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PROSPECTUS AND APPENDIX
This document is incorporated by reference to Post-Effective Amendment No. 2,
Registration Number 33-70272 filed on Form N-1A on April 30, 1995.
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STATEMENT OF ADDITIONAL INFORMATION
LINCOLN NATIONAL CAPITAL APPRECIATION FUND, INC.
This Statement of Additional Information should be read in conjunction with the
Prospectus of Lincoln National Capital Appreciation Fund, Inc. (the Fund) dated
April 29, 1995. You may obtain a copy of the Fund's Prospectus on request and
without charge. Please write Kim Oakman, The Lincoln National Life Insurance
Company, P.O. Box 2340, Fort Wayne, Indiana 46801 or call 1-800-348-1212,
Extension 4912.
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THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS.
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The date of this Statement of Additional Information is April 29, 1995.
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TABLE OF CONTENTS
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<CAPTION>
Page
<S> <C>
Investment Objective and Policies 2
Investment Restrictions 2
Portfolio Transactions and Brokerage 3
Determination of Net Asset Value 4
Investment Techniques 4
Appendix
Investment Adviser and Sub-Adviser A-1
Directors and Officers A-2
Investment Policies and techniques (continued) A-2
Options, Futures, Securities Lending, Repurchase and Reverse
Repurchase Agreements
Custodian A-6
Independent Auditors A-7
Financial Statements A-7
Bond Ratings A-7
Commercial Paper Ratings A-8
U.S. Government Obligations A-8
Taxes A-8
State Requirements A-9
Derivative Transactions-Definitions A-9
</TABLE>
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INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is long-term growth of capital in a manner
consistent with the preservation of capital. The Fund's investment objective and
policies are fundamental and cannot be changed without the affirmative vote of a
majority of the outstanding voting securities of the Fund. See "General
Information," in the Prospectus. There can be no assurance that the objective of
the Fund will be achieved.
This Fund invests in investment-grade common stocks of established companies
with the objective of maximizing longer-term total return. The primary risk is
that associated with common stock investing and the shares will fluctuate in
value with the common stock market. Because the policy of this Fund is to
emphasize investment in established companies, it is expected that the
volatility will be in line with the broad stock market indices such as the Dow
Jones Industrial Average and the Standard & Poor's 500 Composite Index.
In addition the Fund may write (sell) and purchase options; invest in futures
contracts and options thereon; and engage in other derivative transactions such
as (but not limited to) swaps, forward arrangements, and currency options; and
employ other techniques to enhance the portfolio, such as lending its portfolio
securities and engaging in repurchase and reverse repurchase agreements. These
transactions and techniques are subject to limits set out elsewhere in the
Prospectus and in this SAI.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
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The Fund may make short-term investments in repurchase and reverse repurchase
agreements. A repurchase agreement typically involves the purchase by the Fund
of securities (U.S. Government or other money market securities) from a
financial institution such as a bank, broker, dealer or savings and loan
association, coupled with an agreement by the seller to repurchase the same
securities from the Fund at the specified price and at a fixed time in the
future, usually not more than seven days from the date of purchase. The
difference between the prchase price to the Fund and the resale price to the
seller represents the interest earned by the Fund which is unrelated to the
coupon rate or maturity of the purchased security. If the seller defaults, the
Fund may incur a loss if the value of the collateral securing the repurchase
agreement declines, or the Fund may incur disposition costs in connection with
liquidating the collateral. If bankruptcy proceedings are commenced with respect
to the seller, realization upon the collateral by the Fund may be delayed or
limited and a loss may be incurred if the collateral securing the repurchase
agreement declines in value during the bankruptcy proceedings. However,
repurchase agreements will be made only with brokers, dealers and institutions
deemed by the Board of Directors, or its delegate, to be creditworthy; they will
be fully collateralized; and the collateral for each transaction will be in the
actual or constructive possession of the Fund during the term of the
transaction, as provided in the agreement. Repurchase agreements with a duration
of more than seven days are considered illiquid securities and are subject to
the limit stated below.
When the Fund invests in a reverse repurchase agreement it sells a security to
another party, such as a bank or broker-dealer, in return for cash, and agrees
to buy the security back at a future date and price. Reverse repurchase
agreements may be used to provide cash to satisfy unusually heavy redemption
requests of for other temporary or emergency purposes without the necessity of
selling portfolio securities or to earn additional income on portfolio
securities, such as treasury bills and notes. Reverse repurchase agreements may
expose the Fund to greater fluctuation in the value of its assets.
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
Subject to certain limits described in the Statement of Additional
Information, the Fund may purchase and write options on securities (including
index options) and options on foreign currencies, and may invest in futures
contracts for the purchase or sale of instruments based on financial indices,
including interest rates or an index of U.S. Government or foreign government
securities or equity or fixed income securities, futures contracts on foreign
currencies and fixed income securities ("futures contract"), options on futures
contracts, forward contracts, interest rate swaps and swap-related products.
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These instruments will be used primarily to hedge the Fund's securities
positions, i.e., to attempt to reduce the overall level of investment risk that
normally would be expected to be associated with the Fund's securities and to
attempt to protect the Fund against market movements that might adversely affect
the value of its securities or the price of securities that it is considering
purchasing. The use of these instruments by the Fund involves certain risks.
The use of futures, options, forward contracts and swaps exposes the Fund to
additional investment risks and transaction costs. If the Sub-Adviser seeks to
protect the Fund against potential adverse movements in the securities, foreign
currency or interest rate markets using these instruments, and such markets do
not move in a direction adverse to the Fund, that Fund could be left in a less
favorable position than if such strategies had not been used. Risks inherent in
the use of futures, options, forward contracts and swaps include (1) the risk
that interest rates, securities prices and currency markets will not move in the
directions anticipated; (2) imperfect correlation between the price of futures,
options and forward contracts and movements in the prices of securities or
currencies being hedged; (3) the fact that skills needed to use these strategies
are different from those needed to select portfolio securities; (4) the possible
absence of a liquid secondary market for any particular instrument at any time;
and (5) the possible need to defer closing out certain hedged positions to avoid
adverse tax consequences.
INVESTMENT RESTRICTIONS
As indicated in the Prospectus, the Fund is subject to certain fundamental
policies and restrictions that may not be changed without the approval of the
holders of a "majority of the outstanding voting shares of the Fund." This term
is defined under General Information, in the Appendix.
