective
price paid for the warrant added to the subscription price of the related
security may exceed the value of the subscribed security's market price such as
when there is no movement in the level of the underlying security. A Fund will
not invest more than 5% of its net assets, taken at market value, in warrants,
or more than 2% of its net assets, taken at market value, in warrants not listed
on a recognized securities exchange. Warrants acquired by a Fund in units or
attached to other securities shall not be included in determining compliance
with these percentage limitations. See "Investment Restrictions."
Municipal Securities
As stated in the Prospectus, the Municipal Funds and, to a more limited
extent, the Fixed Income Funds may invest in municipal securities. Municipal
securities consist of bonds, notes and other instruments issued by or on behalf
of states, territories and possessions of the United States (including the
District of Columbia) and their political subdivisions, agencies or
instrumentalities, the interest on which is exempt from regular federal income
tax (i.e., excluded from gross income for federal income tax purposes but not
necessarily exempt from the federal alternative minimum tax or from state and
local taxes). Municipal securities may also be issued on
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a taxable basis (i.e., the interest on such securities is not exempt from
regular federal income tax).
Municipal securities are often issued to obtain funds for various
public purposes, including the construction of a wide range of public facilities
such as bridges, highways, housing, hospitals, mass transportation, schools,
streets and water and sewer works. Other public purposes for which municipal
securities may be issued include refunding outstanding obligations, obtaining
funds for general operating expenses, and obtaining funds to lend to other
public institutions and facilities. Municipal securities also include "private
activity" or industrial development bonds, which are issued by or on behalf of
public authorities to provide financing aid to acquire sites or construct or
equip facilities within a municipality for privately or publicly owned
corporations.
The two principal classifications of municipal securities are "general
obligations" and "revenue obligations." General obligations are secured by the
issuer's pledge of its full faith and credit for the payment of principal and
interest although the characteristics and enforcement of general obligations may
vary according to the law applicable to the particular issuer. Revenue
obligations, which include, but are not limited to, private activity bonds,
resource recovery bonds, certificates of participation and certain municipal
notes, are not backed by the credit and taxing authority of the issuer and are
payable solely from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source. Nevertheless, the obligations of the issuer may also be
backed by a letter of credit, guarantee or insurance. General obligations and
revenue obligations may be issued in a variety of forms, including commercial
paper, fixed, variable and floating rate securities, tender option bonds,
auction rate bonds and capital appreciation bonds.
In addition to general obligations and revenue obligations, there is a
variety of hybrid and special types of municipal securities. There are also
numerous differences in the credit backing of municipal securities both within
and between these two principal classifications.
For the purpose of applying a Fund's investment restrictions, the
identification of the issuer of a municipal security which is not a general
obligation is made by the Adviser based on the characteristics of the municipal
security, the most important of which is the source of funds for the payment of
principal and interest on such securities.
An entire issue of municipal securities may be purchased by one or a
small number of institutional investors such as a Fund. Thus, the issue may not
be said to be publicly offered. Unlike some securities that are not publicly
offered, a secondary market exists for many municipal securities that were not
publicly offered initially and such securities can be readily marketable.
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The obligations of an issuer to pay the principal of and interest on a
municipal security are subject to the provisions of bankruptcy, insolvency and
other laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Act, and laws, if any, that may be enacted by Congress or state
legislatures extending the time for payment of principal or interest or imposing
other constraints upon the enforcement of such obligations. There is also the
possibility that, as a result of litigation or other conditions, the power or
ability of the issuer to pay when due principal of or interest on a municipal
security may be materially affected.
Municipal Leases, Certificates of Participation and Other Participation
Interests. A municipal lease is an obligation in the form of a lease or
installment purchase contract which is issued by a state or local government to
acquire equipment and facilities. Income from such obligations is generally
exempt from state and local taxes in the state of issuance (as well as regular
Federal income tax). Municipal leases frequently involve special risks not
normally associated with general obligation or revenue bonds. Leases and
installment purchase or conditional sale contracts (which normally provide for
title to the leased asset to pass eventually to the governmental issuer) have
evolved as a means for governmental issuers to acquire property and equipment
without meeting the constitutional and statutory requirements for the issuance
of debt. The debt issuance limitations are deemed to be inapplicable because of
the inclusion in many leases or contracts of "non-appropriation" clauses that
relieve the governmental issuer of any obligation to make future payments under
the lease or contract unless money is appropriated for such purpose by the
appropriate legislative body on a yearly or other periodic basis. Thus, a Fund's
investment in municipal leases will be subject to the special risk that the
governmental issuer may not appropriate funds for lease payments.
In addition, such leases or contracts may be subject to the temporary
abatement of payments in the event the issuer is prevented from maintaining
occupancy of the leased premises or utilizing the leased equipment. Although the
obligations may be secured by the leased equipment or facilities, the
disposition of the property in the event of nonappropriation or foreclosure
might prove difficult, time consuming and costly, and result in an
unsatisfactory or delayed recoupment of a Fund's original investment.
Certificates of participation represent undivided interests in
municipal leases, installment purchase contracts or other instruments. The
certificates are typically issued by a trust or other entity which has received
an assignment of the payments to be made by the state or political subdivision
under such leases or installment purchase contracts.
Certain municipal lease obligations and certificates of participation
may be deemed illiquid for the purpose of the Funds' respective limitations on
investments in illiquid securities. Other municipal lease obligations and
certificates of participation acquired by a Fund may be determined by the
Adviser, pursuant to guidelines adopted by the Trustees of the Trust, to be
liquid securities for the purpose of such Fund's limitation on
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investments in illiquid securities. In determining the liquidity of municipal
lease obligations and certificates of participation, the Adviser will consider a
variety of factors including: (1) the willingness of dealers to bid for the
security; (2) the number of dealers willing to purchase or sell the obligation
and the number of other potential buyers; (3) the frequency of trades or quotes
for the obligation; and (4) the nature of the marketplace trades. In addition,
the Adviser will consider factors unique to particular lease obligations and
certificates of participation affecting the marketability thereof. These include
the general creditworthiness of the issuer, the importance to the issuer of the
property covered by the lease and the likelihood that the marketability of the
obligation will be maintained throughout the time the obligation is held by a
Fund. No Fund may invest more than 5% of its net assets in municipal leases.
Each Municipal Fund and each Fixed Income Fund may purchase
participations in municipal securities held by a commercial bank or other
financial institution. Such participations provide a Fund with the right to a
pro rata undivided interest in the underlying municipal securities. In addition,
such participations generally provide a Fund with the right to demand payment,
on not more than seven days notice, of all or any part of the Fund's
participation interest in the underlying municipal security, plus accrued
interest.
Municipal Notes. Municipal securities in the form of notes generally
are used to provide for short-term capital needs, in anticipation of an issuer's
receipt of other revenues or financing, and typically have maturities of up to
three years. Such instruments may include Tax Anticipation Notes, Revenue
Anticipation Notes, Bond Anticipation Notes, Tax and Revenue Anticipation Notes
and Construction Loan Notes. Tax Anticipation Notes are issued to finance the
working capital needs of governments. Generally, they are issued in anticipation
of various tax revenues, such as income, sales, property, use and business
taxes, and are payable from these specific future taxes. Revenue Anticipation
Notes are issued in expectation of receipt of other kinds of revenue, such as
federal revenues available under federal revenue sharing programs. Bond
Anticipation Notes are issued to provide interim financing until long-term bond
financing can be arranged. In most cases, the long-term bonds then provide the
funds needed for repayment of the notes. Tax and Revenue Anticipation Notes
combine the funding sources of both Tax Anticipation Notes and Revenue
Anticipation Notes. Construction Loan Notes are sold to provide construction
financing. These notes are secured by mortgage notes insured by the Federal
Housing Authority; however, the proceeds from the insurance may be less than the
economic equivalent of the payment of principal and interest on the mortgage
note if there has been a default. The obligations of an issuer of municipal
notes are generally secured by the anticipated revenues from taxes, grants or
bond financing. An investment in such instruments, however, presents a risk that
the anticipated revenues will not be received or that such revenues will be
insufficient to satisfy the issuer's payment obligations under the notes or that
refinancing will be
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otherwise unavailable.
Tax-Exempt Commercial Paper. Issues of tax-exempt commercial paper
typically represent short-term, unsecured, negotiable promissory notes. These
obligations are issued by state and local governments and their agencies to
finance working capital needs of municipalities or to provide interim
construction financing and are paid from general revenues of municipalities or
are refinanced with long-term debt. In most cases, tax-exempt commercial paper
is backed by letters of credit, lending agreements, note repurchase agreements
or other credit facility agreements offered by banks or other institutions.
Pre-Refunded Municipal Securities. The principal of and interest on
municipal securities that have been pre-refunded are no longer paid from the
original revenue source for the securities. Instead, after pre-refunding the
source of such payments is typically an escrow fund consisting of obligations
issued or guaranteed by the U.S. Government. The assets in the escrow fund are
derived from the proceeds of refunding bonds issued by the same issuer as the
pre-refunded municipal securities. Issuers of municipal securities use this
advance refunding technique to obtain more favorable terms with respect to
securities that are not yet subject to call or redemption by the issuer. For
example, advance refunding enables an issuer to refinance debt at lower market
interest rates, restructure debt to improve cash flow or eliminate restrictive
covenants in the indenture or other governing instrument for the pre-refunded
municipal securities. However, except for a change in the revenue source from
which principal and interest payments are made, the pre-refunded municipal
securities remain outstanding on their original terms until they mature or are
redeemed by the issuer. Pre-refunded municipal securities are usually purchased
at a price which represents a premium over their face value.
Tender Option Bonds. A tender option bond is a municipal security
(generally held pursuant to a custodial arrangement) having a relatively long
maturity and bearing interest at a fixed rate substantially higher than
prevailing short-term tax-exempt rates. The bond is typically issued in
conjunction with the agreement of a third party, such as a bank, broker-dealer
or other financial institution, pursuant to which such institution grants the
security holders the option, at periodic intervals, to tender their securities
to the institution and receive the face value thereof.
As consideration for providing the option, the financial institution
receives periodic fees equal to the difference between the bond's fixed coupon
rate and the rate, as determined by a remarketing or similar agent at or near
the commencement of such period, that would cause the securities, coupled with
the tender option, to trade at par on the date of such determination. Thus,
after payment of this fee, the security holder effectively holds a demand
obligation that bears interest at the prevailing short-term tax-exempt rate.
However, an institution will not be obligated to accept tendered bonds in the
event of certain defaults or a significant
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downgrade in the credit rating assigned to the issuer of the bond. The
liquidity of a tender option bond is a function of the credit quality of both
the bond issuer and the financial institution providing liquidity. Tender option
bonds are deemed to be liquid unless, in the opinion of the Adviser, the credit
quality of the bond issuer and the financial institution is deemed, in light of
the Fund's credit quality requirements, to be inadequate. Each Municipal Fund
intends to invest only in tender option bonds the interest on which will, in the
opinion of bond counsel, counsel for the issuer of interests therein or counsel
selected by the Adviser, be exempt from regular federal income tax. However,
because there can be no assurance that the IRS will agree with such counsel's
opinion in any particular case, there is a risk that a Municipal Fund will not
be considered the owner of such tender option bonds and thus will not be
entitled to treat such interest as exempt from such tax. Additionally, the
federal income tax treatment of certain other aspects of these investments,
including the proper tax treatment of tender option bonds and the associated
fees, in relation to various regulated investment company tax provisions is
unclear. Each Municipal Fund intends to manage its portfolio in a manner
designed to eliminate or minimize any adverse impact from the tax rules
applicable to these investments.
Auction Rate Securities. Auction rate securities consist of auction
rate municipal securities and auction rate preferred securities issued by
closed-end investment companies that invest primarily in municipal securities.
Provided that the auction mechanism is successful, auction rate securities
usually permit the holder to sell the securities in an auction at par value at
specified intervals. The dividend is reset by "Dutch" auction in which bids are
made by broker-dealers and other institutions for a certain amount of securities
at a specified minimum yield. The dividend rate set by the auction is the lowest
interest or dividend rate that covers all securities offered for sale. While
this process is designed to permit auction rate securities to be traded at par
value, there is the risk that an auction will fail due to insufficient demand
for the securities.
Dividends on auction rate preferred securities issued by a closed-end
fund may be designated as exempt from federal income tax to the extent they are
attributable to tax-exempt interest income earned by the fund on the securities
in its portfolio and distributed to holders of the preferred securities,
provided that the preferred securities are treated as equity securities for
federal income tax purposes and the closed-end fund complies with certain
requirements under the Internal Revenue Code of 1986, as amended (the "Code").
For purposes of complying with the 20% limitation on each Municipal Fund's
investments in taxable investments, auction rate preferred securities will be
treated as taxable investments unless substantially all of the dividends on such
securities are expected to be exempt from regular federal income taxes.
Each Fund's investments in auction rate preferred securities of
closed-end funds are subject to limitations on investments in other
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investment companies, which limitations are prescribed by the 1940 Act and
certain state securities regulations. These limitations include a prohibition
against acquiring more than 3% of the voting securities of any other investment
company, and investing more than 5% of the Fund's assets in securities of any
one investment company or more than 10% of its assets in securities of all
investment companies. A Fund will indirectly bear its proportionate share of any
management fees paid by such closed-end funds in addition to the advisory fee
payable directly by the Fund.
Private Activity Bonds. Certain types of municipal securities,
generally referred to as industrial development bonds (and referred to under
current tax law as private activity bonds), are issued by or on behalf of public
authorities to obtain funds for privately-operated housing facilities, airport,
mass transit or port facilities, sewage disposal, solid waste disposal or
hazardous waste treatment or disposal facilities and certain local facilities
for water supply, gas or electricity. Other types of industrial development
bonds, the proceeds of which are used for the construction, equipment, repair or
improvement of privately operated industrial or commercial facilities, may
constitute municipal securities, although the current federal tax laws place
substantial limitations on the size of such issues. The interest from certain
private activity bonds owned by a Fund (including a Municipal Fund's
distributions attributable to such interest) may be a preference item for
purposes of the alternative minimum tax.
Mortgage-Backed Securities
As stated in the Prospectus, the Fixed Income Funds and the Municipal
Funds may invest in mortgage-backed securities, including derivative
instruments. Mortgage-backed securities represent direct or indirect
participations in or obligations collateralized by and payable from mortgage
loans secured by real property. Each Fixed Income Fund and each Municipal Fund
may invest in mortgage-backed securities issued or guaranteed by U.S. Government
agencies or instrumentalities such as the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the
Federal Home Loan Mortgage Corporation ("FHLMC"). Obligations of GNMA are backed
by the full faith and credit of the U.S. Government. Obligations of FNMA and
FHLMC are not backed by the full faith and credit of the U.S. Government but are
considered to be of high quality since they are considered to be
instrumentalities of the United States. The market value and yield of these
mortgage-backed securities can vary due to market interest rate fluctuations and
early prepayments of underlying mortgages. These securities represent ownership
in a pool of Federally insured mortgage loans with a maximum maturity of 30
years. The scheduled monthly interest and principal payments relating to
mortgages in the pool will be "passed through" to investors. Government
mortgage-backed securities differ from conventional bonds in that principal is
paid back to the certificate holders over the life of the loan rather than at
maturity. As a result, there will be monthly scheduled payments of principal and
interest.
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Only the Fixed Income Funds may invest in mortgage-backed securities
issued by non-governmental entities including collateralized mortgage
obligations ("CMOs") and real estate mortgage investment conduits ("REMICs").
CMOs are securities collateralized by mortgages, mortgage pass-throughs,
mortgage pay-through bonds (bonds representing an interest in a pool of
mortgages where the cash flow generated from the mortgage collateral pool is
dedicated to bond repayment), and mortgage-backed bonds (general obligations of
the issuers payable out of the issuers' general funds and additionally secured
by a first lien on a pool of single family detached properties). Many CMOs are
issued with a number of classes or series which have different maturities and
are retired in sequence. Investors purchasing such CMOs in the shortest
maturities receive or are credited with their pro rata portion of the
unscheduled prepayments of principal up to a predetermined portion of the total
CMO obligation. Until that portion of such CMO obligation is repaid, investors
in the longer maturities receive interest only. Accordingly, the CMOs in the
longer maturity series are less likely than other mortgage pass-throughs to be
prepaid prior to their stated maturity. Although some of the mortgages
underlying CMOs may be supported by various types of insurance, and some CMOs
may be backed by GNMA certificates or other mortgage pass-throughs issued or
guaranteed by U.S. Government agencies or instrumentalities, the CMOs themselves
are not generally guaranteed.
REMICs are private entities formed for the purpose of holding a fixed
pool of mortgages secured by an interest in real property. REMICs are similar to
CMOs in that they issue multiple classes of securities, including "regular"
interests and "residual" interests. The Funds do not intend to acquire residual
interests in REMICs under current tax law, due to certain disadvantages for
regulated investment companies that acquire such interests.
Mortgage-backed securities are subject to unscheduled principal
payments representing prepayments on the underlying mortgages. Although these
securities may offer yields higher than those available from other types of
securities, mortgage-backed securities may be less effective than other types of
securities as a means of "locking in" attractive long-term rates because of the
prepayment feature. For instance, when interest rates decline, the value of
these securities likely will not rise as much as comparable debt securities due
to the prepayment feature. In addition, these prepayments can cause the price of
a mortgage-backed security originally purchased at a premium to decline in price
to its par value, which may result in a loss.
Due to prepayments of the underlying mortgage instruments,
mortgage-backed securities do not have a known actual maturity. In the absence
of a known maturity, market participants generally refer to an estimated average
life. The Adviser believes that the estimated average life is the most
appropriate measure of the maturity of a mortgage-backed security. Accordingly,
in order to determine whether such security is a permissible
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investment, it will be deemed to have a remaining maturity of three years or
less if the average life, as estimated by the Adviser, is three years or less at
the time of purchase of the security by a Fund. An average life estimate is a
function of an assumption regarding anticipated prepayment patterns. The
assumption is based upon current interest rates, current conditions in the
relevant housing markets and other factors. The assumption is necessarily
subjective, and thus different market participants could produce somewhat
different average life estimates with regard to the same security. Although the
Adviser will monitor the average life of the portfolio securities of each Fixed
Income Fund and Municipal Fund and make needed adjustments to comply with the
Funds' policy as to average dollar weighted portfolio maturity, there can be no
assurance that the average life of portfolio securities as estimated by the
Adviser will be the actual average life of such securities.
As stated in the Prospectus, no Fund will invest 25% or more of its
total assets in CMOs (other than U.S. Government Securities).
Asset-Backed Securities
As stated in the Prospectus, the Fixed Income Funds may invest in
asset-backed securities, which represent participations in, or are secured by
and payable from, pools of assets including company receivables, truck and auto
loans, leases and credit card receivables. The asset pools that back
asset-backed securities are securitized through the use of privately-formed
trusts or special purpose corporations. Payments or distributions of principal
and interest may be guaranteed up to certain amounts and for a certain time
period by a letter of credit or a pool insurance policy issued by a financial
institution unaffiliated with the trust or corporation, or other credit
enhancements may be present. Certain asset backed securities may be considered
derivative instruments. As stated in the Prospectus, no Fund will invest 25% or
more of its total assets in asset-backed securities.
Foreign Securities
Subject to their respective investment objectives and policies, the
Equity Funds and the Fixed Income Funds may invest in securities of foreign
issuers. While the Equity Funds' non-U.S. investments may be denominated in any
currency, the Fixed Income Funds' investments in foreign securities may be
denominated only in the U.S. dollar. Foreign securities may offer investment
opportunities not available in the United States, but such investments also
involve significant risks not typically associated with investing in domestic
securities. In many foreign countries, there is less publicly available
information about foreign issuers, and there is less government regulation and
supervision of foreign stock exchanges, brokers and listed companies. Also, in
many foreign countries, companies are not subject to uniform accounting,
auditing, and financial reporting standards comparable to those applicable to
domestic issuers. Security trading practices differ and there may be difficulty
in enforcing legal rights outside the United States. Settlement of transactions
in some foreign markets may be delayed or may be less frequent than in the
United States,
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which could affect the liquidity of the Funds' portfolios. Additionally, in
some foreign countries, there is the possibility of expropriation or
confiscatory taxation, limitations on the removal of securities, property, or
other Fund assets, political or social instability or diplomatic developments
which could affect investments in foreign securities.
To the extent the Equity Funds' investments are denominated in foreign
currencies, the net asset values of such Funds may be affected favorably or
unfavorably by fluctuations in currency exchange rates and by changes in
exchange control regulations. For example, if the Adviser increases an Equity
Fund's exposure to a foreign currency, and that currency's value subsequently
falls, the Adviser's currency management may result in increased losses to the
Fund. Similarly, if the Adviser hedges an Equity Fund's exposure to a foreign
currency, and that currency's value rises, the Fund will lose the opportunity to
participate in the currency's appreciation. The Equity Funds will incur
transaction costs in connection with conversions between currencies.
Foreign Government Securities. The foreign government securities in
which the Fixed Income Funds and the Equity Funds may invest generally consist
of debt obligations issued or guaranteed by national, state or provincial
governments or similar political subdivisions. The Fixed Income Funds and the
Equity Funds may invest in foreign government securities in the form of American
Depositary Receipts. Foreign government securities also include debt securities
of supranational entities. Currently, each Fixed Income Fund intends to invest
only in obligations issues or guaranteed by the Asian Development Bank, the
Inter-American Development Bank, the International Bank for Reconstruction and
Development (the "World Bank"), the African Development Bank, the European Coal
and Steel Community, the European Economic Community, the European Investment
Bank and the Nordic Investment Bank. Foreign government securities also include
mortgage-related securities issued or guaranteed by national, state or
provincial governmental instrumentalities, including quasi-governmental
agencies.
Forward Foreign Currency Exchange Contracts
Each of the Equity Funds may exchange currencies in the normal course
of managing its investments in foreign securities and may incur costs in doing
so because a foreign exchange dealer will charge a fee for conversion. An Equity
Fund may conduct foreign currency exchange transactions on a "spot" basis (i.e.,
for prompt delivery and settlement) at the prevailing spot rate for purchasing
or selling currency in the foreign currency exchange market. An Equity Fund also
may enter into forward foreign currency exchange contracts ("forward currency
contracts") or other contracts to purchase and sell currencies for settlement at
a future date. A foreign exchange dealer, in that situation, will expect to
realize a profit based on the difference between the price at which a foreign
currency is sold to the Equity Fund and the price at which the dealer will cover
the purchase in the
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foreign currency market. Foreign exchange transactions are entered into at
prices quoted by dealers, which may include a mark-up over the price that the
dealer must pay for the currency.
A forward currency contract involves an obligation to purchase or sell
a specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are traded in the interbank market conducted
directly between currency traders (usually large commercial banks) and their
customers. A forward contract generally has no deposit requirement, and no
commissions are generally charged at any stage for trades.
At the maturity of a forward contract, an Equity Fund may either accept
or make delivery of the currency specified in the contract or, at or prior to
maturity, enter into a closing purchase transaction involving the purchase or
sale of an offsetting contract. Closing purchase transactions with respect to
forward contracts are usually effected with the currency trader who is a party
to the original forward contract.
The Equity Funds may enter into forward currency contracts only for the
following hedging purposes. First, when an Equity Fund enters into a contract
for the purchase or sale of a security denominated in a foreign currency, or
when an Equity Fund anticipates the receipt in a foreign currency of dividend or
interest payments on such a security which it holds, the Fund may desire to
"lock in" the U.S. dollar price of the security or the U.S. dollar equivalent of
such dividend or interest payment, as the case may be. By entering into a
forward contract for the purchase or sale, for a fixed amount of U.S. dollars,
of the amount of foreign currency involved in the underlying transactions, the
Fund will attempt to protect itself against an adverse change in the
relationship between the U.S. dollar and the subject foreign currency during the
period between the date on which the security is purchased or sold, or on which
the dividend or interest payment is declared, and the date on which such
payments are made or received.
Additionally, when management of an Equity Fund believes that the
currency of a particular foreign country may suffer a substantial decline
against the U.S. dollar, it may cause the Fund to enter into a forward contract
to sell, for a fixed amount of U.S. dollars, the amount of foreign currency
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. The precise matching of the forward
contract amounts and the value of the securities involved will not generally be
possible because the future value of such securities in foreign currencies will
change as a consequence of market movements in the value of those securities
between the date on which the contract is entered into and the date it matures.
Using forward currency contracts in an attempt to protect the value of a Fund's
portfolio securities against a decline in the value of a currency does not
eliminate fluctuations in the underlying prices of the securities. It simply
establishes a rate of exchange which a Fund can achieve at some future point in
time. The precise
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projection of short-term currency market movements is not possible, and
short-term hedging provides a means of fixing the dollar value of only a portion
of a Fund's foreign assets.
A Fund's custodian will place cash or liquid securities into a
segregated account of the Fund in an amount equal to the value of the Fund's
total assets committed to the consummation of forward currency contracts
requiring the Fund to purchase foreign currencies. If the value of the
securities placed in the segregated account declines, additional cash or liwuid
securities will be placed in the account on a daily basis so that the value of
the account will equal the amount of a Fund's commitments with respect to such
contracts. The segregated account will be marked-to-market on a daily basis.
Although forward currency contracts are not presently 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 Funds' ability to
utilize forward currency contracts may be restricted. In addition, a particular
forward currency contract and assets used to cover such contract may be
illiquid.
The Equity Funds generally will not enter into a forward currency
contract with a term of greater than one year.
While the Equity Funds will enter into forward currency contracts to
reduce currency exchange rate risks, transactions in such contracts involve
certain other risks. Thus, while the Equity Funds may benefit from currency
transactions, unanticipated changes in currency prices may result in a poorer
overall performance for a Fund than if it had not engaged in any such
transactions. Moreover, there may be an imperfect correlation between a Fund's
portfolio holdings of securities denominated in a particular currency and
forward contracts entered into by the Fund. Such imperfect correlation may cause
a Fund to sustain losses which will prevent the Fund from achieving a complete
hedge or expose the Fund to risk of foreign currency exchange loss. Forward
currency contracts may be considered derivative instruments.
Each Equity Fund's activities in forward currency exchange contracts,
currency futures contracts and related options and currency options (see below)
may be limited by the requirements of subchapter M of the Code), for
qualification as a regulated investment company.
Options on Securities, Securities Indices and Foreign Currencies
Each of the Equity Funds may write covered put and call options and
purchase put and call options. Such options may relate to particular securities,
to various stock indices, or to currencies. The Funds may write call and put
options which are issued by the Options Clearing Corporation (the "OCC") or
which are traded on U.S. and non-U.S. exchanges and over-the-counter. These
instruments may be considered derivative
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instruments. See "Description of Securities and Investment Techniques
and Related Risks -- Options" in the Prospectus.
A call option on a securities index provides the holder with the right
to receive a cash payment upon exercise of the option if the market value of the
underlying index exceeds the option's exercise price. Conversely, a put option
on a securities index provides the holder with the right to receive a cash
payment upon exercise of the option if the market value of the underlying index
is less than the option's exercise price. The amount of any payment to the
option holder will be equal to the difference between the closing price of the
index at the time of exercise and the exercise price of the option expressed in
U.S. dollars or a foreign currency, times a specified multiple. A put option on
a currency gives its holder the right to sell an amount (specified in units of
the underlying currency) of the underlying currency at the stated exercise price
at any time prior to the option's expiration. Conversely, a call option on a
currency gives its holder the right to purchase an amount (specified in units of
the underlying currency) of the underlying currency at the stated exercise price
at any time prior to the option's expiration.
The Funds will engage in over-the-counter ("OTC") options only with
broker-dealers deemed creditworthy by the Adviser. Closing transactions in
certain options are usually effected directly with the same broker-dealer that
effected the original option transaction. A Fund bears the risk that the
broker-dealer may fail to meet its obligations. There is no assurance that a
Fund will be able to close an unlisted option position. Furthermore, unlisted
options are not subject to the protections afforded purchasers of listed options
by the OCC, which performs the obligations of its members who fail to do so in
connection with the purchase or sale of options. OTC options and the assets used
to cover such options will be deemed illiquid for purposes of each Equity Fund's
15% limitation on investments in 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
approved by the staff of the Commission.
An Equity Fund will write call options only if they are "covered." In
the case of a call option on a security, the option is "covered" if the Fund
owns the security underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or, if additional
cash consideration is required, cash or liquid securities in such amount are
held in a segregated account by the Fund's custodian) upon conversion or
exchange of other securities held by it. For a call option on an index, the
option is covered if the Fund maintains with the Fund's custodian cash or liquid
securities equal to the contract value. A call option on a security or an index
is also covered if the Fund holds a call on the same security or index as the
call written by the Fund where the exercise price of the call held is (i) equal
to or less than the exercise price of the call written, or (ii) greater than the
exercise price of the call written provided the difference is maintained by the
Fund in cash or
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liquid securities in a segregated account with the Fund's custodian. A call
option on currency written by a Fund is covered if the Fund owns an equal amount
of the underlying currency.
When a Fund purchases a put option, the premium paid by it is recorded
as an asset of the Fund. When the Fund writes an option, an amount equal to the
net premium (the premium less the commission paid by the Fund) received by the
Fund is included in the liability section of the Fund's statement of assets and
liabilities as a deferred credit. The amount of this asset or deferred credit
will be marked-to-market on an ongoing basis to reflect the current value of the
option purchased or written. The current value of a traded option is the last
sale price or, in the absence of a sale, the average of the closing bid and
asked prices. If an option purchased by the Fund expires unexercised, the Fund
realizes a loss equal to the premium paid. If the Fund enters into a closing
sale transaction on an option purchased by it, the Fund will realize a gain if
the premium received by the Fund on the closing transaction is more than the
premium paid to purchase the option, or a loss if it is less. If an option
written by the Fund expires on the stipulated expiration date or if the Fund
enters into a closing purchase transaction, it will realize a gain (or loss if
the cost of a closing purchase transaction exceeds the net premium received when
the option is sold) and the deferred credit related to such option will be
eliminated. If an option written by the Fund is exercised, the proceeds to the
Fund from the exercise will be increased by the net premium originally received,
and the Fund will realize a gain or loss.
There are several risks associated with transactions in options on
securities, securities indices and currencies. For example, there are
significant differences between the securities markets, currency markets and the
corresponding options markets that could result in imperfect correlations,
causing a given option transaction not to achieve its objectives. In addition, a
liquid secondary market for particular options, whether traded OTC or on a U.S.
or non-U.S. securities exchange may be absent for reasons which include the
following: there may be insufficient trading interest in certain options;
restrictions may be imposed by an exchange on opening transactions or closing
transactions or both; trading halts, suspensions or other restrictions may be
imposed with respect to particular classes or series of options or underlying
securities; unusual or unforeseen circumstances may interrupt normal operations
on an exchange; the facilities of an exchange or the OCC may not at all times be
adequate to handle current trading volume; or 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),
in which event the secondary market on that exchange (or in that class or series
of options) would cease to exist, although outstanding options 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 hours of trading for options may not conform to the hours during
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which the underlying securities and currencies are traded. To the extent that
the options markets close before the markets for the underlying securities and
currencies, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the options markets. The purchase
of options is a highly specialized activity which involves investment techniques
and risks different from those associated with ordinary portfolio securities
transactions.
The risks described above also apply to options on futures, which are discussed
below.
Futures Contracts and Related Options
To hedge against changes in interest rates or securities prices and for
certain non-hedging purposes, the Equity Funds may purchase and sell various
kinds of futures contracts, and purchase and write call and put options on any
of such futures contracts. The Equity Funds may also enter into closing purchase
and sale transactions with respect to any of such contracts and options. The
futures contracts may be based on various securities (such as U.S. Government
securities), indices, currencies and other financial instruments. The Equity
Funds will engage in futures and related options transactions only for bona fide
hedging or other non-hedging purposes as defined in regulations promulgated by
the CFTC. All futures contracts entered into by the Equity Funds are traded on
U.S. exchanges or boards of trade that are licensed and regulated by the CFTC or
on foreign exchanges approved by the CFTC.
Futures Contracts. A futures contract may generally be described as an
agreement between two parties to buy and sell a particular financial instrument
for an agreed 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).
Futures contracts obligate the long or short holder to take or make delivery of
a specified quantity of a commodity or financial instrument, such as a security
or the cash value of a securities index, during a specified future period at a
specified price.
When interest rates are rising or securities prices are falling, an
Equity Fund can seek to offset a decline in the value of its current portfolio
securities through the sale of futures contracts. When interest rates are
falling or securities prices are rising, an Equity Fund, through the purchase of
futures contracts, can attempt to secure better rates or prices than might later
be available in the market when it effects anticipated purchases.
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 futures contracts on securities will usually
be liquidated in this manner, the Equity Funds may instead make, or take,
delivery of the underlying securities whenever it appears economically
advantageous to do so. A clearing corporation associated with the exchange on
which futures on securities are traded guarantees that, if still open, the sale
or purchase will be performed on the settlement date.
