IAI RETIREMENT FUNDS, INC.
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PROSPECTUS
MAY 1, 1997
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MUTUAL FUNDS
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TABLE OF CONTENTS
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FINANCIAL HIGHLIGHTS.................................................. 3
INVESTMENT OBJECTIVES AND POLICIES.................................... 6
Regional Portfolio........................................... 6
Balanced Portfolio........................................... 6
Reserve Portfolio........................................... 7
OTHER PORTFOLIO INVESTMENT TECHNIQUES................................. 8
PORTFOLIO RISK FACTORS................................................ 10
MANAGEMENT............................................................ 12
INVESTMENT PERFORMANCE................................................ 13
COMPUTATION OF NET ASSET VALUE AND PRICING............................ 14
PURCHASE OF SHARES.................................................... 14
REDEMPTION OF SHARES.................................................. 14
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS............................... 14
DESCRIPTION OF COMMON STOCK........................................... 15
COUNSEL AND AUDITORS.................................................. 15
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT............... 15
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PROSPECTUS DATED MAY 1, 1997
IAI RETIREMENT FUNDS, INC.
IAI Retirement Funds, Inc. (the "Fund"), is a diversified, open-end
management investment company offering insurance companies a selection of
investment vehicles for variable annuity contracts and variable life insurance
policies. This Prospectus describes the three portfolios currently offered by
the Fund (the "Portfolios"). Each Portfolio has its own distinct investment
objective. There can be no assurance that any Portfolio will achieve its
investment objective.
IAI REGIONAL PORTFOLIO ("Regional Portfolio") pursues its objective of capital
appreciation by investing at least 80% of its equity investments in companies
which have their headquarters in Minnesota, Wisconsin, Iowa, Illinois, Nebraska,
Montana, North Dakota or South Dakota.
IAI BALANCED PORTFOLIO'S ("Balanced Portfolio") investment objective is to
maximize total return to investors. IAI Balanced Portfolio pursues its objective
by investing in a broadly diversified portfolio of stocks, bonds and short-term
instruments.
IAI RESERVE PORTFOLIO'S ("Reserve Portfolio") investment objectives are to
provide its shareholders with high levels of capital stability and liquidity
and, to the extent consistent with these primary objectives, a high level of
current income. IAI Reserve Portfolio pursues its investment objectives by
investing primarily in a diversified portfolio of investment grade bonds and
other debt securities of similar quality. IAI Reserve Portfolio's dollar
weighted average maturity will not exceed twenty-five (25) months.
This Prospectus sets forth concisely the information which a prospective
investor should know about the Portfolios before investing and it should be
retained for future reference. A "Statement of Additional Information" dated May
1, 1997, which provides a further discussion of certain areas in this Prospectus
and other matters which may be of interest to some investors, has been filed
with the Securities and Exchange Commission and is incorporated herein by
reference. For a free copy, call or write the Fund at the address or telephone
number shown below.
Shares of each Portfolio may be purchased only by the separate accounts of
insurance companies for the purpose of funding variable annuity and/or variable
life insurance contracts. Particular Portfolios may not be available in your
state due to various insurance regulations. Please check with your insurance
company. Inclusion of a Portfolio in this Prospectus is not to be considered a
solicitation if such Portfolio is not available in your state. This Prospectus
should be read in conjunction with the prospectus of the separate account of the
specific insurance product which accompanies this Prospectus.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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FINANCIAL HIGHLIGHTS
The following information has been audited by KPMG Peat Marwick LLP, independent
auditors, whose report is included in the Portfolio's Annual Report. The
financial statements in the Annual Report are incorporated by reference in (and
are a part of) the Statement of Additional Information. Such Annual Report may
be obtained by shareholders on request from the Fund at no charge.
REGIONAL PORTFOLIO
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Years Ended
December 31, Period From
---------------------------- January 31, 1994*** to
1996 1995 December 31, 1994
---- ---- -----------------
NET ASSET VALUE
Beginning of period $ 14.16 $ 10.62 $ 10.00
-------- ------- -------
OPERATIONS
Net investment income 0.05 0.06 0.03
Net realized and unrealized gains 1.60 3.50 0.59
---------- ---- -------
Total from operations 1.65 3.56 0.62
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DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (0.05) (0.02) ----
Net realized gains (0.74) --- ----
--------- ------- -------
Total distributions (0.79) (0.02) ----
--------- ------- -------
NET ASSET VALUE
End of period $ 15.02 $ 14.16 $10.62
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Total investment return* 11.88% 33.51% 6.20%
Net assets at end of period (000's omitted) $11,831 $ 5,105 $ 865
RATIOS:
Expenses to average daily net assets 1.03% 1.37%** 1.13%
Expenses to average daily net assets
(net of expenses paid indirectly) 1.03% 1.25% N/A
Net investment income to average
daily net assets 0.77% 1.12%** 0.81%
Average brokerage commission rate**** $ .0513 N/A N/A
Portfolio turnover rate
(excluding short-term securities) 78.4% 156.0% 127.6%
* Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of all distributions
at net asset value.
** The Portfolio's adviser voluntarily waived $6,737 and $7,455 in
expenses for the year ended December 31, 1995, and the period ended
December 31, 1994, respectively. If the Portfolio had been charged for
these expenses, the ratio of expenses to average daily net assets would
have been 1.64% and 3.90%, respectively, and the ratio of net
investment income (loss) to average daily net assets would have been
.85% and (1.96%), respectively. For fiscal 1995, the ratio of expenses
to average daily net assets includes expenses paid indirectly by the
Portfolio. Prior period expense ratios have not been adjusted. The
ratio for the period ended December 31, 1994 is annualized.
*** Commencement of operations
**** Beginning in fiscal 1996, the Portfolio is required to disclose an
average brokerage commission rate.
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FINANCIAL HIGHLIGHTS
BALANCED PORTFOLIO
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Years Ended Period From
December 31, February 3, 1994*** to
---------------------------- December 31, 1994
1996 1995 ---------------------
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NET ASSET VALUE
Beginning of period $ 11.78 $ 10.22 $ 10.00
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OPERATIONS
Net investment income 0.22 0.09 0.10
Net realized and unrealized gains 0.92 1.56 0.12
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Total from operations 1.14 1.65 0.22
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DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (0.10) (0.09) ---
Net realized gains (0.11) --- ---
--------- ------- -----
Total distributions (0.21) (0.09) ---
--------- ------- ------
NET ASSET VALUE
End of period $ 12.71 $ 11.78 $ 10.22
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Total investment return* 9.80% 16.21% 2.20%
Net assets at end of period (000's omitted) $ 1,534 $ 764 $ 206
RATIOS:
Expenses to average daily net assets** 1.25% 1.70% 1.25%
Expenses to average daily net assets
(net of expenses paid indirectly) 1.25% 1.25% N/A
Net investment income to average
daily net assets** 2.84% 2.34% 2.28%
Average brokerage commission rate**** $ .0555 N/A N/A
Portfolio turnover rate
(excluding short-term securities) 67.4% 56.0% 21.6%
* Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of all distributions at
net asset value.
** The Portfolio's adviser voluntarily waived $8,031, $13,428 and $7,756 in
expenses for the years ended December 31, 1996 and 1995, and for the period
ended December 31, 1994, respectively. If the Portfolio had been charged
for these expenses, the ratio of expenses to average daily net assets would
have been 1.96%, 5.29% and 10.33%, respectively, and the ratio of net
investment income (loss) to average daily net assets would have been 2.13%,
(1.25%) and (6.80%), respectively. For fiscal 1995, the ratio of expenses
to average daily net assets includes expenses paid indirectly by the
Portfolio. Prior period expense ratios have not been adjusted. The ratio
for the period ended December 31, 1994 is annualized.
*** Commencement of operations
**** Beginning in fiscal 1996, the Portfolio is required to disclose an average
brokerage commission rate.
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FINANCIAL HIGHLIGHTS
RESERVE PORTFOLIO
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Years Ended
December 31, Period From
---------------------------- April 7, 1994*** to
1996 1995 December 31, 1994
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NET ASSET VALUE
Beginning of period $ 10.05 $ 10.03 $ 10.00
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OPERATIONS
Net investment income 0.49 0.48 0.20
Net realized and unrealized gains (losses) (0.01) 0.02 0.02
------- ------- -------
Total from operations 0.48 0.50 0.22
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DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (0.50) (0.48) (0.19)
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Total distributions (0.50) (0.48) (0.19)
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NET ASSET VALUE
End of period $ 10.03 $ 10.05 $ 10.03
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Total investment return* 4.93% 5.09% 2.25%
Net assets at end of period (000's omitted) $ 528 $ 844 $ 544
RATIOS:
Expenses to average daily net assets** 0.85% 1.03% 0.85%
Expenses to average daily net assets
(net of expenses paid indirectly) 0.85% 0.85% N/A
Net investment income to average
daily net assets** 4.54% 4.84% 3.56%
* Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of all distributions at
net asset value.
** The Portfolio's adviser voluntarily waived $9,034, $11,528 and $6,930 in
expenses for the years ended December 31, 1996 and 1995, and for the period
ended December 31, 1994, respectively. If the Portfolio had been charged
for these expenses, the ratio of expenses to average daily net assets would
have been 1.81%, 2.62% and 4.62%, respectively, and the ratio of net
investment income to average daily net assets would have been 3.58%, 3.25%
and (.21%), respectively. For fiscal 1995, the ratio of expenses to average
daily net assets includes expenses paid indirectly by the Portfolio. Prior
period expense ratios have not been adjusted. The ratio for the period
ended December 31, 1994 is annualized.
*** Commencement of operations
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INVESTMENT OBJECTIVES
AND POLICIES
The investment objectives and policies of each of the Portfolios are listed
below. There is no assurance that any Portfolio will achieve its investment
objective(s). The value of shares when redeemed may be higher or lower than when
purchased.
REGIONAL PORTFOLIO
The investment objective of Regional Portfolio is capital appreciation.
Regional Portfolio does not expect to provide significant current income to
investors. Regional Portfolio pursues its objective by investing at least 80% of
its equity investments in companies which have their headquarters in Minnesota,
Wisconsin, Iowa, Illinois, Nebraska, Montana, North Dakota or South Dakota (the
"Eight State Region"). Regional Portfolio's investment objective may not be
changed without shareholder approval. There can be no assurance that Regional
Portfolio will achieve its investment objective.
Regional Portfolio invests primarily in common stocks but may also invest
in securities convertible into common stocks, nonconvertible preferred stocks,
and nonconvertible debt securities. In selecting investments for Regional
Portfolio, Investment Advisers, Inc. ("IAI"), Regional Portfolio's investment
adviser and manager, considers a number of factors, such as product development
and demand, operating ratios, utilization of earnings for expansion, management
abilities, analyses of intrinsic values, market action and overall economic and
political conditions.
Along with investments in nationally recognized companies, Regional
Portfolio invests in companies which are not as well known because they are
newer or have a small capitalization, but which offer the potential for capital
appreciation. The prices of stocks of such companies are more volatile than
prices of stocks of mature companies. All investments are subject to the market
risks inherent in any investment in equity securities.
Regional Portfolio may employ certain other investment techniques, as
described in the section "Other Portfolio Investment Techniques". Please see the
Prospectus section "Portfolio Risk Factors" as well as the Statement of
Additional Information section "Investment Objectives and Policies" for a
discussion of the risks associated with investing in Regional Portfolio.
BALANCED PORTFOLIO
The investment objective of Balanced Portfolio is to maximize total return.
Balanced Portfolio will seek to achieve its objective by investing in a broadly
diversified portfolio of stocks, bonds and short-term instruments. Balanced
Portfolio's investment objective may not be changed without shareholder
approval. There can be no assurance that Balanced Portfolio will achieve its
investment objective.
In seeking to achieve its investment objective, IAI, Balanced Portfolio's
investment adviser and manager, will allocate Balanced Portfolio's assets among
the three classes of assets set forth above. Under normal market conditions,
Balanced Portfolio will hold between 25% and 75% of its assets in stocks and
other equity securities, between 25% and 75% of its assets in bonds and other
fixed income securities, and up to 50% of its assets in short-term instruments.
Balanced Portfolio may also make other investments that do not fall within these
classes.
The stock class includes equity securities of all types and will consist
primarily of common stocks, securities convertible into common stocks, and
non-convertible preferred stocks. The bond class includes all varieties of
fixed-income instruments with maturities of more than one year and will consist
primarily of investment grade bonds and other comparable fixed income
securities. Balanced Portfolio may also invest in U.S. Treasury
inflation-protection securities. The value of such inflation-protection
securities is adjusted for inflation and periodic interest payments are in
amounts equal to a fixed percentage of the inflation-adjusted value of the
principal.
The short-term class includes all types of short-term instruments with
remaining maturities of one year or less and will consist primarily of
commercial paper, bank certificates of deposit, bankers' acceptances, government
securities, repurchase agreements and other similar short-term instruments.
Short-term securities will only be purchased if given one of the top two ratings
by a major rating service or, if unrated, are of comparable quality as
determined by IAI. Within each of these classes, Balanced Portfolio may invest
in both domestic and foreign securities.
Although Balanced Portfolio may invest in below investment grade
securities, Balanced Portfolio currently intends to limit such investments to
10% of its total assets and not to invest in securities rated lower than B by
Moody's or by S&P. Securities rated in the medium to lower rating categories of
nationally recognized statistical rating organizations and unrated securities of
comparable quality are predominately speculative with respect to the capacity to
pay interst and repay principal in accordance with teh terms of the security and
generally involve a greater volatility of price than securities in higher rating
categories. See "Investment Objectives and Policies" in the Statement of
Additional Information for additional information regarding ratings of debt
securities. In purchasing such securities, Balanced Portfolio will rely on IAI's
judgment, analysis and experience in evaluating the creditworthiness of an
issuer of such securities. IAI will take into consideration, among other things,
the issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of the issuer's management and
regulatory matters.
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IAI regularly reviews its allocation of Balanced Portfolio's assets among
the three classes and gradually varies them over time to favor asset classes
that, in IAI's judgment, provide the most favorable total return outlook.
Because Balanced Portfolio seeks to maximize total return over the long-term, it
will not try to pinpoint the precise moment when major reallocations are
warranted. Rather, such reallocations among asset classes will be made gradually
over time and, under normal conditions, a single reallocation decision will not
involve more than 10% of Balanced Portfolio's total assets.
Balanced Portfolio may employ certain other investment techniques, as
described in the section "Other Portfolio Investment Techniques". Please see the
Prospectus section "Portfolio Risk Factors" as well as the Statement of
Additional Information section "Investment Objectives and Policies" for a
discussion of the risks associated with investing in Balanced Portfolio.
RESERVE PORTFOLIO
Reserve Portfolio's investment objectives are to provide its shareholders
with high levels of capital stability and liquidity and, to the extent
consistent with these primary objectives, a high level of current income. Such
objectives may not be changed without shareholder approval. There can be no
assurance that Reserve Portfolio's investment objectives will be attained.
Reserve Portfolio pursues its objectives primarily through investment in a
diversified portfolio of investment grade bonds and other debt securities of
similar quality. Investment grade securities are those securities rated within
the four highest grades assigned by Moody's or S&P. Although Reserve Portfolio
may invest in below investment grade securities, it currently has no intention
of doing so. Reserve Portfolio will maintain a dollar weighted average maturity
of its investment portfolio of twenty-five (25) months or less. For purposes of
such determination, securities that provide for optional maturity dates, at the
holder's option, shall be deemed by Reserve Portfolio to have been issued with
the shorter optional maturity dates.
Other debt securities in which Reserve Portfolio may invest include
securities of, or guaranteed by, the U.S. Government, its agencies or
instrumentalities, corporate debt obligations, debt securities of foreign
issuers, mortgage-related securities, commercial paper rated at least Prime-2 by
Moody's or A-2 by S&P or otherwise issued by companies having an outstanding
unsecured debt issue currently rated A or better by Moody's or S&P, bank
certificates of deposit and other short-term instruments and repurchase
agreements relating to such securities. U.S. Government securities are issued or
guaranteed by the U.S. Treasury or by an agency or instrumentality of the U.S.