As fundamental policies, the Fund may not: (1) Own more than 10% of the
outstanding voting securities of any one issuer and, as to seventy-five percent
(75%) of the value of the total assets of the Fund, purchase the securities of
any one issuer (except cash items and "government securities" as defined under
the 1940 Act), if immediately after and as a result of such purchase the value
of the holdings of the Fund in the securities of such issuer exceeds 5% of the
value of the Fund's total assets. 2) Invest more than 25% of the value of its
assets in any particular industry. or interests in real estate; however, the
Fund may own debt or equity securities issued by companies engaged in those
businesses. (4) Purchase or sell physical commodities other than foreign
currencies unless acquired as a result of ownership of securities (but this
limitation shall not prevent the Fund from purchasing or selling options,
futures, swaps and forward contracts or from investing in securities or other
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instruments backed by physical commodities). (5) Lend any security or make any
other loan if, as a result, more than 25% of the Fund's total assets would be
lent to other parties (but this limitation does not apply to purchases of
commercial paper, debt securities or repurchase agreements). (6) Act as an
underwriter of securities issued by others, except to the extent that the Fund
may be deemed an underwrite in connection with the disposition of its portfolio
securities. (7) Invest in the securities of other investment companies, except
as they may be acquired as part of a merger, consolidation or acquisition of
assets.
The Directors have adopted additional investment restrictions for the Fund.
These restrictions are non-fundamental operating policies of the Fund and, as
such, may be changed by the Directors without shareholder approval. The
additional investment restrictions adopted by the Directors to date include the
following:
(a) The Fund's investments in warrants, valued at the lower of cost or market,
may not exceed 5% of the value of its net assets. Included within that amount,
but not to exceed 2% of the value of the Fund's net assets, may be warrants that
are not listed on the New York American Stock Exchange. Warrants acquired by the
Fund in units or attached to securities shall be deemed to be without
value.
(b) The Fund will not (i) enter into any futures contracts and related options
for purposes other than bona fide hedging transactions within the meaning
of CFTC Regulations if the aggregate initial margin and premiums required
to establish positions in futures contracts and related options that do not
fall within the definition of 'bona fide hedging transactions' will exceed
five percent of the fair market value of the Fund's net assets, after
taking into account unrealized profits and unrealized losses on any such
contracts it has entered into; or (ii) enter into any futures contracts if
the aggregate amount of the Fund's commitments under its outstanding
futures contracts positions would exceed the market value of its total
assets.
(c) The Fund does not currently intend to sell securities short, unless it owns
or has the right to obtain securities equivalent in kind and amount to the
securities sold short without the payment of any additional consideration
therefor, and provided that transactions in options, futures, swaps and
forward contracts are not deemed to constitute selling securities short.
(d) The Fund does not currently intend to purchase securities on margin, except
that the Fund may obtain such short-term credits as are necessary for the
clearance of transactions, and provided that margin payments and other
deposits in connection with transactions in options, futures, swaps and
forward contracts shall not be deemed to constitute
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purchasing securities on margin.
(e) The Fund may not mortgage or pledge any securities owned or held by it in
amounts that exceed, in the aggregate, 15% of its net asset value, provided
that this limitation does not apply to reverse repurchase agreements,
assets deposited to margin, guarantee positions in futures, options, swaps
or forward contracts or the segregation of assets in connection with such
contracts.
(f) The Fund does not intend to purchase securities of any issuer (other than
U.S. Government agencies and instrumentalities or instruments guaranteed by an
entity with a record of more than three years' continuous operation, including
that of predecessors) with a record of less than three years' continuous
operation (including that of predecessors) is such purchase would cause the cost
of the Fund's investments in all such issuers to exceed 5% of the Fund's total
assets taken at market value at the time of such purchase.
(g) The Fund does not currently intend to invest directly in oil, gas, or other
mineral development or exploration programs or leases; however, the Fund
may own debt or equity securities of companies engaged in those businesses.
(h) The Fund may borrow money for temporary or emergency purposes (not for
leveraging or investment) in an amount not exceeding 25% of the value of
its total assets (including the amount borrowed) less liabilities (other
than borrowings). If borrowings exceed 25% of the value of the Fund's total
assets by reason of a decline in net assets, it will reduce its borrowings
within three business days to the extent necessary to comply with the 25%
limitation. This policy shall not prohibit reverse repurchase agreements,
deposits of assets to margin or guarantee positions in futures, options,
swaps or forward contracts, or the segregation of assets in connection with
such contracts.
(i) The Fund does not currently intend to purchase any security or enter into a
repurchase agreement, if as a result, more than 15% of its net assets would
be invested in repurchase agreements not entitling the holder to payment of
principal and interest within seven days, and in securities that are
illiquid by virtue of legal or contractual restrictions on resale or the
absence of a readily available market. The Directors, or (if such authority
is expressly delegated to them, the Adviser & Sub-Adviser) the Fund's
investment adviser acting pursuant to authority delegated by the Directors,
may determine that a readily available market exists for securities
eligible for resale pursuant to Rule 144A under the Securities Act of 1933,
or any successor to such rule, and therefore that such securities are not
subject to the foregoing limitation.
(j) The Fund may not invest in companies for the purpose of exercising control
or management.
PORTFOLIO TRANSACTIONS AND BROKERAGE
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The Adviser is responsible for decisions to buy and sell securities for the
Fund, the selection of brokers and dealers to effect the transactions, and the
negotiation of brokerage commissions, if any. Purchases and sales of securities
on a stock exchange are effected through brokers who charge a commission for
their services. In the over-the-counter market, securities are generally traded
on a "net" basis with dealers acting as principal for their own accounts without
a stated commission, although the price of the security usually includes a
profit to the dealer. In underwritten offerings, securities are purchased at a
fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. On occasion,
certain money market instruments may be purchased directly from an issuer, in
which case no commissions or discounts are paid.
The Adviser currently provides investment advice to a number of other clients.
See Investment Adviser and Sub-Adviser in the Appendix. It will be the practice
of the Adviser to allocate purchase and sale transactions among the Fund and
others whose assets it manages in such manner as it deems equitable. In making
such allocations, major factors to be considered are investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held and the opinions of the persons responsible for managing the
portfolios of the Fund and other client accounts. Fund securities are not
purchased from or sold to the Adviser or any affiliated person (as defined in
the Act) of the Adviser.