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Hedging Strategies. Hedging, by use of futures contracts, seeks to
establish with more certainty the effective price and rate of return on
portfolio securities and securities that a Fund proposes to acquire. The Equity
Funds may, for example, take a "short" position in the futures market by selling
futures contracts in order to hedge against an anticipated rise in interest
rates or a decline in market prices that would adversely affect the value of a
Fund's portfolio securities. Such futures contracts may include contracts for
the future delivery of securities held by a Fund or securities with
characteristics similar to those of the Fund's portfolio securities. If, in the
opinion of the Adviser, there is a sufficient degree of correlation between
price trends for an Equity Fund's portfolio securities and futures contracts
based on other financial instruments, securities indices or other indices, the
Fund may also 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 Adviser will
attempt to estimate the extent of this volatility difference based on historical
patterns and compensate for any such differential by having the Fund enter into
a greater or lesser number of futures contracts or by attempting to achieve only
a partial hedge against price changes affecting a Fund's securities portfolio.
When hedging of this character is successful, any depreciation in the value of
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 would be substantially offset by a
decline in the value of the futures position.
On other occasions, the Equity Funds may take a "long" position by
purchasing futures contracts. This would be done, for example, when a Fund
anticipates the subsequent purchase of particular securities when it has the
necessary cash, but expects the prices then available in the applicable market
to be less favorable than prices that are currently available.
Options on Futures Contracts. The acquisition of put and call options
on futures contracts will give the Equity 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, a Fund obtains the benefit of the
futures position if prices move in a favorable direction but limits 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
which may partially offset a decline in the value of a Fund's assets. By writing
a call option, a Fund becomes obligated, in exchange for the premium, to sell a
futures contract (if the option is exercised), which may have a value higher
than the exercise price. Conversely, the writing of a put option on a futures
contract generates a premium which may partially
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offset an increase in the price of securities that a Fund intends to purchase.
However, a Fund becomes obligated to purchase a futures contract (if the option
is exercised) which 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. The 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 such closing transactions can be effected. The Equity
Funds' ability to establish and close out positions on such options will be
subject to the development and maintenance of a liquid market.
The Equity Funds may use options on futures contracts solely for bona
fide hedging or other non-hedging purposes as described below.
Other Considerations. The Equity Funds will engage in futures and
related options transactions only for bona fide hedging or non-hedging purposes
as permitted by CFTC regulations which permit principals of an investment
company registered under the 1940 Act to engage in such transactions without
registering as commodity pool operators. Each Equity Fund will determine that
the price fluctuations in the futures contracts and options on futures used by
it for hedging purposes are substantially related to price fluctuations in
securities or instruments held by the Fund or securities or instruments which it
expects to purchase. Except as stated below, the Equity Funds' futures
transactions will be entered into for traditional hedging purposes--i.e.,
futures contracts will be sold to protect against a decline in the price of
securities (or the currency in which they are denominated) that a Fund owns or
futures contracts will be purchased to protect a Fund against an increase in the
price of securities (or the currency in which they are denominated) that a Fund
intends to purchase. As evidence of this hedging intent, each Equity Fund
expects that, on 75% or more of the occasions on which it takes a long futures
or option position (involving the purchase of futures contracts), the Fund will
have purchased, or will be in the process of purchasing, equivalent amounts of
related securities (or assets denominated in the related currency) in the cash
market at the time when the futures or option position is closed out. However,
in particular cases, when it is economically advantageous for a Fund to do so, a
long futures position may be terminated or an option may expire without the
corresponding purchase of securities or other assets.
As an alternative to compliance with the bona fide hedging definition,
a CFTC regulation now permits a Fund to elect to comply with a different test
under which the aggregate initial margin and premiums required to establish
non-hedging positions in futures contracts and options on futures will not
exceed 5% of the net asset value of a Fund's portfolio, after taking into
account unrealized profits and losses on any such positions and excluding the
amount by which such options were in-the-money at the time of purchase. A Fund
will engage in transactions in futures contracts and
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related options only to the extent such transactions are consistent with the
requirements of the Code for maintaining its qualification as a regulated
investment company. See "Taxes."
Each Equity Fund will be required, in connection with transactions in
futures contracts and the writing of options on futures contracts, to make
margin deposits, which will be held by its custodian for the benefit of the
futures commission merchant through whom the Fund engages in such futures and
option transactions. These transactions involve brokerage costs, require margin
deposits and, in the case of futures contracts and options obligating a Fund to
purchase securities, require a Fund to segregate cash or liquid securities in an
account maintained with its custodian to cover such contracts and options.
While transactions in futures contracts and options on futures may
reduce certain risks, such transactions themselves entail certain other risks.
Thus, unanticipated changes in interest rates or securities prices may result in
a poorer overall performance for a Fund than if it had not entered into any
futures contracts or options transactions. The other risks associated with the
use of futures contracts and options thereon are (i) imperfect correlation
between the change in market value of the securities held by a Fund and the
prices of the futures and options and (ii) the possible absence of a liquid
secondary market for a futures contract or option and the resulting inability to
close a futures position prior to its maturity date.
In the event of an imperfect correlation between a futures position and
portfolio position which is intended to be protected, the desired protection may
not be obtained and an Equity Fund may be exposed to risk of loss. The risk of
imperfect correlation may be minimized by investing in contracts whose price
behavior is expected to resemble that of the Fund's underlying securities. The
Funds will attempt to minimize the risk that they will be unable to close out
futures positions by entering into such transactions on a national exchange with
an active and liquid secondary market.
Commercial Paper
Commercial paper is a short-term, unsecured negotiable promissory note
of a U.S or non-U.S issuer. Each of the Funds may purchase commercial paper as
described in the Prospectus. Each Fund may also invest in variable rate master
demand notes which typically are issued by large corporate borrowers and which
provide for variable amounts of principal indebtedness and periodic adjustments
in the interest rate. Demand notes are direct lending arrangements between a
Fund and an issuer, and are not normally traded in a secondary market. A Fund,
however, may demand payment of principal and accrued interest at any time. In
addition, while demand notes generally are not rated, their issuers must satisfy
the same criteria as those that apply to issuers of commercial paper. The
Adviser will consider the earning
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power, cash flow and other liquidity ratios of issuers of demand notes and
continually will monitor their financial ability to meet payment on demand. See
also "Fixed Income Securities --Variable and Floating Rate Instruments."
Bank Obligations
As stated in the Prospectus, each Fund's investments in money market
instruments may include certificates of deposit, time deposits and bankers'
acceptances. Certificates of Deposit ("CDs") are short-term negotiable
obligations of commercial banks. Time Deposits ("TDs") are non-negotiable
deposits maintained in banking institutions for specified periods of time at
stated interest rates. Bankers' acceptances are time drafts drawn on commercial
banks by borrowers usually in connection with international transactions.
U.S. commercial banks organized under federal law are supervised and
examined by the Comptroller of the Currency and are required to be members of
the Federal Reserve System and to be insured by the Federal Deposit Insurance
Corporation (the "FDIC"). U.S. banks organized under state law are supervised
and examined by state banking authorities but are members of the Federal Reserve
System only if they elect to join. Most state banks are insured by the FDIC
(although such insurance may not be of material benefit to a Fund, depending
upon the principal amount of CDs of each bank held by the Fund) and are subject
to federal examination and to a substantial body of federal law and regulation.
As a result of governmental regulations, U.S. branches of U.S. banks, among
other things, generally are required to maintain specified levels of reserves,
and are subject to other supervision and regulation designed to promote
financial soundness.
U.S. savings and loan associations, the CDs of which may be purchased
by the Funds, are supervised and subject to examination by the Office of Thrift
Supervision. U.S. savings and loan associations are insured by the Savings
Association Insurance Fund which is administered by the FDIC and backed by the
full faith and credit of the U.S. Government.
Repurchase Agreements
Each of the Funds may enter into repurchase agreements as described in
the Prospectus.
For purposes of the 1940 Act and, generally, for tax purposes, a
repurchase agreement is considered to be a loan from the Fund to the seller of
the obligation. For other purposes, it is not clear whether a court would
consider such an obligation as being owned by the Fund or as being collateral
for a loan by the Fund to the seller. In the event of the commencement of
bankruptcy or insolvency proceedings with respect to the seller of the
obligation before its repurchase, under the repurchase agreement, the Fund may
encounter delay and incur costs before being able to sell the security. Such
delays may result in a loss of interest or decline in price of the obligation.
If the court characterizes the transaction as a loan and the Fund has not
perfected a security interest in the obligation,
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the Fund may be treated as an unsecured creditor of the seller and required to
return the obligation to the seller's estate. As an unsecured creditor, the Fund
would be at risk of losing some or all of the principal and income involved in
the transaction. As with any unsecured debt instrument purchased for the Funds,
the Adviser seeks to minimize the risk of loss from repurchase agreements by
analyzing the creditworthiness of the obligor, in this case, the seller of the
obligation. In addition to the risk of bankruptcy or insolvency proceedings,
there is the risk that the seller may fail to repurchase the security. However,
if the market value of the obligation falls below an amount equal to 102% of the
repurchase price (including accrued interest), the seller of the obligation will
be required to deliver additional securities so that the market value of all
securities subject to the repurchase agreement equals or exceeds the repurchase
price.
"When-Issued" Purchases and Forward Commitments (Delayed Delivery)
These transactions, which involve a commitment by a Fund to purchase or
sell particular securities with payment and delivery taking place at a future
date (perhaps one or two months later), permit the Fund to lock in a price or
yield on a security, regardless of future changes in interest rates. A Fund will
purchase securities on a "when-issued" or forward commitment basis only with the
intention of completing the transaction and actually purchasing the securities.
If deemed appropriate by the Adviser, however, a Fund may dispose of or
renegotiate a commitment after it is entered into, and may sell securities it
has committed to purchase before those securities are delivered to the Fund on
the settlement date. In these cases the Fund may realize a gain or loss, and
distributions attributable to any such gain would be taxable to shareholders.
When a Fund agrees to purchase securities on a "when-issued" or forward
commitment basis, the Fund's custodian will set aside cash or liquid securities
equal to the amount of the commitment in a separate account. Normally, the
custodian will set aside portfolio securities to satisfy a purchase commitment,
and in such a case the Fund may be required subsequently to place additional
assets in the separate account in order to ensure that the value of the account
remains equal to the amount of the Fund's commitments. The market value of a
Fund's net assets will generally fluctuate to a greater degree when it sets
aside portfolio securities to cover such purchase commitments than when it sets
aside cash. Because a Fund's liquidity and ability to manage its portfolio might
be affected when it sets aside cash or portfolio securities to cover such
purchase commitments, each Fund expects that its commitments to purchase
when-issued securities and forward commitments will not exceed 33% of the value
of its total assets. When a Fund engages in "when-issued" and forward commitment
transactions, it relies on the other party to the transaction to consummate the
trade. Failure of such party to do so may result in the Fund incurring a loss or
missing an opportunity to obtain a price considered to be advantageous.
25
<PAGE>
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities, and any subsequent fluctuations
in their market value, are taken into account when determining the market value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest or dividends on the securities it has committed to
purchase until the settlement date.
Borrowing
Each Fund may borrow for temporary or emergency purposes, although
borrowings by the Fixed Income Fund and the Municipal Bond Fund may not exceed
10% of the value of their respective net assets. This borrowing may be
unsecured. The 1940 Act requires a Fund to maintain continuous asset coverage
(that is, total assets including borrowings, less liabilities exclusive of
borrowings) of 300% of the amount borrowed. If the asset coverage should decline
below 300% as a result of market fluctuations or for other reasons, a Fund will
be required to sell some of its portfolio securities within three days to reduce
its borrowings and restore the 300% asset coverage, even though it may be
disadvantageous from an investment standpoint to sell securities at that time.
To limit the potential leveraging effects of a Fund's borrowings, each Equity
Fund, the Short-Term Fixed Income Fund and the Short-Term Municipal Bond Fund
will not make investments while borrowings are in excess of 5% of total assets.
The Fixed Income Fund and the Municipal Bond Fund may not make additional
investments while they have any borrowings outstanding. Borrowing generally will
exaggerate the effect on net asset value of any increase or decrease in the
market value of the portfolio. Money borrowed will be subject to interest costs
which may or may not be recovered by appreciation of the securities purchased. A
Fund also may be required to maintain minimum average balances in connection
with such borrowing or to pay a commitment or other fee to maintain a line of
credit; either of these requirements would increase the cost of borrowing over
the stated interest rate. See "Investment Restrictions."
Lending Portfolio Securities
Each Fund, other than Fixed Income Fund and Municipal Bond Fund, may
lend portfolio securities to brokers, dealers and other financial organizations.
These loans, if and when made by a Fund, may not exceed 33 1/3% of the value of
the Fund's total assets. A Fund's loans of securities will be collateralized by
cash, cash equivalents or U.S. Government securities. The cash or instruments
collateralizing the Fund's loans of securities will be maintained at all times
in a segregated account with the Fund's custodian, in an amount at least equal
to the current market value of the loaned securities. From time to time, a Fund
may pay a part of the interest earned from the investment of collateral received
for securities loaned to the borrower and/or a third party that is unaffiliated
with the Fund and is acting as a "placing broker". No fee will be paid to
affiliated persons of the Fund. The Board of Trustees will make a determination
that the fee paid to the placing broker is reasonable.
26
<PAGE>
By lending portfolio securities, a Fund can increase its income by
continuing to receive amounts equal to the interest or dividends on the loaned
securities as well as by either investing the cash collateral in short-term
instruments or obtaining yield in the form of interest paid by the borrower when
U.S. Government securities are used as collateral. A Fund will comply with the
following conditions whenever it loans securities: (i) the Fund must receive at
least 100% cash collateral or equivalent securities from the borrower; (ii) the
borrower must increase the collateral whenever the market value of the
securities loaned rises above the level of the collateral; (iii) the Fund must
be able to terminate the loan at any time; (iv) the Fund must receive reasonable
interest on the loan, as well as amounts equal to the dividends, interest or
other distributions on the loaned securities, and any increase in market value;
(v) the Fund may pay only reasonable custodian fees in connection with the loan;
and (vi) voting rights on the loaned securities may pass to the borrower except
that, if a material event will occur affecting the investment in the loaned
securities, the Fund must terminate the loan in time to vote the securities on
such event.
INVESTMENT RESTRICTIONS
The fundamental investment restrictions set forth below may not be
changed with respect to a Fund without the approval of a "majority" (as defined
in the 1940 Act) of the outstanding shares of that Fund. For the purposes of the
1940 Act, "majority" means the lesser of (a) 67% or more of the shares of the
Fund present at a meeting, if the holders of more than 50% of the outstanding
shares of the Fund are present or represented by proxy or (b) more than 50% of
the shares of the Fund.
Investment restrictions that involve a maximum percentage of securities
or assets shall not be considered to be violated unless an excess over the
percentage occurs immediately after, and is caused by, an acquisition or
encumbrance of securities or assets of, or borrowings by or on behalf of, a Fund
with the exception of borrowings permitted by fundamental investment restriction
(2) listed below for Short-Term Fixed Income Fund, Short-Term Municipal Bond
Fund and the Equity Funds and fundamental investment restriction (3) listed
below for Fixed Income Fund and Municipal Bond Fund.
The nonfundamental investment restrictions set forth below may be
changed or amended by the Trust's Board of Trustees without shareholder
approval.
Investment Restrictions That Apply to Short-Term Fixed Income Fund,
Short-Term Municipal Bond Fund and the Equity Funds
Fundamental Investment Restrictions. The Trust may not, on behalf of
27
<PAGE>
a Fund:
(1) Issue senior securities, except as permitted by paragraphs (2), (6)
and (7) below. For purposes of this restriction, the issuance of shares of
beneficial interest in multiple classes or series, the purchase or sale of
options, futures contracts and options on futures contracts, forward
commitments, forward foreign exchange contracts, repurchase agreements and
reverse repurchase agreements entered into in accordance with the Fund's
investment policy, and the pledge, mortgage or hypothecation of the Fund's
assets within the meaning of paragraph (3) below are not deemed to be senior
securities, if appropriately covered.
(2) Borrow money (i) except from banks as a temporary measure for
extraordinary emergency purposes and (ii) except that the Fund may enter into
reverse repurchase agreements and dollar rolls, if appropriately covered, with
banks, broker-dealers and other parties; provided that, in each case, the Fund
is required to maintain asset coverage of at least 300% for all borrowings. For
the purposes of this investment restriction, short sales, transactions in
currency, forward contracts, swaps, options, futures contracts and options on
futures contracts, and forward commitment transactions shall not constitute
borrowing.
(3) Pledge, mortgage, or hypothecate its assets, except to secure
indebtedness permitted by paragraph (2) above and to the extent related to the
segregation of assets in connection with the writing of covered put and call
options and the purchase of securities or currencies on a forward commitment or
delayed-delivery basis and collateral and initial or variation margin
arrangements with respect to forward contracts, options, futures contracts and
options on futures contracts.
(4) Act as an underwriter, except to the extent that, in connection
with the disposition of Fund securities, the Fund may be deemed to be an
underwriter for purposes of the Securities Act of 1933.
(5) Purchase or sell real estate, or any interest therein, and real
estate mortgage loans, except that the Fund may invest in securities of
corporate or governmental entities secured by real estate or marketable
interests therein or securities issued by companies (other than real estate
limited partnerships) that invest in real estate or interests therein.
(6) Make loans, except that the Fund may lend Fund securities in
accordance with the Fund's investment policies and may purchase or invest in
repurchase agreements, bank certificates of deposit, all or a portion of an
issue of bonds, bank loan participation agreements, bankers' acceptances,
debentures or other securities, whether or not the purchase is made upon the
original issuance of the securities.
(7) Invest in commodities or commodity contracts or in puts, calls, or
combinations of both, except interest rate futures contracts, options on
securities, securities indices, currency and other financial instruments,
futures contracts on securities, securities indices, currency and other
<PAGE>
28
financial instruments and options on such futures contracts, forward foreign
currency exchange contracts, forward commitments, securities index put or call
warrants and repurchase agreements entered into in accordance with the Fund's
investment policies.
(8) Invest 25% or more of the value of the Fund's total assets in the
securities of one or more issuers conducting their principal business activities
in the same industry or group of industries. This restriction does not apply to
investments in obligations of the U.S. Government or any of its agencies or
instrumentalities.
In addition, each Fund will adhere to the following
fundamental investment restriction:
With respect to 75% of its total assets, a Fund may not
purchase securities of an issuer (other than the U.S. Government, or any of its
agencies or instrumentalities, or other investment companies), if
(a) such purchase would cause more than 5% of the Fund's total
assets taken at market value to be invested in the securities of such
issuer, or
(b) such purchase would at the time result in more than 10%
of the outstanding voting securities of such issuer
being held by the Fund.
NonFundamental Investment Restrictions. The Trust may not, on behalf of a Fund:
(a) Participate on a joint-and-several basis in any securities trading
account. The "bunching" of orders for the sale or purchase of marketable Fund
securities with other accounts under the management of the Adviser to save
commissions or to average prices among them is not deemed to result in a
securities trading account.
(b) Purchase securities on margin or make short sales unless by virtue
of its ownership of other securities, the Fund has the right to obtain, without
payment of additional consideration, securities equivalent in kind and amount to
the securities sold and, if the right is conditional, the sale is made upon the
same conditions, except that a Fund may obtain such short-term credits as may be
necessary for the clearance of purchases and sales of securities and in
connection with transactions involving forward foreign currency exchange
transactions, options, futures and options on futures.
(c) Purchase securities of other investment companies, except in the
open market where no commission or profit to a sponsor or dealer results from
the purchase other than the customary broker's commission and as permitted by
the Investment Company Act of 1940 and the rules and
29
<PAGE>
regulations thereunder.
(d) Purchase securities of any issuer which, together with any
predecessor, has a record of less than three years' continuous operations prior
to the purchase if such purchase would cause investments of the Fund in all such
issuers to exceed 5% of the value of the total assets of the Fund.
(e) Invest for the purpose of exercising control over or management of
any company.
(f) Purchase warrants of any issuer, if, as a result of such purchases,
more than 2% of the value of the Fund's net assets would be invested in warrants
which are not listed on the New York Stock Exchange or the American Stock
Exchange or more than 5% of the value of the net assets of the Fund would be
invested in warrants generally, whether or not so listed. For these purposes,
warrants are to be valued at the lesser of cost or market, but warrants acquired
by the Fund in units with or attached to debt securities shall be deemed to be
without value.
(g) Purchase or retain securities of an issuer if one or more of the
Trustees or officers of the Trust or directors or officers of the Adviser or any
investment management subsidiary of the Adviser individually owns beneficially
more than 0.5% and together own beneficially more than 5% of the securities of
such issuer.
(h) Purchase interests in oil, gas or other mineral leases or
exploration programs; however, this policy will not prohibit the acquisition of
securities of companies engaged in the production or transmission of oil, gas or
other minerals.
(i) Purchase any security, including any repurchase agreement maturing
in more than seven days, which is illiquid, if more than 15% of the net assets
of the Fund, taken at market value, would be invested in such securities.
(j) Invest more than 5% of its total assets in restricted securities,
excluding restricted securities eligible for resale pursuant to Rule 144A under
the Securities Act of 1933; provided, however, that no more than 15% of the
Fund's total assets may be invested in restricted securities including
restricted securities eligible for resale under Rule 144A.
(k) Write covered calls or put options with respect to more than 25% of
the value of its total assets or invest more than 5% of its total assets in
puts, calls, spreads, or straddles, other than protective put options.
The staff of the Commission has taken the position that fixed time
deposits maturing in more than seven days that cannot be traded on a secondary
market and participation interests in loans are illiquid. Until such time (if
any) as this position changes, the Trust, on behalf of each Fund, will include
such investments in determining compliance with the 15%
30
<PAGE>
limitation on investments in illiquid securities. Restricted securities
(including commercial paper issued pursuant to Section 4(2) of the Securities
Act of 1933, which the Board of Trustees has determined are readily marketable
will not be deemed to be illiquid for purposes of such restriction.
"Value" for the purposes of the foregoing investment restrictions shall
mean the market value used in determining each Fund's net asset value.
Investment Restrictions That Apply to the Fixed Income Fund And the
Municipal Bond Fund
Fundamental Investment Restrictions. The Trust may not, on behalf of
the Fixed Income Fund or the Municipal Bond Fund:
(1) Acquire more than 10% of the voting securities of any one issuer.
(2) Invest in companies for the purpose of exercising control.
(3) Borrow money except for temporary or emergency purposes and then only in an
amount not exceeding 10% of the value of its total assets. Any borrowing
will be done from a bank and to the extent that such borrowing exceeds 5%
of the value of a Fund's assets, asset coverage of at least 300% is
required. In the event that such asset coverage shall at any time fall
below 300%, a Fund shall, within three days thereafter or such longer
period as the Securities and Exchange Commission may prescribe by rules and
regulations, reduce the amount of its borrowings to such an extent that the
asset coverage of such borrowings shall be at least 300%. This borrowing
provision is included for temporary liquidity or emergency purposes. All
borrowings will be repaid before making investments and any interest paid
on such borrowings will reduce income.
(4) Make loans, except that a Fund may purchase or hold debt instruments in
accordance with its investment objective and policies, and a Fund may enter
into repurchase agreements.
(5) Pledge, mortgage or hypothecate assets except to secure temporary
borrowings permitted by (3) above in aggregate amounts not to exceed 10% of
total assets taken at current value at the time of the incurrence of such
loan.
(6) Purchase or sell real estate, real estate limited partnership interests,
futures contracts, commodities or commodities contracts and interests in a
pool of securities that are secured by interests in real estate. However,
subject to the permitted investments of the Fund, a Fund may invest in
municipal securities or other obligations secured by real estate or
interests therein.
(7) Make short sales of securities, maintain a short position or
31
<PAGE>
purchase securities on margin, except that a Fund may obtain short-term credits
as necessary for the clearance of security transactions.
(8) Act as an underwriter of securities of other issuers except as it may be
deemed an underwriter in selling a portfolio security.
(9) Purchase securities of other investment companies except as permitted by
the Investment Company Act of 1940 and the rules and regulations
thereunder.
(10) Issue senior securities (as defined in the Investment Company Act of 1940)
except in connection with permitted borrowings as described above or as
permitted by rule, regulation or order of the Securities and Exchange
Commission.
(11) Purchase or retain securities of an issuer if an officer, trustee, partner
or director of the Fund or any investment adviser of the Fund owns
beneficially more than 1/2 of 1% of the shares or securities of such issuer
and all such officers, trustees, partners and directors owning more than
1/2 of 1% of such shares or securities together own more than 5% of such
shares or securities.
(12) Invest in interests in oil, gas or other mineral exploration or development
programs and oil, gas or mineral leases.
(13) Write or purchase puts, calls, options or combinations thereof or invest in
warrants, except that a Fund may purchase "put" bonds as described in the
Prospectus.
Nonfundamental Investment Restrictions.
(1) A Fund may not invest in illiquid securities in an amount
exceeding, in the aggregate, 10% of the Municipal Bond Fund's total assets and
15% of the Fixed Income Fund's net assets. An illiquid security is a security
that cannot be disposed of promptly (within seven days) and in the usual course
of business without a loss, and includes repurchase agreements maturing in
excess of seven days, time deposits with a withdrawal penalty, non-negotiable
instruments and instruments for which no market exists.
(2) A Fund may not purchase securities of any issuer which, together
with any predecessor, has a record of less than three years' continuous
operations prior to the purchase if such purchase would cause investments of the
Fund in all such issuers to exceed 15% of the value of the total assets of the
Fund and the Fund may not invest more than 5% of its total assets in restricted
securities, excluding restricted securities eligible for resale pursuant to Rule
144A under the Securities Act of 1933; provided, however, that no more than 15%
of the Fund's total assets may be invested in restricted securities including
restricted securities eligible for resale under Rule 144A.
32
<PAGE>
(3) A Fund may not purchase securities of other investment companies
except in the open market where no commission or profit to a sponsor or dealer
results from the purchase other than the customary broker's commission and as
permitted by the Investment Company Act of 1940 and the rules and regulations
thereunder.
TRUSTEES AND OFFICERS
Information pertaining to the Trustees and officers of the Trust is set
forth below. An asterisk (*) indicates those Trustees deemed to be "interested
persons" of the Trust for purposes of the 1940 Act.
<TABLE>
<CAPTION>
Positions Principal Occupation
Name and Address With Trust During Past Five Years
<S> <C> <C>
James E. Minnick(1)* President, Chief President, Secretary and
885 Third Avenue Executive Treasurer, MGCM (since 1990).
New York, NY 10022 Officer, and
(age 48) Trustee
Patrick W. W. Disney(1)* Senior Vice Director, Morgan Grenfell
20 Finsbury Circus President and Investment Services Limited
London EC2M 1NB Trustee ("MGIS")(since 1988).
ENGLAND
(age 40)
Paul K. Freeman(2) Trustee Chief Executive Officer,
7257 So. Tucson Way The Eric Group, Inc.
Englewood, CO 80112 (environmental insurance)
(age 46) (since 1986).
33
<PAGE>
Graham E. Jones(2) Trustee Senior Vice President, BGK
330 Garfield Street Realty Inc. (since 1995);
Santa Fe, NM 87501 Financial Manager, Practice
(age 63) Management Systems (medical
information services)(1988-95); Director, 12 closed-end funds
managed by Morgan Stanley
Asset Management; Trustee,
10 open-end mutual funds managed
by Weiss, Peck & Greer.
William N. Searcy(2) Trustee Pension & Savings Trust
2330 Shawnee Mission Pkwy. Officer, Sprint Corporation
Westwood, KS 66205 (telecommunications) (since
(age 50) 1989).
Hugh G. Lynch Trustee Director, International
767 Fifth Avenue Investments, General Motors
New York, NY 10153 Investment Management
(age 59) Corporation (since
September 1990).
Edward T. Tokar Trustee Vice President--Investments,
101 Columbia Road Allied Signal Inc. (advanced
Morristown, NJ 07962 technology and manufacturer)
(age 49) (since 1985).
John G. Alshefski Treasurer, Deirector of Mutual Fund
530 East Swedesford Road Principal Operations, SEI/Fund Resources
Wayne, PA 19087-1658 Accounting (since January 1994); Manager,
(age 30) Officer, Chief International Fund Operations
Financial Officer (1992-1994); Senior Associate,
Price Waterhouse
(1988-1992).
Neil P. Jenkins(3) Vice President Director, MGCM (since
20 Finsburg Circus 1991), Morgan Grenfell
London, England International Funds Management,
(age 36) (since 1995), and Morgan
Grenfell & Co., Ltd. (since
1985).
David W. Baldt Vice President Executive Vice President and
1435 Walnut Street Director of Fixed Income
Philadelphia, PA 19102 Investments, MGCM (since 1989).
(age 47)
Ian D. Kelson Vice President Director, MGIS (since 1988);
20 Finsbury Circus Chief Investment Officer,
34
<PAGE>
London EC2M 1NB Fixed Income, MGIS (since
England 1989).
(age 40)
James H. Grifo Vice President Executive Vice President and
1435 Walnut Street Director, MGCM(since 1996);
Philadelphia, PA 19102 Senior Vice President, GT
(age 45) Global Financial (since 1990).
Martin Hall(4) Vice President Portfolio Manager,
1435 Walnut Street Fixed Income Team,
Philadelphia, PA 19102 MGIS (since 1988)
(age 38)
Mark G. Arthus Secretary and Director, Compliance and
885 Third Avenue Compliance Financial Control, MGCM
New York, NY 10022 Officer (since 1992); Vice President,
(age 40) Senior Compliance Officer
and other positions,
Citibank, N.A. (to 1992)
- -------------------------------------------------------------------------------
</TABLE>
1 Member of the Trust's Valuation and Dividend Committees.
2 Member of the Trust's Audit Committee.
3 Member of the Trust's Dividend Committee.
4 Member of the Trust's Valuation Committee.
Certain of the Trustees and officers of the Trust reside outside the
United States, and substantially all the assets of these persons are located
outside the United States. It may not be possible, therefore, for investors to
effect service of process within the United States upon these persons or to
enforce against them, in United States courts or foreign courts, judgments
obtained in United States courts predicated upon the civil liability provisions
of the federal securities laws of the United States or the laws of the State of
Delaware. In addition, it is not certain that a foreign court would enforce, in
original actions or in actions to enforce judgments obtained in the United
States, liabilities against these Trustees and officers predicated solely upon
the federal securities laws.
Messrs. Jones, Freeman and Searcy are members of the Audit Committee of
the Board of Trustees. The Audit Committee's functions include making
recommendations to the Trustees regarding the selection of independent
accountants, and reviewing with such accountants and the Treasurer of the Trust
matters relating to accounting and auditing practices and procedures, accounting
records, internal accounting controls and the functions performed by the Trust's
custodian, administrator and transfer agent.
As of December 17, 1996, the Trustees and officers of the Trust owned,
35
<PAGE>
as a group, less than one percent of the outstanding shares of each Fund other
than Morgan Grenfell Short-Term Municipal Bond Fund. On such date, the Trustees
and officers of the Trust owned, as a group, 8.54% of the outstanding shares of
Morgan Grenfell Short-Term Municipal Bond Fund.
Compensation of Trustees
The Trust pays each Trustee who is not affiliated with the Adviser an
annual fee of $15,000 provided that they attend each regular Board meeting
during the year. Members of the Audit Committee also receive $1,000 for each
Audit Committee meeting attended. The Chairman of the Audit Committee receives
an additional $1,000 per Audit Committee meeting attended. The Trustees are also
reimbursed for out-of-pocket expenses incurred by them in connection with their
duties as Trustees.
The following table sets forth the compensation paid by the Trust to
the Trustees for the fiscal year of the Trust ended October 31, 1996:
Pension or
Retirement Benefits Aggregate
Accrued as Part of Compensation from
Name of Trustees Fund Expenses the Trust / Complex *
James E. Minnick $ 0 $ 0
Patrick W. Disney $ 0 $ 0
Paul K. Freeman $ 0 $ 18,000
Graham E. Jones $ 0 $ 18,000
William N. Searcy $ 0 $ 21,000
Hugh G. Lynch $ 0 $ 15,000
Edward T. Tokar $ 0 $ 7,500
* The Trustees listed above do not serve on the Board of any other
investment company that may be considered to belong to the same complex as the
Trust.
INVESTMENT ADVISORY AND OTHER SERVICES
The Adviser
36
<PAGE>
MGCM, 885 Third Avenue, New York, New York, acts as the investment
adviser to each Fund other than Microcap Fund pursuant to the terms of two
Management Contracts, each dated December 28, 1994. MGCM acts as the investment
adviser to Microcap Fund pursuant to the terms of a Management Contract dated
August 7, 1996 (referred to collectively herein with the Management Contracts
referred to in the preceding sentence as the "Management Contracts"). Pursuant
to the Management Contracts, the Adviser supervises and assists in the
management of the assets of each Fund and furnishes each Fund with research,
statistical, advisory and managerial services. The Adviser pays the ordinary
office expenses of the Trust and the compensation, if any, of all officers and
employees of the Trust and all Trustees who are "interested persons" (as defined
in the 1940 Act) of the Adviser.
Under the Management Contracts, the Trust, on behalf of each Fund is
obligated to pay the Adviser a monthly fee at an annual rate of each Fund's
average daily net assets as follows:
Annual Rate
Morgan Grenfell Large Cap Growth Fund.................. 0.75%
Morgan Grenfell Smaller Companies Fund................. 1.00%
Morgan Grenfell Microcap Fund ......................... 1.50%
Morgan Grenfell Fixed Income Fund...................... 0.40%
Morgan Grenfell Short-Term Fixed Income Fund........... 0.40%
Morgan Grenfell Municipal Bond Fund.................... 0.40%
Morgan Grenfell Short-Term Municipal Bond Fund......... 0.40%
Each Fund's advisory fees are paid monthly and will be prorated if the
Adviser shall not have acted as the Fund's investment adviser during the entire
monthly period. The Adviser has temporarily agreed, under certain circumstances,
to reduce or not impose its management fee and to make arrangements to limit
certain other expenses as described in the Prospectus under "Expense
Information."