Government. Not all U.S. Government securities are backed by the full faith and
credit of the United States. Some are supported only by the credit of the agency
that issued them. Reserve Portfolio may also invest in U.S. Treasury
inflation-protection securities. The value of such inflation-protection
securities is adjusted for inflation and periodic interest payments are in
amounts equal to a fixed percentage of the inflation-adjusted value of the
pricipal.
Reserve Portfolio may employ certain other investment techniques, as
described in the section "Other Portfolio Investment Techniques". Please see the
Prospectus section "Portfolio Risk Factors" as well as the Statement of
Additional Information section "Investment Objectives and Policies" for a
discussion of the risks associated with investing in Reserve Portfolio.
OTHER PORTFOLIO INVESTMENT
TECHNIQUES
Each Portfolio's ability to utilize certain of the investment techniques
discussed below may be subject to limitations and may subject each Portfolio to
additional risks. Please refer to the section "Portfolio Risk Factors" below and
the Statement of Additional Information for more information regarding such
risks.
REPURCHASE AGREEMENTS
Each Portfolio may invest in repurchase agreements relating to the
securities in which it may invest. In a repurchase agreement, a Portfolio buys a
security at one price and simultaneously agrees to sell it back at a higher
price. Delays or losses could result if the other party to the agreement
defaults or becomes bankrupt.
FOREIGN SECURITIES
Each Portfolio may invest in securities of foreign issuers in accordance
with its investment objectives and policies. In considering whether to purchase
securities of foreign issuers, IAI will consider the political and economic
conditions in a country, the prospect for changes in the value of its currency
and the liquidity of the investment in that country's securities markets.
Regional Portfolio intends to limit its investment in foreign securities
denominated in foreign currency and not publicly traded in the United States to
no more than 10% of its total assets. Reserve Portfolio intends to invest no
more than 15% of the value of its total assets in such securities. Balanced
Portfolio intends to invest no more than 25% of the value of its total assets in
such securities.
ILLIQUID SECURITIES
Each Portfolio may also invest up to 15% of its net assets in
securities that are considered illiquid because of the absence of a readily
available market or due to legal or contractual restrictions. However, certain
restricted securities that are not registered for sale to the general public but
that can be resold to institutional investors may be considered liquid pursuant
to guidelines adopted by the Board of Directors. The institutional trading
market is relatively new, and the liquidity of each Portfolio's investments
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could be impaired if trading does not develop or declines.
VENTURE CAPITAL
Regional and Balanced Portfolios may invest in venture capital limited
partnerships and venture capital funds which, in turn, invest principally in
securities of early stage, developing companies. Investments in venture capital
limited partnerships and venture capital funds present a number of risks not
found in investing in established enterprises including the facts that such a
partnership's or fund's portfolio will be composed almost entirely of
early-stage companies which may lack depth of management and sufficient
resources, which may be marketing a new product for which there is no
established market, and which may be subject to intense competition from larger
companies. Any investment in a venture capital limited partnership or venture
capital fund will lack liquidity, will be difficult to value, and each such
Portfolio will not be entitled to participate in the management of the
partnership or fund. If for any reason the services of the general partners of a
venture capital limited partnership were to become unavailable, such limited
partnership could be adversely affected.
In addition to investing in venture capital limited partnerships and
venture capital funds, Regional and Balanced Portfolios may directly invest in
early-stage, developing companies. The risks associated with investing in these
securities are substantially similar to the risks set forth above. A Portfolio
will typically purchase equity securities in these early-stage, developing
companies; however, from time-to-time a Portfolio may purchase non-investment
grade debt securities in the form of convertible notes. Each Portfolio currently
intends to limit its investments in securities described in this section to no
more than 5% of its net assets.
LEVERAGED BUYOUT TRANSACTIONS (LBOS)
Regional and Balanced Portfolios may invest in leveraged buyout limited
partnerships and funds which, in turn, invest in leveraged buyout transactions
("LBOs"). An LBO, generally, is an acquisition of an existing business by a
newly formed corporation financed largely with debt assumed by such newly formed
corporation to be later repaid with funds generated from the acquired company.
Since most LBOs are by nature highly leveraged (typically with debt to equity
ratios of approximately 9 to 1), equity investments in LBOs may appreciate
substantially in value given only modest growth in the earnings or cash flow of
the acquired business. Investments in LBOs, however, present a number of risks.
Investments in LBO limited partnerships and funds will normally lack liquidity
and may be subject to intense competition from other LBO limited partnerships
and funds. Additionally, if the cash flow of the acquired company is
insufficient to service the debt assumed in the LBO, the LBO limited partnership
or fund could lose all or part of its investment in such acquired company.
WHEN-ISSUED/DELAYED DELIVERY TRANSACTIONS
Balanced and Reserve Portfolios may purchase securities on a "when-issued"
or delayed delivery basis and purchase or sell securities on a "forward
commitment" basis. When such transactions are negotiated, the price is fixed at
the time the commitment is made, but delivery and payment for the securities
take place at a later date. Normally, the settlement date occurs within two
months after the transaction, but delayed settlements beyond two months may be
negotiated. At the time a Portfolio enters into a transaction on a when-issued
or forward commitment basis, a segregated account consisting of cash, government
securities or liquid high-grade debt securities equal to the value of the
when-issued or forward commitment securities will be established and maintained
with the custodian and will be marked to the market daily. During the period
between a commitment and settlement, no payment is made for the securities and,
thus, no interest accrues to the purchaser from the transaction. If a Portfolio
disposes of the right to acquire a when-issued security prior to its acquisition
or disposes of its right to deliver or receive against a forward commitment, it
can incur a gain or loss due to market fluctuation. The use of when-issued
transactions and forward commitments enables a Portfolio to hedge against
anticipated changes in interest rates and prices. A Portfolio may also enter
into such transactions to generate incremental income. In some instances, the
third-party seller of when-issued or forward commitment securities may determine
prior to the settlement date that it will be unable or unwilling to meet its
existing transaction commitments without borrowing securities. If advantageous
from a yield perspective, a Portfolio may, in that event, agree to resell its
purchase commitment to the third-party seller at the current market price on the
date of sale and concurrently enter into another purchase commitment for such
securities at a later date. As an inducement for a Portfolio to "roll over" its
purchase commitment, a Portfolio may receive a negotiated fee. No more than 20%
of a Portfolio's net assets may be invested in when-issued, delayed delivery or
forward commitment transactions, and of such 20%, no more than one-half (i.e.,
10% of its net assets) may be invested in when-issued, delayed delivery or
forward commitment transactions without the intention of actually acquiring
securities (i.e., dollar rolls or "roll" transactions). For additional
information on roll transactions, see "Investment Objectives and Policies --
Dollar Rolls" in the Statement of Additional Information.
ZERO COUPON OBLIGATIONS
Balanced and Reserve Portfolios may also invest in zero coupon obligations
of the U.S. Government or its agencies, tax exempt issuers and corporate
issuers, including rights to stripped coupon and principal payments ("STRIPS").
Zero coupon bonds do not make regular interest payments; rather, they are sold
at a discount from face value. Principal and accreted discount (representing
interest accrued but not paid) are paid at maturity. STRIPS are debt securities
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that are stripped of their interest after the securities are issued, but
otherwise are comparable to zero coupon bonds. The market values of STRIPS and
zero coupon bonds generally fluctuate in response to changes in interest rates
to a greater degree than do interest-paying securities of comparable term and
quality.
MORTGAGE-BACKED SECURITIES
Balanced and Reserve Portfolios may invest in pass-through securities which
are sold by various private, governmental and government-related organizations.
Pass-through securities are formed when mortgages and other debt instruments are
pooled together and undivided interests in the pool are sold to investors such
as Balanced and Reserve Portfolios. The cash flow from the underlying debt
instruments is "passed through" to the holders of the securities in the form of
periodic (generally monthly) payments of interest, principal and prepayments.
Prepayments occur when the holder of an individual debt instrument prepays the
remaining principal and interest before the final scheduled payment month.
Therefore, Balanced and Reserve Portfolios may be subject to a higher rate of
prepayments during periods of declining interest rates when mortgages and other
debt instruments may be more frequently prepaid.
Mortgage pass-through securities include (1) obligations of U.S. government
agencies and instrumentalities which are secured by the full faith and credit of
the U.S. Treasury such as Government National Mortgage Association ("GNMA")
pass-through certificates; (2) obligations which are secured by the right of the
issuer to borrow from the Treasury, such as securities issued by the Federal
Financing Bank, the Federal Home Loan Banks and the United States Postal
Service; and (3) obligations which have the principal and interest payments
guaranteed by the government agency or instrumentality itself (but are not
backed by the full faith and credit of the U.S. government), such as securities
of the Federal National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC"); and (4) obligations of private corporations.
ASSET-BACKED SECURITIES
Balanced and Reserve Portfolios may invest in types of asset-backed
securities which represent forms of consumer credit such as automobile and
credit card receivables, manufactured (mobile) home loans, home improvement
loans and home equity loans. Asset-backed securities are generally privately
issued and pass through cash flows to investors. Generally, asset-backed
securities include many of the risks associated with mortgage-related
securities. In general, however, the collateral supporting asset-backed
securities is of shorter maturity than mortgage loans and is less likely to
experience substantial prepayments. Asset-backed securities involve certain
risks that are not posed by mortgage-backed securities, resulting mainly from
the fact that asset-backed securities do not usually contain the complete
benefit of a security interest in the related collateral. For example, credit
card receivables generally are unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, including the
bankruptcy laws, some of which may reduce the ability to obtain full payment. In
the case of automobile receivables, due to various legal and economic factors,
proceeds for repossessed collateral may not always be sufficient to support
payments on these securities.
ADJUSTING INVESTMENT EXPOSURE
Each Portfolio may, but is not required to, utilize various other
investment strategies as described below to hedge various market risks (such as
interest rates, currency exchange rates, and broad or specific fixed-income
market movements), to manage the effective maturity or duration of the
Portfolios or to enhance potential gain. These strategies may be executed
through the use of derivative contracts. Such strategies are generally accepted
as a part of modern portfolio management and are regularly utilized by many
mutual funds and other institutional investors. Techniques and instruments may
change over time as new instruments and strategies are developed or regulatory
changes occur.
In the course of pursuing these investment strategies, each Portfolio may
purchase and sell exchange-listed and over-the-counter put and call options on
securities, fixed-income indices and other financial instruments, purchase and
sell financial futures contracts and options thereon, enter into various
interest rate transactions such as swaps and enter into various currency
transactions such as currency forward contracts, currency futures contracts,
currency swaps or options on currencies or currency futures.
Such techniques and instruments may be used without limit to attempt to
protect against possible changes in the market value of securities held in or to
be purchased for each Portfolio's portfolio resulting from securities markets or
currency exchange rate fluctuations, to protect each Portfolio's unrealized
gains in the value of its portfolio securities, to facilitate the sale of such
securities for investment purposes, to manage the effective maturity or duration
of the Portfolios, or to establish a position in the derivatives markets as a
temporary substitute for purchasing or selling particular securities. Some may
also be used to enhance potential gain although no more than 5% of each
Portfolio's assets will be committed to techniques and instruments entered into
for non-hedging purposes. Any or all of these investment techniques may be used
at any time and in any combination, and there is no particular strategy that
dictates the use of one technique rather than another, as use of any technique
or instruments is a function of numerous variables including market conditions.
The ability of each Portfolio to utilize these techniques and instruments
successfully will depend on IAI's ability to predict pertinent market movements,
which cannot be assured. Each Portfolio will comply with applicable regulatory
requirements when implementing these strategies, techniques and instruments.
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Such techniques and instruments involving financial futures and options thereon
will be purchased, sold or entered into only for bona fide hedging, risk
management or portfolio management purposes and not for speculative purposes.
BORROWING
Each Portfolio may borrow from banks (or through reverse repurchase
agreements) for temporary or emergency purposes. If a Portfolio borrows money,
its share price may be subject to greater fluctuation until the borrowing is
paid off. If a Portfolio makes additional investments while borrowings are
outstanding, this may be considered a form of leverage. Each Portfolio does not
intend its borrowing to exceed 5% of its net assets.
TEMPORARY DEFENSIVE POSITION
In unusual market conditions, when IAI believes a temporary defensive
position is warranted, each Portfolio may invest without limitation in money
market securities and/or investment grade fixed income securities, that is,
securities rated within the four highest grades assigned by Moody's or S&P, or
money market securities (including repurchase agreements). Money market
securities will only be purchased if they have been given one of the two top
ratings by a major ratings service or, if unrated, are of comparable quality as
determined by IAI. If a Portfolio maintains a temporary defensive position,
investment income may increase and may constitute a large portion of a
Portfolio's return.
PORTFOLIO TURNOVER
Each Portfolio will dispose of securities without regard to the time they
have been held when such action appears advisable to management either as a
result of securities having reached a price objective, or by reason of
developments not foreseen at the time of the investment decision. Since
investment changes usually will be made without reference to the length of time
a security has been held, a significant number of short-term transactions may
result. Accordingly, a Portfolio's annual portfolio turnover rate cannot be
anticipated and may be relatively high. High turnover rates (100% or more)
increase transaction costs and may increase taxable capital gains. Each
Portfolio's historical portfolio turnover rates are set forth in the section
"Financial Highlights."
Further information regarding these and other securities and techniques is
contained in the Statement of Additional Information.
PORTFOLIO RISK FACTORS
INTEREST RATE RISK
As mutual funds investing in fixed income securities, Reserve and Balanced
Portfolios are subject to interest rate risk. Interest rate risk is the
potential for a decline in bond prices due to rising interest rates. In general,
bond prices vary inversely with interest rates. When interest rates rise, bond
prices generally fall. Conversely, when interest rates fall, bond prices
generally rise. The change in price depends on several factors, including the
bond's maturity date. In general, bonds with longer maturities are more
sensitive to changes in interest rates than bonds with shorter maturities. In
managing these Portfolios, IAI will adjust the duration of the investment
portfolio in response to economic and market conditions. Duration is generally
considered a better measure of interest rate risk than is maturity. Duration is
a measure of the expected change in value of a fixed income security (or
portfolio) for a given change in interest rates. For example, if interest rates
rise by one percent, the market value of a security (or portfolio) having a
duration of two generally will fall by approximately two percent. In some
situations, the standard duration calculation does not properly reflect the
interest rate risk of a security. In such situations, IAI will use more
sophisticated analytical techniques, such as modeling principal and interest
payments based upon historical experience or expected volatility, to arrive at
an effective duration that incorporates the additional variables into the
determination of interest rate risk. These techniques may involve estimates of
future economic parameters which may vary from actual future outcomes. IAI
anticipates the duration range for the Reserve Portfolio to be .25 to 1.75 years
and for the fixed income portion of the Balanced Portfolio to be 3.5 to 7 years.
These ranges are merely expectations as of the date of this Prospectus. Such
ranges may change due to market conditions and other economic factors.
Therefore, the expected duration ranges do not limit IAI in how it manages the
Portfolios.
These principals of interest rate risk also apply to U.S. Treasury and
U.S. Government agency securities. As with other bond investments, U.S.
Government securities will rise and fall in value as interest rates change. A
security backed by the U.S. Treasury or the full faith and credit of the United
States is guaranteed only as to the timely payment of interest and principal
when held to maturity. The current market prices for such securities are not
guaranteed and will fluctuate.
CREDIT RISK
Reserve Portfolio and the fixed income component of Balanced Portfolio are
also subject to credit risk. Credit risk, also known as default risk, is the
possibility that a bond issuer will fail to make timely payments of interest or
principal to the Portfolio. The credit risk of a Portfolio depends on the
quality of its investments. Reflecting their higher risks, lower-quality bonds
generally offer higher yields (all other factors being equal).
CALL RISK
Reserve Portfolio and the fixed income component of Balanced Portfolio are
also subject to call risk. Call risk is the possibility that corporate bonds
held by a Portfolio will be repaid prior to maturity. Call provisions, common in
many corporate bonds, allow bond issuers to redeem bonds prior to maturity (at a
specified price). When interest rates are falling, bond issuers often exercise
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these call provisions, paying off bonds that carry high stated interest rates
and often issuing new bonds at lower rates. For a Portfolio, the result would be
that bonds with high interest rates are "called" and must be replaced with
lower-yielding instruments. In these circumstances, the income of a Portfolio
would decline.