In connection with effecting portfolio transactions, primary consideration will
be given to securing most favorable price and efficient execution. Within the
framework of this policy, the reasonableness of commission or other transaction
costs is a major factor in the selection of brokers and is considered together
with other relevant factors, including financial responsibility, research and
investment information and other services provided by such brokers. It is
expected that, as a result of such factors, transaction costs charged by some
brokers may be greater than the amounts other brokers might charge. The Adviser
may determine in good faith that the amount of such higher transaction costs is
reasonable in relation to the value of the brokerage and research services
provided. The Board of Directors of the Fund will review regularly the
reasonableness of commission and other transaction costs incurred by the Fund in
the light of facts and circumstances deemed relevant from time to time, and, in
that connection, will receive reports from the Adviser and published data
concerning transaction costs incurred by institutional investors generally. The
nature of the research services provided to the Adviser by brokerage firms
varies from time to time but generally includes current and historical financial
data concerning particular companies and their
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securities; information and analysis concerning securities markets and economic
and industry matters; and technical and statistical studies and data dealing
with various investment opportunities, risks and trends, all of which the
Adviser regards as a useful supplement to its own internal research
capabilities. The Adviser may from time to time direct trades to brokers which
have provided specific brokerage or research services for the benefit of the
Adviser's clients; in addition the Adviser may allocate trades among brokers
that generally provide superior brokerage and research services. Research
services furnished by brokers are used for the benefit of all of the Adviser's
clients and not solely or necessarily for the benefit of the Fund. The Adviser
believes that the value of research services received is not determinable and
does not significantly reduce its expenses. The Fund does not reduce its fee to
the Adviser by any amount that might be attributable to the value of such
services.
If the Fund effects a closing purchase transaction with respect to an option
written by it, normally such transaction will be executed by the same broker-
dealer who executed the sale of the option. If a call written by the Fund is
exercised, normally the sale of the underlying securities will be executed by
the same broker-dealer who executed the sale of the call.
The writing of options by the Fund will be subject to limitations established by
each of the exchanges governing the maximum number of options in each class
which may be written by a single investor or group of investors acting in
concert, regardless of whether the options are written on the same or different
exchanges or are held or written in one or more accounts or through one or more
brokers. Thus, the number of options which the Fund may write may be affected by
options written by other investment advisory clients of its Adviser. An exchange
may order the liquidations of positions found to be in excess of these limits,
and it may impose certain other sanctions. As of the date of this Prospectus,
these limits (which are subject to change) are 2,000 options (200,000 shares) in
each class of puts or calls.
DETERMINATION OF NET ASSET VALUE
A description of the days on which the Fund's net asset value per share will be
determined is given in the Prospectus. The New York Stock Exchange's most recent
announcement (which is subject to change) states that in 1995 it will be closed
on President's Day, February 20; Good Friday, April 14; Memorial Day, May 29;
Independence Day, July 4; Labor Day, September 4; Thanksgiving Day, November 23;
and Christmas Day, December 25. It may also be closed on other days.
INVESTMENT TECHNIQUES
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
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In a repurchase agreement, the Fund purchases a security and simultaneously
commits to resell that security to the seller at an agreed upon price on an
agreed upon date within a number of days (usually not more than seven) from the
date of purchase. The resale price reflects the purchase price plus an agreed
upon incremental amount that is unrelated to the coupon rate or maturity of the
purchased security. A repurchase agreement involves the obligation of the seller
to pay the agreed upon price, which obligation is in effect secured by the value
(at least equal to the amount of the agreed upon resale price and marked-to-
market daily) of the underlying security. The Fund may engage in a repurchase
agreement with respect to any security in which it is authorized to invest.
While it does not presently appear possible to eliminate all risks from these
transactions (particularly the possibility of a decline in the market value of
the underlying securities, as well as delays and costs to the Fund in the event
of bankruptcy of the seller), it is the policy of the Fund to limit repurchase
agreements to those parties whose creditworthiness has been reviewed and found
satisfactory by the Adviser or Sub-Adviser. In addition, the Fund currently
intends to invest only in repurchase agreements collateralized by U.S.
Government securities.
Reverse Repurchase Agreements may be used to provide cash to satisfy unusually
heavy redemption requests or for other temporary or emergency purposes without
the necessity of selling portfolio securities, or to earn additional income on
portfolio securities, such as Treasury bills and notes. In a reverse repurchase
agreement, the Fund sells a portfolio security 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, the Fund will maintain cash and appropriate liquid assets in a
segregated custodial account to cover its obligation under the agreement. The
Fund will enter into reverse repurchase agreements only with parties that the
Adviser of Sub-Adviser deems creditworthy. Reverse Repurchase Agreements may
expose the Fund to greater fluctuation in the value of its assets.
MORTGAGE-AND ASSET-BACKED SECURITIES
The Fund may invest in mortgage-and asset-backed securities. Government National
Mortgage Association ("GNMA") Certificates are mortgage-backed securities that
evidence an undivided interest in a pool of mortgage loans. GNMA Certificates
differ from bonds in that principal is paid back monthly by the borrowers over
the term of the loan rather than returned in a lump sum at maturity. GNMA
Certificates that the Fund may purchase are the "modified pass-through" type.
"Modified pass-through" GNMA Certificates entitle the holder to receive a share
of all interest and principal payments paid and owned on the mortgage pool, not
of fees paid to the "issuer" and GNMA,
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regardless of whether or not the mortgagor actually makes the payment. GNMA
Certificates are backed as to the timely payment of principal and interest by
the full faith and credit of the U.S. Government.
The Federal Home Loan Mortgage Corporation ("FHLMC") issues two types of
mortgage pass-through securities: mortgage participation certificates ("PCs")
and guaranteed mortgage certificates ("GMCs"). PCs resemble GNMA Certificates in
that each PC represents a pro rata share of all interest and principal payments
made and owned on the underlying pool. FHLMC guarantees timely payments of
interest on PCs and the full return of principal. GMCs also represent a pro rata
interest in a pool of mortgages. However, these instruments pay interest
semiannually and return principal once a year in guaranteed minimum payments.
This type of security is guaranteed by FHLMC as to timely payment of principal
and interest but it is not guaranteed by the full faith and credit of the U.S.
Government.
The Federal National Mortgage Association ("FNMA") issues guaranteed mortgage
pass-through certificates ("FNMA Certificates"). FNMA Certificates resemble GNMA
Certificates in that each FNMA Certificate represents a pro rata share of all
interest and principal payments made and owned on the underlying pool. The
principal and the timely payment of interest on FNMA Certificates are guaranteed
only by FNMA itself, not by the full faith and credit of the U.S. Government.