For the fiscal years ended October 31, 1996, 1995 and 1994, Morgan
Grenfell Fixed Income Fund paid the Adviser net advisory fees of $2,041,053,
$1,150,707 and $532,189, respectively. For the same years, Morgan Grenfell
Municipal Bond Fund paid the Adviser net advisory fees of $791,321, $595,795,
and $444,910, respectively. For the fiscal years ended October 31, 1996 and
1995, Morgan Grenfell Short-Term Fixed Income Fund, Morgan Grenfell Short-Term
Municipal Bond Fund and Morgan Grenfell Smaller Companies Fund paid no advisory
fees to the Adviser. The foregoing advisory fee payments and non-payments
reflect expense limitations that were in effect during the indicated periods.
Morgan Grenfell Large Cap Growth Fund and Morgan Grenfell Microcap Fund were not
in operation during any of the indicated periods and, accordingly, paid no
advisory fees during such periods.
The Management Contract between MGCM and the Trust, on behalf of the
Equity Funds, the Short-Term Fixed Income Fund and the Short-Term Municipal
37
<PAGE>
Bond Fund, was most recently approved on November 21, 1996 by a vote of the
Trust's Board of Trustees, including a majority of those Trustees who were not
parties to such Management Contract or "interested persons" of any such parties.
The Management Contract between MGCM and the Trust, on behalf of the Fixed
Income Fund and the Municipal Bond Fund, was approved on November 21, 1996 by a
vote of the Trust's Board of Trustees, including a majority of those Trustees
who were not parties to such Management Contract or "interested persons" of any
such parties.
The Management Contract between MGCM and the Trust, on behalf of
Microcap Fund, was approved on May 16, 1996 by a vote of the Trust's Board of
Trustees, including a majority of those Trustees who were not parties to such
Management Contract or "interested persons" of any such parties.
The Management Contracts will remain in effect until November 30, 1997
(August 23, 1998, in the case of the Management Contract for Microcap Fund), and
will continue in effect thereafter, with respect to each Fund, only if such
continuance is specifically approved annually by the Trustees, including a
majority of the Trustees who are not parties to the Management Contracts or
"interested persons" of any such parties, or by a vote of a majority of the
outstanding shares of each Fund. The Management Contracts are terminable by vote
of the Board of Trustees, or, with respect to a Fund, by the holders of a
majority of the outstanding shares of the Fund, at any time without penalty on
60 days' written notice to the Adviser. Termination of a Management Contract
(that covers more than one fund) with respect to a Fund will not terminate or
otherwise invalidate any provision of either such Management Contract with
respect to any other Fund. The Adviser may terminate any Management Contract at
any time without penalty on 60 days' written notice to the Trust. Each
Management Contract terminates automatically in the event of its "assignment"
(as such term is defined in the 1940 Act).
Each Management Contract provides that the Adviser shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Trust or any Fund in connection with the performance of the Adviser's
obligations under the Management Contract with the Trust, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
the Adviser in the performance of its duties or from reckless disregard of its
duties and obligations thereunder.
In the management of the Funds and its other accounts, the Adviser
allocates investment opportunities to all accounts for which they are
appropriate subject to the availability of cash in any particular account and
the final decision of the individual or individuals in charge of such accounts.
Where market supply is inadequate for a distribution to all such accounts,
securities are allocated based on a Fund's pro rata portion of the amount
ordered. In some cases this procedure may have an adverse effect on the price or
volume of the security as far as a Fund is concerned. However, it is the
judgment of the Board that the desirability of continuing the Trust's advisory
arrangements with the Adviser outweighs any disadvantages
38
<PAGE>
that may result from contemporaneous transactions. See "Portfolio Brokerage."
MGCM is registered with the Commission as an investment adviser and
provides a full range of investment advisory services to institutional clients.
MGCM is a direct wholly-owned subsidiary of Morgan Grenfell Asset Management,
Ltd., which is a wholly-owned subsidiary of Deutsche Morgan Grenfell Group plc.
Deutsche Morgan Grenfell Group plc is an indirect wholly-owned subsidiary of
Deutsche Bank AG, an international commercial and investment banking group. As
of April 30, 1996, MGCM managed approximately $8.05 billion in assets for
various individual and institutional accounts, including the Morgan Grenfell
SMALLCap Fund, Inc., a registered, closed-end investment company for which it
acts as investment adviser. MGCM also acts as investment subadviser to Fremont
U.S. Micro-Cap Fund, a registered open-end investment company.
Portfolio Turnover
Each Fund's portfolio turnover rate is calculated by dividing the
lesser of the dollar amount of sales or purchases of portfolio securities by the
average monthly value of a Fund's portfolio securities, excluding securities
having a maturity at the date of purchase of one year or less. For the fiscal
periods ended October 31, 1996 and 1995, the portfolio turnover rates for Morgan
Grenfell Fixed Income Fund were 176% and 182%, respectively. For the same
periods, the portfolio turnover rates for Morgan Grenfell Municipal Bond Fund
were 66% and 63%, respectively. For the fiscal yeat ended October 31, 1996, the
portfolio turnover rates for Morgan Grenfell Short-Term Fixed Income Fund,
Morgan Grenfell Short-Term Municipal Bond Fund and the Morgan Grenfell Smaller
Companies Fund were 124%, 129% and 141%, respectively. For the fiscal period
ended October 31, 1995, the portfolio turnover rates for Morgan Grenfell
Short-Term Fixed Income Fund, Morgan Grenfell Short-Term Municipal Bond Fund and
Morgan Grenfell Smaller Companies Fund were 90%, 62% and 23%, respectively.
The Administrator
As described in the Prospectus, SEI Financial Management Corporation
(the "Administrator") serves as the Trust's administrator pursuant to an
administration agreement between the Administrator and the Trust, on behalf of
the Funds (the "Administration Agreement"). Pursuant to the Administration
Agreement, the Administrator has agreed to furnish statistical and research
data, clerical services, and stationery and office supplies; prepare and file
various reports with the appropriate regulatory agencies including the
Commission and state securities commissions; and provide accounting and
bookkeeping services for the Funds, including the computation of each Fund's net
asset value, net investment income and net realized capital gains, if any.
For its services under the Administration Agreement, the Administrator
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receives from all series of the Trust an aggregate monthly fee at the following
annual rates of the aggregate average daily net assets ("aggregate assets") of
such series:
0.12% of aggregate assets under $1 billion
0.08% of next $500 million of aggregate assets
0.06% of next $1 billion of aggregate assets
0.04% of aggregate assets exceeding $2.5 billion
Each Fund pays the Administrator a minimum annual fee of $60,000.
For the fiscal years ended October 31, 1996, 1995 and 1994, Morgan
Grenfell Fixed Income Fund paid the Administrator administration fees of
$655,936, $455,614,and $259,094 respectively. For the same years, Morgan
Grenfell Municipal Bond Fund paid the Administrator administration fees of
$253,839, $227,872,and $231,957 respectively. For the fiscal period ended
October 31, 1996, Morgan Grenfell Short-Term Fixed Income Fund, Morgan Grenfell
Short-Term Municipal Bond Fund and Morgan Grenfell Smaller Companies Fund paid
the Administrator administration fees of $45,833, $45,833 and $37,500,
respectively. For the fiscal period ended October 31, 1995, Morgan Grenfell
Short-Term Fixed Income Fund, Morgan Grenfell Short-Term Municipal Bond Fund and
Morgan Grenfell Smaller Companies Fund paid the Administrator administration
fees of $12,500, $12,500 and $4,167, respectively. The administration fees shown
in this paragraph were paid pursuant to a fee schedule that provided for higher
fees than does the fee schedule that is in effect for the current fiscal year
ending October 31, 1997.
The Administration Agreement provides that the Administrator shall not
be liable under the Administration Agreement except for bad faith or gross
negligence in the performance of its duties or from the reckless disregard by it
of its duties and obligations thereunder.
Expenses of the Trust
The expenses borne by institutional shares of the Funds include: (i)
fees and expenses of any investment adviser and any administrator of the Funds;
(ii) fees and expenses incurred by the Funds in connection with membership in
investment company organizations; (iii) brokers' commissions; (iv) payment for
portfolio pricing services to a pricing agent, if any; (v) legal expenses
(including an allocable portion of the cost of the Trust's employees rendering
legal services to the Funds); (vi) interest, insurance premiums, taxes or
governmental fees; (vii) the fees and expenses of the transfer agent of the
Funds; (viii) clerical expenses of issue, redemption or repurchase of shares of
the Funds; (ix) the expenses of and fees for registering or qualifying shares of
the Funds for sale and of maintaining the registration of the Funds and
registering the Funds as a broker or a dealer; (x) the fees and expenses of
Trustees who are not affiliated with the Adviser; (xi) the cost of preparing and
distributing reports and notices to shareholders, the Commission and other
regulatory authorities; (xii) the fees or disbursements of custodians of the
Funds' assets, including expenses incurred in the performance of any obligations
enumerated by the Declaration of Trust or By-Laws of the Trust insofar as they
govern agreements with any such custodian; (xiii) costs in connection
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with annual or special meetings of shareholders, including proxy material
preparation, printing and mailing; (xiv) charges and expenses of the Trust's
auditor; (xv) litigation and indemnification expenses and other extraordinary
expenses not incurred in the ordinary course of the Trust's business; and (xvi)
expenses of an extraordinary and nonrecurring nature.
Transfer Agent
DST Systems, Inc., 1004 Baltimore, Kansas City, Missouri 64105 (the
"Transfer Agent") serves as the transfer and dividend disbursing agent for the
Funds pursuant to a transfer agency agreement (the "Transfer Agency Agreement"),
under which the Transfer Agent (i) maintains record shareholder accounts, and
(ii) makes periodic reports to the Trust's Board of Trustees concerning the
operations of each Fund.
The Distributor
The Trust, on behalf of the Funds, has entered into a distribution
agreement (the "Distribution Agreement") pursuant to which SEI Financial
Services Company, 1 Freedom Valley Drive, Oaks, Pennsylvania 19456-0100 (the
"Distributor"), as agent, serves as principal underwriter for the continuous
offering of shares, including institutional shares, of each Fund. The
Distributor has agreed to use its best efforts to solicit orders for the
purchase of shares of each Fund, although it is not obligated to sell any
particular amount of shares. Shares of the Funds are not subject to sales loads
or distribution fees. The Adviser, and not the Trust, is responsible for payment
of any expenses or fees incurred in the marketing and distribution of shares of
the Funds.
The Distribution Agreement will remain in effect for one year from its
effective date and will continue in effect thereafter only if such continuance
is specifically approved annually by the Trustees, including a majority of the
Trustees who are not parties to the Distribution Agreement or "interested
persons" of such parties. The Distribution Agreement was approved by the initial
shareholder of each Fund other than Microcap Fund on December 28, 1994. The
Distribution Agreement was approved by the initial shareholder of Microcap Fund
on August 5, 1996. The Distribution Agreement was most recently approved on
November 21, 1996 by a vote of the Trust's Board of Trustees, including a
majority of those Trustees who were not parties to the Distribution Agreement or
"interested persons" of any such parties. The Distribution Agreement is
terminable, as to a Fund, by vote of the Board of Trustees, or by the holders of
a majority of the outstanding shares of the Fund, at any time without penalty on
60 days' written notice to the Trust and Adviser. The Distributor may terminate
the Distribution Agreement at any time without penalty on 90 days' written
notice to the Trust.
Custodian
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As described in the Prospectus, CoreStates Bank, N.A. ("CoreStates"),
whose principal business address is Broad and Chestnut Streets, P.O. Box 7618,
Philadelphia, PA 19101 maintains custody of the assets of Morgan Grenfell Fixed
Income Fund and Morgan Grenfell Municipal Bond Fund. As described in the
Prospectus, The Northern Trust Company ("Northern"), whose principal business
address is Fifty South LaSalle Street, Chicago, Illinois 60675, maintains
custody of the assets of the other Funds.
Under their custody agreements with the Trust, CoreStates and Northern
(i) maintain separate accounts in the name of each Fund, (ii) hold and transfer
portfolio securities on account of each Fund, (iii) accept receipts and make
disbursements of money on behalf of each Fund, (iv) collect and receive all
income and other payments and distributions on account of each Fund's portfolio
securities and (v) make periodic reports to the Trust's Board of Trustees
concerning each Fund's operations. CoreStates and Northern are authorized to
select one or more foreign or domestic banks or companies to serve as
sub-custodian on behalf of the Funds.
PORTFOLIO TRANSACTIONS
Subject to the general supervision of the Board of Trustees, the
Adviser makes decisions with respect to and places orders for all purchases and
sales of portfolio securities for the Funds. In executing portfolio
transactions, the Adviser seeks to obtain the best net results for the Funds,
taking into account such factors as price (including the applicable brokerage
commission or dealer spread), size of the order, difficulty of execution and
operational facilities of the firm involved. Commission rates, being a component
of price, are considered together with such factors. Where transactions are
effected on a foreign securities exchange, the Funds employ brokers, generally
at fixed commission rates. Commissions on transactions on U.S. securities
exchanges are subject to negotiation. Where transactions are effected in the
over-the-counter market or third market, the Funds deal with the primary market
makers unless a more favorable result is obtainable elsewhere. Fixed income
securities purchased or sold on behalf of the Funds normally will be traded in
the over-the-counter market on a net basis (i.e. without a commission) through
dealers acting for their own account and not as brokers or otherwise through
transactions directly with the issuer of the instrument. Some fixed income
securities are purchased and sold on an exchange or in over-the-counter
transactions conducted on an agency basis involving a commission.
Pursuant to the Management Contracts, the Adviser agrees to select
broker-dealers in accordance with guidelines established by the Trust's Board of
Trustees from time to time and in accordance with Section 28(e) of the
Securities Exchange Act of 1934, as amended. In assessing the terms available
for any transaction, the Adviser shall consider all factors it deems relevant,
including the breadth of the market in the security, the price of the security,
the financial condition and execution capability of the broker-dealer, and the
reasonableness of the commission, if any, both for the specific transaction and
on a continuing basis. In addition, the
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Management Contracts authorize the Adviser, subject to the periodic review of
the Trust's Board of Trustees, to cause a Fund to pay a broker-dealer which
furnishes brokerage and research services a higher commission than that which
might be charged by another broker-dealer for effecting the same transaction,
provided that the Adviser determines in good faith that such commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker-dealer, viewed in terms of either the particular
transaction or the overall responsibilities of the Adviser to the Fund. Such
brokerage and research services may consist of pricing information, reports and
statistics on specific companies or industries, general summaries of groups of
bonds and their comparative earnings and yields, or broad overviews of the
securities markets and the economy.
Supplemental research information utilized by the Adviser is in
addition to, and not in lieu of, services required to be performed by the
Adviser and does not reduce the advisory fees payable to the Adviser. The
Trustees will periodically review the commissions paid by the Funds to consider
whether the commissions paid over representative periods of time appear to be
reasonable in relation to the benefits inuring to the Funds. It is possible that
certain of the supplemental research or other services received will primarily
benefit one or more other investment companies or other accounts of the Adviser
for which investment discretion is exercised. Conversely, a Fund may be the
primary beneficiary of the research or services received as a result of
portfolio transactions effected for such other account or investment company.
During the fiscal period ended October 31, 1996, the Adviser did not, pursuant
to any agreement or understanding with a broker or otherwise through an internal
allocation procedure, direct any Fund's brokerage transactions to a broker
because of research services provided by such broker.
Investment decisions for each Fund and for other investment accounts
managed by the Adviser are made independently of each other in the light of
differing conditions. However, the same investment decision may be made for two
or more of such accounts. In such cases, simultaneous transactions are
inevitable. Purchases or sales are then averaged as to price and allocated as to
amount in a manner deemed equitable to each such account. While in some cases
this practice could have a detrimental effect on the price or value of the
security as far as a Fund is concerned, in other cases it is believed to be
beneficial to a Fund. To the extent permitted by law, the Adviser may aggregate
the securities to be sold or purchased for a Fund with those to be sold or
purchased for other investment companies or accounts in executing transactions.
Pursuant to procedures determined by the Trustees and subject to the
general policies of the Funds and Section 17(e) of the 1940 Act, the Adviser may
place securities transactions with brokers with whom it is affiliated
("Affiliated Brokers").
Section 17(e) of the 1940 Act limits to "the usual and customary
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broker's commission" the amount which can be paid by the Funds to an Affiliated
Broker acting as broker in connection with transactions effected on a securities
exchange. The Board, including a majority of the Trustees who are not
"interested persons" of the Trust or the Adviser, has adopted procedures
designed to comply with the requirements of Section 17(e) of the 1940 Act and
Rule 17e-1 promulgated thereunder to ensure that the broker's commission is
"reasonable and fair compared to the commission, fee or other remuneration
received by other brokers in connection with comparable transactions involving
similar securities being purchased or sold on a securities exchange during a
comparable period of time...."
A transaction would not be placed with an Affiliated Broker if a Fund
would have to pay a commission rate less favorable than their contemporaneous
charges for comparable transactions for their other most favored, but
unaffiliated, customers except for accounts for which they act as a clearing
broker, and any of their customers determined, by a majority of the Trustees who
are not "interested persons" of the Fund or the Adviser, not to be comparable to
the Fund. With regard to comparable customers, in isolated situations, subject
to the approval of a majority of the Trustees who are not "interested persons"
of the Trust or the Adviser, exceptions may be made. Since the Adviser, as
investment adviser to the Funds, has the obligation to provide management, which
includes elements of research and related skills, such research and related
skills will not be used by them as a basis for negotiating commissions at a rate
higher than that determined in accordance with the above criteria. The Funds
will not engage in principal transactions with Affiliated Brokers. When
appropriate, however, orders for the account of the Funds placed by Affiliated
Brokers are combined with orders of their respective clients, in order to obtain
a more favorable commission rate. When the same security is purchased for two or
more funds or customers on the same day, each fund or customer pays the average
price and commissions paid are allocated in direct proportion to the number of
shares purchased.
Affiliated Brokers furnish to the Trust at least annually a statement
setting forth the total amount of all compensation retained by them or any
associated person of them in connection with effecting transactions for the
account of the Funds, and the Board reviews and approves all the Funds'
portfolio transactions on a quarterly basis and the compensation received by
Affiliated Brokers in connection therewith. During the fiscal years ended
October 31, 1994, 1995 and 1996, neither the Fixed Income Fund nor the Municipal
Bond Fund paid any brokerage commissions to any Affiliated Broker. During the
fiscal year ended October 31, 1996 and the fiscal period ended October 31, 1995,
neither Short-Term Fixed Income Fund, Short-Term Municipal Bond Fund nor Smaller
Companies Fund paid any brokerage commissions to any affiliated broker.
Affiliated Brokers do not knowingly participate in commissions paid by
the Funds to other brokers or dealers and do not seek or knowingly receive any
reciprocal business as the result of the payment of such commissions. In the
event that an Affiliated Broker learns at any time that it has knowingly
received reciprocal business, it will so inform the Board.
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For the fiscal years ended October 31, 1996, 1995, and 1994, Morgan
Grenfell Fixed Income Fund and Morgan Grenfell Municipal Bond Fund paid no
brokerage commissions. For fiscal years ended October 31, 1996 and 1995, Morgan
Grenfell Short-Term Fixed Income Fund and Morgan Grenfell Short-Term Municipal
Bond Fund paid no brokerage commissions. For the fiscal year ended October 31,
1996 and the fiscal period ended October 31, 1995, Morgan Grenfell Smaller
Companies Fund paid aggregate brokerage commissions of $7,708 and $3,778,
respectively.
NET ASSET VALUE
Under the 1940 Act, the Board of Trustees of the Trust is responsible
for determining in good faith the fair value of the securities of each Fund. In
accordance with procedures adopted by the Board of Trustees, the net asset value
per share of each class of each Fund is calculated by determining the net worth
of the Fund attributable to the class (assets, including securities at value,
minus liabilities) divided by the number of shares of such class outstanding.
Each Fund computes net asset value for each class of its sharesat the close of
such regular trading, which is normally 4:00 p.m. Eastern time, on each day on
which the New York Stock Exchange ("NYSE") is open (a "Business Day"). The NYSE
is closed on Saturdays and Sundays as well as the following holidays: New Year's
Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
For purposes of calculating net asset value for each class of its
shares, equity securities traded on a recognized U.S. or foreign securities
exchange or the National Association of Securities Dealers Automated Quotation
System ("NASDAQ") are valued at their last sale price on the principal exchange
on which they are traded or NASDAQ (if NASDAQ is the principal market for such
securities) on the valuation day or, if no sale occurs, at the bid price.
Unlisted equity securities for which market quotations are readily available are
valued at the most recent bid price.
Debt securities and other fixed income investments of the Funds are
valued at prices supplied by independent pricing agents, which prices reflect
broker-dealer supplied valuations and electronic data processing techniques.
Short-term obligations maturing in sixty days or less may be valued at amortized
cost, which method does not take into account unrealized gains or losses on such
portfolio securities. Amortized cost valuation involves initially valuing a
security at its cost, and thereafter, assuming a constant amortization to
maturity of any discount or premium, regardless of the impact of fluctuating
interest rates on the market value of the security. While this method provides
certainty in valuation, it may result in periods in which the value of the
security, as determined by amortized cost, may be higher or lower than the price
the Fund would receive if the Fund sold the security.
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Other assets and assets in which market quotations are not readily
available are valued at fair value using methods determined in good faith by the
Board of Trustees.
Trading in securities on European and Far Eastern securities exchanges
and over-the-counter markets is normally completed well before the 4:00 P.M.
(Eastern Time) close of business on each Business Day. In addition, European or
Far Eastern securities trading generally or in a particular country or countries
may not take place on all Business Days. Furthermore, trading takes place in
Japanese markets on certain Saturdays and in various foreign markets on days
which are not Business Days and on which the Funds' net asset values are not
calculated. Such calculation may not take place contemporaneously with the
determination of the prices of certain portfolio securities used in such
calculation. Events affecting the values of portfolio securities that occur
between the time their prices are determined and the close of the regular
trading on the NYSE will not be reflected in the Funds' calculation of net asset
values unless the Adviser deems that the particular event would materially
affect net asset value, in which case an adjustment will be made.
PERFORMANCE INFORMATION
Yield
From time to time, each Fixed Income Fund and each Municipal Fund may
advertise its yield and (in the case of the Municipal Funds) its tax-equivalent
yield. Yield and tax-equivalent yield are calculated separately for service
shares and institutional shares of a Fund. Each type of share is subject to
differing yields for the same period. The yield of institutional shares of the
Fund refers to the annualized income generated by an investment in the Fund over
a specified 30-day period. The yield is calculated by assuming that the income
generated by the investment during that period is generated for each like period
over one year and is shown as a percentage of the investment. In particular,
yield will be calculated according to the following formula:
YIELD = 2 [(a - b +1)(6) - 1]
------
cd
Where: a = dividends and interest earned by the
Fund during the period;
b = net expenses accrued for the period;
c = average daily number of shares outstanding during the
period entitled to receive dividends; and
d = maximum offering price per share on
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the last day of the period.
Tax-equivalent yield is computed by dividing the portion of the yield
that is tax exempt by one minus a stated income tax rate and adding the product
to that portion, if any, of the yield that is not tax exempt.
Actual yields will depend on such variables as asset quality, average
asset maturity, the type of instruments a Fund invests in, changes in interest
rates on money market instruments, changes in the expenses of the Fund and other
factors.
Yields are one basis upon which investors may compare the Funds with
other mutual funds; however, yields of other mutual funds and other investment
vehicles may not be comparable because of the factors set forth above and
differences in the methods used in valuing portfolio instruments.
For the 30-day period ended October 31, 1996, the yields of the Fixed
Income Fund, the Municipal Bond Fund, the Short-Term Fixed Income Fund and the
Short-Term Municipal Bond Fund were 6.38%, 5.23%, 5.94% and 5.07%, respectively.
If the expense limitations described in the Prospectus for these Funds had not
been in effect during this period, the yields of these Funds would have been
6.32%, 5.17%, 5.18% and 4.02%, respectively. For the same period, the
tax-equivalent yields of the Municipal Bond Fund and the Short-Term Municipal
Bond Fund were 8.66% and 8.39%, respectively, assuming the highest Federal
Income Tax bracket for individuals (39.6%). If the expense limitations described
in the Prospectus for these Funds had not been in effect during this period, the
tax-equivalent yields of these Funds would have been 8.56% and 6.66%,
respectively, assuming the same Federal Income Tax bracket.
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Total Return
Average annual total return is calculated separately for service shares
and institutional shares of a Fund. Each type of share is subject to different
fees and expenses and, consequently, may have differing average annual total
returns for the same period. Each Fund that advertises "average annual total
return" for a class of its shares computes such return by determining the
average annual compounded rate of return during specified periods that equates
the initial amount invested to the ending redeemable value of such investment
according to the following formula:
ERV
T = [(-----) 1/n - 1]
P
Where: T = average annual total return,
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the
1, 5 or 10 year (or other) periods
at the end of the applicable period
(or a fractional portion thereof);
P = hypothetical initial payment of
$1,000; and
n = period covered by the computation,
expressed in years.
Each Fund that advertises "aggregate total return" for a class of its
shares computes such returns by determining the aggregate compounded rates of
return during specified periods that likewise equate the initial amount invested
to the ending redeemable value of such investment. The formula for calculating
aggregate total return is as follows:
ERV
Aggregate Total Return = [(-----) - 1]
P
The above calculations are made assuming that (1) all dividends and
capital gain distributions are reinvested on the reinvestment dates at the price
per share existing on the reinvestment date, (2) all recurring fees charged to
all shareholder accounts are included, and (3) for any account fees that vary
with the size of the account, a mean (or median) account size in the Fund during
the periods is reflected. The ending redeemable value (variable "ERV" in the
formula) is determined by assuming complete redemption of the hypothetical
investment after deduction of all nonrecurring charges at the end of the
measuring period. For the fiscal year ended October 31, 1996, the average annual
total return of institutional shares of Morgan Grenfell Fixed Income Fund,
Morgan Grenfell
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Municipal Bond Fund, Morgan Grenfell Short-Term Fixed Income Fund, Morgan
Grenfell Short-Term Municipal Bond Fund and Morgan Grenfell Smaller Companies
Fund were 6.27%, 6.90%, 6.09%, 5.90% and 24.58%, respectively. For their
respective periods from commencement of operations to October 31, 1996, the
average annual total returns of institutional shares of Morgan Grenfell Fixed
Income Fund, Morgan Grenfell Municipal Bond Fund, Morgan Grenfell Short-Term
Fixed Income Fund, Morgan Grenfell Short-Term Municipal Bond Fund and Morgan
Grenfell Smaller Companies Fund were 8.29%, 8.93%, 6.09%, 6.24% and 22.69%,
respectively. If the expense limitations described in the Prospectus for the
above Funds had not been in effect during the indicated periods, the total
returns for institutional shares of these Funds for such periods would have been
lower than the total return figures shown in this paragraph.
The Funds may from time to time advertise comparative performance as
measured by various independent sources, including, but not limited to,
Barron's, The Wall Street Journal, Weisenberger Investment Companies Service,
Business Week, Changing Times, Financial World, Forbes, Fortune and Money. In
addition, the Funds may from time to time advertise their performance relative
to certain indices and benchmark investments, including: (a) the Lipper
Analytical Services, Inc. Mutual Fund Performance Analysis, Fixed Income
Analysis and Mutual Fund Indices (which measure total return and average current
yield for the mutual fund industry and rank mutual fund performance); (b) the
CDA Mutual Fund Report published by CDA Investment Technologies, Inc. (which
analyzes price, risk and various measures of return for the mutual fund
industry); (c) the Consumer Price Index published by the U.S. Bureau of Labor
Statistics (which measures changes in the price of goods and services); (d)
Stocks, Bonds, Bills and Inflation published by Ibbotson Associates (which
provides historical performance figures for stocks, government securities and
inflation); (e) the Shearson Lehman Brothers Aggregate Bond Index or its
component indices (the Aggregate Bond Index measures the performance of
Treasury, U.S. Government agency, corporate, mortgage and Yankee bonds); (f) the
Standard & Poor's Bond Indices (which measure yield and price of corporate,
municipal and U.S. Government bonds); and (g) historical investment data
supplied by the research departments of Goldman Sachs, Shearson Lehman Hutton,
First Boston Corporation, Morgan Stanley, Salomon Brothers, Merrill Lynch,
Donaldson Lufkin and Jenrette or other providers of such data. The composition
of the investments in such indices and the characteristics of such benchmark
investments are not identical to, and in some cases are very different from,
those of the Funds' portfolios. These indices and averages are generally
unmanaged and the items included in the calculations of such indices and
averages may not be identical to the formulas used by the Funds to calculate
their performance figures.
TAXES
The following is a summary of the principal U.S. federal income, and
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certain state and local, tax considerations regarding the purchase, ownership
and disposition of shares in the Funds. This summary does not address special
tax rules applicable to certain classes of investors, such as tax-exempt
entities, insurance companies and financial institutions. Each prospective
shareholder is urged to consult his own tax adviser with respect to the specific
federal, state, local and foreign tax consequences of investing in the Funds.
The summary is based on the laws in effect on the date of this Statement of
Additional Information, which are subject to change.
General
Each Fund is a separate taxable entity. Each Fund has elected or
intends to elect to be treated, and intends to qualify for each taxable year, as
a regulated investment company under Subchapter M of the Code.
Qualification of any Fund as a regulated investment company under the
Code requires, among other things, that (a) the Fund derive at least 90% of its
gross income (including tax-exempt interest) for its taxable year from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of stocks or securities or foreign currencies, or
other income (including but not limited to gains from options, futures, and
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies (the "90% gross income test"); (b) the Fund
derive less than 30% of its gross income for its taxable year from the sale or
other disposition of any of the following which was held for less than three
months: (i) stock or securities; (ii) options, futures or forward contracts
(other than options, futures or forward contracts on foreign currencies); and
(iii) foreign currencies and foreign currency options, futures and forward
contracts that are not directly related to the Fund's principal business of
investing in stock or securities or options and futures with respect to stocks
or securities (the "short-short test"); and (c) the Fund diversify its holdings
so that, at the close of each quarter of its taxable year, (i) at least 50% of
the market value of its total (gross) assets is comprised of cash, cash items,
United States Government securities, securities of other regulated investment
companies and other securities limited in respect of any one issuer to an amount
not greater in value than 5% of the value of the Fund's total assets and to not
more than 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its total assets is invested in the securities of
any one issuer (other than United States Government securities and securities of
other regulated investment companies) or two or more issuers controlled by the
Fund and engaged in the same, similar or related trades or businesses. Gains
from the sale or other disposition of foreign currencies (or options, futures or
forward contracts on foreign currencies) that are not directly related to a
Fund's principal business of investing in stock or securities or options and
futures with respect to stock or securities will be treated as gains from the
disposition of investments held for less than three months under the short-short
test (even though characterized as ordinary income for some purposes) if such
currencies or instruments were held for less than three months. In addition,
future Treasury regulations could provide that
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qualifying income under the 90% gross income test will not include gains from
foreign currency transactions or derivatives that are not directly related to a
Fund's principal business of investing in stock or securities or options and
futures with respect to stock or securities. Using foreign currency positions or
entering into foreign currency options, futures or forward contracts for
purposes other than hedging currency risk with respect to securities in a Fund's
portfolio or anticipated to be acquired may not qualify as "directly-related"
under these tests.
If a Fund complies with such provisions, then in any taxable year in
which the Fund distributes at least 90% of the sum of (i) its "investment
company taxable income" (which includes dividends, taxable interest, taxable
accrued original issue discount, recognized market discount income, income from
securities lending, any net short-term capital gain in excess of net long-term
capital loss and certain net realized foreign exchange gains and is reduced by
deductible expenses) and (ii) the excess of its gross tax-exempt interest, if
any, over certain disallowed deductions ("net tax-exempt interest"), the Fund
(but not its shareholders) will be relieved of federal income tax on any income
of the Fund, including long-term capital gains, distributed to shareholders.
However, if a Fund retains any investment company taxable income or net capital
gain (the excess of net long-term capital gain over net short-term capital
loss), it will be subject to federal income tax at regular corporate rates on
the amount retained.
If a Fund retains any net capital gain, the Fund may designate the
retained amount as undistributed capital gains in a notice to its shareholders
who, if subject to U.S. federal income tax on long-term capital gains, (i) will
be required to include in income for federal income tax purposes, as long-term
capital gain, their shares of such undistributed amount, and (ii) will be
entitled to credit their proportionate shares of the tax paid by the Fund
against their U.S. federal income tax liabilities, if any, and to claim refunds
to the extent the credit exceeds such liabilities.
For U.S. federal income tax purposes, the tax basis of shares owned by
a shareholder of a Fund will be increased by an amount equal under current law
to 65% of the amount of undistributed net capital gains included in the
shareholder's gross income. Each Fund intends to distribute at least annually to
its shareholders all or substantially all of its investment company taxable
income, net tax-exempt interest, and net capital gain. If for any taxable year a
Fund does not qualify as a regulated investment company, it will be taxed on all
of its investment company taxable income and net capital gain at corporate
rates, any net tax-exempt interest may be subject to alternative minimum tax,
and its distributions to shareholders will be taxable as ordinary dividends to
the extent of its current and accumulated earnings and profits.