FOREIGN INVESTMENT RISK FACTORS
Investments in foreign securities involve risks that are different in some
respects from investments in securities of U.S. issuers, such as the risk of
fluctuations in the value of the currencies in which they are denominated, the
risk of adverse political and economic developments and, with respect to certain
countries, the possibility of expropriation, nationalization or confiscatory
taxation or limitations on the removal of funds or other assets of the
Portfolios. Securities of some foreign companies are less liquid and more
volatile than securities of comparable domestic companies. There also may be
less publicly available information about foreign issuers than domestic issuers,
and foreign issuers generally are not subject to the uniform accounting,
auditing and financial reporting standards, practices and requirements
applicable to domestic issuers. Because the Portfolios can invest in securities
denominated or quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may affect the value of securities in the
portfolio. Foreign currency exchange rates are determined by forces of supply
and demand in the foreign exchange markets and other economic and financial
conditions affecting the world economy. A decline in the value of any particular
currency against the U.S. dollar will cause a decline in the U.S. dollar value
of a Portfolios' holdings of securities denominated in such currency and,
therefore, will cause an overall decline in a Portfolio's net asset value and
net investment income and capital gains, if any, to be distributed in U.S.
dollars to shareholders by a Portfolio. Delays may be encountered in settling
securities transactions in certain foreign markets, and the Portfolios will
incur costs in converting foreign currencies into U.S dollars. Custody charges
are generally higher for foreign securities.
RISKS ASSOCIATED WITH ADJUSTING
INVESTMENT EXPOSURE
The techniques and instruments described in the section "Adjusting
Investment Exposure", including derivative contracts, have risks associated with
them including possible default by the other party to the transaction,
illiquidity and, to the extent IAI's view as to certain market movements is
incorrect, the risk that the use of such techniques and instruments could result
in losses greater than if they had not been used. Use of put and call options
may result in losses to a Portfolio, force the sale or purchase of portfolio
securities at inopportune times or for prices higher than (in the case of put
options) or lower than (in the case of call options), current market values,
limit the amount of appreciation a Portfolio can realize on its investments or
cause a Portfolio to hold a security it might otherwise sell. The use of
currency transactions can result in a Portfolio incurring losses as a result of
a number of factors including the imposition of exchange controls, suspension of
settlements or the inability to deliver or receive a specified currency. The use
of options and futures transactions entails certain other risks. In particular,
the variable degree of correlation between price movements of futures contracts
and price movements in the related portfolio position of a Portfolio creates the
possibility that losses on the hedging instrument may be greater than gains in
the value of a Portfolio's position. In addition, futures and options markets
may not be liquid in all circumstances and certain over-the-counter options may
not have markets. As a result, in certain markets, a Portfolio might not be able
to close out a transaction without incurring substantial losses, if at all.
Although the use of futures contracts and options transactions for hedging
should tend to minimize the risk of loss due to a decline in the value of the
hedged position, at the same time they tend to limit any potential gain which
might result from an increase in value of such position. Finally, the daily
variation margin requirements for futures contracts would create a greater
ongoing potential financial risk than would purchases of options, where the
exposure is limited to the cost of the initial premium. Losses resulting from
the use of these techniques would reduce net asset value, and possibly income,
and such losses can be greater than if the techniques and instruments had not
been utilized.
RISKS OF GEOGRAPHIC CONCENTRATION
For Regional Portfolio, the objective of capital appreciation along with
the policy of concentrating equity investments in the Eight State Region means
that the assets of the Portfolio will generally be subject to greater risk than
may be involved in investing in securities which do not have appreciation
potential or which have more geographic diversity. For example, the Portfolio's
net asset value could be adversely affected by economic, political, or other
developments having an unfavorable impact upon the Eight State Region; moreover,
because of the geographic limitation, the Portfolio may be less diversified by
industry and company than other funds with a similar investment objective and no
such geographic limitation.
RISKS OF LOWER-RATED DEBT SECURITIES
Balanced Portfolio may invest in debt securities commonly known as "junk"
bonds. Such securities are subject to higher risks and greater market
fluctuations than are lower-yielding, higher-rated securities. The price of junk
bonds has been found to be less sensitive to changes in prevailing interest
rates than higher-rated investments, but is likely to be more sensitive to
adverse economic changes or individual corporate developments. During an
economic downturn or substantial period of rising interest rates, highly
leveraged issuers may experience financial stress which would adversely affect
their ability to service their principal and interest payment obligations, to
meet their projected business goals or to obtain additional financing. If the
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issuers of a fixed-income security owned by the Portfolio were to default, the
Portfolio might incur additional expenses to seek recovery. The risk of loss due
to default by issuers of junk bonds is significantly greater than that
associated with higher-rated securities because such securities generally are
unsecured and frequently are subordinated to the prior payment of senior
indebtedness. In addition, periods of economic uncertainty and change can be
expected to result in an increased volatility of market prices of junk bonds and
a concomitant volatility in the net asset value of a share of the Portfolio.
The secondary market for junk bonds is less liquid than the markets for
higher quality securities and, as such, may have an adverse effect on the market
prices of certain securities. The limited liquidity of the market may also
adversely affect the ability of the Portfolio to arrive at a fair value for
certain junk bonds at certain times and could make it difficult for the
Portfolio to sell certain securities. For a description of Moody's and S&P
ratings, see Appendix A to the Statement of Additional Information.
PREPAYMENT RISKS
To the extent they invest in mortgage-backed securities, Balanced and
Reserve Portfolios are subject to prepayment risk. Prepayment risk is the
possibility that, as interest rates fall, homeowners are more likely to
refinance their home mortgages. When home mortgages are refinanced, the
principal on GNMA certificates held by a Portfolio is "prepaid" earlier than
expected. A Portfolio must then reinvest the unanticipated principal in new GNMA
certificates, or other securities, just at a time when interest rates on new
mortgage investments are falling.
Prepayment risk has two important effects on a Portfolio:
- When interest rates fall and additional mortgage prepayments must be
reinvested at lower interest rates, the income of a Portfolio will be reduced.
- When interest rates fall, prices on GNMA securities will not rise as much
as comparable Treasury bonds, as bond market investors anticipate an increase in
mortgage prepayments and a likely decline in income.
MANAGER RISK
IAI manages each Portfolio according to the traditional methods of "active"
investment management, which involve the buying and selling of securities based
upon economic, financial and market analysis and investment judgment. Manager
risk refers to the possibility that IAI may fail to execute a Portfolio's
investment strategy effectively. As a result, a Portfolio may fail to achieve
its stated objective.
INVESTMENT RESTRICTIONS
Each Portfolio is subject to certain other investment policies and
restrictions described in the Statement of Additional Information, some of which
are fundamental and may not be changed without the approval of the shareholders
of the Portfolio. Each Portfolio is a diversified investment company and has a
fundamental policy that, with respect to 75% of its total assets, it may not
invest more than 5% of its total assets in any one issuer. Each Portfolio, also
as fundamental policies, may not invest 25% or more of its assets in any one
industry and may borrow only for temporary or emergency purposes in an amount
not exceeding one-third of its total assets. Please refer to the Statement of
Additional Information for a further discussion of each Portfolio's investment
restrictions.
MANAGEMENT
Each Portfolio is a separate portfolio represented by a separate class of
common stock of IAI Retirement Funds, Inc., a Minnesota corporation created on
September 28, 1993. Under Minnesota law, the Fund's Board of Directors is
generally responsible for the overall management and operation of the Fund. IAI
serves as the investment adviser and manager of the Portfolios pursuant to a
written advisory agreement (the "Advisory Agreement"). IAI also furnishes
investment advice to other concerns including other investment companies,
pension and profit sharing plans, portfolios of foundations, religious,
educational and charitable institutions, trusts, municipalities and individuals,
having total assets in excess of $15 billion. IAI's ultimate corporate parent is
Lloyds TSB Group plc, a publicly-held financial services organization
headquartered in London, England. Lloyds TSB Group plc is one of the largest
personal and corporate financial services groups in the United Kingdom and is
engaged in a wide range of activities including retail and commercial banking.
The address of IAI is that of the Fund.
Under the Advisory Agreement, IAI provides the Portfolios with investment
advice, statistical and research facilities, and certain equipment and services,
including, but not limited to, office space and necessary office facilities,
equipment, and the services of required personnel. Under the Advisory Agreement,
IAI has the sole authority and responsibility to make and execute investment
decisions for the Portfolios within the framework of each Portfolio's investment
policies, subject to review by the Board of Directors. As compensation for these
services, for the fiscal year ended December 31, 1996, Regional, Balanced and
Reserve Portfolios paid IAI an advisory fee at an annual rate of .65%, .65% and
.45%, respectively, of each Portfolio's average daily net assets.
Each Portfolio is managed by a team of IAI investment professionals. The
team leads are as follows.
Mark Hoonsbeen has responsibility for the management of Regional Portfolio.
Mr. Hoonsbeen is a Vice President of IAI and has managed Regional Portfolio
since he joined IAI in 1994. Prior to joining IAI, Mr. Hoonsbeen served as an
equity portfolio manager for The St. Paul Companies from 1986 to 1994.
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Timothy Palmer and Livingston Douglas have responsibility for the
management of Reserve Portfolio. Mr. Palmer is a Senior Vice President of IAI
and has served as a fixed income portfolio manager since joining IAI in 1990.
Mr. Palmer has managed Reserve Portfolio since its inception. Mr. Douglas is a
Vice President of IAI and has served as a fixed income portfolio manager since
joining IAI in 1993. Prior to joining IAI, Mr. Douglas served as a fixed income
portfolio manager for Mackey-Shields Financial Corp. from 1987 to 1993. Mr.
Douglas has also managed Reserve Portfolio since its inception.
Balanced Fund is managed by an investment committee comprised of several
IAI equity and fixed income portfolio managers.
Pursuant to the terms of an Administrative Agreement, IAI also provides all
required administrative, stock transfer, redemption, dividend disbursing and
accounting services, including, for example, the maintenance of each Portfolio's
accounts, books and records, the daily calculation of each Portfolio's net asset
value, daily and periodic reports, all information necessary to complete tax
returns, questionnaires and other reports requested by the Portfolios, the
maintenance of stock registry records, the processing of requested account
registration changes and redemption requests, and the administration of payments
of dividends and distributions declared by the Portfolios. As compensation for
these services, for the fiscal year ended December 31, 1996, each Portfolio paid
IAI an administrative fee at the annual rate of .10% of such Portfolio's average
daily net assets.
In addition to the advisory fee and the administrative fee paid to IAI,
each Portfolio pays all its other costs and expenses, including, for example,
costs incurred in the purchase and sale of assets, interest, taxes, charges of
the custodian of each Portfolio's assets, costs of reports and proxy materials
sent to Portfolio shareholders, fees paid for independent accounting and legal
services, costs of printing prospectuses for Portfolio shareholders and
registering each Portfolio's shares, postage, fees to disinterested directors,
insurance premiums and costs of attending investment conferences. IAI, in its
discretion, may from time to time waive or reduce its management and/or
administrative fee or otherwise reimburse Fund operating expenses. For the
fiscal year ended December 31, 1996, IAI voluntarily agreed to reimburse total
Portfolio operating expenses (net of expenses paid indirectly) which exceeded
1.25%, 1.25% and .85% of the average daily net assets of Regional, Balanced and
Reserve Portfolios, respectively. Additionally, IAI has voluntarily agreed to
waive fees and expenses for each Portfolio in excess of 1.25%, 1.25% and 0.85%,
respectively, of average daily net assets through May 1, 1998.
IAI shall not be liable for any loss suffered by a Portfolio in the absence
of willful misfeasance, bad faith or gross negligence in the performance of its
duties and obligations.
Each Portfolio sells its shares to separate accounts of one or more
insurance companies unaffiliated with IAI. The Fund currently does not foresee
any disadvantages to policyowners arising out of the fact that Portfolio shares
are offered solely to separate accounts of various insurance companies to serve
as the investment medium for their variable products. Nevertheless, the Board of
Directors monitors events in order to identify any material irreconcilable
conflicts which may possibly arise, and to determine what action, if any, should
be taken in response to such conflicts. If such a conflict were to occur, one or
more insurance companies' separate accounts might be required to withdraw its
investments in one or more Portfolios and shares of another Portfolio may be
substituted. This might force a Portfolio to sell securities at disadvantageous
prices. In addition, the Board of Directors may refuse to sell shares of any
Portfolio to any separate account or may suspend or terminate the offering of
shares of any Portfolio if such action is required by law or regulatory
authority or is in the best interests of the shareholders of the Portfolio.
INVESTMENT PERFORMANCE
Each Portfolio's performance may be quoted in advertising in terms of yield
and total return. All such figures are based on historical earnings and
performance and are not intended to be indicative of future performance. The
investment return on and principal value of an investment in a Portfolio will
fluctuate, so that an investor's shares, when redeemed, may be worth more or
less than their original cost.
Total return is the change in value of an investment in a Portfolio over a
given period, assuming reinvestment of any dividends and capital gains. A
cumulative total return reflects actual performance over a stated period of
time. An average annual total return is a hypothetical rate of return that, if
achieved annually, would have produced the same cumulative total return if
performance had been constant over the entire period.
Yield refers to the income generated by an investment in a Portfolio over a
given period of time, expressed as an annual percentage rate. Yields are
calculated according to a standard that is required for all stock and bond
funds. Because this differs from other accounting methods, the quoted yield may
not equal the income actually paid to shareholders.
Total returns and yields include the effect of deducting a Portfolio's
expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares of the Portfolios may be purchased
only through a variable annuity or variable life contract, you should carefully
review the prospectus of the insurance product you have chosen for information
on relevant charges and expenses. Excluding these charges from quotations of a
Portfolio's performance has the effect of increasing the performance quoted. You
should bear in mind the effect of these charges when comparing a Portfolio's
performance to that of other mutual funds.
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For additional information regarding the calculation of such total return
and yield figures, see "Investment Performance" in the Statement of Additional
Information. Further information about the performance of each Portfolio is
contained in the Fund's Annual Report to shareholders which may be obtained
without charge from the Fund.
COMPUTATION OF NET ASSET
VALUE AND PRICING
Each Portfolio is open for business each day the New York Stock Exchange
("NYSE") is open. IAI normally calculates each Portfolio's net asset value
("NAV") as of the close of business of the NYSE, normally 3 p.m. Central time.
A Portfolio's NAV is the value of a single share. The NAV is computed by
adding up the value of a Portfolio's investments, cash, and other assets,
subtracting its liabilities, and then dividing the result by the number of
shares outstanding.
Each Portfolio's investments with remaining maturities of 60 days or less
may be valued on the basis of amortized cost. This method minimizes the effect
of changes in a security's market value. Other portfolio securities and assets
are valued primarily on the basis of market quotations or, if quotations are not
readily available, by a method that the Board of Directors believes accurately
reflects fair value. Foreign securities are valued on the basis of quotations
from the primary market in which they are traded, and are translated from the
local currency into U.S. dollars using current exchange rates.
The offering price (price to buy one share) and redemption price (price to
sell one share) of a Portfolio are a Portfolio's NAV next computed after receipt
by a Portfolio of a purchase or redemption order.
PURCHASE OF SHARES
Investments in the Fund may be made only by separate accounts established
and maintained by insurance companies for the purpose of funding variable
annuity contracts or variable life insurance policies. Please refer to the
prospectus of your insurance company's separate account for information on how
to invest in each Portfolio. Investments by separate accounts in the Fund are
expressed in terms of full and fractional shares of each Portfolio. All
investments in the Portfolios are credited to an insurance company's separate
account immediately upon acceptance of the investment by a Portfolio.
Investments will be processed at the next NAV calculated after an order is
received and accepted by a Portfolio.
The offering of shares of any Portfolio may be suspended for a period of
time and each Portfolio reserves the right to reject any specific purchase
order. Purchase orders may be refused if, in IAI's opinion, they are of a size
that would disrupt the management of a Portfolio.
Because you may not purchase shares of a Portfolio directly, you should
read the prospectus of the insurance company's separate account to obtain
instructions for purchasing a variable annuity contract or variable life
insurance policy.