Each of the mortgage-backed securities described above is characterized by
monthly payments to the holder, reflecting the monthly payments made by the
borrowers who received the underlying mortgage loans. The payments to the
security holders (such as the Fund), like the payments on the underlying loans,
represent both principal and interest. Although the underlying mortgage loans
are for specified periods of time, such as 20 or 30 years, the borrowers can,
and typically do, pay them off sooner. Thus, the security holders frequently
receive prepayments of principal in addition to the principal that is part of
the regular monthly payments. A borrower is more likely to prepay a mortgage
that bears a relatively high rate of interest. This means that in times of
declining interest rates, some of the Fund's higher yielding mortgage-backed
securities might be converted to cash and the Fund will be forced to accept
lower interest rates where that cash is used to purchase additional securities
in the mortgage-backed securities sector or in the other investment sectors.
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
FUTURES CONTRACTS. The Fund may enter into contracts for the purchase or sale
for future delivery of fixed income securities, foreign currencies or contracts
based on financial indices including interest rates or an index of U.S.
Government
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securities, foreign government securities, equity securities or fixed income
securities. U.S. futures contracts are traded on exchanges which have been
designated "contract markets" by the Commodity Futures Trading Commission
("CFTC") and must be executed through a futures commission merchant (an "FCM"),
or brokerage firm, which is a member of the relevant contract market. Through
their clearing corporations, the exchanges guarantee performance of the
contracts as between the clearing members of the exchange.
The buyer 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 buyer and seller are required to deposit "initial margin" for
the benefit of an FCM when the contract is entered into. Initial margin deposits
are equal to a percentage of the contract's value, as set by the exchange on
which the contract is traded, and may be maintained in cash or certain high-
grade liquid assets. If the value of either party's position declines, that
party will be required to make additional "variation margin" payments with an
FCM 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 are similar to good faith deposits or performance
bonds, unlike margin extended by a securities broker, and initial and variation
margin payments do not constitute purchasing securities on margin for purposes
of the Fund's investment limitations. In the event of the bankruptcy of an FCM
that holds margin on behalf of the Fund, may be entitled to return of margin
owed to it only in proportion to the amount received by FCM's other customers.
Sub-Adviser will attempt to minimize the risk by careful monitoring of the
creditworthiness of the FCMs with which the Fund does business and by depositing
margin payments in a segregated account with the custodian when practical or
otherwise required by law.
The Fund intends to comply with guidelines of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets. The Fund
will use futures contracts and related options solely for bona fide hedging
purposes within the meaning of CFTC regulations; except that, in addition, the
Fund may hold positions in futures contracts and related options that do not
fall within the definition of bona fide hedging transactions, provided that the
aggregate initial margin and premiums required to establish such positions will
not exceed 5% of the fair market value of the Fund's net assets, after taking
into account unrealized profits and unrealized losses on any such contracts it
has entered into.
Although the Fund would hold cash and liquid assets in a segregated account with
a value sufficient to cover its open futures obligations, the segregated assets
would be available to
<PAGE>
the Fund immediately upon closing out the futures position, while settlement of
securities transactions could take several days. However, because the Fund's
cash that may otherwise be invested would be held uninvested or invested in
high-grade liquid assets so long as the futures position remains open, the
Fund's return could be diminished due to the opportunity losses of foregoing
other potential investments.
The acquisition or sale of a futures contract may occur, for example, when the
Fund holds or is considering purchasing equity securities and seeks to protect
itself from fluctuations in prices without buying or selling those securities.
For example, if prices were expected to decrease, the Fund might sell equity
index futures contracts, thereby hoping to offset a potential decline in the
value of equity securities in the portfolio by a corresponding increase in the
value of the futures contract position held by the Fund and thereby preventing
the Fund's net asset value from declining as much as it otherwise would have.
The Fund also could protect against potential price declines by selling
portfolio securities and investing in money market instruments. However, since
the futures market is more liquid than the cash market, the use of futures
contracts as an investment technique allows the Fund to maintain a defensive
position without having to sell portfolio securities.
Similarly, when prices of equity securities are expected to increase, futures
contracts may be bought to attempt to hedge against the possibility of having to
buy equity securities at higher prices. This technique is sometimes known as an
anticipatory hedge. Since the fluctuations in the value of futures contracts
should be similar to those of equity securities, the Fund could take advantage
of the potential rise in the value of equity securities without buying them
until the market has stabilized. At that time, the futures contracts could be
liquidated and the Fund could buy equity securities on the cash market. To the
extent the Fund enters into futures contracts for this purpose, the assets in
the segregated asset account maintained to cover the Fund's obligations with
respect to the futures contracts will consist of high-grade liquid assets from
its portfolio in an amount equal to the difference between the contract price
and the aggregate value of the initial and variation margin payments made by the
Fund with respect to the futures contracts.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial margin and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close out futures contracts through offsetting
transactions which could distort the normal price relationship between the cash
and futures markets. Second, the liquidity of the futures market depends on
participants entering
<PAGE>
into offsetting transactions rather than making or taking delivery. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced and prices in the futures market distorted. Third, from
the point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of the foregoing
distortions, a correct forecast of general price trends by the Sub-Adviser still
may not result in a successful use of futures.
Futures contracts entail risk. Although the Fund believes that use of such
contracts will benefit the Fund, the Fund's overall performance could be worse
than if the Fund had not entered into futures contracts if the Sub-Adviser's
investment judgement proves incorrect. For example, if the Fund has hedged
against the effects of a possible decrease in prices of securities held in its
portfolio and prices increase instead, the Fund will lose part or all of the
benefit of the increased value of these securities because of offsetting losses
in its futures positions. In addition, if the Fund has insufficient cash, it may
have to sell securities from its portfolio to meet daily variation margin
requirements. Those sales may be, but not necessarily be, at increased prices
which reflect the rising market and may occur at a time when the sales are
disadvantageous to the Fund.
The prices of futures contracts depend primarily on the value of their
underlying instruments. Because there are a limited number of types of futures
contracts, it is possible that the standardized futures contracts available to
the Fund will not match exactly the Fund's current or potential investments. The
Fund may buy and sell futures contracts based on underlying instruments with
different characteristics from the securities in which it typically invests--for
example, by hedging investments in portfolio securities with a futures contract
based on a broad index of securities--which involves a risk that the futures
position will not correlate precisely with the performance of the Fund's
investments.