In order to avoid a 4% federal excise tax, each Fund must distribute
(or be deemed to have distributed) by December 31 of each calendar year at least
98% of its taxable ordinary income for such year, at least 98% of the excess of
its capital gains over its capital losses (generally computed on
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the basis of the one-year period ending on October 31 of such year), and all
taxable ordinary income and the excess of capital gains over capital losses for
the previous year that were not distributed in such year and on which no federal
income tax was paid by the Fund. For federal income tax purposes, dividends
declared by a Fund in October, November or December to shareholders of record on
a specified date in such a month and paid during January of the following year
are treated as distributed by the Fund and are taxable to such shareholders as
if received on December 31 of the year declared.
Gains and losses on the sale, lapse, or other termination of options
and futures contracts, options thereon and certain forward contracts (except
certain foreign currency options, forward contracts and futures contracts)
entered into by the Equity Funds will generally be treated as capital gains and
losses. Certain of the futures contracts, forward contracts and options held by
the Funds will be required to be "marked-to-market" for federal income tax
purposes, that is, treated as having been sold at their fair market value on the
last day of the Funds' taxable year. As a result, a Fund may be required to
recognize income or gain without a concurrent receipt of cash. Any gain or loss
recognized on actual or deemed sales of these futures contracts, forward
contracts, or options (except for certain foreign currency options, forward
contracts, and futures contracts) will be treated as 60% long-term capital gain
or loss and 40% short-term capital gain or loss. As a result of certain hedging
transactions entered into by a Fund, such Fund may be required to defer the
recognition of losses on futures or forward contracts and options or underlying
securities or foreign currencies to the extent of any unrecognized gains on
related positions and the characterization of gains or losses as long-term or
short-term may be changed. The tax provisions described above applicable to
options, futures and forward contracts may affect the amount, timing and
character of a Fund's distributions to shareholders. The short-short test
described above may limit a Fund's ability to use options, futures and forward
transactions as well as its ability to engage in short sales. Certain tax
elections may be available to the Funds to mitigate some of the unfavorable
consequences described in this paragraph.
Section 988 of the Code contains special tax rules applicable to
certain foreign currency transactions and instruments that may affect the
amount, timing and character of income, gain or loss recognized by the Equity
Funds. Under these rules, foreign exchange gain or loss realized with respect to
foreign currencies and certain futures and options thereon, foreign
currency-denominated debt instruments, foreign currency forward contracts, and
foreign currency-denominated payables and receivables will generally be treated
as ordinary income or loss, although in some cases elections may be available
that would alter this treatment.
If an Equity Fund or a Fixed Income Fund acquires stock (including,
under proposed regulations, an option to acquire stock such as is inherent in a
convertible bond) in certain non-U.S. corporations that receive at least 75% of
their annual gross income from passive sources (such as interest, dividends,
rents, royalties or capital gain) or hold at least 50% of their assets in
investments producing such passive income ("passive foreign investment
companies"), the Fund could be subject to federal income tax and additional
interest charges on "excess
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distributions" received from such companies or gain from the sale of stock in
such companies, even if all income or gain actually received by the Fund is
timely distributed to its shareholders. The Fund would not be able to pass
through to its shareholders any credit or deduction for such a tax. Certain
elections may, if available, ameliorate these adverse tax consequences, but any
such election could require the Fund to recognize taxable income or gain without
the concurrent receipt of cash. The applicable Funds may limit and/or manage
their holdings in passive foreign investment companies to minimize their tax
liability or maximize their return from these investments.
A Fund that invests in foreign securities may be subject to foreign
withholding or other foreign taxes on certain income (possibly including, in
some cases, capital gains) from such securities. Tax conventions between certain
countries and the U.S. may reduce or eliminate such taxes in some cases. The
Funds will not be entitled to pass through such foreign taxes to their
shareholders, who consequently will not be entitled to any U.S. tax credits or
deductions for such taxes.
Each Fund's investments in zero coupon securities or other securities
bearing original issue discount or, if the Fund elects to include market
discount in income currently, market discount will generally cause it to realize
income prior to the receipt of cash payments with respect to these securities.
Options, futures or forward contracts subject to the mark to market rules
described above may have the same result if recognized mark to market gains
exceed recognized mark to market losses. In order to obtain cash to distribute
this income or gain, maintain its qualification as a regulated investment
company, and avoid federal income or excise taxes, a Fund may be required to
liquidate portfolio securities that it might otherwise have continued to hold.
Each Municipal Fund purchases tax-exempt municipal securities which are
generally accompanied by an opinion of bond counsel to the effect that interest
on such securities is not included in gross income for federal income tax
purposes. It is not economically feasible to, and the Municipal Funds therefore
do not, make any additional independent inquiry into whether such securities are
in fact tax-exempt. Bond counsels' opinions will generally be based in part upon
covenants by the issuers and related parties regarding continuing compliance
with federal tax requirements. Tax laws, especially those enacted during the
last decade, not only limit the purposes for which tax-exempt bonds can be
issued and the supply of such bonds, but also contain numerous and complex
requirements that must be satisfied on a continuing basis in order for bonds to
be and remain tax-exempt. If the issuer of a bond or a user of a bond-financed
facility fails to comply with such requirements at any time, interest on the
bond could become taxable, retroactive to the date the obligation was issued. In
that event, a portion of a Municipal Fund's distributions attributable to
interest such Fund received on such bond for the current year and for prior
years could be characterized or
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recharacterized as taxable income.
Each Fixed Income Fund and each Municipal Fund may purchase municipal
securities together with the right to resell the securities to the seller at an
agreed upon price or yield within a specified period prior to the maturity date
of the securities. Such a right to resell is commonly known as a "put" and is
also referred to as a "standby commitment." A Fund may pay for a standby
commitment either separately, in cash, or in the form of a higher price for the
securities which are acquired subject to the standby commitment, thus increasing
the cost of securities and reducing the yield otherwise available. Additionally,
a Fund may purchase beneficial interests in municipal securities held by trusts,
custodial arrangements or partnerships and/or combined with third-party puts or
other types of features such as interest rate swaps; those investments may
require the Fund to pay "tender fees" or other fees for the various features
provided.
The IRS has issued a revenue ruling to the effect that, under specified
circumstances, a registered investment company will be the owner of tax-exempt
municipal obligations acquired subject to a put option. The IRS has also issued
private letter rulings to certain taxpayers (which do not serve as precedent for
other taxpayers) to the effect that tax-exempt interest received by a regulated
investment company with respect to such obligations will be tax-exempt in the
hands of the company and may be distributed to its shareholders as
exempt-interest dividends. The IRS has subsequently announced that it will not
ordinarily issue advance ruling letters as to the identity of the true owner of
property in cases involving the sale of securities or participation interests
therein if the purchaser has the right to cause the security, or the
participation interest therein, to be purchased by either the seller or a third
party. Each Fund intends to take the position that it is the owner of any
municipal obligations acquired subject to a standby commitment or other third
party put and that tax-exempt interest earned with respect to such municipal
obligations will be tax-exempt in its hands. There is no assurance that the IRS
will agree with such position in any particular case. Additionally, the federal
income tax treatment of certain other aspects of these investments, including
the treatment of tender fees paid by the Fund, in relation to various regulated
investment company tax provisions is unclear. However, the Adviser intends to
manage each Fund's portfolio in a manner designed to minimize any adverse impact
from the tax rules applicable to these investments.
For federal income tax purposes, each Fund is permitted to carry
forward a net capital loss in any year to offset its own capital gains, if any,
during the eight years following the year of the loss. To the extent subsequent
years' capital gains are offset by such losses, they would not result in federal
income tax liability to the applicable Fund and, accordingly, would generally
not be distributed to shareholders. At October 31, 1996, Fixed Income Fund has
capital loss carryforwards of approximately $530,000 and Short-Term Fixed Income
Fund had capital loss carryforwards of approximately $26,000, in each case
expiring (if not previously used) in the fiscal year ended October 31, 2004.
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U.S. Shareholders -- Distributions
A Municipal Fund's distributions from the tax-exempt interest it
receives will generally be exempt from federal income tax, provided that such
Fund qualifies as a regulated investment company, at least 50% of the value of
the Fund's total assets at the close of each quarter of its taxable year
consists of obligations that pay interest excluded from gross income under
Section 103(a) of the Code, and the Fund properly designates such distributions
as "exempt-interest dividends." The portions of such exempt-interest dividends,
if any, derived from interest on certain private activity bonds will constitute
tax preference items and may give rise to, or increase liability under, the
federal alternative minimum tax for particular shareholders. In addition, all
exempt-interest dividends may increase a corporate shareholder's liability, if
any, for the corporate alternative minimum tax and will be taken into account in
determining the portion, if any, of a shareholder's social security benefits or
certain railroad retirement benefits that is subject to tax.
For U.S. federal income tax purposes, distributions by the Funds other
than the Municipal Funds, whether reinvested in additional shares or paid in
cash, generally will be taxable to shareholders who are subject to tax.
Shareholders receiving a distribution in the form of newly issued shares will be
treated for U.S. federal income tax purposes as receiving a distribution in an
amount equal to the amount of cash they would have received had they elected to
receive cash and will have a cost basis in each share received equal to such
amount divided by the number of shares received. Distributions from investment
company taxable income of any Fund, including the Municipal Funds, for the year
will be taxable as ordinary income. Investment company taxable income includes,
among other things, dividends, taxable interest, income from repurchase
agreements and securities loans; accrued, recognized market discount; a portion
of the discount on certain stripped tax-exempt obligations and their coupons;
and net short-term capital gain (in excess of net long-term capital loss) from
the sale of investments or options or futures transactions or the disposition of
rights to when-issued securities prior to issuance. Distributions to corporate
shareholders designated as derived from dividend income received by a Fund, if
any, that would be eligible for the dividends received deduction if the Fund
were not a regulated investment company will be eligible, subject to certain
holding period and debt-financing restrictions, for the 70% dividends received
deduction for corporations. Because eligible dividends are limited to those
received by a Fund from U.S. domestic corporations, all dividends paid by the
Municipal Funds, and all or a substantial portion of the dividends paid by the
Fixed Income Funds, will generally not qualify for the dividends received
deduction. The dividends-received deduction, if available, is reduced to the
extent the shares with respect to which the dividends received are treated as
debt financed under the Code and is eliminated if the shares are deemed to have
been held for less than a minimum period, generally 46 days. The entire
dividend, including the deducted amount, is considered in determining the
excess, if any, of a corporate shareholder's adjusted current earnings over its
alternative minimum taxable income, which may increase its liability for the
federal alternative minimum tax, and the dividend may, if it is treated as an
"extraordinary dividend" under the Code, reduce such shareholder's tax basis in
its shares of a Fund. Capital
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gain dividends (i.e., dividends from net capital gain) paid by any Fund,
including the Municipal Funds, if designated as such in a written notice to
shareholders mailed not later than 60 days after a Fund's taxable year closes,
will be taxed to shareholders as long-term capital gain regardless of how long
shares have been held by shareholders, but are not eligible for the dividends
received deduction for corporations.
Interest on indebtedness incurred directly or indirectly to purchase or
carry shares of a Municipal Fund will not be deductible to the extent it is
deemed related to exempt-interest dividends paid by such Fund.
A Municipal Fund may not be an appropriate investment for persons who
are, or are related to, substantial users of facilities financed by industrial
development or private activity bonds.
Shareholders that are required to file tax returns are required to
report tax-exempt interest income, including exempt-interest dividends, on their
federal income tax returns. Each Municipal Fund will inform shareholders of the
federal income tax status of its distributions after the end of each calendar
year, including the amounts that qualify as exempt-interest dividends and any
portions of such amounts that constitute tax preference items under the federal
alternative minimum tax. Shareholders who have not held shares of a Municipal
Fund for a full taxable year may have designated as tax-exempt or as a tax
preference item a percentage of their distributions which is not exactly equal
to a proportionate share of the amount of tax-exempt interest or tax preference
income earned during the period of their investment in the Fund.
Different tax treatment, including penalties on certain excess
contributions and deferrals, certain pre-retirement and post-retirement
distributions, and certain prohibited transactions, is accorded to accounts
maintained as qualified retirement plans. Shareholders should consult their tax
advisers for more information.
U.S. Shareholders -- Sale of Shares
When a shareholder's shares are sold, redeemed or otherwise disposed
of, the shareholder will generally recognize gain or loss equal to the
difference between the shareholder's adjusted tax basis in the shares and the
cash, or fair market value of any property, received. Assuming the shareholder
holds the shares as a capital asset at the time of such sale or other
disposition, such gain or loss should be capital in character, and long-term if
the shareholder has held the shares for more than one year, otherwise
short-term. However, any loss realized on the sale, redemption or other
disposition of shares with a tax holding period of six months or less will be
treated as a long-term capital loss to the extent of any capital gain dividend
received with respect to such shares and will be disallowed to the extent of any
exempt-interest dividends received with respect to such shares. Additionally,
any loss realized on a sale, redemption or other disposition of shares of a Fund
may be disallowed under "wash sale" rules to the extent the shares disposed of
are replaced with shares of the same Fund within a period of 61 days beginning
30 days before and ending 30 days after the shares are
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disposed of, such as pursuant to a dividend reinvestment in shares of the Fund.
If disallowed, the loss will be reflected in an adjustment to the basis of the
shares acquired.
The Funds may be required to withhold, as "backup withholding," federal
income tax at a rate of 31% from dividends (including distributions from a
Fund's net long-term capital gains, but not including exempt-interest dividends)
and share redemption and exchange proceeds to individuals and other non-exempt
shareholders who fail to furnish the Funds with a correct taxpayer
identification number ("TIN") certified under penalties of perjury, or if the
Internal Revenue Service or a broker notifies the Funds that the payee has
failed to properly report interest or dividend income to the IRS or that the TIN
furnished by the payee to the Funds is incorrect, or if (when required to do so)
the payee fails to certify under penalties of perjury that it is not subject to
backup withholding. Any amounts withheld may be credited against a shareholder's
United States federal income tax liability. Distributions by a Municipal Fund
will not be subject to backup withholding, however, for any year such Fund
reasonably estimates that at least 95% of its dividends will be exempt-interest
dividends.
Non-U.S. Shareholders
Shareholders who, as to the United States, are nonresident aliens,
foreign corporations, fiduciaries of foreign trusts or estates, foreign
partnerships or other non-U.S. investors generally will be subject to U.S.
withholding tax at the rate of 30% on distributions treated as ordinary income
unless the tax is reduced or eliminated pursuant to a tax treaty or the
dividends are effectively connected with a U.S. trade or business of the
shareholder. In the latter case the dividends will be subject to tax on a net
income basis at the graduated rates applicable to U.S. individuals or domestic
corporations. Distributions of net capital gain, including amounts retained by a
Fund which are designated as undistributed capital gains, to a non-U.S.
shareholder will not be subject to U.S. federal income or withholding tax unless
the distributions are effectively connected with the shareholder's trade or
business in the United States or, in the case of a shareholder who is a
nonresident alien individual, the shareholder is present in the United States
for 183 days or more during the taxable year and certain other conditions are
met.
Any gain realized by a non-U.S. shareholder upon a sale or redemption
of shares of a Fund will not be subject to U.S. federal income or withholding
tax unless the gain is effectively connected with the shareholder's trade or
business in the United States, or in the case of a shareholder who is a
nonresident alien individual, the shareholder is present in the United States
for 183 days or more during the taxable year and certain other conditions are
met. Non-U.S. investors should consult their tax advisers about the
applicability of U.S. federal income or withholding taxes to certain
distributions received by them.
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State and Local
The Funds may be subject to state or local taxes in jurisdictions in
which the Funds may be deemed to be doing business. In addition, in those states
or localities which have income tax laws, the treatment of a Fund and its
shareholders under such laws may differ from their treatment under federal
income tax laws, and investment in the Fund may have tax consequences for
shareholders different from those of a direct investment in the Fund's portfolio
securities.
Shareholders should consult their own tax advisers concerning these matters.
GENERAL INFORMATION ABOUT THE TRUST
General
The Trust is an open-end investment company organized as a Delaware
business trust on September 13, 1993. The Trust commenced operations on January
3, 1994. Until December 30, 1994, the Fixed Income Fund and the Municipal Bond
Fund were series of The Advisors' Inner Circle Fund, a Massachusetts business
trust organized under the laws of the Commonwealth of Massachusetts on July 18,
1991.
In the event of a liquidation or dissolution of the Trust or an
individual Fund, shareholders of a particular Fund would be entitled to receive
the assets available for distribution belonging to such Fund. Shareholders of a
Fund are entitled to participate in the net distributable assets of the
particular Fund involved on liquidation, based on the number of shares of the
Fund that are held by each shareholder.
Each service share and institutional share of a Fund is entitled to one
vote per share; however, separate votes will be taken by each Fund or class (or
by more than one Fund or class voting on a single class if similarly affected)
on matters affecting only the Fund or class (or those affected Funds or classes)
or as otherwise required by law. Shares are freely transferable and have no
preemptive, subscription or conversion rights. The Trust does not expect to hold
shareholder meetings except as required by the 1940 Act or the Agreement and
Declaration of Trust (the "Declaration of Trust"). See "Organization and Shares
of the Trust" in the Prospectus.
As of December 17, 1996, the following shareholders owned the following
respective percentages of the outstanding shares of the Fixed Income Fund, the
Municipal Bond Fund, The Short-Term Municipal Bond Fund, the Short-Term Fixed
Income Fund and The Smaller Companies Fund:
Fixed Income Fund:
SEI Trust Company 8.77%
Oaks,PA 19087
BATRUS & Co. 6.13%
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c/o Bankers Trust Company
PO Box 9005
Church Street Station
New York, NY 10006
San Mateo County Employees 8.11%
Retirement Association
2317 Broadway St STE 115
Redwood City, CA 94063-1613
Municipal Bond Fund:
SEI Trust Company 10.14%
Oaks, PA 19456
Batrus & Co., (New York Corporation) 45.79%
c/o Bankers Trust Co.
PO Box 706 Church Street Station
New York, NY 10008
INFID & Co. 10.22%
c/o Bankers Trust Co.
PO Box 9005 Church Street Station
New York, NY 10008
Short-Term Municipal Bond Fund:
SEI Trust Company 6.65%
Oaks, PA 19456
Rocco A. Ortenzio 20.82%
C/O Select Capital Corp
4718 Old Gettysburg Rd.
Mechanicsburg, PA 17055
Robert A. Ortenzio 6.94%
C/O Select Capital Corp
4718 Old Gettysburg Rd.
Mechanicsburg, PA 17055
Wilmington Trust Company 8.54%
FBO David Baldt
1100 N. Market Street
Wilmington, DE 19890
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Timothy Mather 7.04%
4901 S. Franklin St
Englewood, CO 80110
National Financial Services Corp 6.55%
200 Liberty St
1 World Financial Center
New York, NY 10281
Jay R. Brinsfield 5.25%
18625 SE Village Circle
Tequesta, FL 33469
Robert D. Greene 6.93%
26 Island Road
Stuart, FL 34996-7005
Short-Term Fixed Income Fund:
BATRUS & Co., (New York Corporation) 28.69%
c/o Bankers Trust
PO Box 9005 Church Street Station
New York, NY 10006
SEI Trust Company 18.30%
Oaks, PA 19456
Infid & Co. 6.97%
c/o Bankers Trust Co.
PO Box 706 Church Street Station
New York, NY 10008
Harris Trust FBO National Sporting Goods Assn 5.81%
111 W. Monroe Street
Chicago, IL 60603
Smaller Companies Fund:
Morgan Grenfell Capital Management, Inc. 79.71%
(Delaware Corporation)
885 Third Avenue Suite 3200
New York, NY 10022
Deutsche Morgan Grenfell 17.44%
CJ Lawrence
1290 Avenue of the Americas
New York, NY 10104
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Shareholder and Trustee Liability
The Trust is organized as a Delaware business trust and, under Delaware
law, the shareholders of a business trust are not generally subject to liability
for the debts or obligations of the trust. Similarly, Delaware law provides that
none of the Funds will be liable for the debts or obligations of any other Fund.
However, no similar statutory or other authority limiting business trust
shareholder liability exists in other states. As a result, to the extent that a
Delaware business trust or a shareholder is subject to the jurisdiction of the
courts in such other states, the courts may not apply Delaware law and may
thereby subject the Delaware business trust shareholders to liability. To guard
against this risk, the Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations of the Trust. Notice of such
disclaimer will normally be given in each agreement, obligation or instrument
entered into or executed by the Trust or the Trustees. The Declaration of Trust
provides for indemnification by the relevant Fund for any loss suffered by a
shareholder as a result of an obligation of the Fund. The Declaration of Trust
also provides that the Trust shall, upon request, assume the defense of any
claim made against any shareholder for any act or obligation of the Trust and
satisfy any judgment thereon. The Trustees believe that, in view of the above,
the risk of personal liability of shareholders is remote.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he or she
would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of his
or her office.
Consideration for Purchases of Shares
The Trust generally will not issue shares of the Funds for
consideration other than cash. At the Trust's sole discretion, however, it may
issue Fund shares for consideration other than cash in connection with an
acquisition of portfolio securities (other than municipal debt securities issued
by state political subdivisions or their agencies or instrumentalities) or
pursuant to a bona fide purchase of assets, merger or other reorganization,
provided (i) the securities meet the investment objectives and policies of the
Fund; (ii) the securities are acquired by the Fund for investment and not for
resale; (iii) the securities are not restricted as to transfer either by law or
liquidity of market; and (iv) the securities have a value which is readily
ascertainable (and not established only by valuation procedures) as evidenced by
a listing on the American Stock Exchange or the New York Stock Exchange or by
quotation on the NASD
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Automated Quotation System. An exchange of securities for Fund shares will
generally be a taxable transaction to the shareholder.
ADDITIONAL INFORMATION
Independent Accountants
Price Waterhouse LLP serves as the Funds' independent accountants,
providing audit services, including review and consultation in connection with
various filings by the Trust with the Commission and tax authorities.
Registration Statement
The Trust has filed with the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, a Registration Statement under the Securities Act of
1933, as amended, with respect to the securities of the Funds and certain other
series of the Trust. If further information is desired with respect to the
Trust, the Funds or such other series, reference is made to the Registration
Statement and the exhibits filed as a part thereof.
FINANCIAL STATEMENTS
The Trust's audited financial statements for the period ended October
31, 1996 are included in, and incorporated by reference into, this Statement of
Additional Information in reliance upon the report of Price Waterhouse LLP, the
Trust's independent accountants, as experts in accounting and auditing.
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Appendix A
DESCRIPTION OF BOND RATINGS
The rating descriptions set forth below are believed to be the most
recent rating descriptions available from Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Ratings Group ("Standard & Poor's), Duff &
Phelps, Inc. ("Duff") and Fitch Investors Service ("Fitch") at the date of this
Statement of Additional Information for the securities listed. Ratings are
generally given to securities at the time of issuance. While the rating agencies
may from time to time revise such ratings, they undertake no obligation to do
so, and the ratings indicated do not necessilarily represent ratings which will
be given to these securities on the date of a Fund's fiscal year end.
I. Long-Term Debt Ratings
Moody's Investors Service, Inc.
Description of four highest long-term debt ratings by Moody's (Moody's
applies numerical modifiers (1,2 and 3) in each rating category to indicate the
security's ranking within the category):
Aaa: Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to prinicpal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium grade
obligations, ie:, they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment characteristics
and in fact have speculative characteristics as well.
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Standard & Poor's Ratings Group (1)
Description of the four highest long-term debt ratings by Standard &
Poor's (Standard & Poor's may apply a plus (+) or minus (-) to a particular
rating classification to show relative standing within the classification):
AAA: Bonds rated AAA have the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA: Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the higher rated issues only in small degree.
A: Bonds rated A have a very strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than bonds in higher rated
categories.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
bonds in this category than in higher rated categories.
(1) Rates all governmental bodies having $1,000,000 or more of debt outstanding,
unless adequate information is not available.
Duff & Phelps, Inc.
Description of the four highest long-term debt ratings by Duff (Duff
may apply a plus or minus to show relative standing within a rating category):
AAA: Highest credit quality. The risk factors are negligible, being
only slightly more than for risk-free U.S. Treasury debt.
AA: High credit quality. Protection factors are strong. Risk is modest
but may vary slightly from time to time because of economic conditions.
A: Protection factors are average but adequate. However, risk factors
are more variable and greater in periods of economic stress.
BBB: Investment grade. Below average protection factors but still
considered sufficient for prudent investment. Considerable variability in risk
during economic cycles.
Fitch Investores Service
Description of the four highest long-term ratings by Fitch (plus or
minus signs are used with a rating symbol to indicate the relative position of
the credit within the rating category):
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AAA: Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably forseeable
events.
AA: Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA". Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of thest issues is generally rated "F-1+".
A: Bonds considered to be investment grade and of high crdit quality.
The obligor's ability to pay interest and to repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and to repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
II. Short-Term Debt Ratings
Short-term debt ratings may be assigned, for example, to commercial
paper, master demand notes, bank instruments and letters of credit.
Moody's description of its highest short-term debt rating:
Prime-1 Issuers rated Prime-1 (or supporting institutions) have
superior capacity for repayment of senior short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by many of the following
characteristics:
- Lending market positions in well established industries.
- High rates of return on funds employed.
- Conservative capitalization structures with moderate
reliance on debt and ample asset protection.
- Broad margins in earnings coverage of fixed financial
charges and high internal cash generation.
- Well-established access to a range of financial markets and
assured sources of alternative liquidity.
Standard & Poor's description of its highest short-term debt rating:
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A-1 This designation indicated that the degree of safety regarding
timely payment is strong. Those issues determined to have extremely strong
safety characteristics are denoted with a plus sign (+).
III. Short-Term Loan / Municipal Note Ratings
Moody's description of its two highest short-term loan / municipal note ratings:
MIG-1/VMIG-1 This description denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.
MIG-2/VMIG-2 This designation denotes high quality. Margins of
protection are ample although not so large as in the preceeding group.
Standard & Poor's description of its two highest municipal note ratings:
SP-1 Very strong or strong capacity to pay principal and interest.
Those issues determined to possess overwhelming safety characteristics will be
given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
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MORGAN GRENFELL INVESTMENT TRUST
No-Load Open-End Funds
SERVICE SHARES
885 Third Avenue
New York, New York 10022
STATEMENT OF ADDITIONAL INFORMATION
January 16, 1997
Morgan Grenfell Investment Trust (the "Trust") is an open-end, management
investment company consisting of eighteen investment portfolios, each having
separate and distinct investment objectives and policies. This Statement of
Additional Information provides supplementary information pertaining to the
following investment portfolios of the Trust (each, a "Fund"):
(Degree) Morgan Grenfell Fixed Income Fund
(Degree) Morgan Grenfell Municipal Bond Fund
(Degree) Morgan Grenfell Short-Term Fixed Income Fund
(Degree) Morgan Grenfell Short-Term Municipal Bond Fund
(Degree) Morgan Grenfell Smaller Companies Fund
(Degree) Morgan Grenfell MicroCap Fund
(Degree) Morgan Grenfell Large Cap Growth Fund
This Statement of Additional Information is not a prospectus, and should be
read only in conjunction with the Funds' Service Shares Prospectus dated January
16, 1997, as amended or supplemented from time to time (the "Prospectus"). A
copy of the Prospectus may be obtained without charge from any Service
Organization that has an agreement with the Trust or SEI Financial Services
Company, the Trust's Distributor, by calling 1-800-550-6426 or writing to 1
Freedom Valley Drive, Oaks, Pennsylvania 19456-0100.
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TABLE OF CONTENTS
Page
Introduction..................................................... 3
Additional Information on Fund Investments
and Strategies and Related Risks............................... 4
Investment Restrictions.......................................... 30
Trustees and Officers............................................ 36
Investment Advisory and Other Services........................... 40
Service Plan..................................................... 46
Portfolio Transactions .......................................... 48
Net Asset Value.................................................. 51
Performance Information.......................................... 52
Taxes............................................................ 56
General Information About the Trust.............................. 65
Additional Information........................................... 70
Financial Statements............................................. 70
Appendix A -- Description of Ratings............................. A-1
No person has been authorized to give any information or to make any
representations not contained in this Statement of Additional Information or in
the Prospectus in connection with the offering made by the Prospectus and, if
given or made, such information or representations must not be relied upon as
having been authorized by the Trust or its Distributor. The Prospectus does not
constitute an offering by the Trust or by the Distributor in any jurisdiction in
which such offering may not lawfully be made.
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INTRODUCTION
The Trust is an open-end, management investment company that currently
consists of eighteen separate investment portfolios. This Statement of
Additional Information relates to the following seven separate investment
portfolios of the Trust (the "Funds"):
Morgan Grenfell Smaller Companies Fund
Morgan Grenfell MicroCap Fund
Morgan Grenfell Large Cap Growth Fund
(collectively, the "Equity Funds")
Morgan Grenfell Fixed Income Fund
Morgan Grenfell Short-Term Fixed Income Fund
(collectively, the "Fixed Income Funds")
Morgan Grenfell Municipal Bond Fund
Morgan Grenfell Short-Term Municipal Bond Fund
(collectively, the "Municipal Funds")
The Funds are classified as "diversified" within the meaning of the
Investment Company Act of 1940 (the "1940 Act").
Morgan Grenfell Capital Management, Inc. (the "Adviser" or "MGCM") serves
as investment adviser to the Funds. SEI Financial Services Company (the
"Distributor") serves as the Funds' principal underwriter and distributor. SEI
Financial Management Corporation serves as the Funds' administrator.
The information contained in this Statement of Additional Information
generally supplements the information contained in the Prospectus. No investor
should invest in service shares of a Fund without first reading the Prospectus.
Capitalized terms used herein and not otherwise defined have the same meaning
ascribed to them in the Prospectus.
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ADDITIONAL INFORMATION ON FUND INVESTMENTS
AND STRATEGIES AND RELATED RISKS
The following supplements the information contained in the Prospectus
concerning the investment objectives and policies of each Fund.
Fixed Income Securities
Variable and Floating Rate Instruments. Debt instruments purchased by a
Fund may be structured to have variable or floating interest rates. These
instruments may include variable amount master demand notes that permit the
indebtedness to vary in addition to providing for periodic adjustments in the
interest rates. The Adviser will consider the earning power, cash flows and
other liquidity ratios of the issuers and guarantors of such instruments and, if
the instrument is subject to a demand feature, will continuously monitor their
financial ability to meet payment on demand. Where necessary to ensure that a
variable or floating rate instrument is equivalent to the quality standards
applicable to a Fund's fixed income investments, the issuer's obligation to pay
the principal of the instrument will be backed by an unconditional bank letter
or line of credit, guarantee or commitment to lend. Any bank providing such a
bank letter, line of credit, guarantee or loan commitment will meet the Fund's
investment quality standards relating to investments in bank obligations. A Fund
will invest in variable and floating rate instruments only when the Adviser
deems the investment to involve minimal credit risk. The Adviser will also
continuously monitor the creditworthiness of issuers of such instruments to
determine whether a Fund should continue to hold the investments.
The absence of an active secondary market for certain variable and floating
rate notes could make it difficult to dispose of the instruments, and a Fund
could suffer a loss if the issuer defaults or during periods in which a Fund is
not entitled to exercise its demand rights.
Variable and floating rate instruments held by a Fund will be subject to
the Fund's limitation on investments in illiquid securities when a reliable
trading market for the instruments does not exist and the Fund may not demand
payment of the principal amount of such instruments within seven days.
Yields and Ratings. The yields on certain obligations, including the money
market instruments in which each Fund may invest (such as commercial paper and
bank obligations), are dependent on a variety of factors, including general
money market conditions, conditions in the particular market for the obligation,
the financial condition of the issuer, the size of the offering,
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the maturity of the obligation and the ratings of the issue. The ratings of
Standard and Poors Ratings Group ("Standard & Poor's"), Moody's Investors
Service, Inc. ("Moody's") and other recognized rating organizations represent
their respective opinions as to the quality of the obligations they undertake to
rate. Ratings, however, are general and are not absolute standards of quality or
value. Consequently, obligations with the same rating, maturity and interest
rate may have different market prices. See Appendix A for a description of the
ratings provided by Standard & Poor's, Moody's and certain other recognized
rating organizations.
Subsequent to its purchase by a Fund, a rated security may cease to be
rated or its rating may be reduced below the minimum rating required for
purchase by a Fund. The Board of Trustees or the Adviser, pursuant to guidelines
established by the Board of Trustees, will consider such an event in determining
whether the Fund should continue to hold the security in accordance with the
interests of the Fund and applicable regulations of the Securities and Exchange
Commission (the "Commission"). In no event, however, will a Fund hold more than
5% of its net assets in fixed income securities that are not investment grade.
Custodial Receipts. Each of the Fixed Income Funds may acquire U.S.