REDEMPTION OF SHARES
Shares of any Portfolio may be redeemed on any business day. Redemptions
are effected at the per share NAV next determined after the redemption request
has been accepted by a Portfolio. Redemption proceeds will normally be wired to
the insurance company on the next business day after receipt of the redemption
instructions by a Portfolio but in no event later than seven days following
receipt of instruction. Each Portfolio may suspend redemptions or postpone
payment dates on days when the NYSE is closed (other than weekends or holidays),
when trading on the NYSE is restricted, or as permitted by the Securities and
Exchange Commission.
Please refer to the prospectus of your insurance company's separate account
for information on how to redeem from each Portfolio.
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS
The policy of Reserve Portfolio is to pay dividends from net investment
income monthly, while Regional and Balanced Portfolios pay dividends
semiannually. The Portfolios make distributions of realized capital gains, if
any, annually. However, provisions in the Internal Revenue Code of 1986, as
amended (the "Code"), may result in additional net investment income and capital
gains distributions by the Portfolios. Such income and capital gains are
automatically reinvested in additional shares of the Portfolios.
The Fund intends to qualify for tax purposes as a regulated investment
company under the Code during the current taxable year. If so qualified, the
Fund will not be subject to federal income tax on income that it distributes to
its shareholders.
It is expected that Portfolio shares will be held under the terms of
variable annuity contracts or variable life insurance policies. Under current
tax law, dividends or capital gains distributions from the Portfolios are not
currently taxable when left to accumulate within a variable annuity contract or
variable life insurance policy. Depending on the variable contract or policy,
withdrawals may be subject to ordinary tax and, in addition, to a 10% penalty
tax on withdrawals before age 59-1/2.
For a discussion of the tax status of your variable contract or policy, see
the prospectus of your insurance company's separate account. See "Tax Status" in
the Statement of Additional Information for further information. It is suggested
you keep all statements you receive to assist in your personal recordkeeping.
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DESCRIPTION OF COMMON STOCK
All shares of the Portfolios have equal rights as to redemption, dividends
and liquidation, and will be fully paid and nonassessable when issued and will
have no preemptive or conversion rights.
The shares of the Portfolios have noncumulative voting rights, which means
that the holders of more than 50% of the shares voting for the election of
directors can elect 100% of the directors if they choose to do so. On some
issues, such as the election of directors, all shares of IAI Retirement Funds,
Inc., vote together as one series. On an issue affecting only a particular
Portfolio, such as voting on an Advisory Agreement, only the approval of that
Portfolio's shareholders is required to make the agreement effective with
respect to such Portfolio. An insurance company issuing a variable contract or
policy that participates in the Fund will vote shares in the separate account as
required by law and interpretations thereof, as may be amended or changed from
time to time. In accordance with current law and interpretations thereof, a
participating insurance company is required to request voting instructions from
contract- and policyowners and, with certain exceptions, must vote shares in the
separate account in proportion to the voting instructions received. For a
further discussion, please refer to your insurance company's separate account
prospectus.
Annual or periodically scheduled regular meetings of shareholders will
not be held except as required by law. Minnesota corporation law does not
require an annual meeting; instead, it provides for the Board of Directors to
convene shareholder meetings when it deems appropriate. In addition, if a
regular meeting of shareholders has not been held during the immediately
preceding fifteen months, shareholders holding three percent or more of the
voting shares of the Fund may demand a regular meeting of shareholders of the
Fund by written notice of demand given to the chief executive officer or the
chief financial officer of the Fund. Within thirty days after receipt of the
demand by one of those officers, the Board of Directors shall cause a regular
meeting of shareholders to be called and held no later than ninety days after
receipt of the demand, all at the expense of the Fund. An annual meeting will be
held on the removal of a director or directors of the Fund if requested in
writing by holders of not less than 10% of the outstanding shares of the Fund.
COUNSEL AND AUDITORS
The firm of Dorsey & Whitney LLP, 220 South Sixth Street, Minneapolis,
Minnesota 55402, provides legal counsel for the Fund. KPMG Peat Marwick LLP,
4200 Norwest Center, Minneapolis, Minnesota 55402, serves as the independent
auditors for the Fund.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
The Custodian for the Fund is Norwest Bank Minnesota, N.A., Norwest Center,
Sixth and Marquette, Minneapolis, Minnesota 55479. Norwest employs foreign
subcustodians and depositories, which were approved by the Fund's Board of
Directors in accordance with the rules and regulations of the Securities and
Exchange Commission, for the purpose of providing custodial services for the
Fund's assets held outside the United States. IAI acts as the Fund's transfer
agent and dividend disbursing agent, at P.O. Box 357, Minneapolis, Minnesota
55440.
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[LOGO]
MUTUAL FUNDS
3700 FIRST BANK PLACE, P.O. Box 357, MINNEAPOLIS, MINNESOTA 55440-0357 USA
800.945.863
612.376.2700
<PAGE>
IAI RETIREMENT FUNDS, INC.
Statement of Additional Information
dated May 1, 1997
This Statement of Additional Information is not a prospectus. This
Statement of Additional Information relates to a Prospectus dated May 1, 1997
and should be read in conjunction therewith. Copies of the Prospectus may be
obtained from the insurance companies whose separate accounts may purchase
shares of the Fund.
TABLE OF CONTENTS
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Page
INVESTMENT OBJECTIVES AND POLICIES...................................... 2
INVESTMENT RESTRICTIONS.................................................14
INVESTMENT PERFORMANCE..................................................16
MANAGEMENT..............................................................18
CUSTODIAL SERVICE.......................................................22
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE......................22
CAPITAL STOCK...........................................................23
NET ASSET VALUE AND PUBLIC OFFERING PRICE...............................24
TAX STATUS..............................................................25
LIMITATION OF DIRECTOR LIABILITY........................................25
FINANCIAL STATEMENTS....................................................26
Appendix A-- Ratings of Debt Securities.................................A-1
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INVESTMENT OBJECTIVES AND POLICIES
IAI Retirement Funds, Inc. (the "Fund") is designed to provide investment
vehicles for variable annuity contracts and/or variable life insurance policies
of various insurance companies.
The investment objectives and policies of IAI Reserve Portfolio ("Reserve
Portfolio"), IAI Balanced Portfolio ("Balanced Portfolio") and IAI Regional
Portfolio ("Regional Portfolio") (individually, "Portfolio" and collectively,
the "Portfolios") are summarized on the front page of the Prospectus and in the
text of the Prospectus under "Investment Objectives and Policies." Investors
should understand that all investments have a risk factor. There can be no
guarantee against loss resulting from an investment in any Portfolio, and there
can be no assurance that a Portfolio's investment policies will be successful,
or that its investment objectives will be attained. Certain of the Portfolios'
investment practices are further explained below.
REPURCHASE AGREEMENTS
Each Portfolio may invest in repurchase agreements relating to the
securities in which it may invest. A repurchase agreement involves the purchase
of securities with the condition that, after a stated period of time, the
original seller will buy back the securities at a predetermined price or yield.
Each Portfolio's custodian will have custody of, and will hold in a segregated
account, securities acquired by the Portfolio under a repurchase agreement or
other securities as collateral. In the case of a security registered on a book
entry system, the book entry will be maintained in the Portfolio's name or that
of its custodian. Repurchase agreements involve certain risks not associated
with direct investments in securities. For example, if the seller of the
agreement defaults on its obligation to repurchase the underlying securities at
a time when the value of the securities has declined, a Portfolio may incur a
loss upon disposition of such securities. In the event that bankruptcy
proceedings are commenced with respect to the seller of the agreement, a
Portfolio's ability to dispose of the collateral to recover its investment may
be restricted or delayed. While collateral will at all times be maintained in an
amount equal to the repurchase price under the agreement (including accrued
interest due thereunder), to the extent proceeds from the sale of collateral
were less than the repurchase price, a Portfolio could suffer a loss.
REVERSE REPURCHASE AGREEMENTS
Each Portfolio may invest in reverse repurchase agreements as a form of
borrowing. In a reverse repurchase agreement, a Portfolio sells an instrument to
another party, such as a bank or broker-dealer, in return for cash and agrees to
repurchase the instrument at a particular price and time. While a reverse
repurchase agreement is outstanding, each Portfolio will comply with guidelines
established by the Securities and Exchange Commission regarding the segregation
of assets. Each Portfolio will enter into reverse repurchase agreements only
with parties whose creditworthiness has been found satisfactory by Investment
Advisers, Inc. ("IAI"), the Portfolios' investment adviser and manager. Such
transactions may increase fluctuations in the market value of the Portfolios'
assets and may be viewed as a form of leverage. Each Portfolio does not
currently intend to invest more than 5% of its net assets in reverse repurchase
agreements.
SECURITIES OF FOREIGN ISSUERS
Each Portfolio may invest in securities of foreign issuers in accordance
with its investment objectives and policies. Investing in foreign securities may
result in greater risk than that incurred by investing in domestic securities.
There is generally less publicly available information about foreign issuers
comparable to reports and ratings that are published about companies in the
United States. Also, foreign issuers are not subject to uniform accounting and
auditing and financial reporting standards, practices and requirements
comparable to those applicable to United States companies. Furthermore, volume
and liquidity in most foreign bond markets in less than in the United States and
at times volatility of price can be greater than in the United States. There is
generally less government supervision of foreign bond markets, brokers and
companies than in the United States.
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It is contemplated that most foreign securities will be purchased in
over-the-counter markets or on stock exchanges located in the countries in which
the respective principal offices of the issuers of the various securities are
located, if that is the best available market. Foreign stock markets are
generally not as developed or efficient as those in the United States. While
growing in volume, they usually have substantially less volume than the New York
Stock Exchange, and securities of some foreign companies are less liquid and
more volatile than securities of comparable United States companies. Similarly,
volume and liquidity in most foreign bond markets is less than in the United
States and at times volatility of price can be greater than in the United
States. Commissions on foreign stock exchanges are generally higher than
commissions on United States exchanges, although each Portfolio will endeavor to
achieve the most favorable net results on its portfolio transactions. There is
generally less government supervision and regulation of foreign stock exchanges,
brokers and listed companies than in the United States.
With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations, expropriation or
confiscatory taxation, limitations on the removal of funds or other assets of
the Portfolio, political or social instability, or diplomatic developments which
could affect United States investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the United States'
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
Each Portfolio is not aware at this time of the existence of any investment
or exchange control regulations which might substantially impair the operations
of the Portfolio as described in the Prospectus and this Statement of Additional
Information. It should be noted, however, that this situation could change at
any time.
The dividends and interest payable on certain of the Portfolios' foreign
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to the Portfolios' shareholders. The
expense ratio of each Portfolio should not be materially affected by such
Portfolio's investment in foreign securities.
U.S. TREASURY INFLATION PROTECTION SECURITIES
Both the Balanced and Reserve Portfolios may purchase securities issued by
the United States government, which include U.S. Treasury inflation-protection
securities.
Inflation-protection securities are a new type of marketable book-entry
security issued by the United States Department of Treasury ("Treasury") with a
nominal return linked to the inflation rate in prices. Inflation-protection
securities will be auctioned and issued on a quarterly basis on the 15th of
January, April, July, and October, beginning on January 15, 1997. Initially,
they will be issued as 10-year notes, with other maturities added thereafter.
The index used to measure inflation will be the non-seasonally adjusted U.S.
City Average All Items Consumer Price Index for All Urban Consumers ("CPI-U").
The value of the principal will be adjusted for inflation, and every six
months the security will pay interest, which will be an amount equal to a fixed
percentage of the inflation-adjusted value of the principal. The final payment
of principal of the security will not be less than the original par amount of
the security at issuance.
The principal of the inflation-protection security will be indexed to the
non-seasonally adjusted CPI-U. To calculate the inflation-adjusted principal
value for a particular valuation date, the value of the principal at issuance is
multiplied by the index ratio applicable to that valuation date. The index ratio
for any date is the ratio of the reference CPI applicable to such date to the
reference CPI applicable to the original issue date. Semiannual coupon interest
is determined by multiplying the inflation-adjusted principal amount by one-half
of the stated rate of interest on each interest payment date.
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Inflation-adjusted principal or the original par amount, whichever is
larger, will be paid on the maturity date as specified in the applicable
offering announcement. If at maturity the inflation-adjusted principal is less
than the original principal value of the security an additional amount will be
paid at maturity so that the additional amount plus the inflation-adjusted
principal equals the original principal amount. Some inflation-protection
securities may be stripped into principal and interest components. In the case
of a stripped security, the holder of the stripped principal would receive this
additional amount. The final interest payment, however, will be based on the
final inflation-adjusted principal value, not the original par amount.
The reference CPI for the first day of any calendar month is the CPI-U for
the third preceding calendar month. (For example, the reference CPI for December
1 is the CPI-U reported for September of the same year, which is released in
October.) The reference CPI for any other day of the month is calculated by a
linear interpolation between the reference CPI applicable to the first day of
the month and the reference CPI applicable to the first day of the following
month.
Any revisions the Bureau of Labor Statistics (or successor agency) makes to
any CPI-U number that has been previously released will not be used in
calculations of the value of outstanding inflation-protection securities. In the
case that the CPI-U for a particular month is not reported by the last day of
the following month, the Treasury will announce an index number based on the
last year-over-year CPI-U inflation rate available. Any calculations of the
Treasury's payment obligations on the inflation-protection security that need
that month's CPI-U number will be based on the index number that the Treasury
has announced. If the CPI-U is based to a different year, the Treasury will
continue to use the CPI-U series based on the base reference period in effect
when the security was first issued as long as that series continues to be
published. If the CPI-U is discontinued during the period the
inflation-protection security is outstanding, the Treasury will, in consultation
with the Bureau of Labor Statistics (or successor agency), determine an
appropriate substitute index and methodology for linking the discontinued series
with the new price index series. Determinations of the Secretary of the Treasury
in this regard are final.
Inflation-protection securities will be held and transferred in either of
two book-entry systems: the commercial book-entry system (TRADES) and TREASURY
DIRECT. The securities will be maintained and transferred at their original par
amount, i.e., not at their inflation-adjusted value. STRIPS components will be
maintained and transferred in TRADES at their value based on the original par
amount of the fully constituted security.
LENDING PORTFOLIO SECURITIES
In order to generate additional income, each Portfolio may lend portfolio
securities to broker-dealers, banks or other financial borrowers of securities.
As with other extensions of credit, there are risks of delay in recovery or even
loss of rights in the collateral should the borrower of the securities fail
financially. However, the Portfolios will only enter into loan arrangments with
broker-dealers, banks or other institutions which IAI has determined are
creditworthy under guidelines established by the Portfolios' Board of Directors.
The Portfolios may also experience a loss, if upon the failure of a borrower to
return loaned securities, the collateral is not sufficient invalue or liquidity
to cover the value of such loaned securities (including accrued interest
thereon). However, the Portfolios will receive collateral in the form of cash,
United States Government securities, certificates of deposit or other
high-grade, short-term obligations or interest-bearing cash equivalents equal to
at least 102% of the value of the securities loaned. The value of the colateral
and of the securities loaned will be marked to market on a daily basis. During
the time portfolio securities are on loan, the borrower pays a Portfolio an
amount equivalent to any dividends or interest paid on the securities and a
Portfolio may invest the cash collateral and earn additional income or may
receive an agreed upon amount of interest income from the borrower. However, the
amounts received by a Portfolio may be reduced by finders' fees paid to
broker-dealers and related expenses.
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EXTENDIBLE NOTES
Reserve Portfolio is permitted to invest up to 25% of the value of its
total assets in extendible notes. An extendible note is a debt arrangement under
which the holder, at its option, may require the issuer to repurchase the note
for a predetermined fixed price at one or more times prior to the ultimate
maturity date of the note. Typically, an extendible note is issued at an
interest rate that can be adjusted at fixed times throughout its term. At the
same time as the interest rate is adjusted by the issuer, the holder of the note
is typically given the option to "put" the note back to the issuer at a
predetermined price (e.g., at 100% of the outstanding principal amount plus
unpaid accrued interest) if the extended interest rate is undesirable to the
holder. This option to put the note back to the issuer (i.e., to require the
issuer to repurchase the note) provides the holder with an optional maturity
date that is shorter than the actual maturity date of the note.