Futures prices can also diverge from the prices of their underlying instruments,
even if the underlying instruments closely correlate with the Fund's
investments. Futures prices are affected by factors such as current and
anticipated short-term interest rates, changes in volatility of the underlying
instruments and the time remaining until expiration of the contract. Those
factors may affect securities prices differently from futures prices. Imperfect
correlations between the Fund's investments and its futures positions also may
result from differing levels of demand in the futures markets and the securities
markets, from structural differences in how futures and securities are traded,
and from imposition of daily price
<PAGE>
fluctuation limits for futures contracts. The Fund may buy or sell futures
contracts with a greater or lesser value than the securities it wishes to hedge
or is considering purchasing in order to attempt to compensate for differences
in historical volatility between the futures contract and the securities,
although this may not be successful in all cases. If price changes in the Fund's
futures positions are poorly correlated with its other investments, its futures
position may fail to produce desired gains or result in losses that are not
offset by the gains in the Fund's other investments.
Because futures contracts are generally settled within a day from the date they
are closed out, compared with a settlement period of seven days for some types
of securities, the futures markets can provide superior liquidity to the
securities markets. Nevertheless, there is no assurance that a liquid secondary
market will exist for any particular futures contract at any particular time. In
addition, futures exchanges may establish daily price fluctuation limits for
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, it may be impossible for the Fund to enter
into new positions or close out existing positions. If the secondary market for
a futures contract is not liquid because of price fluctuation limits or
otherwise, the Fund may not be able to promptly liquidate unfavorable futures
positions and potentially could be required to continue to hold a futures
position until the delivery date, regardless of changes in its value. As a
result, the Fund's access to other assets held to cover its futures positions
also could be impaired.
OPTIONS ON FUTURES CONTRACTS. The Fund may buy and write put and call options
on futures contracts for hedging purposes. An option on a future gives the Fund
the right (but not the obligation) to buy or sell a futures contract as a
specified price on or before a specified date. The purchase of a call option on
a futures contract is similar in some respects to the purchase of a call option
on an individual security. Depending on the pricing of the option compared to
either the price of the futures contract upon which it is based or the price of
the underlying instrument, ownership of the option may or may not be less risky
than ownership of the futures contract or the underlying instrument. As with the
purchase of futures contracts, when the Fund is not fully invested it may buy a
call option on a futures contract to hedge against a market advance.
The writing of a call option on a futures contract constitutes a partial hedge
against declining prices of the security or foreign currency which is
deliverable under, or of the index comprising, the futures contract. If the
futures price at the expiration of the option is below the exercise price, the
Fund will retain the full amount of the option premium which provides a partial
hedge
<PAGE>
against any decline that may have occurred in the Fund's portfolio holdings. The
writing of a put option on a futures contract constitutes a partial hedge
against increasing prices of the security or foreign currency which is
deliverable under, or of the index comprising, the futures contract. If the
futures price at expiration of the option is higher than the exercise price, the
Fund will retain the full amount of the option premium which provides a partial
hedge against any increase in the price of securities which the Fund is
considering buying. If a call or put option the Fund has written is exercised,
the Fund will incur a loss which will be reduced by the amount of the premium it
received. Depending on the degree of existing options on futures may to some
extent be reduced or increased by changes in the value of portfolio securities.
The purchase of a put option on a futures contract is similar in some respects
to the purchase of protective put options on portfolio securities. For example,
the Fund may buy a put option on a futures contract to hedge its portfolio
against the risk of falling prices.
The amount of risk the Fund assumes when it buys an option on a futures contract
is the premium paid for the option plus related transaction costs. In addition
to the correlation risks discussed above, the purchase of an option also entails
the risk that changes in the value of the underlying futures contract will not
be fully reflected in the value of the options bought.
FORWARD CONTRACTS. The Fund may enter into forward foreign currency exchange
contracts ("forward currency contracts") with stated contract values of up to
the value of the Fund's assets. A forward currency contract is on obligation to
buy or sell an amount of a specified currency for an agreed price (which may be
in U.S. dollars or a foreign currency). The Fund will exchange foreign
currencies for U.S. dollars and for other foreign currencies in the normal
course of business and may buy and sell currencies through forward currency
contracts in order to fix a price for securities it has agreed to buy or sell
("transaction hedge"). The Fund also may hedge some or all of its investments
denominated in foreign currency against a decline in the value of that currency
relative to the U.S. dollar by entering into forward currency contracts to sell
an amount of that currency (or a proxy currency whose performance is expected to
replicate the performance of that currency) approximating the value of some or
all of its portfolio securities denominated in that currency ("position hedge")
or by participating in options or futures contracts with respect to the
currency. The Fund also may enter into a forward currency contract with respect
to a currency where the Fund is considering the purchase of investments
denominated
<PAGE>
in that currency but has not yet done so ("anticipatory hedge").
In any of these circumstances the Fund may, alternatively, enter into a forward
currency contract with respect to a different foreign currency when the Fund
believes that the U.S. dollar value of that currency will correlate with the
U.S. dollar value of the currency in which portfolio securities of, or being
considered for purchase by, the Fund is denominated ("cross-hedge").
These types of hedging minimize the effect of currency appreciation as well as
depreciation, but do not protect against a decline in the security's value
relative to other securities denominated in the foreign currency. Shifting the
Fund's currency exposure from one foreign currency to another removes the
Funds's opportunity to profit from increases in the value of the original
currency and involves a risk of increased losses to the Fund if the Sub-
Adviser's projection of future exchange rates is inaccurate.
The Fund will cover outstanding forward positions by maintaining liquid
portfolio securities denominated in the currency underlying the forward contract
or, in the case of a cross-hedge, in the currency being hedged. To the extent
that the Fund is not able to cover its forward currency positions with
underlying portfolio securities, the Fund's custodian will segregate cash or
high-grade liquid assets having a value equal to the aggregate amount of the
Fund's commitments under forward contracts entered into with respect to position
hedges, cross-hedges and anticipatory hedges. If the value of the securities
used to cover a position or the value of segregated assets declines, the Fund
will find alternative cover or segregate additional cash or high-grade liquid
assets on a daily basis so that the value of the covered and segregated assets
will be equal to the amount of the Fund's commitments with respect to such
contracts. As an alternative to segregating assets, the Fund may buy call
options permitting the Fund to buy the amount of foreign currency being hedged
by a forward sale contract or the Fund may buy put options permitting it to sell
the amount of foreign currency subject to a forward buy contract.