Government Securities and their unmatured interest coupons that have been
separated ("stripped") by their holder, typically a custodian bank or investment
brokerage firm. Having separated the interest coupons from the underlying
principal of the U.S. Government Securities, the holder will resell the stripped
securities in custodial receipt programs with a number of different names,
including "Treasury Income Growth Receipts" ("TIGRs") and "Certificate of
Accrual on Treasury Securities" ("CATS"). The stripped coupons are sold
separately from the underlying principal, which is usually sold at a deep
discount because the buyer receives only the right to receive a future fixed
payment on the security and does not receive any rights to periodic interest
(cash) payments. The underlying U.S. Treasury bonds and notes themselves are
generally held in book-entry form at a Federal Reserve Bank. Counsel to the
underwriters of these certificates or other evidences of ownership of U.S.
Treasury securities have stated that, in their opinion, purchasers of the
stripped securities most likely will be deemed the beneficial holders of the
underlying U.S. Government Securities for federal tax and securities purposes.
In the case of CATS and TIGRS, the Internal Revenue Service ( the "IRS") has
reached this conclusion for the purpose of applying the tax diversification
requirements applicable to regulated investment companies such as the Funds.
CATS and TIGRS are not considered U.S. Government Securities by the staff of the
Commission. Further, the IRS conclusion noted above is contained only in a
general counsel memorandum,
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which is an internal document of no precedential value or binding effect, and a
private letter ruling, which also may not be relied upon by the Funds. The Trust
is not aware of any binding legislative, judicial or administrative authority on
this issue.
Preferred Stock
Subject to their investment objectives, the Equity Funds may purchase
preferred stock. Preferred stocks are equity securities, but possess certain
attributes of debt securities and are generally considered fixed income
securities. Holders of preferred stocks normally have the right to receive
dividends at a fixed rate when and as declared by the issuer's board of
directors, but do not participate in other amounts available for distribution by
the issuing corporation. Dividends on the preferred stock may be cumulative, and
in such cases all cumulative dividends usually must be paid prior to dividend
payments to common stockholders. Because of this preference, preferred stocks
generally entail less risk than common stocks. Upon liquidation, preferred
stocks are entitled to a specified liquidation preference, which is generally
the same as the par or stated value, and are senior in right of payment to
common stocks. However, preferred stocks are equity securities in that they do
not represent a liability of the issuer and therefore do not offer as great a
degree of protection of capital or assurance of continued income as investments
in corporate debt securities. In addition, preferred stocks are subordinated in
right of payment to all debt obligations and creditors of the issuer, and
convertible preferred stocks may be subordinated to other preferred stock of the
same issuer. See "Convertible Securities and Preferred Stocks" in the Prospectus
for a description of certain characteristics of convertible preferred stock.
Warrants
As stated in the Prospectus, the Equity Funds may purchase warrants,
which are privileges issued by corporations enabling the owners to subscribe to
and purchase a specified number of shares of the corporation at a specified
price during a specified period of time. The purchase of warrants involves a
risk that a Fund could lose the purchase value of a warrant if the right to
subscribe to additional shares is not exercised prior to the warrant's
expiration. Also, the purchase of warrants involves the risk that the effective
price paid for the warrant added to the subscription price of the related
security may exceed the value of the subscribed security's market price such as
when there is no movement in the level of the underlying security. An Equity
Fund will not invest more than 5% of its net assets, taken at market value, in
warrants, or more than 2% of its net assets, taken at market value, in warrants
not listed on a recognized securities exchange. Warrants acquired by a Fund in
units or attached to other securities shall
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not be included in determining compliance with these percentage limitations. See
"Investment Restrictions."
Municipal Securities
As stated in the Prospectus, the Municipal Funds and, to a more limited
extent, the Fixed Income Funds may invest in municipal securities. Municipal
securities consist of bonds, notes and other instruments issued by or on behalf
of states, territories and possessions of the United States (including the
District of Columbia) and their political subdivisions, agencies or
instrumentalities, the interest on which is exempt from regular federal income
tax (i.e., excluded from gross income for federal income tax purposes but not
necessarily exempt from the federal alternative minimum tax or from state and
local taxes). Municipal securities may also be issued on a taxable basis (i.e.,
the interest on such securities is not exempt from regular federal income tax).
Municipal securities are often issued to obtain funds for various
public purposes, including the construction of a wide range of public facilities
such as bridges, highways, housing, hospitals, mass transportation, schools,
streets and water and sewer works. Other public purposes for which municipal
securities may be issued include refunding outstanding obligations, obtaining
funds for general operating expenses, and obtaining funds to lend to other
public institutions and facilities. Municipal securities also include "private
activity" or industrial development bonds, which are issued by or on behalf of
public authorities to provide financing aid to acquire sites or construct or
equip facilities within a municipality for privately or publicly owned
corporations.
The two principal classifications of municipal securities are "general
obligations" and "revenue obligations." General obligations are secured by the
issuer's pledge of its full faith and credit for the payment of principal and
interest although the characteristics and enforcement of general obligations may
vary according to the law applicable to the particular issuer. Revenue
obligations, which include, but are not limited to, private activity bonds,
resource recovery bonds, certificates of participation and certain municipal
notes, are not backed by the credit and taxing authority of the issuer and are
payable solely from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source. Nevertheless, the obligations of the issuer may also be
backed by a letter of credit, guarantee or insurance. General obligations and
revenue obligations may be issued in a variety of forms, including commercial
paper, fixed,
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variable and floating rate securities, tender option bonds, auction rate bonds
and capital appreciation bonds.
In addition to general obligations and revenue obligations, there is a
variety of hybrid and special types of municipal securities. There are also
numerous differences in the credit backing of municipal securities both within
and between these two principal classifications.
For the purpose of applying a Fund's investment restrictions, the
identification of the issuer of a municipal security which is not a general
obligation is made by the Adviser based on the characteristics of the municipal
security, the most important of which is the source of funds for the payment of
principal and interest on such securities.
An entire issue of municipal securities may be purchased by one or a
small number of institutional investors such as a Fund. Thus, the issue may not
be said to be publicly offered. Unlike some securities that are not publicly
offered, a secondary market exists for many municipal securities that were not
publicly offered initially and such securities can be readily marketable.
The obligations of an issuer to pay the principal of and interest on a
municipal security are subject to the provisions of bankruptcy, insolvency and
other laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Act, and laws, if any, that may be enacted by Congress or state
legislatures extending the time for payment of principal or interest or imposing
other constraints upon the enforcement of such obligations. There is also the
possibility that, as a result of litigation or other conditions, the power or
ability of the issuer to pay when due principal of or interest on a municipal
security may be materially affected.
Municipal Leases, Certificates of Participation and Other Participation
Interests. A municipal lease is an obligation in the form of a lease or
installment purchase contract which is issued by a state or local government to
acquire equipment and facilities. Income from such obligations is generally
exempt from state and local taxes in the state of issuance (as well as regular
Federal income tax). Municipal leases frequently involve special risks not
normally associated with general obligation or revenue bonds. Leases and
installment purchase or conditional sale contracts (which normally provide for
title to the leased asset to pass eventually to the governmental issuer) have
evolved as a means for governmental issuers to acquire property and equipment
without meeting the constitutional and statutory requirements for the issuance
of debt. The debt issuance limitations are deemed to be inapplicable because of
the inclusion in many leases or contracts of "non-appropriation" clauses that
relieve the governmental issuer of any
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obligation to make future payments under the lease or contract unless money is
appropriated for such purpose by the appropriate legislative body on a yearly or
other periodic basis. Thus, a Fund's investment in municipal leases will be
subject to the special risk that the governmental issuer may not appropriate
funds for lease payments.
In addition, such leases or contracts may be subject to the temporary
abatement of payments in the event the issuer is prevented from maintaining
occupancy of the leased premises or utilizing the leased equipment. Although the
obligations may be secured by the leased equipment or facilities, the
disposition of the property in the event of nonappropriation or foreclosure
might prove difficult, time consuming and costly, and result in an
unsatisfactory or delayed recoupment of a Fund's original investment.
Certificates of participation represent undivided interests in
municipal leases, installment purchase contracts or other instruments. The
certificates are typically issued by a trust or other entity which has received
an assignment of the payments to be made by the state or political subdivision
under such leases or installment purchase contracts.
Certain municipal lease obligations and certificates of participation
may be deemed illiquid for the purpose of the Funds' respective limitations on
investments in illiquid securities. Other municipal lease obligations and
certificates of participation acquired by a Fund may be determined by the
Adviser, pursuant to guidelines adopted by the Trustees of the Trust, to be
liquid securities for the purpose of such Fund's limitation on investments in
illiquid securities. In determining the liquidity of municipal lease obligations
and certificates of participation, the Adviser will consider a variety of
factors including: (1) the willingness of dealers to bid for the security; (2)
the number of dealers willing to purchase or sell the obligation and the number
of other potential buyers; (3) the frequency of trades or quotes for the
obligation; and (4) the nature of the marketplace trades. In addition, the
Adviser will consider factors unique to particular lease obligations and
certificates of participation affecting the marketability thereof. These include
the general creditworthiness of the issuer, the importance to the issuer of the
property covered by the lease and the likelihood that the marketability of the
obligation will be maintained throughout the time the obligation is held by a
Fund. No Fund may invest more than 5% of its net assets in municipal leases.
Each Municipal Fund and each Fixed Income Fund may purchase
participations in municipal securities held by a commercial bank or other
financial institution. Such participations provide a Fund with the right to
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a pro rata undivided interest in the underlying municipal securities. In
addition, such participations generally provide a Fund with the right to demand
payment, on not more than seven days notice, of all or any part of the Fund's
participation interest in the underlying municipal security, plus accrued
interest.
Municipal Notes. Municipal securities in the form of notes generally
are used to provide for short-term capital needs, in anticipation of an issuer's
receipt of other revenues or financing, and typically have maturities of up to
three years. Such instruments may include Tax Anticipation Notes, Revenue
Anticipation Notes, Bond Anticipation Notes, Tax and Revenue Anticipation Notes
and Construction Loan Notes. Tax Anticipation Notes are issued to finance the
working capital needs of governments. Generally, they are issued in anticipation
of various tax revenues, such as income, sales, property, use and business
taxes, and are payable from these specific future taxes. Revenue Anticipation
Notes are issued in expectation of receipt of other kinds of revenue, such as
federal revenues available under federal revenue sharing programs. Bond
Anticipation Notes are issued to provide interim financing until long-term bond
financing can be arranged. In most cases, the long-term bonds then provide the
funds needed for repayment of the notes. Tax and Revenue Anticipation Notes
combine the funding sources of both Tax Anticipation Notes and Revenue
Anticipation Notes. Construction Loan Notes are sold to provide construction
financing. These notes are secured by mortgage notes insured by the Federal
Housing Authority; however, the proceeds from the insurance may be less than the
economic equivalent of the payment of principal and interest on the mortgage
note if there has been a default. The obligations of an issuer of municipal
notes are generally secured by the anticipated revenues from taxes, grants or
bond financing. An investment in such instruments, however, presents a risk that
the anticipated revenues will not be received or that such revenues will be
insufficient to satisfy the issuer's payment obligations under the notes or that
refinancing will be otherwise unavailable.
Tax-Exempt Commercial Paper. Issues of tax-exempt commercial paper
typically represent short-term, unsecured, negotiable promissory notes. These
obligations are issued by state and local governments and their agencies to
finance working capital needs of municipalities or to provide interim
construction financing and are paid from general revenues of municipalities or
are refinanced with long-term debt. In most cases, tax-exempt commercial paper
is backed by letters of credit, lending agreements, note repurchase agreements
or other credit facility agreements offered by banks or other institutions.
Pre-Refunded Municipal Securities. The principal of and interest on
municipal securities that have been pre-refunded are no longer paid from the
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original revenue source for the securities. Instead, after pre-refunding the
source of such payments is typically an escrow fund consisting of obligations
issued or guaranteed by the U.S. Government. The assets in the escrow fund are
derived from the proceeds of refunding bonds issued by the same issuer as the
pre-refunded municipal securities. Issuers of municipal securities use this
advance refunding technique to obtain more favorable terms with respect to
securities that are not yet subject to call or redemption by the issuer. For
example, advance refunding enables an issuer to refinance debt at lower market
interest rates, restructure debt to improve cash flow or eliminate restrictive
covenants in the indenture or other governing instrument for the pre-refunded
municipal securities. However, except for a change in the revenue source from
which principal and interest payments are made, the pre-refunded municipal
securities remain outstanding on their original terms until they mature or are
redeemed by the issuer. Pre-refunded municipal securities are usually purchased
at a price which represents a premium over their face value.
Tender Option Bonds. A tender option bond is a municipal security
(generally held pursuant to a custodial arrangement) having a relatively long
maturity and bearing interest at a fixed rate substantially higher than
prevailing short-term tax-exempt rates. The bond is typically issued in
conjunction with the agreement of a third party, such as a bank, broker-dealer
or other financial institution, pursuant to which such institution grants the
security holders the option, at periodic intervals, to tender their securities
to the institution and receive the face value thereof.
As consideration for providing the option, the financial institution
receives periodic fees equal to the difference between the bond's fixed coupon
rate and the rate, as determined by a remarketing or similar agent at or near
the commencement of such period, that would cause the securities, coupled with
the tender option, to trade at par on the date of such determination. Thus,
after payment of this fee, the security holder effectively holds a demand
obligation that bears interest at the prevailing short-term tax-exempt rate.
However, an institution will not be obligated to accept tendered bonds in the
event of certain defaults or a significant downgrade in the credit rating
assigned to the issuer of the bond. The liquidity of a tender option bond is a
function of the credit quality of both the bond issuer and the financial
institution providing liquidity. Tender option bonds are deemed to be liquid
unless, in the opinion of the Adviser, the credit quality of the bond issuer and
the financial institution is deemed, in light of the Fund's credit quality
requirements, to be inadequate. Each Municipal Fund intends to invest only in
tender option bonds the
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interest on which will, in the opinion of bond counsel, counsel for the issuer
of interests therein or counsel selected by the Adviser, be exempt from regular
federal income tax. However, because there can be no assurance that the IRS will
agree with such counsel's opinion in any particular case, there is a risk that a
Municipal Fund will not be considered the owner of such tender option bonds and
thus will not be entitled to treat such interest as exempt from such tax.
Additionally, the federal income tax treatment of certain other aspects of these
investments, including the proper tax treatment of tender option bonds and the
associated fees, in relation to various regulated investment company tax
provisions is unclear. Each Municipal Fund intends to manage its portfolio in a
manner designed to eliminate or minimize any adverse impact from the tax rules
applicable to these investments.
Auction Rate Securities. Auction rate securities consist of auction
rate municipal securities and auction rate preferred securities issued by
closed-end investment companies that invest primarily in municipal securities.
Provided that the auction mechanism is successful, auction rate securities
usually permit the holder to sell the securities in an auction at par value at
specified intervals. The dividend is reset by "Dutch" auction in which bids are
made by broker-dealers and other institutions for a certain amount of securities
at a specified minimum yield. The dividend rate set by the auction is the lowest
interest or dividend rate that covers all securities offered for sale. While
this process is designed to permit auction rate securities to be traded at par
value, there is the risk that an auction will fail due to insufficient demand
for the securities.
Dividends on auction rate preferred securities issued by a closed-end
fund may be designated as exempt from federal income tax to the extent they are
attributable to tax-exempt interest income earned by the fund on the securities
in its portfolio and distributed to holders of the preferred securities,
provided that the preferred securities are treated as equity securities for
federal income tax purposes and the closed-end fund complies with certain
requirements under the Internal Revenue Code of 1986, as amended (the "Code").
For purposes of complying with the 20% limitation on each Municipal Fund's
investments in taxable investments, auction rate preferred securities will be
treated as taxable investments unless substantially all of the dividends on such
securities are expected to be exempt from regular federal income taxes.
Each Fund's investments in auction rate preferred securities of closed-end
funds are subject to limitations on investments in other investment companies,
which limitations are prescribed by the 1940 Act. These limitations include a
prohibition against acquiring more than 3% of the voting securities of any other
investment company, and investing more than 5% of the Fund's assets in
securities of any one investment company or more than
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10% of its assets in securities of all investment companies. A Fund will
indirectly bear its proportionate share of any management fees paid by such
closed-end funds in addition to the advisory fee payable directly by the Fund.
Private Activity Bonds. Certain types of municipal securities,
generally referred to as industrial development bonds (and referred to under
current tax law as private activity bonds), are issued by or on behalf of public
authorities to obtain funds for privately-operated housing facilities, airport,
mass transit or port facilities, sewage disposal, solid waste disposal or
hazardous waste treatment or disposal facilities and certain local facilities
for water supply, gas or electricity. Other types of industrial development
bonds, the proceeds of which are used for the construction, equipment, repair or
improvement of privately operated industrial or commercial facilities, may
constitute municipal securities, although the current federal tax laws place
substantial limitations on the size of such issues. The interest from certain
private activity bonds owned by a Fund (including a Municipal Fund's
distributions attributable to such interest) may be a preference item for
purposes of the alternative minimum tax.
Mortgage-Backed Securities
As stated in the Prospectus, the Fixed Income Funds and the Municipal
Funds may invest in mortgage-backed securities, including derivative
instruments. Mortgage-backed securities represent direct or indirect
participations in or obligations collateralized by and payable from mortgage
loans secured by real property. Each Fixed Income Fund and each Municipal Fund
may invest in mortgage-backed securities issued or guaranteed by U.S. Government
agencies or instrumentalities such as the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the
Federal Home Loan Mortgage Corporation ("FHLMC"). Obligations of GNMA are backed
by the full faith and credit of the U.S. Government. Obligations of FNMA and
FHLMC are not backed by the full faith and credit of the U.S. Government but are
considered to be of high quality since they are considered to be
instrumentalities of the United States. The market value and yield of these
mortgage-backed securities can vary due to market interest rate fluctuations and
early prepayments of underlying mortgages. These securities represent ownership
in a pool of Federally insured mortgage loans with a maximum maturity of 30
years. The scheduled monthly interest and principal payments relating to
mortgages in the pool will be "passed through" to investors. Government
mortgage-backed securities differ from conventional bonds in that principal is
paid back to the
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certificate holders over the life of the loan rather than at maturity. As a
result, there will be monthly scheduled payments of principal and interest.
Only the Fixed Income Funds may invest in mortgage-backed securities
issued by non-governmental entities including collateralized mortgage
obligations ("CMOs") and real estate mortgage investment conduits ("REMICs").
CMOs are securities collateralized by mortgages, mortgage pass-throughs,
mortgage pay-through bonds (bonds representing an interest in a pool of
mortgages where the cash flow generated from the mortgage collateral pool is
dedicated to bond repayment), and mortgage-backed bonds (general obligations of
the issuers payable out of the issuers' general funds and additionally secured
by a first lien on a pool of single family detached properties). Many CMOs are
issued with a number of classes or series which have different maturities and
are retired in sequence. Investors purchasing such CMOs in the shortest
maturities receive or are credited with their pro rata portion of the
unscheduled prepayments of principal up to a predetermined portion of the total
CMO obligation. Until that portion of such CMO obligation is repaid, investors
in the longer maturities receive interest only. Accordingly, the CMOs in the
longer maturity series are less likely than other mortgage pass-throughs to be
prepaid prior to their stated maturity. Although some of the mortgages
underlying CMOs may be supported by various types of insurance, and some CMOs
may be backed by GNMA certificates or other mortgage pass-throughs issued or
guaranteed by U.S. Government agencies or instrumentalities, the CMOs themselves
are not generally guaranteed.
REMICs are private entities formed for the purpose of holding a fixed
pool of mortgages secured by an interest in real property. REMICs are similar to
CMOs in that they issue multiple classes of securities, including "regular"
interests and "residual" interests. The Funds do not intend to acquire residual
interests in REMICs under current tax law, due to certain disadvantages for
regulated investment companies that acquire such interests.
Mortgage-backed securities are subject to unscheduled principal
payments representing prepayments on the underlying mortgages. Although these
securities may offer yields higher than those available from other types of
securities, mortgage-backed securities may be less effective than other types of
securities as a means of "locking in" attractive long-term rates because of the
prepayment feature. For instance, when interest rates decline, the value of
these securities likely will not rise as much as comparable debt securities due
to the prepayment feature. In addition, these prepayments can cause the price of
a mortgage-backed security originally purchased at a premium to decline in price
to its par value, which may result in a loss.
Due to prepayments of the underlying mortgage instruments, mortgage-backed
securities do not have a known actual maturity. In the absence of a
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known maturity, market participants generally refer to an estimated average
life. The Adviser believes that the estimated average life is the most
appropriate measure of the maturity of a mortgage-backed security. Accordingly,
in order to determine whether such security is a permissible investment, it will
be deemed to have a remaining maturity of three years or less if the average
life, as estimated by the Adviser, is three years or less at the time of
purchase of the security by a Fund. An average life estimate is a function of an
assumption regarding anticipated prepayment patterns. The assumption is based
upon current interest rates, current conditions in the relevant housing markets
and other factors. The assumption is necessarily subjective, and thus different
market participants could produce somewhat different average life estimates with
regard to the same security. Although the Adviser will monitor the average life
of the portfolio securities of each Fixed Income Fund and Municipal Fund and
make needed adjustments to comply with the Funds' policy as to average dollar
weighted portfolio maturity, there can be no assurance that the average life of
portfolio securities as estimated by the Adviser will be the actual average life
of such securities.
As stated in the Prospectus, no Fund will invest 25% or more of its total
assets in CMOs (other than U.S. Government Securities).
Asset-Backed Securities
As stated in the Prospectus, the Fixed Income Funds may invest in
asset-backed securities, which represent participations in, or are secured by
and payable from, pools of assets including company receivables, truck and auto
loans, leases and credit card receivables. The asset pools that back
asset-backed securities are securitized through the use of privately-formed
trusts or special purpose corporations. Payments or distributions of principal
and interest may be guaranteed up to certain amounts and for a certain time
period by a letter of credit or a pool insurance policy issued by a financial
institution unaffiliated with the trust or corporation, or other credit
enhancements may be present. Certain asset backed securities may be considered
derivative instruments. As stated in the Prospectus, no Fund will invest 25% or
more of its total assets in asset-backed securities.
Foreign Securities
Subject to their respective investment objectives and policies, the
Equity Funds and the Fixed Income Funds may invest in securities of foreign
issuers. While the Equity Funds' non-U.S. investments may be denominated in any
currency, the Fixed Income Funds' investments in foreign securities may
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be denominated only in the U.S. dollar. Foreign securities may offer investment
opportunities not available in the United States, but such investments also
involve significant risks not typically associated with investing in domestic
securities. In many foreign countries, there is less publicly available
information about foreign issuers, and there is less government regulation and
supervision of foreign stock exchanges, brokers and listed companies. Also, in
many foreign countries, companies are not subject to uniform accounting,
auditing, and financial reporting standards comparable to those applicable to
domestic issuers. Security trading practices differ and there may be difficulty
in enforcing legal rights outside the United States. Settlement of transactions
in some foreign markets may be delayed or may be less frequent than in the
United States, which could affect the liquidity of the Funds' portfolios.
Additionally, in some foreign countries, there is the possibility of
expropriation or confiscatory taxation, limitations on the removal of
securities, property, or other Fund assets, political or social instability or
diplomatic developments which could affect investments in foreign securities.
To the extent an Equity Fund's investments are denominated in foreign
currencies, the net asset values of such Fund may be affected favorably or
unfavorably by fluctuations in currency exchange rates and by changes in
exchange control regulations. For example, if the Adviser increases the Fund's
exposure to a foreign currency, and that currency's value subsequently falls,
the Adviser's currency management may result in increased losses to the Fund.
Similarly, if the Adviser hedges the Fund's exposure to a foreign currency, and
that currency's value rises, the Fund will lose the opportunity to participate
in the currency's appreciation. The Equity Funds will incur transaction costs in
connection with conversions between currencies.
Foreign Government Securities. The foreign government securities in
which the Fixed Income Funds and the Equity Funds may invest generally consist
of debt obligations issued or guaranteed by national, state or provincial
governments or similar political subdivisions. The Fixed Income Funds and Equity
Funds may invest in foreign government securities in the form of American
Depository Receipts. Foreign government securities also include debt securities
of supranational entities. Currently, each Fixed Income Fund intends to invest
only in obligations issued or guaranteed by the Asian Development Bank, the
Inter-American Development Bank, the International Bank for Reconstruction and
Development (the "World Bank"), the African Development Bank, the European Coal
and Steel Community, the European Economic Community, the European Investment
Bank and the Nordic Investment Bank. Foreign government securities also include
mortgage-related securities issued or guaranteed by national, state or
provincial governmental instrumentalities, including quasi-governmental
agencies.
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Forward Foreign Currency Exchange Contracts
Each of the Equity Funds may exchange currencies in the normal course
of managing its investments in foreign securities and may incur costs in doing
so because a foreign exchange dealer will charge a fee for conversion. An Equity
Fund may conduct foreign currency exchange transactions on a "spot" basis (i.e.,
for prompt delivery and settlement) at the prevailing spot rate for purchasing
or selling currency in the foreign currency exchange market. An Equity Fund also
may enter into forward foreign currency exchange contracts ("forward currency
contracts") or other contracts to purchase and sell currencies for settlement at
a future date. A foreign exchange dealer, in that situation, will expect to
realize a profit based on the difference between the price at which a foreign
currency is sold to the Equity Fund and the price at which the dealer will cover
the purchase in the foreign currency market. Foreign exchange transactions are
entered into at prices quoted by dealers, which may include a mark-up over the
price that the dealer must pay for the currency.
A forward currency contract involves an obligation to purchase or sell
a specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are traded in the interbank market conducted
directly between currency traders (usually large commercial banks) and their
customers. A forward contract generally has no deposit requirement, and no
commissions are generally charged at any stage for trades.
At the maturity of a forward contract, an Equity Fund may either accept
or make delivery of the currency specified in the contract or, at or prior to
maturity, enter into a closing purchase transaction involving the purchase or
sale of an offsetting contract. Closing purchase transactions with respect to
forward contracts are usually effected with the currency trader who is a party
to the original forward contract.
The Equity Funds may enter into forward currency contracts only for the
following hedging purposes. First, when an Equity Fund enters into a contract
for the purchase or sale of a security denominated in a foreign currency, or
when an Equity Fund anticipates the receipt in a foreign currency of dividend or
interest payments on such a security which it holds, the Fund may desire to
"lock in" the U.S. dollar price of the security or the U.S. dollar equivalent of
such dividend or interest payment, as the case may be. By entering into a
forward contract for the purchase or sale, for a fixed amount of U.S. dollars,
of the amount of foreign currency involved in
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the underlying transactions, the Fund will attempt to protect itself against an
adverse change in the relationship between the U.S. dollar and the subject
foreign currency during the period between the date on which the security is
purchased or sold, or on which the dividend or interest payment is declared, and
the date on which such payments are made or received.
Additionally, when management of an Equity Fund believes that the
currency of a particular foreign country may suffer a substantial decline
against the U.S. dollar, it may cause the Fund to enter into a forward contract
to sell, for a fixed amount of U.S. dollars, the amount of foreign currency
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. The precise matching of the forward
contract amounts and the value of the securities involved will not generally be
possible because the future value of such securities in foreign currencies will
change as a consequence of market movements in the value of those securities
between the date on which the contract is entered into and the date it matures.
Using forward currency contracts in an attempt to protect the value of a Fund's
portfolio securities against a decline in the value of a currency does not
eliminate fluctuations in the underlying prices of the securities. It simply
establishes a rate of exchange which the Fund can achieve at some future point
in time. The precise projection of short-term currency market movements is not
possible, and short-term hedging provides a means of fixing the dollar value of
only a portion of a Fund's foreign assets.
A Fund's custodian will place cash or liquid securities into a
segregated account of the Fund in an amount equal to the value of the Fund's
total assets committed to the consummation of forward currency contracts
requiring the Fund to purchase foreign currencies. If the value of the
securities placed in the segregated account declines, additional cash or liquid
securities will be placed in the account on a daily basis so that the value of
the account will equal the amount of the Fund's commitments with respect to such
contracts. The segregated account will be marked-to-market on a daily basis.
Although forward currency contracts are not presently 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 Fund's ability to
utilize forward currency contracts may be restricted. In addition, a particular
forward currency contract and assets used to cover such contract may be
illiquid.
The Equity Funds generally will not enter into a forward currency
contract with a term of greater than one year.
While the Equity Funds will enter into forward currency contracts to
reduce currency exchange rate risks, transactions in such contracts involve
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certain other risks. Thus, while the Equity Funds may benefit from currency
transactions, unanticipated changes in currency prices may result in a poorer
overall performance for either Fund than if it had not engaged in any such
transactions. Moreover, there may be an imperfect correlation between a Fund's
portfolio holdings of securities denominated in a particular currency and
forward contracts entered into by the Fund. Such imperfect correlation may cause
the Fund to sustain losses which will prevent the Fund from achieving a complete
hedge or expose the Fund to risk of foreign currency exchange loss. Forward
currency contracts may be considered derivative instruments.
Each Equity Fund's activities in forward currency contracts, currency
futures contracts and related options and currency options (see below) may be
limited by the requirements of Subchapter M of the Code for qualification as a
regulated investment company.
Options on Securities, Securities Indices and Foreign Currencies
Each of the Equity Funds may write covered put and call options and
purchase put and call options. Such options may relate to particular securities,
to various stock indices, or to currencies. The Equity Funds may write call and
put options which are issued by the Options Clearing Corporation (the "OCC") or
which are traded on U.S. and non-U.S. exchanges and over-the-counter. These
instruments may be considered derivative instruments. See "Description of
Securities and Investment Techniques and Related Risks -- Options" in the
Prospectus.
A call option on a securities index provides the holder with the right
to receive a cash payment upon exercise of the option if the market value of the
underlying index exceeds the option's exercise price. Conversely, a put option
on a securities index provides the holder with the right to receive a cash
payment upon exercise of the option if the market value of the underlying index
is less than the option's exercise price. The amount of any payment to the
option holder will be equal to the difference between the closing price of the
index at the time of exercise and the exercise price of the option expressed in
U.S. dollars or a foreign currency, times a specified multiple. A put option on
a currency gives its holder the right to sell an amount (specified in units of
the underlying currency) of the underlying currency at the stated exercise price
at any time prior to the option's expiration. Conversely, a call option on a
currency gives its holder the right to purchase an amount (specified in units of
the underlying currency) of the underlying currency at the stated exercise price
at any time prior to the option's expiration.
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The Equity Funds will engage in over-the-counter ("OTC") options only
with broker-dealers deemed creditworthy by the Adviser. Closing transactions in
certain options are usually effected directly with the same broker-dealer that
effected the original option transaction. A Fund bears the risk that the
broker-dealer may fail to meet its obligations. There is no assurance that a
Fund will be able to close an unlisted option position. Furthermore, unlisted
options are not subject to the protections afforded purchasers of listed options
by the OCC, which performs the obligations of its members who fail to do so in
connection with the purchase or sale of options.
An Equity Fund will write call options only if they are "covered." In
the case of a call option on a security, the option is "covered" if the Fund
owns the security underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or, if additional
cash consideration is required, cash or liquid securities in such amount are
held in a segregated account by the Fund's custodian) upon conversion or
exchange of other securities held by it. For a call option on an index, the
option is covered if the Fund maintains with the Fund's custodian cash or liquid
securities equal to the contract value. A call option on a security or an index
is also covered if the Fund holds a call on the same security or index as the
call written by the Fund where the exercise price of the call held is (i) equal
to or less than the exercise price of the call written, or (ii) greater than the
exercise price of the call written provided the difference is maintained by the
Fund in cash or liquid securities in a segregated account with the Fund's
custodian. A call option on currency written by the Fund is covered if the Fund
owns an equal amount of the underlying currency.
When an Equity Fund purchases a put option, the premium paid by it is
recorded as an asset of the Fund. When the Fund writes an option, an amount
equal to the net premium (the premium less the commission paid by the Fund)
received by the Fund is included in the liability section of the Fund's
statement of assets and liabilities as a deferred credit. The amount of this
asset or deferred credit will be marked-to-market on an ongoing basis to reflect
the current value of the option purchased or written. The current value of a
traded option is the last sale price or, in the absence of a sale, the average
of the closing bid and asked prices. If an option purchased by a Fund expires
unexercised, the Fund realizes a loss equal to the premium paid. If a Fund
enters into a closing sale transaction on an option purchased by it, the Fund
will realize a gain if the premium received by a Fund on the closing transaction
is more than the premium paid to purchase the option, or a loss if it is less.
If an option written by a Fund expires on the stipulated expiration date or if a
Fund enters into a closing purchase transaction, it will realize a gain (or loss
if the cost of a closing
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purchase transaction exceeds the net premium received when the option is sold)
and the deferred credit related to such option will be eliminated. If an option
written by a Fund is exercised, the proceeds to the Fund from the exercise will
be increased by the net premium originally received, and the Fund will realize a
gain or loss.
There are several risks associated with transactions in options on
securities, securities indices and currencies. For example, there are
significant differences between the securities markets, currency markets and the
corresponding options markets that could result in imperfect correlations,
causing a given option transaction not to achieve its objectives. In addition, a
liquid secondary market for particular options, whether traded OTC or on a U.S.
or non-U.S. securities exchange may be absent for reasons which include the
following: there may be insufficient trading interest in certain options;
restrictions may be imposed by an exchange on opening transactions or closing
transactions or both; trading halts, suspensions or other restrictions may be
imposed with respect to particular classes or series of options or underlying
securities; unusual or unforeseen circumstances may interrupt normal operations
on an exchange; the facilities of an exchange or the OCC may not at all times be
adequate to handle current trading volume; or 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),
in which event the secondary market on that exchange (or in that class or series
of options) would cease to exist, although outstanding options 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 hours of trading for options may not conform to the hours during
which the underlying securities and currencies are traded. To the extent that
the options markets close before the markets for the underlying securities and
currencies, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the options markets. The purchase
of options is a highly specialized activity which involves investment techniques
and risks different from those associated with ordinary portfolio securities
transactions. The risks described above also apply to options on futures, which
are discussed below.