Extendible notes may be issued with maturity dates in excess of ten years
from the date of issuance. However, is such extendible notes provide for an
optional maturity date of ten years or less, then such notes are deemed by the
Portfolio to have been issued for the shorter optional maturity date. Investment
in extendible notes is not expected to have a material impact on the effective
portfolio maturity of the Portfolio.
An investment in an extendible note is liquid, and the note may be resold
to another investor prior to its optional maturity date at its market value. The
market value of an extendible note with a given optional maturity date is
determined and fluctuates in a similar manner as the market value of a fixed
maturity note with a maturity equivalent to the optional maturity of the
extendible note. Compared to fixed term notes of the same issuer, however,
extendible notes with equivalent optional maturities generally yield higher
returns without a material increase in risk to the Portfolio.
The creditworthiness of the issuers of extendible notes is monitored and
rated by Moody's and by S&P, and investments by the Reserve Portfolio in such
extendible notes are restricted to notes with the same investment ratings as are
acceptable to the Portfolio with respect to other forms of investment. The
creditworthiness of such issuers is also monitored by IAI.
VARIABLE OR FLOATING RATE INSTRUMENTS
Balanced and Reserve Portfolios may purchase instruments with variable or
floating rates. Such instruments (including notes purchased directly from
issuers) bear variable or floating interest rates and carry rights that permit
holders to demand payment of the unpaid principal balance plus accrued interest
from the issuers or certain financial intermediaries. Floating rate securities
have interest rates that change whenever there is a change in a designated base
rate while variable rate instruments provide for a specified periodic adjustment
in the interest rate. These formulas are designed to result in a market value
for the instrument that approximates its par value.
DELAYED-DELIVERY TRANSACTIONS
Reserve and Balanced Portfolios may buy and sell securities on a
delayed-delivery or when-issued basis. These transactions involve a commitment
by a Portfolio to purchase or sell specific securities at a predetermined price
or yield, with payment and delivery taking place after the customary settlement
period for that type of security (and more than seven days in the future).
Typically, no interest accrues to the purchaser until the security is delivered.
Each Portfolio may receive fees for entering into delayed-delivery transactions.
When purchasing securities on a delayed-delivery basis, a Portfolio assumes
the rights and risks of ownership, including the risk of price and yield
fluctuations. Because a Portfolio is not required to pay for securities until
the delivery date, these risks are in addition to the risks associated with such
Portfolio's other investments. If a Portfolio remains substantially fully
invested at a time when delayed delivery purchases are outstanding,
delayed-delivery purchases may result in a form of leverage. When
delayed-delivery purchases are outstanding, a Portfolio will set aside
appropriate liquid assets in a segregated custodial account to cover its
purchase obligations. When a Portfolio has sold a security on a delayed-delivery
basis, such Portfolio does not participate in further gains or losses with
respect to the security. If the other party to a delayed-delivery transaction
fails to deliver or pay for the securities, a Portfolio could miss a favorable
price or yield opportunity, or could suffer a loss.
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Such Portfolios may renegotiate delayed-delivery transactions after they
are entered into, and may sell underlying securities before they are delivered,
which may result in capital gains or losses.
MORTGAGE-BACKED SECURITIES
Reserve and Balanced Portfolios may purchase mortgage-backed securities
issued by government and non-government entities such as banks, mortgage
lenders, or other financial institutions. A mortgage-backed security may be an
obligation of the issuer backed by a mortgage or pool of mortgages or a direct
interest in an underlying pool of mortgages. Some mortgage-backed securities,
such as collateralized mortgage obligations or CMOs, make payments of both
principal and interest at a variety of intervals; others make semiannual
interest payments at a predetermined rate and repay principal at maturity (like
a typical bond). Mortgage-backed securities are based on different types of
mortgages including those on commercial real estate or residential properties.
Other types of mortgage-backed securities will likely be developed in the
future, and each Portfolio may invest in them if IAI determines they are
consistent with such Portfolio's investment objectives and policies.
The value of mortgage-backed securities may change due to shifts in the
market's perception of issuers. In addition, regulatory or tax changes may
adversely affect the mortgage securities market as a whole. Non-government
mortgage-backed securities may offer higher yields than those issued by
government entities, but also may be subject to greater price changes than
government issues. Mortgage-backed securities are subject to prepayment risk.
Prepayment, which occurs when unscheduled or early payments are made on the
underlying mortgages, may shorten the effective maturities of these securities
and may lower their total returns.
STRIPPED MORTGAGE-BACKED SECURITIES
Reserve Portfolio may purchase stripped mortgage-back securities. Such
securities are created when a U.S. government agency or a financial institution
separates the interest and principal components of a mortgage-backed security
and sells them as individual securities. The holder of the "principal-only"
security (PO) receives the principal payments made by the underlying
mortgage-backed security, while the holder of the "interest-only" security (IO)
receives interest payments from the same underlying security. The prices of
stripped mortgage-backed securities may be particularly affected by changes in
interest rates. As interest rates fall, prepayment rates tend to increase, which
tends to reduce prices of IOs and increase prices of POs. Rising interest rates
can have the opposite effect.
ASSET-BACKED SECURITIES
Reserve and Balanced Portfolios may purchase asset-backed securities.
Asset-backed securities represent interests in pools of consumer loans
(generally unrelated to mortgage loans) and often are structured as pass-through
securities. Interest and principal payments alternately depend upon payment of
the underlying loans by individuals, although the securities may be supported by
letters of credit or other credit enhancements. The value of asset-backed
securities may also depend on the creditworthiness of the servicing agent for
the loan pool, the originator of the loans, or the financial institution
providing the credit enhancement.
ZERO COUPON BONDS
Reserve and Balanced Portfolios may purchase zero coupon bonds. Zero coupon
bonds do not make interest payments; instead, they are sold at a deep discount
from their face value and are redeemed at face value when they mature. Because
zero coupon bonds do not pay current income, their prices can be very volatile
when interest rates change. In calculating its dividends, a Portfolio takes into
account as income a portion of the difference between a zero coupon bond's
purchase price and its face value.
A broker-dealer creates a derivative zero by separating the interest and
principal components of a U.S. Treasury security and selling them as two
individual securities. CATS (Certificates of Accrual on Treasury Securities),
TIGRs (Treasury Investment Growth Receipts), and TRs (Treasury Receipts) are
examples of derivative zeros.
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The Federal Reserve Bank creates STRIPS (Separate Trading of Registered
Interest and Principal of Securities) by separating the interest and principal
components of an outstanding U.S. Treasury bond and selling them as individual
securities. Bonds issued by the Resolution Funding Corporation (REFCORP) and the
Financing Corporation (FICO) can also be separated in this fashion. Original
issue zeroes are zero coupon securities originally issued by the U.S.
government, a government agency, or a corporation in zero coupon form.
LOWER-RATED DEBT SECURITIES
Reserve and Balanced Portfolios may invest in lower-rated debt securities.
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if such
issuers are highly leveraged. During such periods, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be adversely affected by
specific issuer developments or the issuer's inability to meet specific
projected business forecasts or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield securities because such securities may be unsecured and
may be subordinated to other creditors of the issuer.
High yield securities frequently have call or redemption features which
would permit an issuer to repurchase the security from a Portfolio. If a call
were exercised by the issuer during a period of declining interest rates, a
Portfolio likely would have to replace such called security with a lower
yielding security, thus decreasing the net investment income to a Portfolio and
dividends to shareholders.
A Portfolio may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. The secondary
trading market for high yield securities is generally not as liquid as the
secondary market for higher rated securities. Reduced secondary market liquidity
may have an adverse impact on market price and a Portfolio's ability to dispose
of particular issues when necessary to meet such Portfolio's liquidity needs or
in response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect a
Portfolio's net asset value. In addition, a Portfolio may incur additional
expenses to the extent it is required to seek recovery upon a default on a
portfolio holding or participate in the restructuring of the obligation.
ILLIQUID SECURITIES
Each Portfolio may also invest up to 15% of its net assets in securities
that are considered illiquid because of the absence of a readily available
market or due to legal or contractual restrictions. However, certain restricted
securities that are not registered for sale to the general public but that can
be resold to institutional investors may be considered liquid pursuant to
guidelines adopted by the Board of Directors. In the case of a Rule 144A
Security, such security is deemed to be liquid if:
(1) IAI reasonably expects to be able to resell the security to a qualified
institutional buyer, as defined in paragraph (a)(1) of Rule 144A, who is aware
of the Portfolio's reliance upon Rule 144A in selling the security without
registration, as required by paragraph (d)(2) of Rule 144A;
(2) the Rule 144A Security is not (a) of the same class as securities
listed on any national securities exchange or quoted in NASDAQ as determined
under paragraph (d)(3)(i) of Rule 144A, or (b) a security of a registered
investment company (other than a closed-end investment company); and
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(3) the issuer (a) is a foreign government eligible to register securities
under Schedule B of the Securities Act of 1933, (b) is a company that files
periodic reports under the Securities Act of 1934 on Forms 8-K, 10-Q, 10-K or
20-F or provides information under Rule 12g3-2(b) thereunder, or (c) has agreed
in writing to provide the holder and any prospective purchaser of the Rule 144A
Security with reasonably current financial information as required under
paragraph (d)(4)(i) of Rule 144A.
Other securities are deemed to be liquid if IAI determines that the
security can be disposed of within seven days in the ordinary course of business
at approximately the amount at which the Portfolios have valued the instrument
for purposes of calculating a Portfolio's net asset value. In making this
determination, IAI will consider such factors as may be relevant to a
Portfolio's ability to dispose of the security, including but not limited to,
the following factors (none of which, standing alone, would necessarily be
determinative):
1. the frequency of trades and quotes for the security;
2. the number of dealers willing to purchase or sell the security and the
number of potential purchasers;
3. dealer undertakings to make a market in the security; and
4. the nature of the security and the nature of the marketplace trades
(e.g., the time needed to dispose of the security, the method of soliciting
offers and the mechanics of transfer).
It is not possible to predict with assurance the maintenance of an
institutional trading market for such securities and the liquidity of a
Portfolio's investments could be impaired if trading declines.
DOLLAR ROLLS
In connection with its ability to purchase securities on a when-issued or
forward commitment basis, a Portfolio may enter into "dollar rolls" in which
such Portfolio sells securities for delivery in the current month and
simultaneously contracts with the same counterparty to repurchase similar (same
type, coupon and maturity) but not identical securities on a specified future
date. A Portfolio gives up the right to receive principal and interest paid on
the securities sold. However, a Portfolio would benefit to the extent of any
difference between the price received for the securities sold and lower forward
price for the futures purchase plus any fee income received. Unless such
benefits exceed the income and capital appreciation that would have been
realized on the securities sold as part of the dollar roll, the use of this
technique will diminish the investment performance of a Portfolio compared with
what such performance would have been without the use of dollar rolls. Each
Portfolio will hold and maintain in a segregated account until the settlement
date cash, government securities, or liquid high-grade debt securities in an
amount equal to the value of the when-issued or forward commitment securities.
The benefits derived from the use of dollar rolls may depend, among other
things, upon IAI's ability to predict interest rates correctly. There is no
assurance that dollar rolls can be successfully employed. In addition, the use
of dollar rolls by a Portfolio while remaining substantially fully invested
increases the amount of a Portfolio's assets that are subject to market risk to
an amount that is greater than such Portfolio's net asset value, which could
result in increased volatility of the price of such Portfolio's shares.
SWAP AGREEMENTS
Regional and Balanced Portfolios may engage in swap agreements. Swap
agreements can be individually negotiated and structured to include exposure to
a variety of different types of investments or market factors. Depending on
their structure, swap agreements may increase or decrease the Fund's exposure to
long- or short-term interest rates (in the U.S. or abroad), foreign currency
values, mortgage securities, corporate borrowing rates, or other factors such as
security prices or inflation rates. Swap agreements can take many different
forms and are known by a variety of names. Each Portfolio is not limited to any
particular form of swap agreement if IAI determines it is consistent with such
Portfolio's investment objectives and policies.
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Swap agreements will tend to shift a Portfolio's investment exposure from
one type of investment to another. For example, if a Portfolio agrees to
exchange payments in dollars for payments in foreign currency, the swap
agreement would tend to decrease such Portfolio's exposure to U.S. interest
rates and increase its exposure to foreign currency and interest rates.
Depending on how they are used, swap agreements may increase or decrease the
overall volatility of a Portfolio's investments and its share price.
The most significant factor in the performance of swap agreements is the
change in the specific interest rate, currency, or other factors that determine
the amounts of payments due to and from a Portfolio. If a swap agreement calls
for payments by a Portfolio, such Portfolio must be prepared to make such
payments when due. In addition, if the counterparty's creditworthiness declined,
the value of a swap agreement would be likely to decline, potentially resulting
in losses. Each Portfolio expects to be able to eliminate its exposure under
swap agreements either by assignment or other disposition, or by entering into
an offsetting swap agreement with the same party or a similarly creditworthy
party.
Each Portfolio will maintain appropriate liquid assets in a segregated
custodial account to cover its current obligations under swap agreements. If a
Portfolio enters into a swap agreement on a net basis, it will segregate assets
with a daily value at least equal to the excess, if any, of such Portfolio's
accrued obligations under the swap agreement over the accrued amount the
Portfolio is entitled to receive under the agreement. If a Portfolio enters into
a swap agreement on other than a net basis, it will segregate assets with a
value equal to the full amount of a Portfolio's accrued obligations under the
agreement.
INDEXED SECURITIES
Each Portfolio may purchase securities whose prices are indexed to the
prices of other securities, securities indexes, currencies, precious metals or
other commodities, or other financial indicators. Indexed securities typically,
but not always, are debt securities or deposits whose value at maturity or
coupon rate is determined by reference to a specific instrument or statistic.
Gold-indexed securities, for example, typically provide for a maturity value
that depends on the price of gold, resulting in a security whose price tends to
rise and fall together with gold prices. Currency-indexed securities typically
are short-term to intermediate-term debt securities whose maturity values or
interest rates are determined by reference to the values of one or more
specified foreign currencies, and may offer higher yields than U.S.
dollar-denominated securities of equivalent issuers. Currency-indexed securities
may be positively or negatively indexed; that is, their maturity value may
increase when the specified currency value increases, resulting in a security
that performs similarly to a foreign-denominated instrument, or their maturity
value may decline when foreign currencies increase, resulting in a security
whose price characteristics are similar to a put on the underlying currency.
Currency-indexed securities may also have prices that depend on the values of a
number of different foreign currencies relative to each other.
The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers of
indexed securities have included banks, corporations, and certain U.S.
government agencies. IAI will use its judgment in determining whether indexed
securities should be treated as short-term instruments, bonds, stocks, or as a
separate asset class for purposes of each Portfolio's investment policies,
depending on the individual characteristics of the securities. Indexed
securities may be more volatile than the underlying instruments.
FOREIGN CURRENCY TRANSACTIONS
Each Portfolio may hold foreign currency deposits from time to time and may
convert dollars and foreign currencies in the foreign exchange markets. Currency
conversion involves dealer spreads and other costs, although commissions usually
are not charged. Currencies may be exchanged on a spot (i.e., cash) basis, or by
entering into forward contracts to purchase or sell foreign currencies at a
future date and price. Forward contracts generally are traded in an interbank
market conducted directly between currency traders (usually large commercial
banks) and their customers. The parties to a forward contract may agree to
offset or terminate the contract before its maturity, or may hold the contract
to maturity and complete the contemplated currency exchange.
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<PAGE>
Each Portfolio may use currency forward contracts to manage currency risks
and to facilitate transactions in foreign securities. The following discussion
summarizes the principal currency management strategies involving forward
contracts that could be used by the Portfolios.
In connection with purchases and sales of securities denominated in foreign
currencies, each Portfolio may enter into currency forward contracts to fix a
definite price for the purchase or sale in advance of the trade's settlement
date. This technique is sometimes referred to as a "settlement hedge" or
"transaction hedge." IAI expects to enter into settlement hedges in the normal
course of managing each Portfolio's foreign investments. Each Portfolio could
also enter into forward contracts to purchase or sell a foreign currency in
anticipation of future purchases or sales of securities denominated in foreign
currency, even if the specific investments have not yet been selected by IAI.