While forward contracts are not currently regulated by the CFTC, the CFTC may in
the future assert authority to regulate forward contracts. In such event, the
Fund's ability to utilize forward contracts may be restricted. Forward contracts
will reduce the potential gain from a positive change in the relationship
between the U.S. dollar and foreign currencies. Unforeseen changes in currency
prices may result in poorer overall performance for the Fund than if it had not
entered into such contracts. The use of foreign currency forward contracts will
not eliminate fluctuations in the underlying U.S. dollar equivalent value of the
proceeds of or rates of return on the Fund's foreign currency
<PAGE>
denominated portfolio securities.
<PAGE>
The matching of the increase in value of a forward contract and the decline in
the U.S. dollar equivalent value of the foreign currency denominated asset that
is the subject of the hedge generally will not be precise. In addition, the Fund
may not always be able to enter into forward contracts at attractive prices and
may be limited in its ability to use these contracts to hedge Fund assets.
Also, with regard to the Fund's use of cross-hedges, there can be no assurance
that historical correlations between the movement of certain foreign currencies
relative to the U.S. dollar will continue. Poor correlation may exist between
movements in the exchange rates of the foreign currencies underlying the Fund's
cross-hedges and the movements in the exchange rates of the foreign currencies
in which its assets that are the subject of such cross-hedges are denominated.
OPTIONS ON FOREIGN CURRENCIES. The Fund may buy and write options on foreign
currencies for hedging purposes in a manner similar to that in which futures or
forward contracts on foreign currencies will be utilized. For example, a decline
in the U. S. dollar value of a foreign currency in which portfolio securities
are denominated will reduce the U.S. dollar value of such securities, even if
their value in the foreign currency remains constant. In order to protect
against such diminutions in the value of portfolio securities, the Fund may buy
put options on the foreign currency. If the value of the currency declines, the
Fund will have the right to sell such currency for a fixed amount in U.S.
dollars and will offset, in whole or in part, the adverse effect on its
portfolio.
Conversely, when a rise in the U.S. dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, the Fund may buy call options thereon. The purchase of
such options could offset, as least partially, the effects of the adverse
movements in exchange rates. As in the case of other types of options, however,
the benefit to the Fund from purchases of foreign currency options will be
reduced by the amount of the premium and related transaction costs. In addition,
if currency exchange rates do not move in the direction or to the extent
desired, the Fund could sustain losses on transactions in foreign currency
options that would require the Fund to forego a portion or all of the benefits
of advantageous changes in those rates.
The Fund may write options on foreign currencies for hedging purposes. For
example, to hedge against a potential decline in the U.S. dollar value of
foreign currency denominated securities due to adverse fluctuations in exchange
rates, the Fund could, instead of purchasing a put option, write a call option
on the
<PAGE>
relevant currency. If the expected decline occurs, the option will most likely
not be exercised and the diminution in value of portfolio securities will be
offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against a potential
increase in the U.S. dollar cost of securities to be acquired, the Fund could
write a put option on the relevant currency which, if rates move in the manner
projected, will expire unexercised and allow the Fund to hedge the increased
cost up to the amount of the premium. As in the case of other types of options,
however, the writing of a foreign currency option will constitute only a partial
hedge up to the amount of the premium. If exchange rates do not move in the
expected direction, the option may be exercised and the Fund would be required
to buy or sell the underlying currency at a loss which may not be offset by the
amount of the premium. Through the writing of options on foreign currencies, the
Fund also may lose all or a portion of the benefits which might otherwise have
been obtained from favorable movements in exchange rates.
The Fund may write covered call options on foreign currencies. A call option
written on a foreign currency by the Fund is "covered" if the Fund owns the
underlying foreign currency covered by the call or has an absolute and immediate
right to acquire that foreign currency without additional cash consideration (or
for additional cash consideration held in a segregated account by its custodian)
upon conversion or exchange of other foreign currency held in its portfolio. A
call option is also covered if the Fund has a call on the same foreign currency
and in the same principal amount as the call written if the exercise price of
the call held (i) is equal to or less than the exercise price of the call
written or (ii) is greater than the exercise price of the call written, if the
difference is maintained by the Fund in cash or high-grade liquid assets in a
segregated account with the Fund's custodian.
The Fund also may write call options on foreign currencies for cross-hedging
purposes that would not be deemed to be covered. A call option on a foreign
currency is for cross-hedging purposes if it is not covered but is designed to
provide a hedge against a decline due to an adverse change in the exchange rate
in the U.S. dollar value of a security which the Fund owns or has the right to
acquire and which is denominated in the currency underlying the option. In such
circumstances, the Fund collateralizes the option by maintaining, in a
segregated account with the Fund's custodian, cash or high-grade liquid assets
in an amount not less than the value of the underlying foreign currency in U.S.
dollars marked-to-market daily.
<PAGE>
OPTIONS ON SECURITIES. In an effort to reduce fluctuations in net asset value
and preserve the Fund's assets, the Fund may write covered put and call options
and buy covered put and call options on securities that are traded on United
States and foreign securities exchanges and over-the-counter. The Fund may write
and buy options on the same types of securities that the Fund may purchase
directly.
A put option written by the Fund is "covered" if the Fund (i) maintains cash not
available for investment or high-grade liquid assets with a value equal to the
exercise price in a segregated account with its custodian or (ii) holds a put on
the same security and in the same principal amount as the put written and the
exercise price of the put held is equal to or greater than the exercise price of
the put written. The premium paid by the buyer of an option will reflect, among
other things, the relationship of the exercise price to the market price and the
volatility of the underlying security, the remaining term of the option, supply
and demand and interest rates.
A call option written by the Fund is "covered" if the Fund owns the underlying
security covered by the call or has an absolute and immediate right to acquire
that security without additional cash consideration (or for additional cash
consideration held in a segregated account by its custodian) upon conversion or
exchange of other securities held in its portfolio. A call option is also deemed
to be covered if the Fund holds a call on the same security and in the same
principal amount as the call written and the exercise price of the call held (i)
is equal to or less than the exercise price of the call written or (ii) is
greater than the exercise price of the call written if the difference is
maintained by the Fund in cash and high-grade liquid assets in a segregated
account with its custodian.