Futures Contracts and Related Options
To hedge against changes in interest rates or securities prices and for
certain non-hedging purposes, the Equity Funds may purchase and sell various
kinds of futures contracts, and purchase and write call and put options on
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any of such futures contracts. The Equity Funds may also enter into closing
purchase and sale transactions with respect to any of such contracts and
options. The futures contracts may be based on various securities (such as U.S.
Government securities), indices, currencies and other financial instruments. The
Equity Funds will engage in futures and related options transactions only for
bona fide hedging or other non-hedging purposes as defined in regulations
promulgated by the CFTC. All futures contracts entered into by the Equity Funds
are traded on U.S. exchanges or boards of trade that are licensed and regulated
by the CFTC or on foreign exchanges approved by the CFTC.
Futures Contracts. A futures contract may generally be described as an
agreement between two parties to buy and sell a particular financial instrument
for an agreed 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).
Futures contracts obligate the long or short holder to take or make delivery of
a specified quantity of a commodity or financial instrument, such as a security
or the cash value of a securities index, during a specified future period at a
specified price.
When interest rates are rising or securities prices are falling, an
Equity Fund can seek to offset a decline in the value of its current portfolio
securities through the sale of futures contracts. When interest rates are
falling or securities prices are rising, an Equity Fund, through the purchase of
futures contracts, can attempt to secure better rates or prices than might later
be available in the market when it effects anticipated purchases.
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 futures contracts on securities will usually
be liquidated in this manner, the Equity Funds may instead make, or take,
delivery of the underlying securities whenever it appears economically
advantageous to do so. A clearing corporation associated with the exchange on
which futures on securities are traded guarantees that, if still open, the sale
or purchase will be performed on the settlement date.
Hedging Strategies. Hedging, by use of futures contracts, seeks to
establish with more certainty the effective price and rate of return on
portfolio securities and securities that a Fund proposes to acquire. the Equity
Funds may, for example, take a "short" position in the futures market by selling
futures contracts in order to hedge against an anticipated rise in interest
rates or a decline in market prices that would adversely affect the value of the
Fund's portfolio securities. Such futures contracts may include
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contracts for the future delivery of securities held by a Fund or securities
with characteristics similar to those of the Fund's portfolio securities. If, in
the opinion of the Adviser, there is a sufficient degree of correlation between
price trends for an Equity Fund's portfolio securities and futures contracts
based on other financial instruments, securities indices or other indices, the
Fund may also 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 Adviser will
attempt to estimate the extent of this volatility difference based on historical
patterns and compensate for any such differential by having the Fund enter into
a greater or lesser number of futures contracts or by attempting to achieve only
a partial hedge against price changes affecting a Fund's securities portfolio.
When hedging of this character is successful, any depreciation in the value of
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 would be substantially offset by a
decline in the value of the futures position.
On other occasions, the Equity Funds may take a "long" position by
purchasing futures contracts. This would be done, for example, when a Fund
anticipates the subsequent purchase of particular securities when it has the
necessary cash, but expects the prices then available in the applicable market
to be less favorable than prices that are currently available.
Options on Futures Contracts. The acquisition of put and call options
on futures contracts will give the Equity 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, a Fund obtains the benefit of the
futures position if prices move in a favorable direction but limits 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
which may partially offset a decline in the value of a Fund's assets. By writing
a call option, a Fund becomes obligated, in exchange for the premium, to sell a
futures contract (if the option is exercised), which may have a value higher
than the exercise price. Conversely, the writing of a put option on a futures
contract generates a premium which may partially offset an increase in the price
of securities that the Fund intends to purchase. However, a Fund becomes
obligated to purchase a futures contract (if the option is exercised) which may
have a value lower than the exercise price.
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Thus, the loss incurred by a Fund in writing options on futures is potentially
unlimited and may exceed the amount of the premium received. The 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 such closing transactions can be effected. The Equity
Funds ability to establish and close out positions on such options will be
subject to the development and maintenance of a liquid market.
The Equity Funds may use options on futures contracts solely for bona
fide hedging or other non-hedging purposes as described below.
Other Considerations. The Equity Funds will engage in futures and
related options transactions only for bona fide hedging or non-hedging purposes
as permitted by CFTC regulations which permit principals of an investment
company registered under the 1940 Act to engage in such transactions without
registering as commodity pool operators. Each Equity Fund will determine that
the price fluctuations in the futures contracts and options on futures used by
it for hedging purposes are substantially related to price fluctuations in
securities or instruments held by the Fund or securities or instruments which it
expects to purchase. Except as stated below, the Equity Funds futures
transactions will be entered into for traditional hedging purposes--i.e.,
futures contracts will be sold to protect against a decline in the price of
securities (or the currency in which they are denominated) that a Fund owns or
futures contracts will be purchased to protect the Fund against an increase in
the price of securities (or the currency in which they are denominated) that the
Fund intends to purchase. As evidence of this hedging intent, each Equity Fund
expects that, on 75% or more of the occasions on which it takes a long futures
or option position (involving the purchase of futures contracts), the Fund will
have purchased, or will be in the process of purchasing, equivalent amounts of
related securities (or assets denominated in the related currency) in the cash
market at the time when the futures or option position is closed out. However,
in particular cases, when it is economically advantageous for a Fund to do so, a
long futures position may be terminated or an option may expire without the
corresponding purchase of securities or other assets.
As an alternative to compliance with the bona fide hedging definition,
a CFTC regulation now permits a Fund to elect to comply with a different test
under which the aggregate initial margin and premiums required to establish
non-hedging positions in futures contracts and options on futures will not
exceed 5% of the net asset value of the Fund's portfolio, after taking into
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account unrealized profits and losses on any such positions and excluding the
amount by which such options were in-the-money at the time of purchase. Each
Equity Fund will engage in transactions in futures contracts and related options
only to the extent such transactions are consistent with the requirements of the
Code for maintaining its qualification as a regulated investment company. See
"Taxes."
Each Equity Fund will be required, in connection with transactions in
futures contracts and the writing of options on futures contracts, to make
margin deposits, which will be held by its custodian for the benefit of the
futures commission merchant through whom the Fund engages in such futures and
option transactions. These transactions involve brokerage costs, require margin
deposits and, in the case of futures contracts and options obligating the Fund
to purchase securities, require the Fund to segregate cash or liquid securities
in an account maintained with its custodian to cover such contracts and options.
While transactions in futures contracts and options on futures may
reduce certain risks, such transactions themselves entail certain other risks.
Thus, unanticipated changes in interest rates or securities prices may result in
a poorer overall performance for a Fund than if it had not entered into any
futures contracts or options transactions. The other risks associated with the
use of futures contracts and options thereon are (i) imperfect correlation
between the change in market value of the securities held by a Fund and the
prices of the futures and options and (ii) the possible absence of a liquid
secondary market for a futures contract or option and the resulting inability to
close a futures position prior to its maturity date.
In the event of an imperfect correlation between a futures position and
portfolio position which is intended to be protected, the desired protection may
not be obtained and an Equity Fund may be exposed to risk of loss. The risk of
imperfect correlation may be minimized by investing in contracts whose price
behavior is expected to resemble that of the Fund's underlying securities. The
Equity Funds will attempt to minimize the risk that they will be unable to close
out futures positions by entering into such transactions on a national exchange
with an active and liquid secondary market.
Commercial Paper
Commercial paper is a short-term, unsecured negotiable promissory note
of a U.S or non-U.S issuer. Each of the Funds may purchase commercial paper
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as described in the Prospectus. Each Fund may also invest in variable rate
master demand notes which typically are issued by large corporate borrowers and
which provide for variable amounts of principal indebtedness and periodic
adjustments in the interest rate. Demand notes are direct lending arrangements
between a Fund and an issuer, and are not normally traded in a secondary market.
A Fund, however, may demand payment of principal and accrued interest at any
time. In addition, while demand notes generally are not rated, their issuers
must satisfy the same criteria as those that apply to issuers of commercial
paper. The Adviser will consider the earning power, cash flow and other
liquidity ratios of issuers of demand notes and continually will monitor their
financial ability to meet payment on demand. See also "Fixed Income Securities
- --Variable and Floating Rate Instruments."
Bank Obligations
As stated in the Prospectus, each Fund's investments in money market
instruments may include certificates of deposit, time deposits and bankers'
acceptances. Certificates of Deposit ("CDs") are short-term negotiable
obligations of commercial banks. Time Deposits ("TDs") are non-negotiable
deposits maintained in banking institutions for specified periods of time at
stated interest rates. Bankers' acceptances are time drafts drawn on commercial
banks by borrowers usually in connection with international transactions.
U.S. commercial banks organized under federal law are supervised and
examined by the Comptroller of the Currency and are required to be members of
the Federal Reserve System and to be insured by the Federal Deposit Insurance
Corporation (the "FDIC"). U.S. banks organized under state law are supervised
and examined by state banking authorities but are members of the Federal Reserve
System only if they elect to join. Most state banks are insured by the FDIC
(although such insurance may not be of material benefit to a Fund, depending
upon the principal amount of CDs of each bank held by the Fund) and are subject
to federal examination and to a substantial body of federal law and regulation.
As a result of governmental regulations, U.S. branches of U.S. banks, among
other things, generally are required to maintain specified levels of reserves,
and are subject to other supervision and regulation designed to promote
financial soundness.
U.S. savings and loan associations, the CDs of which may be purchased by
the Funds, are supervised and subject to examination by the Office of Thrift
Supervision. U.S. savings and loan associations are insured by the Savings
Association Insurance Fund which is administered by the FDIC and backed by the
full faith and credit of the U.S. Government.
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Repurchase Agreements
Each of the Funds may enter into repurchase agreements as described in
the Prospectus.
For purposes of the 1940 Act and, generally, for tax purposes, a
repurchase agreement is considered to be a loan from the Fund to the seller of
the obligation. For other purposes, it is not clear whether a court would
consider such an obligation as being owned by the Fund or as being collateral
for a loan by the Fund to the seller. In the event of the commencement of
bankruptcy or insolvency proceedings with respect to the seller of the
obligation before its repurchase, under the repurchase agreement, the Fund may
encounter delay and incur costs before being able to sell the security. Such
delays may result in a loss of interest or decline in price of the obligation.
If the court characterizes the transaction as a loan and the Fund has not
perfected a security interest in the obligation, the Fund may be treated as an
unsecured creditor of the seller and required to return the obligation to the
seller's estate. As an unsecured creditor, the Fund would be at risk of losing
some or all of the principal and income involved in the transaction. As with any
unsecured debt instrument purchased for the Funds, the Adviser seeks to minimize
the risk of loss from repurchase agreements by analyzing the creditworthiness of
the obligor, in this case, the seller of the obligation. In addition to the risk
of bankruptcy or insolvency proceedings, there is the risk that the seller may
fail to repurchase the security. However, if the market value of the obligation
falls below an amount equal to 102% of the repurchase price (including accrued
interest), the seller of the obligation will be required to deliver additional
securities so that the market value of all securities subject to the repurchase
agreement equals or exceeds the repurchase price.
"When-Issued" Purchases and Forward Commitments (Delayed Delivery)
These transactions, which involve a commitment by a Fund to purchase or
sell particular securities with payment and delivery taking place at a future
date (perhaps one or two months later), permit the Fund to lock in a price or
yield on a security, regardless of future changes in interest rates. A Fund will
purchase securities on a "when-issued" or forward commitment basis only with the
intention of completing the transaction and actually purchasing the securities.
If deemed appropriate by the Adviser, however, a Fund may dispose of or
renegotiate a commitment after it is entered into, and may sell securities it
has committed to purchase before those securities are delivered to the Fund on
the settlement date. In these cases the Fund may realize a
27
<PAGE>
gain or loss, and distributions attributable to any such gain would be taxable
to shareholders.
When a Fund agrees to purchase securities on a "when-issued" or forward
commitment basis, the Fund's custodian will set aside cash or liquid securities
equal to the amount of the commitment in a separate account. Normally, the
custodian will set aside portfolio securities to satisfy a purchase commitment,
and in such a case the Fund may be required subsequently to place additional
assets in the separate account in order to ensure that the value of the account
remains equal to the amount of the Fund's commitments. The market value of a
Fund's net assets will generally fluctuate to a greater degree when it sets
aside portfolio securities to cover such purchase commitments than when it sets
aside cash. Because a Fund's liquidity and ability to manage its portfolio might
be affected when it sets aside cash or portfolio securities to cover such
purchase commitments, each Fund expects that its commitments to purchase
when-issued securities and forward commitments will not exceed 33% of the value
of its total assets. When a Fund engages in "when-issued" and forward commitment
transactions, it relies on the other party to the transaction to consummate the
trade. Failure of such party to do so may result in the Fund incurring a loss or
missing an opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities, and any subsequent fluctuations
in their market value, are taken into account when determining the market value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest or dividends on the securities it has committed to
purchase until the settlement date.
Borrowing
Each Fund may borrow for temporary or emergency purposes, although
borrowings by the Fixed Income Fund and the Municipal Bond Fund may not exceed
10% of the value of their respective net assets. This borrowing may be
unsecured. The 1940 Act requires a Fund to maintain continuous asset coverage
(that is, total assets including borrowings, less liabilities exclusive of
borrowings) of 300% of the amount borrowed. If the asset coverage should decline
below 300% as a result of market fluctuations or for other reasons, a Fund will
be required to sell some of its portfolio securities within three days to reduce
its borrowings and restore the 300% asset coverage, even though it may be
disadvantageous from an investment standpoint to sell securities at that time.
To limit the potential leveraging effects of a Fund's borrowings, the Equity
Funds, the Short-Term Fixed Income Fund and the Short-Term Municipal Bond Fund
will not make
28
<PAGE>
investments while borrowings are in excess of 5% of total assets. The Fixed
Income Fund and the Municipal Bond Fund may not make additional investments
while they have any borrowings outstanding. Borrowing generally will exaggerate
the effect on net asset value of any increase or decrease in the market value of
the portfolio. Money borrowed will be subject to interest costs which may or may
not be recovered by appreciation of the securities purchased. A Fund also may be
required to maintain minimum average balances in connection with such borrowing
or to pay a commitment or other fee to maintain a line of credit; either of
these requirements would increase the cost of borrowing over the stated interest
rate. See "Investment Restrictions."
Lending Portfolio Securities
Each Fund, other than Fixed Income Fund and Municipal Bond Fund, may
lend portfolio securities to brokers, dealers and other financial organizations.
These loans, if and when made by a Fund, may not exceed 33 1/3% of the value of
the Fund's total assets. A Fund's loans of securities will be collateralized by
cash, cash equivalents or U.S. Government securities. The cash or instruments
collateralizing the Fund's loans of securities will be maintained at all times
in a segregated account with the Fund's custodian, in an amount at least equal
to the current market value of the loaned securities. From time to time, a Fund
may pay a part of the interest earned from the investment of collateral received
for securities loaned to the borrower and/or a third party that is unaffiliated
with the Fund and is acting as a "placing broker". No fee will be paid to
affiliated persons of the Fund. The Board of Trustees will make a determination
that the fee paid to the placing broker is reasonable.
By lending portfolio securities, a Fund can increase its income by
continuing to receive amounts equal to the interest or dividends on the loaned
securities as well as by either investing the cash collateral in short-term
instruments or obtaining yield in the form of interest paid by the borrower when
U.S. Government securities are used as collateral. A Fund will comply with the
following conditions whenever it loans securities: (i) the Fund must receive at
least 100% cash collateral or equivalent securities from the borrower; (ii) the
borrower must increase the collateral whenever the market value of the
securities loaned rises above the level of the collateral; (iii) the Fund must
be able to terminate the loan at any time; (iv) the Fund must receive reasonable
interest on the loan, as well as amounts equal to the dividends, interest or
other distributions on the loaned securities, and any increase in market value;
(v) the Fund may pay only reasonable custodian fees in connection with the loan;
and (vi) voting rights
29
<PAGE>
on the loaned securities may pass to the borrower except that, if a material
event will occur affecting the investment in the loaned securities, the Fund
must terminate the loan in time to vote the securities on such event.
INVESTMENT RESTRICTIONS
The fundamental investment restrictions set forth below may not be
changed with respect to a Fund without the approval of a "majority" (as defined
in the 1940 Act) of the outstanding shares of that Fund. For the purposes of the
1940 Act, "majority" means the lesser of (a) 67% or more of the shares of the
Fund present at a meeting, if the holders of more than 50% of the outstanding
shares of the Fund are present or represented by proxy or (b) more than 50% of
the shares of the Fund. Investment restrictions that involve a maximum
percentage of securities or assets shall not be considered to be violated unless
an excess over the percentage occurs immediately after, and is caused by, an
acquisition or encumbrance of securities or assets of, or borrowings by or on
behalf of, a Fund with the exception of borrowings permitted by fundamental
investment restriction (2) listed below for Short Term-Fixed Income Fund,
Short-Term Municipal Bond Fund and the Equity Funds and fundamental investment
restriction (3) listed below for Fixed Income Fund and Municipal Bond Fund.
The nonfundamental investment restrictions set forth below may be
changed or amended by the Trust's Board of Trustees without shareholder
approval.
Investment Restrictions That Apply to Short-Term Fixed Income Fund, Short-Term
Municipal Bond Fund and the Equity Funds
Fundamental Investment Restrictions. The Trust may not, on behalf of a Fund:
(1) Issue senior securities, except as permitted by paragraphs (2), (6)
and (7) below. For purposes of this restriction, the issuance of shares of
beneficial interest in multiple classes or series, the purchase or sale of
options, futures contracts and options on futures contracts, forward
commitments, forward foreign exchange contracts, repurchase agreements and
reverse repurchase agreements entered into in accordance with the Fund's
investment policy, and the pledge, mortgage or hypothecation of the Fund's
assets within the meaning of paragraph (3) below are not deemed to be senior
securities, if appropriately covered.
(2) Borrow money (i) except from banks as a temporary measure for
extraordinary emergency purposes and (ii) except that the Fund may enter into
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<PAGE>
reverse repurchase agreements and dollar rolls, if appropriately covered, with
banks, broker-dealers and other parties; provided that, in each case, the Fund
is required to maintain asset coverage of at least 300% for all borrowings. For
the purposes of this investment restriction, short sales, transactions in
currency, forward contracts, swaps, options, futures contracts and options on
futures contracts, and forward commitment transactions shall not constitute
borrowing.
(3) Pledge, mortgage, or hypothecate its assets, except to secure
indebtedness permitted by paragraph (2) above and to the extent related to the
segregation of assets in connection with the writing of covered put and call
options and the purchase of securities or currencies on a forward commitment or
delayed-delivery basis and collateral and initial or variation margin
arrangements with respect to forward contracts, options, futures contracts and
options on futures contracts.
(4) Act as an underwriter, except to the extent that, in connection
with the disposition of Fund securities, the Fund may be deemed to be an
underwriter for purposes of the Securities Act of 1933.
(5) Purchase or sell real estate, or any interest therein, and real
estate mortgage loans, except that the Fund may invest in securities of
corporate or governmental entities secured by real estate or marketable
interests therein or securities issued by companies (other than real estate
limited partnerships) that invest in real estate or interests therein.
(6) Make loans, except that the Fund may lend Fund securities in
accordance with the Fund's investment policies and may purchase or invest in
repurchase agreements, bank certificates of deposit, all or a portion of an
issue of bonds, bank loan participation agreements, bankers' acceptances,
debentures or other securities, whether or not the purchase is made upon the
original issuance of the securities.
(7) Invest in commodities or commodity contracts or in puts, calls, or
combinations of both, except interest rate futures contracts, options on
securities, securities indices, currency and other financial instruments,
futures contracts on securities, securities indices, currency and other
financial instruments and options on such futures contracts, forward foreign
currency exchange contracts, forward commitments, securities index put or call
warrants and repurchase agreements entered into in accordance with the Fund's
investment policies.
(8) Invest 25% or more of the value of the Fund's total assets in the
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<PAGE>
securities of one or more issuers conducting their principal business activities
in the same industry or group of industries. This restriction does not apply to
investments in obligations of the U.S. Government or any of its agencies or
instrumentalities.
In addition, each Fund will adhere to the following
fundamental investment restriction:
With respect to 75% of its total assets, a Fund may not
purchase securities of an issuer (other than the U.S. Government, or any of its
agencies or instrumentalities, or other investment companies), if
(a) such purchase would cause more than 5% of the Fund's
total assets taken at market value to be invested in
the securities of such issuer, or
(b) such purchase would at the time result in more than 10%
of the outstanding voting securities of such issuer
being held by the Fund.
NonFundamental Investment Restrictions. The Trust may not, on behalf of a Fund:
(a) Participate on a joint-and-several basis in any securities trading
account. The "bunching" of orders for the sale or purchase of marketable Fund
securities with other accounts under the management of the Adviser to save
commissions or to average prices among them is not deemed to result in a
securities trading account.
(b) Purchase securities on margin or make short sales unless by virtue
of its ownership of other securities, the Fund has the right to obtain, without
payment of additional consideration, securities equivalent in kind and amount to
the securities sold and, if the right is conditional, the sale is made upon the
same conditions, except that a Fund may obtain such short-term credits as may be
necessary for the clearance of purchases and sales of securities and in
connection with transactions involving forward foreign currency exchange
transactions, options, futures and options on futures.
(c) Purchase securities of other investment companies, except in the
open market where no commission or profit to a sponsor or dealer results from
the purchase other than the customary broker's commission and as permitted by
the Investment Company Act of 1940 and the rules and regulations thereunder.
(d) Purchase securities of any issuer which, together with any
predecessor, has a record of less than three years' continuous operations prior
to the purchase if such purchase would cause investments of the Fund in
32
<PAGE>
all such issuers to exceed 5% of the value of the total assets of the Fund.
(e) Invest for the purpose of exercising control over or management of
any company.
(f) Purchase warrants of any issuer, if, as a result of such purchases,
more than 2% of the value of the Fund's net assets would be invested in warrants
which are not listed on the New York Stock Exchange or the American Stock
Exchange or more than 5% of the value of the net assets of the Fund would be
invested in warrants generally, whether or not so listed. For these purposes,
warrants are to be valued at the lesser of cost or market, but warrants acquired
by the Fund in units with or attached to debt securities shall be deemed to be
without value.
(g) Purchase or retain securities of an issuer if one or more of the
Trustees or officers of the Trust or directors or officers of the Adviser or any
investment management subsidiary of the Adviser individually owns beneficially
more than 0.5% and together own beneficially more than 5% of the securities of
such issuer.
(h) Purchase interests in oil, gas or other mineral leases or
exploration programs; however, this policy will not prohibit the acquisition of
securities of companies engaged in the production or transmission of oil, gas or
other minerals.
(i) Purchase any security, including any repurchase agreement maturing
in more than seven days, which is illiquid, if more than 15% of the net assets
of the Fund, taken at market value, would be invested in such securities.
(j) Invest more than 5% of its total assets in restricted securities,
excluding restricted securities eligible for resale pursuant to Rule 144A under
the Securities Act of 1933; provided, however, that no more than 15% of the
Fund's total assets may be invested in restricted securities including
restricted securities eligible for resale under Rule 144A.
(k) Write covered calls or put options with respect to more than 25% of
the value of its total assets or invest more than 5% of its total assets in
puts, calls, spreads, or straddles, other than protective put options.
The staff of the Commission has taken the position that fixed time
deposits maturing in more than seven days that cannot be traded on a secondary
market and participation interests in loans are illiquid. Until
33
<PAGE>
such time (if any) as this position changes, the Trust, on behalf of each Fund,
will include such investments in determining compliance with the 15% limitation
on investments in illiquid securities. Restricted securities (including
commercial paper issued pursuant to Section 4(2) of the Securities Act of 1933
which the Board of Trustees has determined are readily marketable will not be
deemed to be illiquid for purposes of such restriction.
"Value" for the purposes of the foregoing investment restrictions shall
mean the market value used in determining each Fund's net asset value.
Investment Restrictions That Apply to the Fixed Income Fund And the Municipal
Bond Fund
Fundamental Investment Restrictions. The Trust may not, on behalf of
the Fixed Income Fund or the Municipal Bond Fund:
(1) Acquire more than 10% of the voting securities of any one issuer.
(2) Invest in companies for the purpose of exercising control.
(3) Borrow money except for temporary or emergency purposes and then only
in an amount not exceeding 10% of the value of its total assets. Any
borrowing will be done from a bank and to the extent that such
borrowing exceeds 5% of the value of a Fund's assets, asset coverage
of at least 300% is required. In the event that such asset coverage
shall at any time fall below 300%, a Fund shall, within three days
thereafter or such longer period as the Securities and Exchange
Commission may prescribe by rules and regulations, reduce the amount
of its borrowings to such an extent that the asset coverage of such
borrowings shall be at least 300%. This borrowing provision is
included for temporary liquidity or emergency purposes. All borrowings
will be repaid before making investments and any interest paid on such
borrowings will reduce income.
(4) Make loans, except that a Fund may purchase or hold debt instruments
in accordance with its investment objective and policies, and a Fund
may enter into repurchase agreements.
(5) Pledge, mortgage or hypothecate assets except to secure temporary
borrowings permitted by (3) above in aggregate amounts not to exceed
10% of total assets taken at current value at the time of the
incurrence of such loan.
(6) Purchase or sell real estate, real estate limited partnership
interests, futures contracts, commodities or commodities contracts and
interests in a pool of securities that are secured by interests in
real
34
<PAGE>
estate. However, subject to the permitted investments of the Fund, a
Fund may invest in municipal securities or other obligations secured
by real estate or interests therein.
(7) Make short sales of securities, maintain a short position or purchase
securities on margin, except that a Fund may obtain short-term credits
as necessary for the clearance of security transactions.
(8) Act as an underwriter of securities of other issuers except as it may
be deemed an underwriter in selling a portfolio security.
(9) Purchase securities of other investment companies except as permitted
by the Investment Company Act of 1940 and the rules and regulations
thereunder.
(10) Issue senior securities (as defined in the Investment Company Act of
1940) except in connection with permitted borrowings as described
above or as permitted by rule, regulation or order of the Securities
and Exchange Commission.
(11) Purchase or retain securities of an issuer if an officer, trustee,
partner or director of the Fund or any investment adviser of the Fund
owns beneficially more than 1/2 of 1% of the shares or securities of
such issuer and all such officers, trustees, partners and directors
owning more than 1/2 of 1% of such shares or securities together own
more than 5% of such shares or securities.
(12) Invest in interests in oil, gas or other mineral exploration or
development programs and oil, gas or mineral leases.
(13) Write or purchase puts, calls, options or combinations thereof or
invest in warrants, except that a Fund may purchase "put" bonds as
described in the Prospectus.
Nonfundamental Investment Restrictions.
(1) A Fund may not invest in illiquid securities in an amount
exceeding, in the aggregate, 10% of the Municipal Bond Fund's total assets and
15% of the Fixed Income Fund's net assets. An illiquid security is a security
that cannot be disposed of promptly (within seven days) and in the usual course
of business without a loss, and includes repurchase agreements maturing in
excess of seven days, time deposits with a withdrawal penalty, non-negotiable
instruments and instruments for which no
35
<PAGE>
market exists.
(2) A Fund may not purchase securities of any issuer which, together
with any predecessor, has a record of less than three years' continuous
operations prior to the purchase if such purchase would cause investments of the
Fund in all such issuers to exceed 15% of the value of the total assets of the
Fund and the Fund may not invest more than 5% of its total assets in restricted
securities, excluding restricted securities eligible for resale pursuant to Rule
144A under the Securities Act of 1933; provided, however, that no more than 15%
of the Fund's total assets may be invested in restricted securities including
restricted securities eligible for resale under Rule 144A.
(3) A Fund may not purchase securities of other investment companies
except in the open market where no commission or profit to a sponsor or dealer
results from the purchase other than the customary broker's commission and as
permitted by the Investment Company Act of 1940 and the rules and regulations
thereunder.
TRUSTEES AND OFFICERS
Information pertaining to the Trustees and officers of the Trust is set
forth below. An asterisk (*) indicates those Trustees deemed to be "interested
persons" of the Trust for purposes of the 1940 Act.
<TABLE>
<CAPTION>
Positions Principal Occupation
Name and Address and Age With Trust During Past Five Years
- ------------------------ ---------------- ------------------------------
<S> <C> <C>
James E. Minnick(1)* President, Chief President, Secretary and
885 Third Avenue Executive Treasurer, MGCM (since 1990).
New York, NY 10022 Officer and
(age 48) Trustee
Patrick W. W. Disney(1)* Senior Vice Director, Morgan Grenfell
20 Finsbury Circus President and Investment Services Limited
London EC2M 1NB Trustee ("MGIS")(since 1988).
ENGLAND
(age 40)
Paul K. Freeman(2) Trustee Chief Executive Officer,
7257 South Tuscon Way The Eric Group, Inc.
Englewood, CO 80112 (environmental insurance)
(age 46) (since 1986).
36
<PAGE>
Graham E. Jones(2) Trustee Senior Vice President, BGK
330 Garfield Street, Suite 200 Realty Inc. (since 1995);
Santa Fe, NM 87501 Financial Manager, Practice
(age 63) Management Systems (medical
information services)(1988-95);
Director, 12 closed-end funds
managed by Morgan Stanley Asset
Management; Trustee, 10 open-end
mutual funds managed by Weiss,
Peck & Greer.
William N. Searcy(2) Trustee Pension & Savings Trust
2330 Shawnee Mission Parkway Officer, Sprint Corporation
Westwood, KS 66205 (telecommunications) (since
(age 50) 1989).
Hugh G. Lynch Trustee Director, International
767 Fifth Avenue Investments, General Motors
New York, NY 10153 Investment Management
(age 59) Corporation (since
September 1990).
Edward T. Tokar Trustee Vice President--Investments,
101 Columbia Road Allied Signal Inc. (advanced
Morristown, NJ 07962 technology and manufacturer)
(age 49) (since 1985).
John G. Alshefski Treasurer, Director of Fund Operations
530 East Swedesford Road Principal SEI/Fund Resources (since
Wayne, PA 19087-1658 Accounting January 1994); Manager,
(age 30) Officer, Chief International Fund Operations
Financial Officer (1992-1994); Senior Associate,
Price Waterhouse (1988-1992).
Neil P. Jenkins(3) Vice President Director, MGCM (since
20 Finsbury Circus 1991), Morgan Grenfell
London, England EC2M INB International Funds Management,
(age 36) (since 1995), and Morgan Grenfell
& Co., Ltd. (since 1985).
37
<PAGE>
David W. Baldt Vice President Executive Vice President
1435 Walnut Street Investments, MGCM (since
Philadelphia, PA 19102 Director of Fixed Income 1989).
(age 47)
Ian D. Kelson Vice President Director, MGIS(since 1988);
20 Finsbury Circus Chief Investment Officer,
London EC2M 1NB Fixed Income, MGIS (since
England 1989).
(age 40)
James H. Grifo Vice President Executive Vice President,
1435 Walnut Street MGCM (since 1996); Senior
Philadelphia, PA 19102 Vice President, GT Global
(age 45) Financial (since 1990).
Martin Hall(4) Vice President Portfolio Manager, Fixed
1435 Walnut Street Income Team, MGIS (since
Philadelphia, PA 19102 1988)
(age 38)
Mark G. Arthus Secretary and Director, Compliance and
885 Third Avenue Compliance Financial Control, MGCM
New York, NY 10022 Officer (since 1992); Vice President,
(age 40) Senior Compliance Officer
and other positions,
Citibank, N.A. (to 1992)
</TABLE>
- ---------------
1 Member of the Trust's Valuation and Dividend Committees.
2 Member of the Trust's Audit Committee.
3 Member of the Trust's Dividend Committee.
4 Member of the Trust's Valuation Committee.
Certain of the Trustees and officers of the Trust reside outside the
United States, and substantially all the assets of these persons are located
outside the United States. It may not be possible, therefore, for investors to
effect service of process within the United States upon these persons or to
enforce against them, in United States courts or foreign courts, judgments
obtained in United States courts predicated upon the civil liability provisions
of the federal securities laws of the United States or the laws of the State of
Delaware. In addition, it is not certain that a foreign court would enforce, in
original actions or in actions to enforce judgments obtained in the United
States, liabilities against these Trustees and officers predicated solely upon
the federal securities laws.
38
<PAGE>
Messrs. Jones, Freeman and Searcy are members of the Audit Committee of
the Board of Trustees. The Audit Committee's functions include making
recommendations to the Trustees regarding the selection of independent
accountants, and reviewing with such accountants and the Treasurer of the Trust
matters relating to accounting and auditing practices and procedures, accounting
records, internal accounting controls and the functions performed by the Trust's
custodian, administrator and transfer agent.
As of December 17, 1996, the Trustees and officers of the Trust owned,
as a group, less than one percent of the outstanding shares of each Fund other
than Morgan Grenfell Short-Term Municipal Bond Fund. On such date, the Trustees
and officers of the Trust owned, as a group, 8.54% of the outstanding shares of
Morgan Grenfell Short-Term Municipal Bond Fund.