Each Portfolio may also use forward contracts to hedge against a decline in
the value of existing investments denominated in foreign currency. For example,
if a Portfolio owned securities denominated in pounds sterling, it could enter
into a forward contract to sell pounds sterling in return for U.S. dollars to
hedge against possible declines in the pound's value. Such a hedge, sometimes
referred to as a "position hedge," would tend to offset both positive and
negative currency fluctuations but would not offset changes in security values
caused by other factors. Each Portfolio could also hedge the position by selling
another currency expected to perform similarly to the pound sterling -- for
example, by entering into a forward contract to sell Deutschmarks or European
Currency Units in return for U.S. dollars. This type of hedge, sometimes
referred to as a "proxy hedge," could offer advantages in terms of cost, yield,
or efficiency, but generally would not hedge currency exposure as effectively as
a simple hedge into U.S. dollars. Proxy hedges may result in losses if the
currency used to hedge does not perform similarly to the currency in which the
hedged securities are denominated.
Under certain conditions, SEC guidelines require mutual funds to set aside
appropriate liquid assets in a segregated custodial account to cover currency
forward contracts. As required by SEC guidelines, the Portfolios will segregate
assets to cover currency forward contracts, if any, whose purpose is essentially
speculative. Each Portfolio will not segregate assets to cover forward contracts
entered into for hedging purposes, including settlement hedges, position hedges,
and proxy hedges.
Successful use of forward currency contracts will depend on IAI's skill in
analyzing and predicting currency values. Forward contracts may substantially
change the Portfolios' investment exposure to changes in currency exchange
rates, and could result in losses to the Portfolios if currencies do not perform
as IAI anticipates. For example, if a currency's value rose at a time when IAI
had hedged a Portfolio by selling that currency in exchange for dollars, such
Portfolio would be unable to participate in the currency's appreciation. If IAI
hedges currency exposure through proxy hedges, a Portfolio could realize
currency losses from the hedge and the security position at the same time if the
two currencies do not move in tandem. Similarly, if IAI increases a Portfolio's
exposure to a foreign currency, and that currency's value declines, such
Portfolio will realize a loss. There is no assurance that IAI's use of forward
currency contracts will be advantageous to the Portfolios or that it will hedge
at an appropriate time. The policies described in this section are
non-fundamental policies of the Portfolios.
LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS
Each Portfolio has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the Commodity Futures
Trading Commission (CFTC) and the National Futures Association, which regulate
trading in the futures markets, before engaging in any purchases or sales of
futures contracts or options on futures contracts. Each Portfolio intends to
comply with Section 4.5 of the regulations under the Commodity Exchange Act,
which limits the extent to which the Portfolios can commit assets to initial
margin deposits and option premiums.
-10-
<PAGE>
The above limitations on the Portfolios' investments in futures contracts
and options, and the Portfolios' policies regarding futures contracts and
options discussed elsewhere in this Statement of Additional Information may be
changed as regulatory agencies permit. With respect to positions in commodity
futures or commodity option contracts which do not come within the meaning and
intent of bona fide hedging in the CFTC rules, the aggregate initial margin and
premiums required to establish such positions will not exceed five percent of
the liquidation value of the Portfolios, after taking into account unrealized
profits and unrealized losses on any such contracts it has entered into; and,
provided further, that in the case of an option that is in-the-money, such
amount may be excluded in computing such five percent.
FUTURES CONTRACTS
When a Portfolio purchases a futures contract, it agrees to purchase a
specified underlying instrument at a specified future date. When a Portfolio
sells a futures contract, it agrees to sell the underlying instrument at a
specified future date. The price at which the purchase and sale will take place
is fixed when a Portfolio enters into the contract. Some currently available
futures contracts are based on specific securities, such as U.S. Treasury bonds
or notes, and some are based on indexes of securities prices, such as the
Standard & Poor's 500 Composite Stock Price Index (S&P 500). Futures can be held
until their delivery dates, or can be closed out before then if a liquid
secondary market is available.
The value of a futures contract tends to increase and decrease in tandem
with the value of its underlying instrument. Therefore, purchasing futures
contracts will tend to increase a Portfolio's exposure to positive and negative
price fluctuations in the underlying instrument, much as if it had purchased the
underlying instrument directly. When a Portfolio sells a futures contract, by
contrast, the value of its futures position will tend to move in a direction
contrary to the market. Selling futures contracts, therefore, will tend to
offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
FUTURES MARGIN PAYMENTS
The purchaser or seller of a futures contract is not required to deliver or
pay for the underlying instrument unless the contract is held until the delivery
date. However, both the purchaser and seller are required to deposit "initial
margin" with a futures broker, known as a futures commission merchant (FCM),
when the contract is entered into. Initial margin deposits are typically equal
to a percentage of the contract's value. If the value of either party's position
declines, that party will be required to make additional "variation margin"
payments to settle the change in value on a daily basis. The party that has a
gain may be entitled to receive all or a portion of this amount. Initial and
variation margin payments do not constitute purchasing securities on margin for
purposes of the Portfolios' investment limitations. In the event of the
bankruptcy of an FCM that holds margin on behalf of a Portfolio, such Portfolio
may be entitled to return of margin owed to it only in proportion to the amount
received by the FMC's other customers, potentially resulting in losses to such
Portfolio.
PURCHASING PUT AND CALL OPTIONS
By purchasing a put option, a Portfolio obtains the right (but not the
obligation) to sell the option's underlying instrument at a fixed strike price.
In return for this right, a Portfolio pays the current market price for the
option (known as the option premium). Options have various types of underlying
instruments, including specific securities, indexes of securities prices, and
futures contracts. A Portfolio may terminate its position in a put option it has
purchased by allowing it to expire or by exercising the option. If the option is
allowed to expire, a Portfolio will lose the entire premium it paid. If a
Portfolio exercises the option, it completes the sale of the underlying
instrument at the strike price. A Portfolio may also terminate a put option
position by closing it out in the secondary market at its current price, if a
liquid secondary market exists.
The buyer of a typical put option can expect to realize a gain if security
prices fall substantially. However, if the underlying instrument's price does
not fall enough to offset the cost of purchasing the option, a put buyer can
expect to suffer a loss (limited to the amount of the premium paid, plus related
transaction costs).
-11-
<PAGE>
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the underlying instrument at the option's strike
price. A call buyer typically attempts to participate in potential price
increases of the underlying instrument with risk limited to the cost of the
option if security prices fall. At the same time, the buyer can expect to suffer
a loss if security prices do not rise sufficiently to offset the cost of the
option.
WRITING PUT AND CALL OPTIONS
When a Portfolio writes a put option, it takes the opposite side of the
transaction from the option's purchaser. In return for receipt of the premium, a
Portfolio assumes the obligation to pay the strike price for the option's
underlying instrument if the other party to the option chooses to exercise it.
When writing an option on a futures contract a Portfolio would be required to
make margin payments to an FCM as described above for futures contracts. Each
Portfolio may seek to terminate its position in a put option it writes before
exercise by closing out the option in the secondary market at its current price.
If the secondary market is not liquid for a put option a Portfolio has written,
however, such Portfolio must continue to be prepared to pay the strike price
while the option is outstanding, regardless of price changes, and must continue
to set aside assets to cover its position. If security prices rise, a put writer
would generally expect to profit, although its gain would be limited to the
amount of the premium it received.
If security prices remain the same over time, it is likely that the writer
will also profit, because it should be able to close out the option at a lower
price. If security prices fall, the put writer would expect to suffer a loss.
This loss should be less than the loss from purchasing the underlying instrument
directly, however, because the premium received for writing the option should
mitigate the effects of the decline.
Writing a call option obligates a Portfolio to sell or deliver the option's
underlying instrument, in return for the strike price, upon exercise of the
option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. Through receipt of the option
premium, a call writer mitigates the effects of a price decline. At the same
time, because a call writer must be prepared to deliver the underlying
instrument in return for the strike price, even if its current value is greater,
a call writer gives up some ability to participate in security price increases.
COMBINED POSITIONS
Each Portfolio may purchase and write options in combination with each
other, or in combination with futures or forward contracts, to adjust the risk
and return characteristics of the overall position. For example, each Portfolio
may purchase a put option and write a call option on the same underlying
instrument, in order to construct a combined position whose risk and return
characteristics are similar to selling a futures contract. Another possible
combined position would involve writing a call option at one strike price and
buying a call option at a lower price, in order to reduce the risk of the
written call option in the event of a substantial price increase. Because
combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
CORRELATION OF PRICE CHANGES
Because there are a limited number of types of exchange-traded options and
futures contracts, it is likely that the standardized contracts available will
not match a Portfolio's current or anticipated investments exactly. Each
Portfolio may invest in options and futures contracts based on securities with
different issuers, maturities, or other characteristics from the securities in
which it typically invests, which involves a risk that the options or futures
position will not track the performance of such Portfolio's other investments.
-12-
<PAGE>
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match a Portfolio's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. Each Portfolio may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in a Portfolio's options or futures
positions are poorly correlated with its other investments, the positions may
fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS
There is no assurance a liquid secondary market will exist for any
particular options or futures contract at any particular time. Options may have
relatively low trading volume and liquidity if their strike prices are not close
to the underlying instrument's current price. In addition, exchanges may
establish daily price fluctuation limits for options and futures contracts, and
may halt trading if a contract's price moves upward or downward more than the
limit in a given day. On volatile trading days when the price fluctuation limit
is reached or a trading halt is imposed, it may be impossible for a Portfolio to
enter into new positions or close out existing positions. If the secondary
market for a contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable positions, and
potentially could require a Portfolio to continue to hold a position until
delivery or expiration regardless of changes in its value. As a result, a
Portfolio's access to other assets held to cover its options or futures
positions could also be impaired.
OTC OPTIONS
Unlike exchange-traded options, which are standardized with respect to the
underlying instrument, expiration date, contract size, and strike price, the
terms of over-the-counter options (options not traded on exchanges) generally
are established through negotiation with the other party to the option contract.
While this type of arrangement allows a Portfolio greater flexibility to tailor
an option to its needs, OTC options generally involve greater credit risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
OPTIONS AND FUTURES RELATING TO FOREIGN CURRENCIES
Currency futures contracts are similar to forward currency exchange
contracts, except that they are traded on exchanges (and have margin
requirements) and are standardized as to contract size and delivery date. Most
currency futures contracts call for payment or delivery in U.S. dollars. The
underlying instrument of a currency option may be a foreign currency, which
generally is purchased or delivered in exchange for U.S. dollars, or may be a
futures contract. The purchaser of a currency call obtains the right to purchase
the underlying currency, and the purchaser of a currency put obtains the right
to sell the underlying currency.
The uses and risks of currency options and futures are similar to options
and futures relating to securities or indexes, as discussed above. Each
Portfolio may purchase and sell currency futures and may purchase and write
currency options to increase or decrease its exposure to different foreign
currencies. Each Portfolio may also purchase and write currency options in
conjunction with each other or with currency futures or forward contracts.
Currency futures and options values can be expected to correlate with exchange
rates, but may not reflect other factors that affect the value of a Portfolio's
investments. A currency hedge, for example, should protect a Yen-denominated
security from a decline in the Yen, but will not protect a Portfolio against a
price decline resulting from deterioration in the issuer's creditworthiness.
Because the value of a Portfolio's foreign-denominated investments changes in
response to many factors other than exchange rates, it may not be possible to
match the amount of currency options and futures to the value of a Portfolio's
investments exactly over time.
-13-
<PAGE>
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS
Each Portfolio will comply with guidelines established by the Securities
and Exchange Commission with respect to coverage of options and futures
strategies by mutual funds, and if the guidelines so require will set aside
appropriate liquid assets in a segregated custodial account in the amount
prescribed. Securities held in a segregated account cannot be sold while the
futures or option strategy is outstanding, unless they are replaced with other
suitable assets. As a result, there is a possibility that segregation of a large
percentage of a Portfolio's assets could impede portfolio management or the
Portfolio's ability to meet redemption requests or other current obligations.
INVESTMENT RESTRICTIONS
As indicated in the Prospectus, each Portfolio is subject to certain
policies and restrictions which are "fundamental" and may not be changed without
shareholder approval. Shareholder approval consists of the approval of the
lesser of (i) more than 50% of the outstanding voting securities of a Portfolio,
or (ii) 67% or more of the voting securities present at a meeting if the holders
of more than 50% of the outstanding voting securities of a Portfolio are present
or represented by proxy. Limitations 1 through 8 below are deemed fundamental
limitations for each Portfolio. The remaining limitations set forth below serve
as operating policies of each Portfolio and may be changed by the Board of
Directors without shareholder approval.
Each Portfolio may not:
1. Purchase the securities of any issuer if such purchase would cause the
Portfolio to fail to meet the requirements of a "diversified company" as defined
under the Investment Company Act of 1940, as amended (the "1940 Act").
As currently defined in the 1940 Act, "diversified company" means a
management company which meets the following requirements: at least 75% of the
value of its total assets is represented by cash and cash items (including
receivables), government securities, securities of other investment companies
and other securities for the purposes of this calculation limited in respect to
any one issuer to an amount not greater in valeu than 5% of the value of the
total assets of such management company and not more than 10% of the outstanding
voting securities of such issuer.
2. Purchase the securities of any issuer (other than "Government
securities" as defined under the 1940 Act) if, as a result, more than 25% of the
value of the Portfolio's total assets would be invested in the securities of
companies whose principal business activities are in the same industry.
3. Issue any senior securities, except as permitted by the 1940 Act or the
Rules and Regulations of the Securities and Exchange Commission.
4. Borrow money, except from banks for temporary or emergency purposes
provided that such borrowings may not exceed 33-1/3% of the value of a
Portfolio's net assets (including the amount borrowed). Any borrowings that come
to exceed this amount will be reduced within three days (not including Sundays
and holidays) to the extent necessary to comply with the 33-1/3% limitation.
This limitation shall not prohibit the Fund from engaging in reverse repurchase
agreements, making deposits of assets to margin or guarantee positions in
futures, options, swaps or forward contracts, or segregating assets in
connection with such agreements or contracts.
To the extent a Portfolio engages in reverse repurchase agreements, because
such transactions are considered borrowing, reverse repurchase agreements are
included in the 33-1/3% limitation.
5. Act as an underwriter of securities of other issuers, except to the
extent that in connection with the disposition of portfolio securities the
Portfolio may be deemed to be an underwriter under applicable laws.
6. Purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments. This restriction shall not prevent the
Portfolio from investing in securities or other instruments backed by real
estate or securities of companies engaged in the real estate business.
-14-
<PAGE>
7. Purchase or sell commodities other than foreign currencies unless
acquired as a result of ownership of securities. This limitation shall not
prevent the Portfolio from purchasing or selling options, futures, swaps and
forward contracts or from investing in securities or other instruments backed by
commodities.
For purposes of applying this restriction, "commodities" shall be deemed to
include commodity contracts.
8. Make loans to other persons except to the extent not inconsistent with
the 1940 Act or the Rules and Regulations of the Securities and Exchange
Commission. This limitation does not apply to purchases of commercial paper,
debt securities or repurchase agreements, or to the lending of portfolio
securities.
9. Purchase securities on margin, except that the Portfolio may obtain such
short-term credits as may be necessary for the clearance of purchases or sales
of securities and provided that margin payments in connection with transactions
in options, futures, swaps and forward contracts shall not be deemed to
constitute purchasing securities on margin.
10. Sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, and
provided that transactions in options, swaps and forward futures contracts are
not deemed to constitute selling securities short.
11. Except as part of a merger, consolidation, acquisition, or
reorganization, invest more than 5% of the value of its total assets in the
securities of any one investment company or more than 10% of the value of its
total assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting securities of
any one investment company.
12. Mortgage, pledge or hypothecate its assets except to the extent
necessary to secure permitted borrowings. This limitation does not apply to
reverse repurchase agreements or in the case of assets deposited to margin or
guarantee positions in futures, options, swaps or forward contracts or placed in
a segregated account in connection with such contracts.