The Fund also may write call options that are not covered for cross-hedging
purposes. The Fund collateralizes its obligation under a written call option for
cross-hedging purposes by maintaining cash or high-grade liquid assets in a
segregated account with its custodian in an amount not less than the market
value of the underlying security, marked to market daily. The Fund would write a
call option for cross-hedging purposes, instead of writing a covered call
option, when the premium to be received from the cross-hedge transaction would
exceed that which would be received from writing a covered call option and the
Sub-Adviser believes that writing the option would achieve the desired hedge.
The writer of an option may have no control when the underlying securities must
be sold, in the case of a call option, or bought, in the case of a put option,
since with regard to certain
<PAGE>
options, the writer may be assigned an exercise notice at any time prior to the
termination of the obligation. Whether or not an option expires unexercised, the
writer retains the amount of the premium. This amount, of course, may, in the
case of a covered call option, be offset by a decline in the market value of the
underlying security during the option period. If a call option is exercised, the
writer must fulfill the obligation to buy the underlying security at the
exercise price, which will usually exceed the then market value of the
underlying security.
The writer of an option that wishes to terminate its obligation may effect a
"closing purchase transaction." This is accomplished by buying an option of the
same series as the option previously written. The effect of the purchase is that
the writer's position will be canceled by the clearing corporation. However, a
writer may not effect a closing purchase transaction after being notified of the
exercise of an option. Likewise, an investor who is the holder of an option may
liquidate its position by effecting a "closing sale transaction". This is
accomplished by selling an option of the same series as the option previously
bought. there is no guarantee that either a closing purchase or a closing sale
transaction can be effected.
In the case of a written call option, effecting a closing transaction will
permit the Fund to write another call option on the underlying security with
either a different exercise price or expiration date or both. In the case of a
written put option, such transaction will permit the Fund to write another put
option to the extent that the exercise price thereof is secured by deposited
high-grade liquid assets. Effecting a closing transaction also will permit the
Fund to use the cash or proceeds from the con-current sale of any securities
subject to the option for other investments. If the Fund desires to sell a
particular security from its portfolio on which it has written a call option,
the Fund will effect a closing transaction prior to or concurrent with the sale
of the security.
The Fund will realize a profit from a closing transaction if the price of the
purchase transaction is less than the premium received from writing the option
or the price received from a sale transaction is more than the premium paid to
buy the option. The Fund will realize a loss from a closing transaction if the
price of the purchase transaction is more than the premium received from writing
the option or the price received from a sale transaction is less than the
premium paid to buy the option. Because increases in the market of a call option
generally will reflect increases in the market price of the underlying security,
any loss resulting from the repurchase of a call option is likely to be offset
in whole or in part by appreciation of the
<PAGE>
underlying security owned by the Fund.
An option position may be closed out only where a secondary market for an option
of the same series exists. If a secondary market does not exist, the Fund may
not be able to effect closing transactions in particular options and the Fund
would have to exercise the options in order to realize any profit. If the Fund
is unable to effect a closing purchase transaction in a secondary market, it
will not be able to sell the underlying security until the option expires or the
Fund delivers the underlying security upon exercise. The absence of a liquid
secondary market may be due to the following: (i) insufficient trading interest
in certain options, (ii) restrictions imposed by a national securities exchange
on which the option is traded ("Exchange") on opening or closing transactions or
both, (iii) trading halts, suspensions or other restrictions imposed with
respect to particular classes or series of options or underlying securities,
(iv) unusual or unforeseen circumstances that interrupt normal operations on an
Exchange, (v) the facilities of an Exchange or of the Options Clearing
Corporation ("OCC") may not at all times be adequate to handle current trading
volume, or (vi) one or more Exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the trading of options
(or a particular class or series of options), in which event the secondary
market on that Exchange (or in that class or series of options), in which event
the secondary market on that Exchange (or in that class or series of options)
would cease to exist, although outstanding options on that Exchange that had
been issued by the OCC as a result of trades on that Exchange would continue to
be exercisable in accordance with their terms.
The Fund may write options in connection with buy-and-write transactions. In
other words the Fund may buy a security and then write a call option against
that security. The exercise price of such call will depend upon the expected
price movement of the underlying security. The exercise price of a call option
may be below ("in-the-money"), equal to ("at-the-money") the current value of
the underlying security at the time the option is written. Buy-and-write
transactions using in-the-money call options may be used when it is expected
that the price of the underlying security will remain flat or decline moderately
during the option period. Buy-and-write transactions using at-the-money call
options may be used when it is expected that the price of the underlying
security will remain fixed or advance moderately during the option period. Buy-
and-write transactions using out-of-the-money call options may be used when it
is expected that the premiums received from writing the call option plus the
appreciation in the market price of the underlying security up to the exercise
price will be greater than the appreciation in the price of the underlying
security alone. If the call options are
<PAGE>
exercised in such transactions, the Fund's maximum gain will be the premium
received by it for writing the option, adjusted upwards or downwards by the
difference between the Fund's purchase price of the security and the exercise
price. If the options are not exercised and the price of the underlying security
declines, the amount of such decline will be offset by the amount of premium
received.
The writing of covered put options is similar in terms of risk and return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the Fund may elect to close the position or take
delivery of the security at the exercise price and the Fund's return will be the
premium received from the put options minus the amount by which the market price
of the security is below the exercise price.
The Fund may buy put options to hedge against a decline in the value of its
portfolio. By using put options in this way, the Fund will reduce any profit it
might otherwise have realized in the underlying security by the amount of the
premium paid for the put option and by transaction costs.
The Fund may buy call options to hedge against an increase in the price of
securities that it may buy in the future. The premium paid for the call option
plus any transaction costs will reduce the benefit, if any, realized by the Fund
upon exercise of the option, and, unless the price of the underlying security
rises sufficiently, the option may expire worthless to the Fund.
SWAPS AND SWAP-RELATED PRODUCTS. The Fund may enter into interest rate swaps,
caps and floors on either an asset-based or liability-based basis, depending
upon whether it is hedging its assets or its liabilities, and will usually enter
into interest rate swaps on a net basis (i.e., the two payment streams are
netted out, with the Fund receiving or paying, as the case may be, only the net
amount of the two payments). The net amount of the excess, if any, of the Fund's
obligations over its entitlement with respect to each interest rate swap will be
calculated on a daily basis and an amount of cash or high-grade liquid assets
having an aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account by the Fund's custodian. If the Fund enters
into an interest rate swap on other than a net basis, it would maintain a
segregated account in the full amount accrued on a daily basis of its
obligations with respect to the swap. The Fund will not
<PAGE>
enter into any interest rate swap, cap or floor transaction unless the unsecured
senior debt or the claims-paying ability of the other party thereto is rated in
one of the three highest rating categories of at least one nationally recognized
statistical rating organization at the time of entering into such transaction.