Compensation of Trustees
The Trust pays each Trustee who is not affiliated with the Adviser an
annual fee of $15,000 provided that they attend each regular Board meeting
during the year. Members of the Audit Committee also receive $1,000 for each
Audit Committee meeting attended. The Chairman of the Audit Committee also
receives an additional $1,000 per Audit Committee meeting attended. The Trustees
are also reimbursed for out-of-pocket expenses incurred by them in connection
with their duties as Trustees.
The following table sets forth the compensation paid by the Trust to
the Trustees for the fiscal year of the Trust ended October 31, 1996:
Pension or
Retirement Benefits Aggregate
Accrued as Part of Compensation from
Name of Trustees Fund Expenses the Trust / Complex *
- ------------------ -------------------- ---------------------
James E. Minnick $ 0 $ 0
Patrick W. Disney $ 0 $ 0
Paul K. Freeman $ 0 $ 18,000
Graham E. Jones $ 0 $ 18,000
William N. Searcy $ 0 $ 21,000
Hugh G. Lynch $ 0 $ 15,000
Edward T. Tokar $ 0 $ 7,500
* The Trustees listed above do not serve on the Board of any other
investment company that may be considered to belong to the same complex as the
Trust.
39
<PAGE>
INVESTMENT ADVISORY AND OTHER SERVICES
The Adviser
MGCM, 885 Third Avenue, New York, New York, acts as the investment
adviser to the Funds pursuant to the terms of two Management Contracts, each
dated December 28, 1994 (the "Management Contracts"). One Management Contract is
between MGCM and the Trust, on behalf of the Fixed Income Fund and Municipal
Bond Fund. The other Management Contract is between MGCM and the Trust, on
behalf of the Equity Funds and Short-Term Fixed Income Fund and Short-Term
Municipal Bond Fund. Pursuant to the Management Contracts, the Adviser
supervises and assists in the management of the assets of each Fund and
furnishes each Fund with research, statistical, advisory and managerial
services. The Adviser pays the ordinary office expenses of the Trust and the
compensation, if any, of all officers and employees of the Trust and all
Trustees who are "interested persons" (as defined in the 1940 Act) of the
Adviser.
Under the Management Contracts, the Trust, on behalf of each Fund is
obligated to pay the Adviser a monthly fee at an annual rate of each Fund's
average daily net assets as follows:
Annual Rate
Morgan Grenfell Fixed Income Fund........................... 0.40%
Morgan Grenfell Short-Term Fixed Income Fund................ 0.40%
Morgan Grenfell Municipal Bond Fund......................... 0.40%
Morgan Grenfell Short-Term Municipal Bond Fund.............. 0.40%
Morgan Grenfell Smaller Companies Fund...................... 1.00%
Morgan Grenfell MicroCap Fund............................... 1.50%
Morgan Grenfell Large Cap Growth Fund....................... 0.75%
Each Fund's advisory fees are paid monthly and will be prorated if the
Adviser shall not have acted as the Fund's investment adviser during the entire
monthly period. The Adviser has temporarily agreed, under certain circumstances,
to reduce or not impose its management fee and to make arrangements to limit
certain other expenses as described in the Prospectus under "Expense
Information."
For the fiscal years ended October 31, 1996, 1995 and 1994, Morgan
Grenfell Fixed Income Fund paid the Adviser net advisory fees of $2,041,053,
$1,150,707 and $532,189 respectively. For the same years, Morgan Grenfell
Municipal Bond Fund paid the Adviser net advisory fees of $791,321, $595,795 and
$444,910 respectively. For the fiscal year ended October 31, 1996 and October
31, 1995, Morgan Grenfell Short-Term Fixed
40
<PAGE>
Income Fund, Morgan Grenfell Short-Term Municipal Bond Fund and Morgan Grenfell
Smaller Companies Fund paid no advisory fees to the Adviser. The foregoing
advisory fee payments and non-payments reflect expense limitations that were in
effect during the indicated periods. Morgan Grenfell MicroCap Fund and Morgan
Grenfell Large Cap Growth Fund were not in operation during the indicated
periods and therefore paid no advisory fees during such periods.
The Management Contract between MGCM and the Trust, on behalf of the
Equity Funds, the Short-Term Fixed Income Fund and the Short-Term Municipal Bond
Fund, was most recently approved on November 21, 1996 by a vote of the Trust's
Board of Trustees, including a majority of those Trustees who were not parties
to such Management Contract or "interested persons" of any such parties. The
Management Contract between MGCM and the Trust, on behalf of the Fixed Income
Fund and the Municipal Bond Fund, was approved on November 21, 1996 by a vote of
the Trust's Board of Trustees, including a majority of those Trustees who were
not parties to such Management Contract or "interested persons" of any such
parties.
The Management Contracts will remain in effect until November 30, 1997,
and will continue in effect thereafter, with respect to each Fund, only if such
continuance is specifically approved annually by the Trustees, including a
majority of the Trustees who are not parties to the Management Contracts or
"interested persons" of any such parties, or by a vote of a majority of the
outstanding shares of each Fund. The Management Contracts are terminable by vote
of the Board of Trustees, or, with respect to a Fund, by the holders of a
majority of the outstanding shares of the Fund, at any time without penalty on
60 days' written notice to the Adviser. Termination of a Management Contract
with respect to a Fund will not terminate or otherwise invalidate any provision
of either Management Contract with respect to any other Fund. The Adviser may
terminate either Management Contract at any time without penalty on 60 days'
written notice to the Trust. Each Management Contract terminates automatically
in the event of its "assignment" (as such term is defined in the 1940 Act).
Each Management Contract provides that the Adviser shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Trust or any Fund in connection with the performance of the Adviser's
obligations under the Management Contract with the Trust, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
the Adviser in the performance of its duties or from reckless disregard of its
duties and obligations thereunder.
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In the management of the Funds and its other accounts, the Adviser
allocates investment opportunities to all accounts for which they are
appropriate subject to the availability of cash in any particular account and
the final decision of the individual or individuals in charge of such accounts.
Where market supply is inadequate for a distribution to all such accounts,
securities are allocated based on a Fund's pro rata portion of the amount
ordered. In some cases this procedure may have an adverse effect on the price or
volume of the security as far as a Fund is concerned. However, it is the
judgment of the Board that the desirability of continuing the Trust's advisory
arrangements with the Adviser outweighs any disadvantages that may result from
contemporaneous transactions. See "Portfolio Brokerage."
MGCM is registered with the Commission as an investment adviser and
provides a full range of investment advisory services to institutional clients.
MGCM is a direct wholly-owned subsidiary of Morgan Grenfell Asset Management,
Ltd., which is an indirect wholly-owned subsidiary of Deutsche Bank AG, an
international commercial and investment banking group. As of September 30, 1996,
MGCM managed approximately $8.5 billion in assets for various individual and
institutional accounts, including the Morgan Grenfell SmallCap Fund, Inc., a
registered, closed-end investment company for which it acts as investment
adviser. MGCM also acts as investment subadviser to Fremont U.S. Micro-Cap Fund,
a registered open-end investment company.
Portfolio Turnover
Each Fund's portfolio turnover rate is calculated by dividing the
lesser of the dollar amount of sales or purchases of portfolio securities by the
average monthly value of a Fund's portfolio securities, excluding securities
having a maturity at the date of purchase of one year or less. For the fiscal
periods ended October 31, 1996 and 1995, the portfolio turnover rates for Morgan
Grenfell Fixed Income Fund were 176% and 182%, respectively. For the same
periods, the portfolio turnover rates for Morgan Grenfell Municipal Bond Fund
were 66% and 63% respectively. For the fiscal year ended October 31, 1996, the
portfolio turnover rates for Morgan Grenfell Short-Term Fixed Income Fund,
Morgan Grenfell Short-Term Municipal Bond Fund and Morgan Grenfell Smaller
Companies Fund were 124%, 129% and 141%, respectively. For the fiscal period
ended October 31, 1995, the portfolio turnover rates for Morgan Grenfell
Short-Term Fixed Income Fund, Morgan Grenfell Short-Term Municipal Bond Fund and
Morgan Grenfell Smaller Companies Fund were 90%, 62% and 23%, respectively.
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The Administrator
As described in the Prospectus, SEI Financial Management Corporation
(the "Administrator") serves as the Trust's administrator pursuant to an
administration agreement between the Administrator and the Trust, on behalf of
the Funds (the "Administration Agreement"). Pursuant to the Administration
Agreement, the Administrator has agreed to furnish statistical and research
data, clerical services, and stationery and office supplies; prepare and file
various reports with the appropriate regulatory agencies including the
Commission and state securities commissions; and provide accounting and
bookkeeping services for the Funds, including the computation of each Fund's net
asset value, net investment income and net realized capital gains, if any.
For its services under the Administration Agreement, the Administrator
receives from all series of the Trust an aggregate monthly fee at the following
annual rates of the aggregate average daily net assets ("aggregate assets") of
such series:
0.12% of aggregate assets under $1 billion
0.08% of next $500 million of aggregate assets
0.06% of next $1 billion of aggregate assets
0.04% of aggregate assets exceeding $2.5 billion
Each Fund pays the Administrator a minimum annual fee of $60,000.
For the fiscal years ended October 31, 1996, 1995 and 1994, Morgan
Grenfell Fixed Income Fund paid the Administrator administration fees of
$655,936, $455,614 and $259,094, respectively. For the same years, Morgan
Grenfell Municipal Bond Fund paid the Administrator administration fees of
$253,839, $227,872 and $231,957, respectively. For the fiscal year ended October
31, 1996, Morgan Grenfell Short-Term Fixed Income Fund, Morgan Grenfell
Short-Term Municipal Bond Fund and Morgan Grenfell Smaller Companies Fund paid
the Administrator fees of $45,833, $45,833, and $37,500, respectively. For the
fiscal period ended October 31, 1995, Morgan Grenfell Short-Term Fixed Income
Fund, Morgan Grenfell Short-Term Municipal Bond Fund and Morgan Grenfell Smaller
Companies Fund paid the Administrator administration fees of $12,500, $12,500
and $4,167, respectively. The administration fees shown in this paragraph were
paid pursuant to a fee schedule that provided for higher fees than does the fee
schedule that is in effect for the current fiscal year ending October 31, 1997.
The Administration Agreement provides that the Administrator shall not
be liable under the Administration Agreement except for bad faith or gross
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negligence in the performance of its duties or from the reckless disregard by it
of its duties and obligations thereunder.
Expenses of the Trust
The expenses borne by service shares of the Funds include the service
shares' allocable share of: (i) fees and expenses of any investment adviser and
any administrator of the Funds; (ii) fees and expenses incurred by the Funds in
connection with membership in investment company organizations; (iii) brokers'
commissions; (iv) payment for portfolio pricing services to a pricing agent, if
any; (v) legal expenses (including an allocable portion of the cost of the
Trust's employees rendering legal services to the Funds); (vi) interest,
insurance premiums, taxes or governmental fees; (vii) the fees and expenses of
the transfer agent of the Funds; (viii) clerical expenses of issue, redemption
or repurchase of shares of the Funds; (ix) the expenses of and fees for
registering or qualifying shares of the Funds for sale and of maintaining the
registration of the Funds and registering the Funds as a broker or a dealer; (x)
the fees and expenses of Trustees who are not affiliated with the Adviser; (xi)
the cost of preparing and distributing reports and notices to shareholders, the
Commission and other regulatory authorities; (xii) the fees or disbursements of
custodians of the Fund's assets, including expenses incurred in the performance
of any obligations enumerated by the Declaration of Trust or By-Laws of the
Trust insofar as they govern agreements with any such custodian; (xiii) costs in
connection with annual or special meetings of shareholders, including proxy
material preparation, printing and mailing; (xiv) charges and expenses of the
Trust's auditor; (xv) litigation and indemnification expenses and other
extraordinary expenses not incurred in the ordinary course of the Trust's
business; and (xvi) expenses of an extraordinary and nonrecurring nature.
Transfer Agent
DST Systems, Inc., 1004 Baltimore, Kansas City, Missouri 64105 (the
"Transfer Agent") serves as the transfer and dividend disbursing agent for the
Funds pursuant to a transfer agency agreement (the "Transfer Agency Agreement"),
under which the Transfer Agent (i) maintains record shareholder accounts, and
(ii) makes periodic reports to the Trust's Board of Trustees concerning the
operations of each Fund.
The Distributor
The Trust, on behalf of the Funds, has entered into a distribution
agreement (the "Distribution Agreement") pursuant to which SEI Financial
Services Company, 1 Freedom Valley Drive, Oaks, Pennsylvania 19456 (the
"Distributor"), as agent, serves as principal underwriter for the continuous
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offering of shares (including service shares) of each Fund. The Distributor has
agreed to use its best efforts to solicit orders for the purchase of shares of
each Fund, although it is not obligated to sell any particular amount of shares.
Shares of the Funds are not subject to sales loads or distribution fees. The
Trust is not responsible for payment of any expenses or fees incurred in the
marketing and distribution of shares of the Funds.
The Distribution Agreement will remain in effect for one year from its
effective date and will continue in effect thereafter only if such continuance
is specifically approved annually by the Trustees, including a majority of the
Trustees who are not parties to the Distribution Agreement or "interested
persons" of such parties. The Distribution Agreement was approved by the initial
shareholder of each Fund on December 28, 1994. The Distribution Agreement was
most recently approved on November 21, 1996 by a vote of the Trust's Board of
Trustees, including a majority of those Trustees who were not parties to the
Distribution Agreement or "interested persons" of any such parties. The
Distribution Agreement is terminable, as to a Fund, by vote of the Board of
Trustees, or by the holders of a majority of the outstanding shares of the Fund,
at any time without penalty on 60 days' written notice to the Trust and Adviser.
The Distributor may terminate the Distribution Agreement at any time without
penalty on 90 days' written notice to the Trust.
Custodian
As described in the Prospectus, CoreStates Bank, N.A. ("CoreStates"),
whose principal business address is Broad and Chestnut Streets, P.O. Box 7618,
Philadelphia, PA 19101 maintains custody of the assets of Morgan Grenfell Fixed
Income Fund and Morgan Grenfell Municipal Bond Fund. As described in the
Prospectus, The Northern Trust Company ("Northern"), whose principal business
address is Fifty South LaSalle Street, Chicago, Illinois 60675, maintains
custody of the assets of the other Funds.
Under their custody agreements with the Trust, CoreStates and Northern
(i) maintain separate accounts in the name of each Fund, (ii) hold and transfer
portfolio securities on account of each Fund, (iii) accept receipts and make
disbursements of money on behalf of each Fund, (iv) collect and receive all
income and other payments and distributions on account of each Fund's portfolio
securities and (v) make periodic reports to the Trust's Board of Trustees
concerning each Fund's operations. CoreStates and Northern are authorized to
select one or more foreign or domestic banks or companies to serve as
sub-custodian on behalf of the Funds.
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SERVICE PLAN
Each Fund has adopted a service plan (the "Plan") with respect to its
service shares which authorizes it to compensate Service Organizations whose
customers invest in service shares of the Funds for providing certain personal,
account administration and/or shareholder liaison services. Pursuant to the
Plans, the Funds may enter into agreements with Service Organizations ("Service
Agreements"). Under such Service Agreements or otherwise, the Service
Organizations may perform some or all of the following services: (I) acting as
record holder and nominee of all service shares beneficially owned by their
customers; (ii) establishing and maintaining individual accounts and records
with respect to the service shares owned by each customer; (iii) providing
facilities to answer inquiries and respond to correspondence from customers
about the status of their accounts or about other aspects of the Trust or
applicable Fund; (iv) processing and issuing confirmations concerning customer
orders to purchase, redeem and exchange service shares; and (v) receiving and
transmitting funds representing the purchase price or redemption proceeds of
such service shares.
As compensation for such services, each Fund will pay each Service
Organization with which it has a Service Agreement a service fee in an amount up
to .25% (on an annualized basis) of the average daily net assets of the Fund's
service shares attributable to customers of such Service Organization. Service
Organizations may from time to time be required to meet certain other criteria
in order to receive service fees. As of October 31, 1996, the Trust's fiscal
year end, service shares of the Funds had not been offered.
In accordance with the terms of the Service Plans, the officers of the
Trust provide to the Trust's Board of Trustees for their review a quarterly
written report of the amounts expended under the Service Plans and the purpose
for which such expenditures were made. In the Trustees' quarterly review of such
reports, they will consider the continued appropriateness and the level of
compensation that the Service Plans provide.
Conflict of interest restrictions (including the Employee Retirement
Income Security Act of 1974 ("ERISA") may apply to a Service Organization's
receipt of compensation paid by a Fund in connection with the investment of
fiduciary assets in service shares of the Fund. Service Organizations that are
subject to the jurisdiction of the SEC, the Department of Labor or state
securities commissions are urged to consult their own legal advisers before
investing fiduciary assets in service shares and receiving service fees.
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The Trust believes that fiduciaries of ERISA plans may properly receive
fees under a Service Plan if the plan fiduciary otherwise properly discharges
its fiduciary duties, including (if applicable) those under ERISA. Under ERISA,
a plan fiduciary, such as a trustee or investment manager, must meet the
fiduciary responsibility standards set forth in part 4 of Title I of ERISA.
Those standards are designed to help ensure that the fidcuiary's decisions are
made in the best interests of the plan and are not colored by self-interest.
Section 403(c)(1) of ERISA provides, in part, that the assets of a plan
shall be held for the exclusive purpose of providing benefits to the plan's
participants and their beneficiaries and defraying reasonable expenses of
administering the plan. Section 404(a)(1) sets forth a similar requirement on
how a plan fiduciary must discharge his or her duties with respect to the plan,
and provides further that such fiduciary must act prudently and solely in the
interests of the participants and beneficiaries. These basic provisions are
supplemented by the per se prohibitions of certain classes of transactions set
forth in Section 406 of ERISA.
Section 406(a)(1)(D) of ERISA prohibits a fiduciary of an ERISA plan
from causing that plan to engage in a transaction if he knows or should know
that the transaction would constitute a direct or indirect transfer to, or use
by or for the benefit of, a party in interest, of any assets of that plan.
Section 3(14) includes within the definition of "party in interest" with respect
to a plan any fiduciary with respect to that plan. Thus, Section 406(a)(1)(D)
would not only prohibit a fiduciary from causing the plan to engage in a
transaction which would benefit a third person who is a party in interest, but
it would also prohibit the fiduciary from similarly benefiting himself. In
addition, Section 406(b)(1) specifically prohibits a fiduciary with respect to a
plan from dealing with the assets of that plan in his own interest or for his
own account. Section 406(b)(3) supplements these provisions by prohibiting a
plan fiduciary from receiving any consideration for his own personal account
from any party dealing with the plan in connection with a transaction involving
the assets of the plan.
In accordance with the foregoing, however, a fiduciary of an ERISA plan
may properly receive service fees under a Service Plan if the fees are used for
the exclusive purpose of providing benefits to the plan's participants and their
beneficiaries or for defraying reasonable expenses of administering the plan for
which the plan would otherwise be liable. See, e.g., Department of Labor ERISA
Technical Release No. 86-1 (stating a violation of ERISA would not occur where a
broker-dealer rebates commission dollars to a plan fiduciary who, in turn,
reduces its fees for which plan is otherwise
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responsible for paying). Thus, the fiduciary duty issues involved in a plan
fiduciary's receipt of the service fee must be assessed on a case-by-case basis
by the relevant plan fiduciary.
PORTFOLIO TRANSACTIONS
Subject to the general supervision of the Board of Trustees, the
Adviser makes decisions with respect to and places orders for all purchases and
sales of portfolio securities for the Funds. In executing portfolio
transactions, the Adviser seeks to obtain the best net results for the Funds,
taking into account such factors as price (including the applicable brokerage
commission or dealer spread), size of the order, difficulty of execution and
operational facilities of the firm involved. Commission rates, being a component
of price, are considered together with such factors. Where transactions are
effected on a foreign securities exchange, the Funds employ brokers, generally
at fixed commission rates. Commissions on transactions on U.S. securities
exchanges are subject to negotiation. Where transactions are effected in the
over-the-counter market or third market, the Funds deal with the primary market
makers unless a more favorable result is obtainable elsewhere. Fixed income
securities purchased or sold on behalf of the Funds normally will be traded in
the over-the-counter market on a net basis (i.e. without a commission) through
dealers acting for their own account and not as brokers or otherwise through
transactions directly with the issuer of the instrument. Some fixed income
securities are purchased and sold on an exchange or in over-the-counter
transactions conducted on an agency basis involving a commission.
Pursuant to the Advisory Agreements, the Adviser agrees to select
broker-dealers in accordance with guidelines established by the Trust's Board of
Trustees from time to time and in accordance with Section 28(e) of the
Securities Exchange Act of 1934, as amended. In assessing the terms available
for any transaction, the Adviser shall consider all factors it deems relevant,
including the breadth of the market in the security, the price of the security,
the financial condition and execution capability of the broker-dealer, and the
reasonableness of the commission, if any, both for the specific transaction and
on a continuing basis. In addition, the Advisory Agreements authorize the
Adviser, subject to the periodic review of the Trust's Board of Trustees, to
cause a Fund to pay a broker-dealer which furnishes brokerage and research
services a higher commission than that which might be charged by another
broker-dealer for effecting the same transaction, provided that the Adviser
determines in good faith that such commission is reasonable in relation to the
value of the brokerage and research services provided by such broker-dealer,
viewed in terms of either the particular transaction or the overall
responsibilities of the Adviser to the Fund. Such
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brokerage and research services may consist of pricing information, reports and
statistics on specific companies or industries, general summaries of groups of
bonds and their comparative earnings and yields, or broad overviews of the
securities markets and the economy.
Supplemental research information utilized by the Adviser is in
addition to, and not in lieu of, services required to be performed by the
Adviser and does not reduce the advisory fees payable to the Adviser. The
Trustees will periodically review the commissions paid by the Funds to consider
whether the commissions paid over representative periods of time appear to be
reasonable in relation to the benefits inuring to the Funds. It is possible that
certain of the supplemental research or other services received will primarily
benefit one or more other investment companies or other accounts of the Adviser
for which investment discretion is exercised. Conversely, a Fund may be the
primary beneficiary of the research or services received as a result of
portfolio transactions effected for such other account or investment company.
During the fiscal period ended October 31, 1996, the Adviser did not, pursuant
to any agreement or understanding with a broker or otherwise through an internal
allocation procedure, direct any Fund's brokerage transactions to a broker
because of research services provided by such broker.
Investment decisions for each Fund and for other investment accounts
managed by the Adviser are made independently of each other in the light of
differing conditions. However, the same investment decision may be made for two
or more of such accounts. In such cases, simultaneous transactions are
inevitable. Purchases or sales are then averaged as to price and allocated as to
amount in a manner deemed equitable to each such account. While in some cases
this practice could have a detrimental effect on the price or value of the
security as far as a Fund is concerned, in other cases it is believed to be
beneficial to a Fund. To the extent permitted by law, the Adviser may aggregate
the securities to be sold or purchased for a Fund with those to be sold or
purchased for other investment companies or accounts in executing transactions.
Pursuant to procedures determined by the Trustees and subject to the
general policies of the Funds and Section 17(e) of the 1940 Act, the Adviser may
place securities transactions with brokers with whom it is affiliated
("Affiliated Brokers").
Section 17(e) of the 1940 Act limits to "the usual and customary
broker's commission" the amount which can be paid by the Funds to an Affiliated
Broker acting as broker in connection with transactions effected
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on a securities exchange. The Board, including a majority of the Trustees who
are not "interested persons" of the Trust or the Adviser, has adopted procedures
designed to comply with the requirements of Section 17(e) of the 1940 Act and
Rule 17e-1 promulgated thereunder to ensure that the broker's commission is
"reasonable and fair compared to the commission, fee or other remuneration
received by other brokers in connection with comparable transactions involving
similar securities being purchased or sold on a securities exchange during a
comparable period of time...."
Transactions would not be placed with Affiliated Brokers if a Fund
would have to pay a commission rate less favorable than their contemporaneous
charges for comparable transactions for their other most favored, but
unaffiliated, customers except for accounts for which they act as a clearing
broker, and any of their customers determined, by a majority of the Trustees who
are not "interested persons" of the Fund or the Adviser, not to be comparable to
the Fund. With regard to comparable customers, in isolated situations, subject
to the approval of a majority of the Trustees who are not "interested persons"
of the Trust or the Adviser, exceptions may be made. Since the Adviser, as
investment adviser to the Funds, has the obligation to provide management, which
includes elements of research and related skills, such research and related
skills will not be used by them as a basis for negotiating commissions at a rate
higher than that determined in accordance with the above criteria. The Funds
will not engage in principal transactions with Affiliated Brokers. When
appropriate, however, orders for the account of the Funds placed by Affiliated
Brokers are combined with orders of their respective clients, in order to obtain
a more favorable commission rate. When the same security is purchased for two or
more funds or customers on the same day, each fund or customer pays the average
price and commissions paid are allocated in direct proportion to the number of
shares purchased.
Affiliated Brokers furnish to the Trust at least annually a statement
setting forth the total amount of all compensation retained by them or any
associated person of them in connection with effecting transactions for the
account of the Funds, and the Board reviews and approves all the Funds'
portfolio transactions on a quarterly basis and the compensation received by
Affiliated Brokers in connection therewith. During the fiscal years ended
October 31, 1994, 1995 and 1996, neither the Fixed Income Fund nor the Municipal
Bond Fund paid any brokerage commissions to any Affiliated Broker. During the
fiscal periods ended October 31, 1995 and October 31, 1996, neither Short-Term
Fixed Income Fund, Short-Term Municipal Bond Fund nor Smaller Companies Fund
paid any brokerage commissions to any affiliated broker.
Affiliated Brokers do not knowingly participate in commissions paid by
the Funds to other brokers or dealers and do not seek or knowingly receive
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any reciprocal business as the result of the payment of such commissions. In the
event that an Affiliated Broker learns at any time that it has knowingly
received reciprocal business, it will so inform the Board.
For the fiscal years ended October 31, 1996, 1995 and 1994, Morgan
Grenfell Fixed Income Fund and Morgan Grenfell Municipal Bond Fund paid no
brokerage commissions. For fiscal year ended October 31, 1995, Morgan Grenfell
Short-Term Fixed Income Fund and Morgan Grenfell Short-Term Municipal Bond Fund
paid no brokerage commissions. For the fiscal periods ended October 31, 1996 and
October 31, 1995, Morgan Grenfell Smaller Companies Fund paid aggregate
brokerage commissions of $7,708 and $3,778, respectively.
NET ASSET VALUE
Under the 1940 Act, the Board of Trustees of the Trust is responsible
for determining in good faith the fair value of the securities of each Fund. In
accordance with procedures adopted by the Board of Trustees, the net asset value
per share of each class of each Fund is calculated by determining the net worth
of the Fund attributable to the class (assets, including securities at value,
minus liabilities) divided by the number of shares of such class outstanding.
Each Fund computes net asset value for each class of its shares at the close of
such regular trading, which is normally 4:00 p.m. Eastern time, on each day on
which the New York Stock Exchange ("NYSE") is open (a "Business Day"). The NYSE
is closed on Saturdays and Sundays as well as the following holidays: New Year's
Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
For purposes of calculating net asset value, equity securities traded
on a recognized U.S. or foreign securities exchange or the National Association
of Securities Dealers Automated Quotation System ("NASDAQ") are valued at their
last sale price on the principal exchange on which they are traded or NASDAQ (if
NASDAQ is the principal market for such securities) on the valuation day or, if
no sale occurs, at the bid price. Unlisted equity securities for which market
quotations are readily available are valued at the most recent bid price.
Debt securities and other fixed income investments of the Funds are
valued at prices supplied by independent pricing agents, which prices reflect
broker-dealer supplied valuations and electronic data processing techniques.
Short-term obligations maturing in sixty days or less may be valued at amortized
cost, which method does not take into account unrealized gains or
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losses on such portfolio securities. Amortized cost valuation involves initially
valuing a security at its cost, and thereafter, assuming a constant amortization
to maturity of any discount or premium, regardless of the impact of fluctuating
interest rates on the market value of the security. While this method provides
certainty in valuation, it may result in periods in which the value of the
security, as determined by amortized cost, may be higher or lower than the price
the Fund would receive if the Fund sold the security.
Other assets and assets in which market quotations are not readily
available are valued at fair value using methods determined in good faith by the
Board of Trustees.
Trading in securities on European and Far Eastern securities exchanges
and over-the-counter markets is normally completed well before the 4:00 P.M.
(Eastern Time) close of business on each Business Day. In addition, European or
Far Eastern securities trading generally or in a particular country or countries
may not take place on all Business Days. Furthermore, trading takes place in
Japanese markets on certain Saturdays and in various foreign markets on days
which are not Business Days and on which the Funds' net asset values are not
calculated. Such calculation may not take place contemporaneously with the
determination of the prices of certain portfolio securities used in such
calculation. Events affecting the values of portfolio securities that occur
between the time their prices are determined and the close of regular trading on
the NYSE will not be reflected in the Funds' calculation of net asset values
unless the Adviser deems that the particular event would materially affect net
asset value, in which case an adjustment will be made.
PERFORMANCE INFORMATION
Yield
From time to time, each Fixed Income Fund and each Municipal Fund may
advertise its yield and (in the case of the Municipal Funds) its tax-equivalent
yield. Yield and tax-equivalent yield are calculated separately for service
shares and institutional shares of a Fund. Each type of share is subject to
differing yields for the same period. The yield of service shares of a Fund
refers to the annualized income generated by an investment in the service shares
of the Fund over a specified 30-day period. The yield is calculated by assuming
that the income generated by the investment during that period is generated for
each like period over one year and is shown as a percentage of the investment.
In particular, yield will be calculated
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according to the following formula:
YIELD = 2 [(a - b +1)(6) - 1]
cd
Where: a = dividends and interest earned by the
Fund during the period;
b = net expenses accrued for the period;
c = average daily number of shares out-standing during the
period entitled to receive dividends; and
d = maximum offering price per share on
the last day of the period.
Tax-equivalent yield is computed by dividing the portion of the yield
that is tax exempt by one minus a stated income tax rate and adding the product
to that portion, if any, of the yield that is not tax exempt.
Actual yields will depend on such variables as asset quality, average
asset maturity, the type of instruments a Fund invests in, changes in interest
rates on money market instruments, changes in the expenses of the service shares
of the Fund and other factors.
Yields are one basis upon which investors may compare the Funds with
other mutual funds; however, yields of other mutual funds and other investment
vehicles may not be comparable because of the factors set forth above and
differences in the methods used in valuing portfolio instruments.
For the 30-day period ended October 31, 1996, the yields of the
institutional shares of Fixed Income Fund, the Municipal Bond Fund, the
Short-Term Fixed Income Fund and the Short-Term Municipal Bond Fund were 6.38%,
5.23%, 5.94% and 5.07%, respectively. If the expense limitations described in
the Prospectus for these Funds had not been in effect during this period, the
yields of institutional shares of these Funds would have been 6.32%, 5.17%,
5.18% and 4.02%, respectively. For the same period, the tax-equivalent yields of
institutional shares of the Municipal Bond Fund and the Short-Term Municipal
Bond Fund were 8.66% and 8.39%, respectively, assuming the highest Federal
Income Tax bracket for individuals (39.6%). If the expense limitations described
in the Prospectus for these Funds had not been in effect during this period, the
tax-equivalent yields of institutional shares of these Funds would have been
8.56% and 6.66%,
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respectively, assuming the same Federal Income Tax bracket. No service shares of
the Funds were outstanding during the fiscal year ended October 31, 1996.
Total Return
Average annual total return is calculated separately for service shares
and institutional shares of a Fund. Each type of share is subject to different
fees and expenses and, consequently, may have differing average annual total
returns for the same period. Each Fund that advertises "average annual total
return" for a class of its shares computes such return by determining the
average annual compounded rate of return during specified periods that equates
the initial amount invested to the ending redeemable value of such investment
according to the following formula:
ERV
T = [(-----) (1/n) - 1]
P
Where: T = average annual total return,
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the
1, 5 or 10 year (or other) periods
at the end of the applicable period
(or a fractional portion thereof);
P = hypothetical initial payment of
$1,000; and
n = period covered by the computation,
expressed in years.
Each Fund that advertises "aggregate total return" for a class of its
shares computes such returns by determining the aggregate compounded rates of
return during specified periods that likewise equate the initial amount invested
to the ending redeemable value of such investment. The formula for calculating
aggregate total return is as follows:
ERV
Aggregate Total Return = [(-----) - 1]
P
The above calculations are made assuming that (1) all dividends and
capital gain distributions are reinvested on the reinvestment dates at the
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price per share existing on the reinvestment date, (2) all recurring fees
charged to all shareholder accounts are included, and (3) for any account fees
that vary with the size of the account, a mean (or median) account size in the
Fund during the periods is reflected. The ending redeemable value (variable
"ERV" in the formula) is determined by assuming complete redemption of the
hypothetical investment after deduction of all nonrecurring charges at the end
of the measuring period. For the fiscal year ended October 31, 1996 the average
annual return of institutional shares of Morgan Grenfell Fixed Income Fund,
Morgan Grenfell Municipal Bond Fund, Morgan Grenfell Short-Term Fixed Income
Fund, Morgan Grenfell Short-Term Municipal Bond Fund and Morgan Grenfell Smaller
Companies Fund were 6.27%, 6.90%, 6.09%, 5.90% and 24.58%, respectively. For
their respective periods from commencement of operations to October 31, 1996,
the average annual returns of institutional shares of Morgan Grenfell Fixed
Income Fund, Morgan Grenfell Municipal Bond Fund, Morgan Grenfell Short-Term
Fixed Income Fund, Morgan Grenfell Short-Term Municipal Bond Fund and Morgan
Grenfell Smaller Companies Fund were 8.29%, 8.93%, 6.09%, 6.24% and 22.69%,
respectively. If the expense limitations described in the Prospectus for the
above Funds had not been in effect during the indicated periods, the total
returns of these Funds for such periods would have been lower than the total
return figures shown in this paragraph. As of October 31, 1996, no service
shares of the Funds had been issued.