13. Participate on a joint or a joint and several basis in any securities
trading account.
14. Invest more than 15% of its net assets in illiquid investments.
15. Invest directly in interests (including partnership interests) in oil,
gas or other mineral exploration or development leases or programs, except a
Portfolio may purchase or sell securities issued by corporations engaging in
oil, gas or other mineral exploration or development business.
Any of the investment policies set forth under "Investment Objectives and
Policies" in the Prospectus, or any restriction set forth above under
"Investment Restrictions" which involves a maximum percentage of securities or
assets (other than Restriction 4) shall not be considered to be violated unless
an excess over the percentage occurs immediately after an acquisition of
securities or utilization of assets and results therefrom. With respect to
Restriction 14, a Portfolio is under a continuing obligation to ensure that it
does not violate the maximum percentage either by acquisition or by virtue of a
decrease in the value of the Fund's liquid assets.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of portfolio securities owned by each Portfolio
during the same fiscal year. "Portfolio securities" for purposes of this
calculation do not include securities with a maturity date of less than twelve
(12) months from the date of investment. A 100% portfolio turnover rate would
occur, for example, if the lesser of the value of purchases or sales of
portfolio securities for a particular year were equal to the average monthly
value of the portfolio securities owned during such year. Each Portfolio's
historical portfolio turnover rates are set forth in the Prospectus section
"Financial Highlights".
-15-
<PAGE>
INVESTMENT PERFORMANCE
Advertisements and other sales literature may refer to monthly, quarterly,
yearly, cumulative and average annual total return. Each such calculation
assumes all dividends and capital gain distributions are reinvested at net asset
value on the appropriate reinvestment dates as described in the Prospectus, and
includes all recurring fees, such as investment advisory and management fees,
charged as expenses to all shareholder accounts. Each of monthly, quarterly and
yearly total return is computed in the same manner as cumulative total return,
as set forth below.
Cumulative total return is computed by finding the cumulative rate of
return over the period indicated in the advertisement that would equate the
initial amount invested to the ending redeemable value, according to the
following formula:
CTR = (ERV-P) 100
-----
P
Where: CTR = Cumulative total return;
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of such
period; and
P = initial payment of $1,000
Average annual total return is computed by finding the average annual
compounded rates of return over the periods indicated in the advertisement that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of
such period.
Reserve and Balanced Portfolios may quote yield figures from time to time.
The "yield" is computed by dividing the net investment income per share earned
during a 30-day period (using the average number of shares entitled to receive
dividends) by the net asset value per share on the last day of the period. The
yield formula provides for monthly compounding which assumes that net investment
income is earned and reinvested at a constant rate and annualized at the end of
a six-month period.
The yield formula is as follows:
YIELD = 2[(a-b) + 1)6 -1]
---
cd
-16-
<PAGE>
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = the net asset value of the Portfolio at the end of the
period.
The table below shows the yearly total return for the Portfolios for the
periods indicated:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Regional Portfolio Balanced Portfolio Reserve Portfolio
Period Ended 12/31 Total Return Total Return Total Return
------------------ ------------ ------------ ------------
1994* 6.20% 2.20% 2.25%
1995 33.51% 16.21% 5.09%
1996 11.88% 9.80% 4.93%
</TABLE>
_____________________________
* For the period commencing January 31, 1994 (Regional),
February 3, 1994 (Balanced) and April 7, 1994 (Reserve).
The average annual return of Regional Portfolio for the year ended December
31, 1996 and from inception of the Regional Portfolio through December 31, 1996
was 11.88% and 17.13%, respectively.
The average annual return of Balanced Portfolio for the year ended December
31, 1996 and from inception of the Balanced Portfolio through December 31, 1996
was 9.80% and 9.55%, respectively. Balanced Portfolio's yield for the thirty-day
period ended December 31, 1996 was 2.81%.
The average annual return of Reserve Portfolio for the year ended December
31, 1996 and from inception of the Reserve Portfolio through December 31, 1996
was 4.93% and 4.48%, respectively. Reserve Portfolio's yield for the thirty-day
period ended December 31, 1996 was 4.67%.
In advertising and sales literature, a Portfolio's performance may be
compared with that of other mutual funds, indexes or averages of other mutual
funds, indexes of related financial assets or data, and other competing
investment and deposit products available from or through other financial
institutions. The composition of these indexes, averages or products differs
from that of a Portfolio. The comparison of a Portfolio to an alternative
investment should be made with consideration of differences in features and
expected performance.
Yields and total returns quoted for a Portfolio include the effect of
deducting the Portfolio's expenses, but may not include charges and expenses
attributable to any particular insurance product. Since shares of the Fund may
only be purchased through a variable annuity or variable life contract, you
should carefully review the prospectus of the insurance product you have chosen
for information on relevant charges and expenses. Excluding these charges from
quotations of a Portfolio's performance has the effect of increasing the
performance quoted. You should bear in mind the effect of these charges when
comparing a Portfolio's performance to that of other mutual funds.
-17-
<PAGE>
MANAGEMENT
The names, addresses, positions and principal occupations of the directors and
executive officers of the Fund are given below.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Noel P. Rahn* 58 Chairman of the Chief Executive Officer and a Director of IAI
3700 First Bank Place Board since 1974. Mr. Rahn is also Chairman of the
P.O. Box 357 IAI Mutual Funds.
Minneapolis, Minnesota 55440
Madeline Betsch 54 Director Executive Vice President, Director of Client
19 South 1st Street Services, of CME-KHBB Advertising since May
Minneapolis, Minnesota 55401 1985, and prior thereto was a Vice President
with Campbell-Mithun, Inc. (advertising
agency) since February 1977. Ms. Betsch is
currently retired. Ms. Betsch is also a
Director of the IAI Mutual Funds.
W. William Hodgson 72 Director W. William Hodgson served as information
1698 Dodd Road manager for the North Central Home Office of
Mendota Heights, Minnesota 55118 the Prudential Insurance Company of America
from 1961 until 1984; he is currently
retired. Mr. Hodgson is also a Director of
the IAI Mutual Funds.
George R. Long 66 Director George R. Long serves as Director of Pacific
29 Las Brisas Way Industries and has been Chairman of Mayfield
Naples, Florida 33963 International (financial consultants and
venture capitalists) since 1973. Mr. Long is
also a Director of the IAI Mutual Funds.
J. Peter Thompson 65 Director J. Peter Thompson has been a grain farmer in
Route 1 southwestern Minnesota since 1974. Prior to
Mountain Lake, Minnesota 56159 that, Mr. Thompson was employed by Paine
Webber, Jackson & Curtis, Incorporated, (a diversified
financial services concern), most recently as Senior Vice
President and General Partner. Mr. Thompson is also a
Director of the IAI Mutual Funds.
Charles H. Withers 70 Director Charles H. Withers was Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960
P.O. Box 6118 through March 31, 1980; he is currently
Rochester, Minnesota 55903 retired. Mr. Withers is also a Director of
the IAI Mutual Funds.
Archie C. Black, III 34 Treasurer Senior Vice President and Chief Financial
3700 First Bank Place Officer of IAI and has served IAI in several
P.O. Box 357 capacities since 1987. Mr. Black is also
Minneapolis, Minnesota 55440 Treasurer of the IAI Mutual Funds.
-18-
<PAGE>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
William C. Joas 34 Secretary Vice President of IAI and has served as an
3700 First Bank Place attorney for IAI since 1990. Mr. Joas is also
P.O. Box 357 Secretary of the IAI Mutual Funds.
Minneapolis, Minnesota 55440
Mark Hoonsbeen 35 Vice President, Vice President of IAI. Prior to joining IAI
3700 First Bank Place Investments in 1994, Mr. Hoonsbeen served as an equity
P.O. Box 357 (Regional portfolio manager for The St. Paul Companies,
Minneapolis, Minnesota 55440 Portfolio) Inc. (a diversified financial services
concern) from 1986 to 1994. Mr. Hoonsbeen is
also a Vice President, Investments of IAI
Regional Fund.
Timothy A. Palmer 34 Vice President, Senior Vice President and has served as a
3700 First Bank Place Investments fixed income portfolio manager of IAI since
P.O. Box 357 (Reserve 1990. Mr. Palmer is also Vice President,
Minneapolis, Minnesota 55440 Portfolio) Investments of IAI Reserve Fund and IAI
Institutional Bond Fund.
Livingston Douglas 36 Vice President, Vice President of IAI. Prior to joining IAI
3700 First Bank Place Investments in 1993, Mr. Douglas served as a portfolio
P.O. Box 357 (Reserve manager for Mackey-Shields Financial Corp.
Minneapolis, Minnesota 55440 Portfolio) from 1987 to 1993. Mr. Douglas is also Vice
President, Investments of IAI Bond Fund, and IAI
Reserve Fund.
Susan J. Haedt 34 Vice President, Vice President of IAI and Director of Fund
3700 First Bank Place Director of Operations. Prior to joining IAI in 1992, Ms.
P.O. Box 357 Operations Haedt served as a Senior Manager at KPMG Peat
Minneapolis, Minnesota 55440 Marwick LLP (an international tax, accounting
and consulting firm). Ms. Haedt is also Vice
President, Director of Operations of the IAI
Mutual Funds.
</TABLE>
____________________________-
* Directors of the Funds who are interested persons (as that term is defined by
the Investment Company Act of 1940) of IAI and the Funds.
Each Fund has agreed to reduced initial subscription requirements for
employees and directors of a Fund or IAI, their spouses, children and
grandchildren. With respect to such persons, the minimum initial investment in
one or more of the IAI Family of Funds is $500; provided that the minimum amount
that can be allocated to any one of the Funds is $250. Subsequent subscriptions
are limited to a minimum of $100 for each of the Funds.
No compensation is paid by the Fund to any of its officers. Directors who
are not affiliated with IAI receive from the IAI Mutual Funds a $15,000 annual
retainer, $2,500 for each Board meeting attended, $3,600 for each Audit
Committee meeting attended (as applicable) and $1,800 for each Securities
Valuation Committee meeting attended. Each Portfolio will pay its pro rata share
of these fees based on its net assets. Such unaffiliated directors also are
reimbursed for expenses incurred in connection with attending meetings.
-19-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Aggregate Compensation Aggregate Compensation
from each Portfolio* from the
Name of Person, Position 19 IAI Mutual Funds**
------------------------ ------------------- ----------------
Betsch, Madeline - Director $52 $34,700
Hodgson, W. William - Director $52 $34,700
Long, George R. - Director $60 $34,700
Thompson, J. Peter - Director $52 $34,700
Withers, Charles H. - Director $60 $34,700
- -------------------------
<FN>
* The directors waived all such compensation through September 19, 1996.
** For the calendar year ended December 31, 1996 provided that a
director misses no meetings; excludes expenses incurred in
connection with attending meetings.
</FN>
</TABLE>
The Board of Directors for each of the Funds has approved a Code of Ethics.
The Code permits access persons to engage in personal securities transactions
subject to certain policies and procedures. Such procedures prohibit the
acquiring of any securities in an initial public offering. In addition, all
securities acquired through private placement must be pre-cleared. Procedures
have been adopted which would implement blackout periods for certain securities,
as well as a ban on short-term trading profits. Additional policies prohibit the
receipt of gifts in certain instances. Procedures have been implemented to
monitor employee trading. Each access person of the Adviser is required to
certify annually that they have read and understood the Code of Ethics. An
annual report is provided to the Funds' Board of Directors summarizing existing
procedures and changes, identifying material violations and recommending any
changes needed.
IAI's ultimate corporate parent is Lloyds TSB Group, plc ("Lloyds TSB"), a
publicly-held financial services organization headquartered in London, England.
Lloyds TSB is one of the largest personal and corporate financial services
groups in the United Kingdom, engaged in a wide range of activities including
commercial and retail banking. The principal offices of Lloyds TSB are located
at St. George's House, 6/8 Eastcheap, London, EC3M 1LL.
INVESTMENT ADVISORY AGREEMENT
Pursuant to an Investment Advisory Agreement between the Fund and IAI (the
"Advisory Agreement"), IAI has agreed to provide each Portfolio with investment
advice, statistical and research facilities, and certain equipment and services,
including, but not limited to, office space and necessary office facilities,
equipment, and the services of required personnel. In return, each Portfolio
pays IAI a monthly fee. Under the Advisory Agreement, IAI has the sole authority
and responsibility to make and execute investment decisions for the Portfolios
within the framework of each Portfolio's investment policies, subject to review
by the directors of the Fund.
Regional Portfolio has agreed to pay an advisory fee equal to an annual
rate of .65% of its average daily net assets. Balanced Portfolio has agreed to
pay an advisory fee equal to an annual rate of .65% of its average daily net
assets. Reserve Portfolio has agreed to pay an advisory fee equal to an annual
rate of .45% of its average daily net assets. As of December 31, 1996, Regional,
Balanced and Reserve Portfolios had net assets of $11,830,989, $1,534,046, and
$527,916, respectively. Pursuant to the Advisory Agreement, the Portfolios have
paid IAI advisory fees, net of waivers, as follows:
-20-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Regional Portfolio Balanced Portfolio Reserve Portfolio
------------------ ------------------ -----------------
Fiscal Period Ended
December 31, 1994* $ 1,734 $ 522 $ 821
Fiscal Year Ended
December 31, 1995 $ 15,913 $ 2,428 $ 3,265
Fiscal Year Ended
December 31, 1996 $ 51,843 $ 7,333 $ 4,218
<FN>
* For fiscal periods commencing January 31, 1994 (Regional), February 3, 1994
(Balanced) and April 7, 1994 (Reserve).
</FN>
</TABLE>
Although investment decisions for each Portfolio are made independently
from those of the other Portfolios, funds and accounts as to which IAI gives
investment advice, it may occasionally develop that the same security is
suitable for more than one Portfolio, fund and/or other account. If and when
more than one Portfolio, fund or other account simultaneously purchase or sell
the same security, the transactions will be averaged as to price and allocated
as to amount in accordance with arrangements equitable to such Portfolios, funds
and accounts. The simultaneous purchase or sale of the same securities by more
than one Portfolio or by any Portfolio and other accounts may have detrimental
effects on each Portfolio, as they may affect the price paid or received by a
Portfolio or the size of the position obtainable by a Portfolio.
ADMINISTRATIVE AGREEMENT
The Fund has engaged IAI to serve as the Portfolios' administrative,
dividend disbursing, redemption, accounting services and transfer agent pursuant
to an Administrative Agreement. Under the Administrative Agreement, IAI has
agreed to provide to the Fund all required administrative, stock transfer,
redemption, dividend disbursing and accounting services including, without
limitation, the following: (1) the maintenance of the Portfolios' accounts,
books and records; (2) the calculations of the daily net asset value in
accordance with the Fund's current Prospectus and Statement of Additional
Information; (3) daily and periodic reports; (4) all information necessary to
complete tax returns, questionnaires and other reports requested by the Fund;
(5) the maintenance of stock registry records; (6) the processing of requested
account registration changes, stock certificate issuances and redemption
requests; and (7) the administration of payments of dividends and distributions
declared by each Portfolio. As compensation for these services, each Portfolio
has agreed to pay IAI a fee equal to an annual rate of .10% of such Portfolio's
average daily net assets. Pursuant to the Administration Agreement, for the
fiscal year ended December 31, 1996, Regional, Balanced and Reserve Portfolios
paid IAI administrative fees of $7,977, $1,128, and $938, respectively.
ALLOCATION OF EXPENSES
In addition to the advisory and administrative fees paid to IAI, each
Portfolio pays all its other costs and expenses, including, for example, costs
incurred in the purchase and sale of assets, interest, taxes, charges of the
custodian of the Portfolio's assets, costs of reports and proxy material sent to
Portfolio shareholders, fees paid for independent accounting and legal services,
costs of printing Prospectuses for Portfolio shareholders and registering the
Portfolios' shares, postage, fees to directors who are not "interested persons"
of each Portfolio, insurance premiums, costs of attending investment conferences
and such other costs which may be designated as extraordinary. Certain state
securities commissions may impose limitations on certain of each Portfolio's
expenses, and IAI may be required by such state commissions to reimburse each
Portfolio for expenses in excess of any limitations as a requirement to selling
shares of such Portfolio in those states. IAI, in its discretion, may from time
to time waive or reduce its management and/or administrative fee or otherwise
reimburse Fund operating expenses. IAI has voluntarily agreed to waive fees and
expenses for Regional, Balanced, and Reserve Portfolios in excess of 1.25%,
1.25%, and 0.85%, respectively, of average daily net assets through May 1, 1998.