The Sub-Adviser will monitor the creditworthiness of all counterparties on an
ongoing basis. If there is a default by the other party to such a transaction,
the Fund will have contractual remedies pursuant to the agreements related to
the transaction.
The swap market has grown substantially in recent years with a large number of
banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. The Sub-Adviser has determined that,
as a result, the swap market has become relatively liquid. Caps and floors are
more recent innovations for which standardized documentation has not yet been
developed and, accordingly, they are less liquid than swaps. To the extent the
Fund sells (i.e., writes) caps and floors, it will maintain cash or high-grade
liquid assets having an aggregate net asset value at least equal to the full
amount, accrued on a daily basis, of its obligations with respect to any caps or
floors in a segregated account.
There is no limit on the amount of interest rate swap transactions that may be
entered into by the Fund. These transactions may in some instances involve the
delivery of securities or other underlying assets by the Fund or its
counterparty to collateralize obligations under the swap. Under the
documentation currently used in those markets, the risk of loss with respect to
interest rate swaps is limited to the net amount of the payments that the Fund
is contractually obligated to make. If the other party to an interest rate swap
that is not collateralized defaults, the Fund would risk the loss of the net
amount of the payments that it contractually is entitled to receive. The Fund
may buy and sell (i.e., write) caps and floors without limitation, subject to
the segregated account requirement described above.
ADDITIONAL RISKS OF OPTIONS ON FOREIGN CURRENCIES, FORWARD CONTRACTS AND FOREIGN
INSTRUMENTS. Unlike transactions entered into by the Fund in futures contracts,
options on foreign currencies and forward contracts are not traded on contract
markets regulated by the CFTC or (with the exception of certain foreign currency
options) by the SEC. To the contrary, such instruments are traded through
financial institutions acting as market-makers, although foreign currency
options re also traded on certain national securities exchanges, such as the
Philadelphia Stock Exchange and the Chicago Board Options Exchange, subject to
SEC regulation. Similarly, options on
<PAGE>
currencies may be traded over-the-counter. In an over-the-counter trading
environment, many of the protections afforded to exchange participants will not
be available. For example, there are no daily price fluctuation limits, and
adverse market movements could therefore continue to an unlimited extent over a
period of time. Although the buyer of an option cannot lose more than the amount
of the premium plus related transaction costs, this entire amount could be lost.
Moreover, an option writer and a buyer or seller of futures or forward contracts
could lose amounts substantially in excess of any premium received or initial
margin or collateral posted due to the potential additional margin and
collateral requirements associated with such positions.
Options on foreign currencies traded on national securities exchanges are within
the jurisdiction of the SEC, as are other securities traded on such exchanges.
As a result, many of the protections provided to traders on organized exchanges
will be available with respect to such transactions. In particular, all foreign
currency option positions entered into on a national securities exchange are
cleared and guaranteed by the OCC, thereby reducing the risk of counterparty
default. Further, a liquid secondary market in options traded on a national
securities exchange may be more readily available than in the over-the-counter
market, potentially permitting the Fund to liquidate open positions at a profit
prior to exercise or expiration, or to limit losses in the event of adverse
market movements.
The purchase and sale of exchange-traded foreign currency options, however, is
subject to the risks of the availability of a liquid secondary market described
above, as well as the risks regarding adverse market movements, margining of
options written, the nature of the foreign currency market, possible
intervention by governmental authorities and the effects of other political and
economic events. In addition, exchange-traded options on foreign currencies
involve certain risks not presented by the over-the-counter market. For example,
exercise and settlement of such options must be made exclusively through the
OCC, which has established banking relationships in applicable foreign countries
for this purpose. As a result, the OCC may, if it determines that foreign
governmental restrictions or taxes would prevent the orderly settlement of
foreign currency option exercises, or would result in undue burdens on the OCC
Or its clearing member, impose special procedures on exercise and settlement,
such as technical changes in the mechanics of delivery of currency, the fixing
of dollar settlement prices or prohibitions on exercise.
In addition, options on U.S. Government securities, futures
<PAGE>
contracts, options on futures contracts, forward contracts and options on
foreign currencies may be traded on foreign exchanges and over-the-counter in
foreign countries. Such transactions are subject to the risk of governmental
actions affecting trading in or the prices of foreign currencies or securities.
The value of such positions also could be adversely affected by (i) other
complex foreign political and economic factors, (ii) lesser availability than in
the United States of data on which to make trading decisions, (iii) delays in
the Fund's ability to act upon economic events occurring in foreign markets
during non-business hours in the United States, (iv) the imposition of different
exercise and settlement terms and procedures and margin requirements than in the
United States, and (v) low trading volume.
RISK FACTORS - FUTURES, OPTIONS AND OTHER DERIVATIVES
LENDING OF PORTFOLIO SECURITIES
The Fund may from time to time lend securities from its portfolio to brokers,
dealers and financial institutions and receive collateral from the borrower, in
the form of cash (which may be invested in short-term securities), U.S.
Government obligations or certificates of deposit. Such collateral will be
maintained at all times in an amount equal to at least 102% of the current
market value of the loaned securities, and will be in the actual or constructive
possession of the Fund during the term of the loan. The Fund will retain the
incidents of ownership of the loaned securities and will be entitled to the
interest or dividends payable on the loaned securities. In addition, the Fund
will recieve interest on the amount of the loan. The loans will be terminable by
the Fund at any time and will not be made to any affiliates of the Fund or the
Adviser. The Fund may pay reasonable finder's fees to persons unaffiliated with
it in connection with the arrangment of the loans.
As with any extensions of credit, there are risks of delay in recovery and, in
some cases, even loss of rights in the collateral or the loaned securities
should the borrower of securities fail financially. However, loans of portfolio
securities will be made only to firms deemed by the Adviser or Sub-Adviser to be
creditworthy. As a fundamental policy the Fund will not lend securities if, as a
result, more than 25% of its total assets would be lent to other parties.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION APPENDIX
This document is incorporated by reference to Post-Effective Amendment No. 2,
Registration Number 33-70272 filed on Form N-1A on April 30, 1995.