The Funds may from time to time advertise comparative performance as
measured by various independent sources, including, but not limited to,
Barron's, The Wall Street Journal, Weisenberger Investment Companies Service,
Business Week, Changing Times, Financial World, Forbes, Fortune and Money. In
addition, the Funds may from time to time advertise their performance relative
to certain indices and benchmark investments, including: (a) the Lipper
Analytical Services, Inc. Mutual Fund Performance Analysis, Fixed Income
Analysis and Mutual Fund Indices (which measure total return and average current
yield for the mutual fund industry and rank mutual fund performance); (b) the
CDA Mutual Fund Report published by CDA Investment Technologies, Inc. (which
analyzes price, risk and various measures of return for the mutual fund
industry); (c) the Consumer Price Index published by the U.S. Bureau of Labor
Statistics (which measures changes in the price of goods and services); (d)
Stocks, Bonds, Bills and Inflation published by Ibbotson Associates (which
provides historical performance figures for stocks, government securities and
inflation); (e) the Shearson Lehman Brothers Aggregate Bond Index or its
component indices (the Aggregate Bond Index measures the performance of
Treasury, U.S. Government agency, corporate, mortgage and Yankee bonds); (f) the
Standard & Poor's Bond Indices (which measure yield and price of corporate,
municipal and U.S. Government bonds);
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and (g) historical investment data supplied by the research departments of
Goldman Sachs, Shearson Lehman Hutton, First Boston Corporation, Morgan Stanley,
Salomon Brothers, Merrill Lynch, Donaldson Lufkin and Jenrette or other
providers of such data. The composition of the investments in such indices and
the characteristics of such benchmark investments are not identical to, and in
some cases are very different from, those of the Fund's portfolio. These indices
and averages are generally unmanaged and the items included in the calculations
of such indices and averages may not be identical to the formulas used by the
Funds to calculate their performance figures.
TAXES
The following is a summary of the principal U.S. federal income, and
certain state and local, tax considerations regarding the purchase, ownership
and disposition of shares in the Funds. This summary does not address special
tax rules applicable to certain classes of investors, such as tax-exempt
entities, insurance companies and financial institutions. Each prospective
shareholder is urged to consult his own tax adviser with respect to the specific
federal, state, local and foreign tax consequences of investing in the Funds.
The summary is based on the laws in effect on the date of this Statement of
Additional Information, which are subject to change.
General
Each Fund is a separate taxable entity. Each Fund has elected or
intends to elect to be treated, and intends to qualify for each taxable year, as
a regulated investment company under Subchapter M of the Code.
Qualification of any Fund as a regulated investment company under the
Code requires, among other things, that (a) the Fund derive at least 90% of its
gross income (including tax-exempt interest) for its taxable year from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of stocks or securities or foreign currencies, or
other income (including but not limited to gains from options, futures, and
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies (the "90% gross income test"); (b) the Fund
derive less than 30% of its gross income for its taxable year from the sale or
other disposition of any of the following which was held for less than three
months: (i) stock or securities; (ii) options, futures or forward contracts
(other than options, futures or forward contracts on foreign currencies); and
(iii) foreign currencies and foreign currency options, futures and forward
contracts that are not directly related to the Fund's principal business of
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investing in stock or securities or options and futures with respect to stocks
or securities (the "short-short test"); and (c) the Fund diversify its holdings
so that, at the close of each quarter of its taxable year, (i) at least 50% of
the market value of its total (gross) assets is comprised of cash, cash items,
United States Government securities, securities of other regulated investment
companies and other securities limited in respect of any one issuer to an amount
not greater in value than 5% of the value of the Fund's total assets and to not
more than 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its total assets is invested in the securities of
any one issuer (other than United States Government securities and securities of
other regulated investment companies) or two or more issuers controlled by the
Fund and engaged in the same, similar or related trades or businesses. Gains
from the sale or other disposition of foreign currencies (or options, futures or
forward contracts on foreign currencies) that are not directly related to a
Fund's principal business of investing in stock or securities or options and
futures with respect to stock or securities will be treated as gains from the
disposition of investments held for less than three months under the short-short
test (even though characterized as ordinary income for some purposes) if such
currencies or instruments were held for less than three months. In addition,
future Treasury regulations could provide that qualifying income under the 90%
gross income test will not include gains from foreign currency transactions or
derivatives that are not directly related to a Fund's principal business of
investing in stock or securities or options and futures with respect to stock or
securities. Using foreign currency positions or entering into foreign currency
options, futures or forward contracts for purposes other than hedging currency
risk with respect to securities in a Fund's portfolio or anticipated to be
acquired may not qualify as "directly-related" under these tests.
If a Fund complies with such provisions, then in any taxable year in
which the Fund distributes at least 90% of the sum of (i) its "investment
company taxable income" (which includes dividends, taxable interest, taxable
accrued original issue discount, recognized market discount income, income from
securities lending, any net short-term capital gain in excess of net long-term
capital loss and certain net realized foreign exchange gains and is reduced by
deductible expenses) and (ii) the excess of its gross tax-exempt interest, if
any, over certain disallowed deductions ("net tax-exempt interest"), the Fund
(but not its shareholders) will be relieved of federal income tax on any income
of the Fund, including long-term capital gains, distributed to shareholders.
However, if a Fund retains any investment company taxable income or net capital
gain (the excess of net long-term capital gain over net short-term capital
loss), it will be subject to federal income tax
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at regular corporate rates on the amount retained.
If a Fund retains any net capital gain, the Fund may designate the
retained amount as undistributed capital gains in a notice to its shareholders
who, if subject to U.S. federal income tax on long-term capital gains, (i) will
be required to include in income for federal income tax purposes, as long-term
capital gain, their shares of such undistributed amount, and (ii) will be
entitled to credit their proportionate shares of the tax paid by the Fund
against their U.S. federal income tax liabilities, if any, and to claim refunds
to the extent the credit exceeds such liabilities.
For U.S. federal income tax purposes, the tax basis of shares owned by
a shareholder of a Fund will be increased by an amount equal under current law
to 65% of the amount of undistributed net capital gains included in the
shareholder's gross income. Each Fund intends to distribute at least annually to
its shareholders all or substantially all of its investment company taxable
income, net tax-exempt interest, and net capital gain. If for any taxable year a
Fund does not qualify as a regulated investment company, it will be taxed on all
of its investment company taxable income and net capital gain at corporate
rates, any net tax-exempt interest may be subject to alternative minimum tax,
and its distributions to shareholders will be taxable as ordinary dividends to
the extent of its current and accumulated earnings and profits.
In order to avoid a 4% federal excise tax, each Fund must distribute
(or be deemed to have distributed) by December 31 of each calendar year at least
98% of its taxable ordinary income for such year, at least 98% of the excess of
its capital gains over its capital losses (generally computed on the basis of
the one-year period ending on October 31 of such year), and all taxable ordinary
income and the excess of capital gains over capital losses for the previous year
that were not distributed in such year and on which no federal income tax was
paid by the Fund. For federal income tax purposes, dividends declared by a Fund
in October, November or December to shareholders of record on a specified date
in such a month and paid during January of the following year are treated as
distributed by the Fund and are taxable to such shareholders as if received on
December 31 of the year declared.
Gains and losses on the sale, lapse, or other termination of options
and futures contracts, options thereon and certain forward contracts (except
certain foreign currency options, forward contracts and futures contracts)
entered into by an Equity Fund will generally be treated as capital gains and
losses. Certain of the futures contracts, forward contracts and options held by
an Equity Fund may be required to be "marked-to-market" for federal income tax
purposes, that is, treated as having been sold at their fair market value on the
last day of the Fund's taxable year. As a result, a Fund may be required to
recognize income or gain without a concurrent receipt of cash. Any gain or loss
recognized on actual or deemed sales of these futures contracts, forward
contracts, or options (except for certain foreign currency options, forward
contracts, and
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futures contracts) will be treated as 60% long-term capital gain or loss and 40%
short-short capital gain or loss. As a result of certain hedging transactions
entered into by an Equity Fund, such Fund may be required to defer the
recognition of losses on futures or forward contracts and options or underlying
securities or foreign currencies to the extent of any unrecognized gains on
related positions and the characterization of gains or losses as long-term or
short-term may be changed. The tax provisions described above applicable to
options, futures and forward contracts may affect the amount, timing and
character of the Fund's distributions to shareholders. The short-short test
described above may limit a Fund's ability to use options, futures and forward
transactions as well as its ability to engage in short sales. Certain tax
elections may be available to an Equity Fund to mitigate some of the unfavorable
consequences described in this paragraph.
Section 988 of the Code contains special tax rules applicable to
certain foreign currency transactions and instruments that may affect the
amount, timing and character of income, gain or loss recognized by an Equity
Fund. Under these rules, foreign exchange gain or loss realized with respect to
foreign currencies and certain futures and options thereon, foreign
currency-denominated debt instruments, foreign currency forward contracts, and
foreign currency-denominated payables and receivables will generally be treated
as ordinary income or loss, although in some cases elections may be available
that would alter this treatment.
If an Equity Fund or a Fixed Income Fund acquires stock (including,
under proposed regulations, an option to acquire stock such as is inherent in a
convertible bond) in certain non-U.S. corporations that receive at least 75% of
their annual gross income from passive sources (such as interest, dividends,
rents, royalties or capital gain) or hold at least 50% of their assets in
investments producing such passive income ("passive foreign investment
companies"), the Fund could be subject to federal income tax and additional
interest charges on "excess distributions" received from such companies or gain
from the sale of stock in such companies, even if all income or gain actually
received by the Fund is timely distributed to its shareholders. The Fund would
not be able to pass through to its shareholders any credit or deduction for such
a tax. Certain elections may, if available, ameliorate these adverse tax
consequences, but any such election could require the Fund to recognize taxable
income or gain without the concurrent receipt of cash. The applicable Funds may
limit and/or manage their holdings in passive foreign investment companies to
minimize their tax liability or maximize their return from these investments.
A Fund that invests in foreign securities may be subject to foreign
withholding or other foreign taxes on certain income (possibly including, in
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some cases, capital gains) from such securities. Tax conventions between certain
countries and the U.S. may reduce or eliminate such taxes in some cases. The
Funds will not be entitled to pass through such foreign taxes to their
shareholders, who consequently will not be entitled to any U.S. tax credits or
deductions for such taxes.
Each Fund's investments in zero coupon securities or other securities
bearing original issue discount or, if the Fund elects to include market
discount in income currently, market discount will generally cause it to realize
income prior to the receipt of cash payments with respect to these securities.
Options, futures or forward contracts subject to the mark to market rules
described above may have the same result if recognized mark to market gains
exceed recognized mark to market losses. In order to obtain cash to distribute
this income or gain, maintain its qualification as a regulated investment
company, and avoid federal income or excise taxes, a Fund may be required to
liquidate portfolio securities that it might otherwise have continued to hold.
Each Municipal Fund purchases tax-exempt municipal securities which are
generally accompanied by an opinion of bond counsel to the effect that interest
on such securities is not included in gross income for federal income tax
purposes. It is not economically feasible to, and the Municipal Funds therefore
do not, make any additional independent inquiry into whether such securities are
in fact tax-exempt. Bond counsels' opinions will generally be based in part upon
covenants by the issuers and related parties regarding continuing compliance
with federal tax requirements. Tax laws, especially those enacted during the
last decade, not only limit the purposes for which tax-exempt bonds can be
issued and the supply of such bonds, but also contain numerous and complex
requirements that must be satisfied on a continuing basis in order for bonds to
be and remain tax-exempt. If the issuer of a bond or a user of a bond-financed
facility fails to comply with such requirements at any time, interest on the
bond could become taxable, retroactive to the date the obligation was issued. In
that event, a portion of a Municipal Fund's distributions attributable to
interest such Fund received on such bond for the current year and for prior
years could be characterized or recharacterized as taxable income.
Each Fixed Income Fund and each Municipal Fund may purchase municipal
securities together with the right to resell the securities to the seller at an
agreed upon price or yield within a specified period prior to the maturity date
of the securities. Such a right to resell is commonly known as a "put" and is
also referred to as a "standby commitment." A Fund may pay for a standby
commitment either separately, in cash, or in the form of a higher price for the
securities which are acquired subject to the standby
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commitment, thus increasing the cost of securities and reducing the return
otherwise available. Additionally, a Fund may purchase beneficial interests in
municipal securities held by trusts, custodial arrangements or partnerships
and/or combined with third-party puts or other types of features such as
interest rate swaps; those investments may require the Fund to pay "tender fees"
or other fees for the various features provided.
The IRS has issued a revenue ruling to the effect that, under specified
circumstances, a registered investment company will be the owner of tax-exempt
municipal obligations acquired subject to a put option. The IRS has also issued
private letter rulings to certain taxpayers (which do not serve as precedent for
other taxpayers) to the effect that tax-exempt interest received by a regulated
investment company with respect to such obligations will be tax-exempt in the
hands of the company and may be distributed to its shareholders as
exempt-interest dividends. The IRS has subsequently announced that it will not
ordinarily issue advance ruling letters as to the identity of the true owner of
property in cases involving the sale of securities or participation interests
therein if the purchaser has the right to cause the security, or the
participation interest therein, to be purchased by either the seller or a third
party. Each Fund intends to take the position that it is the owner of any
municipal obligations acquired subject to a standby commitment or other third
party put and that tax-exempt interest earned with respect to such municipal
obligations will be tax-exempt in its hands. There is no assurance that the IRS
will agree with such position in any particular case. Additionally, the federal
income tax treatment of certain other aspects of these investments, including
the treatment of tender fees paid by the Fund, in relation to various regulated
investment company tax provisions is unclear. However, the Adviser intends to
manage each Fund's portfolio in a manner designed to minimize any adverse impact
from the tax rules applicable to these investments.
For federal income tax purposes, each Fund is permitted to carry
forward a net capital loss in any year to offset its own capital gains, if any,
during the eight years following the year of the loss. To the extent subsequent
years' capital gains are offset by such losses, they would not result in federal
income tax liability to the applicable Fund and, accordingly, would generally
not be distributed to shareholders. At October 31, 1996, Fixed Income Fund had
capital loss carryforwards of approximately $530,000 and Short-Term Fixed Income
Fund had capital loss carryforwards of approximately $26,000, in each case
expiring (if not previously used) in the fiscal year ended October 31, 2004.
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U.S. Shareholders -- Distributions
A Municipal Fund's distributions from the tax-exempt interest it
receives will generally be exempt from federal income tax, provided that such
Fund qualifies as a regulated investment company, at least 50% of the value of
the Fund's total assets at the close of each quarter of its taxable year
consists of obligations that pay interest excluded from gross income under
Section 103(a) of the Code, and the Fund properly designates such distributions
as "exempt-interest dividends." The portions of such exempt-interest dividends,
if any, derived from interest on certain private activity bonds will constitute
tax preference items and may give rise to, or increase liability under, the
federal alternative minimum tax for particular shareholders. In addition, all
exempt-interest dividends may increase a corporate shareholder's liability, if
any, for the corporate alternative minimum tax and will be taken into account in
determining the portion, if any, of a shareholder's social security benefits or
certain railroad retirement benefits that is subject to tax.
For U.S. federal income tax purposes, distributions by the Funds other
than the Municipal Funds, whether reinvested in additional shares or paid in
cash, generally will be taxable to shareholders who are subject to tax.
Shareholders receiving a distribution in the form of newly issued shares will be
treated for U.S. federal income tax purposes as receiving a distribution in an
amount equal to the amount of cash they would have received had they elected to
receive cash and will have a cost basis in each share received equal to such
amount divided by the number of shares received. Distributions from investment
company taxable income of any Fund, including the Municipal Funds, for the year
will be taxable as ordinary income. Investment company taxable income includes,
among other things, dividends, taxable interest, income from repurchase
agreements and securities loans; accrued, recognized market discount; a portion
of the discount on certain stripped tax-exempt obligations and their coupons;
and net short-term capital gain (in excess of net long-term capital loss) from
the sale of investments or options or futures transactions or the disposition of
rights to when-issued securities prior to issuance. Distributions to corporate
shareholders designated as derived from dividend income received by a Fund, if
any, that would be eligible for the dividends received deduction if the Fund
were not a regulated investment company will be eligible, subject to certain
holding period and debt-financing restrictions, for the 70% dividends received
deduction for corporations. Because eligible dividends are limited to those
received by a Fund from U.S. domestic corporations, all dividends paid by the
Municipal Funds, and all or a substantial portion of the dividends paid by the
Fixed Income Funds, will generally not qualify for the dividends received
deduction. The dividends-received deduction, if available, is reduced to the
extent the shares with respect to which the dividends received are treated as
debt financed under the Code and is eliminated if the shares are deemed to have
been held for less than a minimum period, generally 46 days. The entire
dividend, including the deducted amount, is considered in determining the
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excess, if any, of a corporate shareholder's adjusted current earnings over its
alternative minimum taxable income, which may increase its liability for the
federal alternative minimum tax, and the dividend may, if it is treated as an
"extraordinary dividend" under the Code, reduce such shareholder's tax basis in
its shares of a Fund. Capital gain dividends (i.e., dividends from net capital
gain) paid by any Fund, including the Municipal Funds, if designated as such in
a written notice to shareholders mailed not later than 60 days after a Fund's
taxable year closes, will be taxed to shareholders as long-term capital gain
regardless of how long shares have been held by shareholders, but are not
eligible for the dividends received deduction for corporations.
Interest on indebtedness incurred directly or indirectly to purchase or
carry shares of a Municipal Fund will not be deductible to the extent it is
deemed related to exempt-interest dividends paid by such Fund.
A Municipal Fund may not be an appropriate investment for persons who
are, or are related to, substantial users of facilities financed by industrial
development or private activity bonds.
Shareholders that are required to file tax returns are required to
report tax-exempt interest income, including exempt-interest dividends, on their
federal income tax returns. Each Municipal Fund will inform shareholders of the
federal income tax status of its distributions after the end of each calendar
year, including the amounts that qualify as exempt-interest dividends and any
portions of such amounts that constitute tax preference items under the federal
alternative minimum tax. Shareholders who have not held shares of a Municipal
Fund for a full taxable year may have designated as tax-exempt or as a tax
preference item a percentage of their distributions which is not exactly equal
to a proportionate share of the amount of tax-exempt interest or tax preference
income earned during the period of their investment in the Fund.
Different tax treatment, including penalties on certain excess
contributions and deferrals, certain pre-retirement and post-retirement
distributions, and certain prohibited transactions is accorded to accounts
maintained as qualified retirement plans. Shareholders should consult their tax
advisers for more information.
U.S. Shareholders -- Sale of Shares
When a shareholder's shares are sold, redeemed or otherwise disposed
of, the shareholder will generally recognize gain or loss equal to the
difference
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between the shareholder's adjusted tax basis in the shares and the cash, or fair
market value of any property, received. Assuming the shareholder holds the
shares as a capital asset at the time of such sale or other disposition, such
gain or loss should be capital in character, and long-term if the shareholder
has held the shares for more than one year, otherwise short-term. However, any
loss realized on the sale, redemption or other disposition of shares with a tax
holding period of six months or less will be disallowed to the extent of any
exempt-interest dividends received with respect to such shares and, to the
extent in excess of any disallowed amount, will be treated as a long-term
capital loss to the extent of any capital gain dividend received with respect to
such shares. Additionally, any loss realized on a sale, redemption or other
disposition of shares of a Fund may be disallowed under "wash sale" rules to the
extent the shares disposed of are replaced with shares of the same Fund within a
period of 61 days beginning 30 days before and ending 30 days after the shares
are disposed of, such as pursuant to a dividend reinvestment in shares of the
Fund. If disallowed, the loss will be reflected in an adjustment to the basis
of the shares acquired.
The Funds may be required to withhold, as "backup withholding," federal
income tax at a rate of 31% from dividends (including distributions from a
Fund's net long-term capital gains, but not including exempt-interest dividends)
and share redemption and exchange proceeds to individuals and other non-exempt
shareholders who fail to furnish the Funds with a correct taxpayer
identification number ("TIN") certified under penalties of perjury, or if the
Internal Revenue Service or a broker notifies the Funds that the payee has
failed to properly report interest or dividend income to the Internal Revenue
Service or that the TIN furnished by the payee to the Funds is incorrect, or if
(when required to do so) the payee fails to certify under penalties of perjury
that it is not subject to backup withholding. Any amounts withheld may be
credited against a shareholder's United States federal income tax liability.
Distributions by a Municipal Fund will not be subject to backup withholding,
however, for any year such Fund reasonably estimates that at least 95% of its
dividends will be exempt-interest dividends.
Non-U.S. Shareholders
Shareholders who, as to the United States, are nonresident aliens,
foreign corporations, fiduciaries of foreign trusts or estates, foreign
partnerships or other non-U.S. investors generally will be subject to U.S.
withholding tax at the rate of 30% on distributions treated as ordinary income
unless the tax rate is reduced pursuant to a tax treaty or the dividends are
effectively connected with a U.S. trade or business of the shareholder. In the
latter case the dividends will be subject to tax on a net income basis at the
graduated rates applicable to U.S. individuals or domestic corporations.
Distributions of net capital gain, including amounts
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retained by a Fund which are designated as undistributed capital gains, to a
non-U.S. shareholder will not be subject to U.S. federal income or withholding
tax unless the distributions are effectively connected with the shareholder's
trade or business in the United States or, in the case of a shareholder who is a
nonresident alien individual, the shareholder is present in the United States
for 183 days or more during the taxable year and certain other conditions are
met.
Any gain realized by a non-U.S. shareholder upon a sale or redemption
of shares of a Fund will not be subject to U.S. federal income or withholding
tax unless the gain is effectively connected with the shareholder's trade or
business in the United States, or in the case of a shareholder who is a
nonresident alien individual, the shareholder is present in the United States
for 183 days or more during the taxable year and certain other conditions are
met. Non-U.S. investors should consult their tax advisers about the
applicability of U.S. federal income or withholding taxes to certain
distributions received by them.
State and Local
The Funds may be subject to state or local taxes in jurisdictions in
which the Funds may be deemed to be doing business. In addition, in those states
or localities which have income tax laws, the treatment of a Fund and its
shareholders under such laws may differ from their treatment under federal
income tax laws, and investment in the Fund may have tax consequences for
shareholders different from those of a direct investment in the Fund's portfolio
securities. Shareholders should consult their own tax advisers concerning these
matters.
GENERAL INFORMATION ABOUT THE TRUST
General
The Trust is an open-end investment company organized as a Delaware
business trust on September 13, 1993. The Trust commenced operations on January
3, 1994. Until December 30, 1994, the Fixed Income Fund and the Municipal Bond
Fund were series of The Advisors' Inner Circle Fund, a Massachusetts business
trust organized under the laws of the Commonwealth of Massachusetts on July 18,
1991.
In the event of a liquidation or dissolution of the Trust or an
individual Fund, shareholders of a particular Fund would be entitled to receive
the assets available for distribution belonging to such Fund.
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Shareholders of a Fund are entitled to participate in the net distributable
assets of the particular Fund involved on liquidation, based on the number of
shares of the Fund that are held by each shareholder.
Each service share and institutional share of a Fund is entitled to one
vote per share; however, separate votes will be taken by each Fund or class (or
by more than one Fund or class voting on a single class if similarly affected)
on matters affecting only the Fund or class (or those affected Funds or classes)
or as otherwise required by law. Shares are freely transferable and have no
preemptive, subscription or conversion rights. The Trust does not expect to hold
shareholder meetings except as required by the 1940 Act or the Agreement and
Declaration of Trust (the "Declaration of Trust"). See "Organization and Shares
of the Trust" in the Prospectus.
As of December 17, 1996, the following shareholders owned the following
respective percentages of the outstanding shares of the Fixed Income Fund, the
Municipal Bond Fund, The Short-Term Municipal Bond Fund, the Short-Term Fixed
Income Fund and The Smaller Companies Fund:
Fixed Income Fund:
SEI Trust Company 8.77%
Oaks,PA 19456-0100
BATRUS & Co. 6.13%
c/o Bankers Trust Company
PO Box 9005
Church Street Station
New York, NY 10006
San Mateo County Employees 8.11%
Retirement Association
2317 Broadway St STE 115
Redwood City, CA 94063-1613
Municipal Bond Fund:
SEI Trust Company 10.14%
Oaks, PA 19456-0100
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Batrus & Co., (New York Corporation) 45.79%
c/o Bankers Trust Co.
PO Box 706 Church Street Station
New York, NY 10008
INFID & Co. 10.22%
c/o Bankers Trust Co.
PO Box 9005 Church Street Station
New York, NY 10008
Short-Term Municipal Bond Fund:
SEI Trust Company 6.65%
Oaks, PA 19456-0100
Rocco A. Ortenzio 20.82%
C/O Select Capital Corp
4718 Old Gettysburg Rd.
Mechanicsburg, PA 17055
Robert A. Ortenzio 6.94%
C/O Select Capital Corp
4718 Old Gettysburg Rd.
Mechanicsburg, PA 17055
Wilmington Trust Company 8.54%
FBO David Baldt
1100 N. Market Street
Wilmington, DE 19890
Timothy Mather 7.04%
4901 S. Franklin St
Englewood, CO 80110
National Financial Services Corp 6.55%
200 Liberty St
1 World Financial Center
New York, NY 10281
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Jay R. Brinsfield 5.25%
18625 SE Village Circle
Tequesta, FL 33469
Robert D. Greene 6.93%
26 Island Road
Stuart, FL 34996-7005
Short-Term Fixed Income Fund:
BATRUS & Co., (New York Corporation) 28.69%
c/o Bankers Trust
PO Box 9005 Church Street Station
New York, NY 10006
SEI Trust Company 18.30%
Oaks, PA 19456-0100
Infid & Co. 6.97%
c/o Bankers Trust Co.
PO Box 706 Church Street Station
New York, NY 10008
Harris Trust FBO National Sporting Goods Assn 5.81%
111 W. Monroe Street
Chicago, IL 60603
Smaller Companies Fund:
Morgan Grenfell Capital Management, Inc. 79.71%
(Delaware Corporation)
885 Third Avenue Suite 3200
New York, NY 10022
Deutsche Morgan Grenfell 17.44%
CJ Lawrence
1290 Avenue of the Americas
New York, NY 10104
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Shareholder and Trustee Liability
The Trust is organized as a Delaware business trust and, under Delaware
law, the shareholders of a business trust are not generally subject to liability
for the debts or obligations of the trust. Similarly, Delaware law provides that
none of the Funds will be liable for the debts or obligations of any other Fund.
However, no similar statutory or other authority limiting business trust
shareholder liability exists in other states. As a result, to the extent that a
Delaware business trust or a shareholder is subject to the jurisdiction of the
courts in such other states, the courts may not apply Delaware law and may
thereby subject the Delaware business trust shareholders to liability. To guard
against this risk, the Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations of the Trust. Notice of such
disclaimer will normally be given in each agreement, obligation or instrument
entered into or executed by the Trust or the Trustees. The Declaration of Trust
provides for indemnification by the relevant Fund for any loss suffered by a
shareholder as a result of an obligation of the Fund. The Declaration of Trust
also provides that the Trust shall, upon request, assume the defense of any
claim made against any shareholder for any act or obligation of the Trust and
satisfy any judgment thereon. The Trustees believe that, in view of the above,
the risk of personal liability of shareholders is remote.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he or she
would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of his
or her office.
Consideration for Purchases of Shares
The Trust generally will not issue shares of the Funds for
consideration other than cash. At the Trust's sole discretion, however, it may
issue Fund shares for consideration other than cash in connection with an
acquisition of portfolio securities (other than municipal debt securities issued
by state political subdivisions or their agencies or instrumentalities) or
pursuant to a bona fide purchase of assets, merger or other reorganization,
provided (i) the securities meet the investment objectives and policies of the
Fund; (ii) the securities are acquired by the Fund for investment and not for
resale; (iii) the securities are not restricted as to transfer either by law or
liquidity of market; and (iv) the securities have a value which is readily
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ascertainable (and not established only by valuation procedures) as evidenced by
a listing on the American Stock Exchange or the New York Stock Exchange or by
quotation on the NASD Automated Quotation System. An exchange of securities for
Fund shares will generally be a taxable transaction to the shareholder.
ADDITIONAL INFORMATION
Independent Accountants
Price Waterhouse LLP serves as the Funds' independent accountants,
providing audit services, including review and consultation in connection with
various filings by the Trust with the Commission and tax authorities.
Registration Statement
The Trust has filed with the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, a Registration Statement under the Securities Act of
1933, as amended, with respect to the securities of the Funds and certain other
series of the Trust. If further information is desired with respect to the
Trust, the Funds or such other series, reference is made to the Registration
Statement and the exhibits filed as a part thereof.
FINANCIAL STATEMENTS
The Trust's audited financial statements for the period ended October
31, 1996 are included in, and incorporated by reference into, this Statement of
Additional Information in reliance upon the report of Price Waterhouse LLP, the
Trust's independent accountants, as experts in accounting and auditing.
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Appendix A
DESCRIPTION OF BOND RATINGS
The rating descriptions set forth below are believed to be the most
recent rating descriptions available from Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Ratings Group ("Standard & Poor's), Duff &
Phelps, Inc. ("Duff") and Fitch Investors Service ("Fitch") at the date of this
Statement of Additional Information for the securities listed. Ratings are
generally given to securities at the time of issuance. While the rating agencies
may from time to time revise such ratings, they undertake no obligation to do
so, and the ratings indicated do not necessilarily represent ratings which will
be given to these securities on the date of a Fund's fiscal year end.
I. Long-Term Debt Ratings
Moody's Investors Service, Inc.
Description of four highest long-term debt ratings by Moody's (Moody's
applies numerical modifiers (1,2 and 3) in each rating category to indicate the
security's ranking within the category):
Aaa: Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to prinicpal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium grade
obligations, ie:, they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment characteristics
and in fact have speculative characteristics as well.
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Standard & Poor's Ratings Group (1)
Description of the four highest long-term debt ratings by Standard &
Poor's (Standard & Poor's may apply a plus (+) or minus (-) to a particular
rating classification to show relative standing within the classification):
AAA: Bonds rated AAA have the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA: Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the higher rated issues only in small degree.
A: Bonds rated A have a very strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than bonds in higher rated
categories.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
bonds in this category than in higher rated categories.
(1) Rates all governmental bodies having $1,000,000 or more of debt outstanding,
unless adequate information is not available.
Duff & Phelps, Inc.
Description of the four highest long-term debt ratings by Duff (Duff
may apply a plus or minus to show relative standing within a rating category):
AAA: Highest credit quality. The risk factors are negligible, being
only slightly more than for risk-free U.S. Treasury debt.
AA: High credit quality. Protection factors are strong. Risk is modest
but may vary slightly from time to time because of economic conditions.
A: Protection factors are average but adequate. However, risk factors
are more variable and greater in periods of economic stress.
BBB: Investment grade. Below average protection factors but still
considered sufficient for prudent investment. Considerable variability in risk
during economic cycles.
Fitch Investores Service
Description of the four highest long-term ratings by Fitch (plus or
minus signs are used with a rating symbol to indicate the relative position of
the credit within the rating category):
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AAA: Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably forseeable
events.
AA: Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA". Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of thest issues is generally rated "F-1+".
A: Bonds considered to be investment grade and of high crdit quality.
The obligor's ability to pay interest and to repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and to repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
II. Short-Term Debt Ratings
Short-term debt ratings may be assigned, for example, to commercial
paper, master demand notes, bank instruments and letters of credit.
Moody's description of its highest short-term debt rating:
Prime-1 Issuers rated Prime-1 (or supporting institutions) have
superior capacity for repayment of senior short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by many of the following
characteristics:
- Lending market positions in well established industries.
- High rates of return on funds employed.
- Conservative capitalization structures with moderate
reliance on debt and ample asset protection.
- Broad margins in earnings coverage of fixed financial
charges and high internal cash generation.
- Well-established access to a range of financial markets and
assured sources of alternative liquidity.
Standard & Poor's description of its highest short-term debt rating:
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A-1 This designation indicated that the degree of safety regarding
timely payment is strong. Those issues determined to have extremely strong
safety characteristics are denoted with a plus sign (+).
III. Short-Term Loan / Municipal Note Ratings
Moody's description of its two highest short-term loan / municipal note ratings:
MIG-1/VMIG-1 This description denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.
MIG-2/VMIG-2 This designation denotes high quality. Margins of
protection are ample although not so large as in the preceeding group.
Standard & Poor's description of its two highest municipal note ratings:
SP-1 Very strong or strong capacity to pay principal and interest.
Those issues determined to possess overwhelming safety characteristics will be
given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
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