IAI is not liable for any loss suffered by a Portfolio in the absence of willful
misfeasance, bad faith or gross negligence in the performance of its duties and
obligations. For the fiscal year ended December 31, 1996, IAI voluntarily
-21-
<PAGE>
reimbursed total Portfolio operating expenses (net of expenses paid indirectly)
which exceeded 1.25%, 1.25%, and .85% of the average daily net assets of
Regional, Balanced and Reserve Portfolios, respectively.
DURATION OF AGREEMENTS
The Advisory Agreement and the Administrative Agreement will terminate
automatically in the event of their assignment. In addition, each Agreement is
terminable at any time with respect to a Portfolio without penalty by the Board
of Directors of the Fund or by vote of a majority of the Portfolio's outstanding
voting securities on not more than 60 days' written notice to IAI, and by IAI on
60 days' notice to the Fund. Each Agreement shall continue in effect from year
to year only so long as such continuance is specifically approved at least
annually by either the Board of Directors of the Fund or by vote of a majority
of the outstanding voting securities of the affected Portfolio, provided that in
either event such continuance is also approved by the vote of a majority of
directors who are not parties to the Agreement or interested persons of such
parties cast in person at a meeting called for the purpose of voting on such
approval.
CUSTODIAL SERVICE
The custodian for the Fund is Norwest Bank Minnesota, N.A. Norwest Center,
Sixth and Marquette, Minneapolis, MN 55479. Norwest has entered into an
agreement with Morgan Stanley Trust Company, 1 Pierrepont Plaza, Brooklyn, New
York ("Morgan Stanley") which enables the Fund to utilize the subcustodian and
depository network of Morgan Stanley. Such agreements, subcustodians and
depositories were approved by the Fund's Board of Directors in accordance with
the rules and regulations of the Securities and Exchange Commission, for the
purpose of providing custodial services for the Fund's assets held outside the
United States.
The Custodian maintains records of all cash transactions of the Portfolios.
All other books and records of the Portfolios, including books and records of
the Portfolio's investment portfolios, are maintained by IAI.
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
Fixed income and non-listed equity transactions of the Portfolios are
generally effected with dealers without the payment of brokerage commissions but
at a net price which usually includes a spread or markup. In effecting such
portfolio transactions on behalf of the Portfolios, IAI seeks the most favorable
net price consistent with the best execution. However, frequently IAI selects a
dealer to effect a particular transaction without contacting all dealers who
might be able to effect such transaction because of the volatility of the market
and the desire of IAI to accept a particular price for a security because the
price offered by the dealer meets its guidelines for profit, yield or both.
So long as IAI believes that it is obtaining the best net price (including
the spread or markup) consistent with the best execution, as described above, it
gives consideration in placing portfolio transactions to dealers furnishing
research, statistical information, or other services to IAI. This allows IAI to
supplement its own investment research activities and enables IAI to obtain the
views and information of individuals and research staffs of many different
securities firms prior to making investment decisions for the Portfolios. To the
extent portfolio transactions are effected with dealers who furnish research
services to it, IAI receives a benefit which is not capable of evaluation in
dollar amounts.
Generally, Regional Portfolio and Balanced Portfolio must deal with
brokers. IAI selects and (where applicable) negotiates commissions with the
brokers who execute the transactions for each Portfolio. The primary criteria
for the selection of a broker is the ability of the broker, in the opinion of
IAI, to secure prompt execution of the transactions on favorable terms,
including the reasonableness of the commission and considering the state of the
market at the time. In selecting a broker, IAI may consider whether such broker
provides brokerage and research services (as defined in the Securities Exchange
Act of 1934). IAI may direct Portfolio transactions to brokers who furnish
research services to IAI. Such research services include advice, both directly
and in writing, as to the value of securities, the advisability of investing in,
purchasing or selling securities, and the availability of securities or
purchasers or sellers of securities, as well as analyses and reports concerning
issues, industries, securities, economic factors and trends, portfolio strategy,
and the performance of accounts. By allocating brokerage business in order to
obtain research services for IAI, each Portfolio enables IAI to supplement its
own investment research activities and allows IAI to obtain the views and
information of individuals and research staffs of many different securities
-22-
<PAGE>
research firms prior to making investment decisions for each Portfolio. To the
extent such commissions are directed to brokers who furnish research services to
IAI, IAI receives a benefit, not capable of evaluation in dollar amounts,
without providing any direct monetary benefit to each Portfolio from these
commissions. Generally, the Portfolios pay higher than the lowest commission
rates available.
Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and subject to the policies set forth in the preceding
paragraphs and such other policies as the Board of Directors of each Portfolio
may determine, IAI may consider sales of shares of each Portfolio as a factor in
the selection of broker-dealers to execute the Fund's securities transactions.
IAI believes that most research services obtained by it generally benefit
one or more of the investment companies or other accounts which it manages.
Research services obtained from transactions in fixed income securities would
primarily benefit the managed funds investing such fixed income securities and
managed accounts investing in fixed income securities.
CAPITAL STOCK
Each Portfolio is a separate portfolio of IAI Retirement Funds, Inc., a
corporation organized on September 28, 1993, pursuant to the laws of the State
of Minnesota whose shares of common stock are currently issued in three series
(Series A, B and C). Each share of a series is entitled to participate pro rata
in any dividends and other distributions of such series and all shares of a
series have equal rights in the event of liquidation of that series. The Board
of Directors of IAI Retirement Funds, Inc., is empowered under the Articles of
Incorporation of such company to issue other series of the company's common
stock without shareholder approval. IAI Retirement Funds, Inc., has authorized
10,000,000,000 shares of $.01 par value common stock to be issued as Series A
common shares, 10,000,000,000 shares of $.01 par value common stock to be issued
as Series B common shares, and 10,000,000,000 shares of $.01 par value common
stock to be issued as Series C common shares. The investment portfolio
represented by Series A common shares is referred to as IAI Regional Portfolio,
by Series B common shares as IAI Balanced Portfolio, and by Series C common
shares as IAI Reserve Portfolio. As of December 31, 1996, IAI Regional Portfolio
had 787,450 shares outstanding, IAI Balanced Portfolio had 120,716 shares
outstanding, and IAI Reserve Portfolio had 52,656 shares outstanding.
As of April 9, 1997, no person held of record, or to the knowledge of the
Fund, beneficially owned more than 5% of a Portfolio, except as set forth in the
following tables:
<TABLE>
<CAPTION>
REGIONAL PORTFOLIO
<S> <C> <C>
- ------------------------------------------------------------------------
Name and Address Percent of
of Shareholder Number of Shares Class
- ------------------------------------------------------------------------
Lincoln Benefit Life Company 719,590.595 85.61%
Annuity Products
P.O. Box 82532
Lincoln, Nebraska 68501
Lincoln Benefit Life Company 120,916.341 14.39%
Life Products
P.O. Box 82532
Lincoln, Nebraska 68501
</TABLE>
-23-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
BALANCED PORTFOLIO
- ------------------------------------------------------------------------------
Name and Address Percent of
of Shareholder Number of Shares Class
- ------------------------------------------------------------------------------
Lincoln Benefit Life Company 108,753.757 84.95%
Annuity Products
P.O. Box 82532
Lincoln, Nebraska 68501
Lincoln Benefit Life Company 19,261.788 15.05%
Life Products
P.O. Box 82532
Lincoln, Nebraska 68501
RESERVE PORTFOLIO
- ----------------------------------------------------------------------------
Name and Address Percent of
of Shareholder Number of Shares Class
- -----------------------------------------------------------------------------
Lincoln Benefit Life Company 43,502.130 78.25%
Annuity Products
P.O. Box 82532
Lincoln, Nebraska 68501
Lincoln Benefit Life Company 12,091.389 21.75%
Life Products
P.O. Box 82532
Lincoln, Nebraska 68501
</TABLE>
In addition, as of April 9, 1997, none of Regional, Balanced and Reserve
Portfolios' officers and directors owned any of the outstanding shares of the
Portfolios.
Due to its ownership of more than 25% of the outstanding shares of each of
the Portfolios through its Life and Annuity Products, Lincoln Benefit Life
Company may be said to control each of such Portfolios. Lincoln Benefit Life
Company is an insurance company organized under the laws of Nebraska. Lincoln
Benefit Life Company is a wholly-owned subsidiary of Allstate Life Insurance
Company, which in turn is wholly-owned by Allstate Insurance Company. Allstate
Insurance Company is a wholly-owned subsidiary of The Allstate Corporation.
NET ASSET VALUE AND PUBLIC OFFERING PRICE
The portfolio securities in which the Fund invests fluctuate in value, and
hence, for each Portfolio, the net asset value per share also fluctuates.
The net asset value per share of each Portfolio is determined once daily as
of the close of trading on the New York Stock Exchange on each business day on
which the New York Stock Exchange is open for trading, and may be determined on
additional days as required by the Rules of the Securities and Exchange
Commission. The New York Stock Exchange is closed, and the net asset values per
share of each are not determined, on the following national holidays: New Year's
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day.
-24-
<PAGE>
On December 31, 1996, the net asset value and public offering price per
share of each Portfolio was calculated as follows:
REGIONAL PORTFOLIO
NAV = Net Assets ($11,830,989) = $15.02
-------------------------
Shares Outstanding (787,450)
BALANCED PORTFOLIO
NAV = Net Assets ($1,534,046) = $12.71
--------------------------
Shares Outstanding (120,716)
RESERVE PORTFOLIO
NAV = Net Assets ($527,916) = $10.03
-------------------------------
Shares Outstanding (52,656)
TAX STATUS
The Board of Directors intends that each of the Portfolios will comply with
the diversification requirements imposed by section 817(h) of the Internal
Revenue Code as a condition to favorable tax treatment of variable annuity and
variable life insurance contracts. Under Internal Revenue Service Regulations,
such requirements are satisfied if, at the end of each calendar quarter: (1) not
more than 55% of the Portfolio's assets are attributable to any one investment;
not more than 70% of such assets are attributable to any two investments; not
more than 80% of such assets are attributable to any three investments; and not
more than 90% of such assets are attributable to any four investments. If a
Portfolio fails to be adequately diversified within the meaning of section
817(h) of the Internal Revenue Code, the variable contracts funded by the
Portfolio could lose their favorable tax status. See the accompanying prospectus
for your separate account for more information.
LIMITATION OF DIRECTOR LIABILITY
Under Minnesota law, the Fund's Board of Directors owes certain fiduciary
duties to the Fund and to its shareholders. Minnesota law provides that a
director "shall discharge the duties of the position of director in good faith,
in a manner the director reasonably believes to be in the best interest of the
corporation, and with the care an ordinarily prudent person in a like position
would exercise under similar circumstances." Fiduciary duties of a director of a
Minnesota corporation include, therefore, both a duty of "loyalty" (to act in
good faith and act in a manner reasonably believed to be in the best interests
of the corporation) and a duty of "care" (to act with the care an ordinarily
prudent person in a like position would exercise under similar circumstances).
Minnesota law authorizes corporations to eliminate or limit the personal
liability of a director to the corporation or its shareholders for monetary
damages for breach of the fiduciary duty of "care." Minnesota law does not,
however, permit a corporation to eliminate or limit the liability of a director
(i) for any breach of the director's duty of "loyalty" to the corporation or its
shareholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for authorizing a
dividend, stock repurchase or redemption or other distribution in violation of
Minnesota law or for violation of certain provisions of Minnesota securities
laws, or (iv) for any transaction from which the director derived an improper
personal benefit. The Articles of Incorporation of IAI Retirement Funds, Inc.,
limit the liability of directors to the fullest extent permitted by Minnesota
statutes, except to the extent that such liability cannot be limited as provided
in the Investment Company Act of 1940 (which Act prohibits any provisions which
purport to limit the liability of directors arising from such directors' willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of their role as directors).
-25-
<PAGE>
Minnesota law does not eliminate the duty of "care" imposed upon a
director. It only authorizes a corporation to eliminate monetary liability for
violations of that duty. Minnesota law, further, does not permit elimination or
limitation of liability of "officers" of the corporation for breach of their
duties as officers (including the liability of directors who serve as officers
for breach of their duties as officers.) Minnesota law does not permit
elimination or limitation of the availability of equitable relief, such as
injunctive or rescissionary relief. Further, Minnesota law does not permit
elimination or limitation of a director's liability under the Securities Act of
1933 or the Securities Exchange Act of 1934, and it is uncertain whether and to
what extent the elimination of monetary liability would extend to violations of
duties imposed on directors by the Investment Company Act of 1940 and the rules
and regulations adopted under such Act.
FINANCIAL STATEMENTS
The financial statements, included as a part of the Fund's 1996 Annual
Report to shareholders, are incorporated herein by reference. Such Annual Report
may be obtained by shareholders on request from the Fund at no additional
charge.
-26-
<PAGE>
APPENDIX A
RATINGS OF DEBT SECURITIES
RATINGS BY MOODY'S
CORPORATE BONDS
Aaa. Bonds 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 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 rated A possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa. Bonds rated Baa are considered medium grade obligations; i.e., 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.
Ba. Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during other good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B. Bonds rated B generally lack characteristics of the desirable
investment. Assurances of interest and principal payment or maintenance of other
terms of the contract over any long period of time may be small.
Caa. Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca. Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings.
C. Bonds rated C are the lowest-rated class of bonds and issued so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
Conditional Ratings. The designation "Con." followed by a rating indicates
bonds for which the security depends upon the completion of some act or the
fulfillment of some condition. These are bonds secured by (a) earnings of
projects under construction, (b) earnings or projects unseasoned in operating
experience, (c) rentals which begin when facilities are completed, or (d)
payments to which some other limiting condition attaches. Parenthetical rating
denotes probable credit stature upon completion of construction or elimination
of basis of condition.
A-1
<PAGE>
Note: Moody's applies numerical modifiers 1, 2, and 3 in the Aa and A
classifications of its corporate bond rating system. The modifier 1 indicates
that the security ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the
issue ranks in the lower end of its generic rating category. With respect to
municipal securities, those bonds in the Aa, A, Baa, Ba, and B groups which
Moody's believes possess the strongest investment attributes are designated by
the symbols Aa1, A1, Baa1, Ba1, and B1.
COMMERCIAL PAPER
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime - 1 Superior ability for repayment of senior short-term debt
obligations
Prime - 2 Strong ability for repayment of senior short-term debt
obligations
Prime - 3 Acceptable ability for repayment of senior short-term debt
obligations
If an issuer represents to Moody's that its Commercial Paper obligations
are supported by the credit of another entity or entities, Moody's, in assigning
ratings to such issuers, evaluates the financial strength of the indicated
affiliated corporations, commercial banks, insurance companies, foreign
governments, or other entities, but only as one factor in the total rating
assessment.
RATINGS BY S&P
CORPORATE BONDS
AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
BBB. Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits 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
debt in this category than in higher-rated categories.
BB. Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments.
B. Debt rated B has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB-rating.
A-2
<PAGE>
CCC. Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal.
CC. Debt rated CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating.
C. The rating C typically applied to debt subordinated to senior debt which
assigned an actual or implied CCC-debt rating. The C rating may be used to cover
a situation where a bankruptcy petition has been filed but debt service payments
are continued.
C1. The rating C1 is reserved for income bonds on which no interest is
being paid.
D. Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. The D rating will be used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
In order to provide more detailed indications of credit quality, S&P's bond
letter ratings described above (except for the AAA category) may be modified by
the addition of a plus or a minus sign to show relative standing within the
rating category.
COMMERCIAL PAPER
A. This highest rating category indicates the greatest capacity for timely
payment. Issues in this category are further defined with the designations 1, 2,
and 3 to indicate the relative degree to safety.
A-1. This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are designed A-1+.
A-2. Capacity for timely payments on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designed A-1.
A-3. Issues carrying this designation have adequate capacity for timely
repayment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
A-3
