<PAGE>
PREFACE TO THE LINCOLN NATIONAL FUND PROSPECTUSES
THE PREFACE AND DIRECTORY ARE PART OF THE PROSPECTUS FOR EACH OF THE FOLLOWING
FUNDS:
Lincoln National Aggressive Growth Fund, Inc. (AG)
Lincoln National Social Awareness Fund, Inc. (SA)
Shares of the FUNDS are sold to Lincoln National Life Insurance Co. (LINCOLN
LIFE) for allocation to its Variable Annuity Account L and to Lincoln Life &
Annuity Company of New York (LLANY) for allocation to its Variable Annuity
Account L. Lincoln Life and LLANY use these shares to fund VARIABLE ANNUITY
CONTRACTS.
Each of these Variable Annuity Accounts may be referred to as a VARIABLE
ACCOUNT. For each FUND, see Description of the fund in its Prospectus for a
statement of that FUND'S investment objective. Each of these FUNDS is referred
to individually as a FUND; collectively, as the FUNDS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (SEC) NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THESE PROSPECTUSES. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
These Prospectuses set forth concisely the information about each FUND that you
ought to know before investing. Please read and keep this Prospectus booklet for
future reference.
A separate STATEMENT OF ADDITIONAL INFORMATION (SAI) for each FUND has been
filed with the SEC. By this reference, each SAI, dated May 1, 1998, is
incorporated into the Prospectus of the FUND with which it is registered. A free
copy will be provided upon request. Either write Lincoln National Life Insurance
Co., P.O. Box 9740, Portland, Maine 04104 or call 1-800-341-0441. For Variable
Annuity contracts issued by LLANY, either write Lincoln Life & Annuity Company
of New York, TDA Client Services, P.O. Box 1337, Syracuse, NY 13201-1337 or call
1-800-893-1337.
The Financial Highlights table of each FUND contains per-share data calculated
on the basis of a share outstanding throughout the period, together with
financial ratios and other supplemental data. The Financial Highlights table is
incorporated by reference to the FUND'S 1997 Annual Report. A copy of the Annual
Report will be provided on request and without charge. Either write Lincoln
National Life Insurance Co., P.O. Box 9740, Portland, Maine 04104 or call
1-800-341-0441. For Variable Annuity contracts issued by LLANY, either write
Lincoln Life & Annuity Company of New York, TDA Client Services, P.O. Box 1337,
Syracuse, NY 13201-1337 or call 1-800-893-1337.
NO DEALER, SALESPERSON, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THESE
PROSPECTUSES, IN CONNECTION WITH THE OFFERS CONTAINED IN THEM. IF ANY ARE GIVEN
OR MADE, THE INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE FUND(S) IN QUESTION. THESE PROSPECTUSES DO NOT CONSTITUTE
OFFERS BY THE FUNDS TO SELL, OR SOLICITATIONS OF ANY OFFERS TO BUY, ANY OF THE
SECURITIES OFFERED BY THEM IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL FOR THE FUNDS TO MAKE THOSE OFFERS.
Prospectuses dated May 1, 1998
1
<PAGE>
DIRECTORY FOR THE FUND PROSPECTUSES
<TABLE>
<CAPTION>
SUBJECT PAGE
- --------------------------------------------------------
<S> <C>
PREFACE 1
DESCRIPTION OF THE FUND
Aggressive Growth Fund 3
Social Awareness Fund 9
- --------------------------------------------------------
INVESTMENT POLICIES AND TECHNIQUES
Aggressive Growth Fund 3
Social Awareness Fund 9
- --------------------------------------------------------
INVESTMENT RESTRICTIONS
Aggressive Growth Fund 6
Social Awareness Fund 10
- --------------------------------------------------------
STRATEGIC PORTFOLIO TRANSACTIONS
Aggressive Growth Fund 7
Social Awareness Fund 10
<CAPTION>
SUBJECT PAGE
- --------------------------------------------------------
<S> <C>
APPENDIX -- CONTAINS IMPORTANT INFORMATION
FOR ALL FUNDS
Net asset value 13
Management of the funds 13
Purchase of securities being offered 14
Sale and redemption of shares 14
Distributions and federal income tax
considerations 15
Management discussion of fund performance 15
Description of shares 15
Strategic portfolio transactions --
additional information 16
Foreign investments 18
General information 19
Statement of Additional Information
Table of contents 21
</TABLE>
2
<PAGE>
LINCOLN NATIONAL
AGGRESSIVE GROWTH FUND, INC.
DESCRIPTION OF THE FUND
The Aggressive Growth Fund (FUND) was incorporated in Maryland in 1993. It is a
diversified open-end management investment company whose investment objective is
to maximize capital appreciation. The FUND pursues its objective by investing in
a diversified portfolio of equity securities of small and medium-sized companies
which have a dominant position within their respective industries, are
undervalued or have potential for growth in earnings. The FUND invests primarily
in companies with market capitalizations of between $250 million and $5 billion
at the time of purchase. A company's market capitalization is calculated by
multiplying the total number of shares of its common stock outstanding by the
market price of the stock. The principal risks of this FUND are those associated
with investing in smaller, lesser-known companies. Investment in these companies
involves greater risk than investing in larger, more mature, better-known
issuers, including a greater possibility of portfolio price volatility than you
may find in broad stock market indices such as the Dow Jones Industrial Average
and the Standard & Poor's 500 Index (S&P 500). Additional risks are discussed
under Special risk factors.
In selecting investments, the ADVISOR or sub-advisor seeks small and medium
capitalization companies that it believes are either undervalued in the
marketplace or have earnings that may be expected to grow faster than the U.S.
economy in general. These companies will typically possess one or more of these
characteristics: high quality management, a leading or dominant position in a
product and a relatively high rate of return on uninvested capital. When
selecting stocks, little importance is placed on the anticipated dividend
income.
The FUND'S objective is fundamental and cannot be changed without the
affirmative vote of a majority of its outstanding voting securities. All other
investment policies and practices of the FUND are not fundamental and may be
changed by a majority vote of the Board of Directors. See General information in
the Appendix. There is no assurance that the objective of the FUND will be
achieved.
PORTFOLIO MANAGER
Since 1994, the FUND has been managed on a team basis by Edward J. Petner, Chief
Executive Officer and Chief Investment Officer and Kevin P. Ferguson, Senior
Vice President of Investment Management/Research of Lynch and Mayer, Inc. (L&M),
sub-advisor to the fund. Petner has been active in investment management since
1983, during which time he has worked for L&M. He holds a MBA from the Wharton
School University of Pennsylvania. Ferguson has been active in investment
management with L&M since 1992. He holds a MBA from New York University.
INVESTMENT POLICIES AND TECHNIQUES
The FUND will invest mainly in common stocks of small and medium-sized
companies. The FUND may invest up to 15% of its total assets in companies with
capitalizations of less than $250 million or greater than $5 billion at the time
of purchase. However, it may also invest up to 35% of the value of its assets in
convertible bonds; convertible preferred stock and warrants to purchase common
stock; futures contracts; and options contracts.
The FUND may invest up to 15% of its assets in securities of foreign issuers,
defined as those which are denominated in a foreign currency and not publicly
traded in the United States. Foreign investing involves risks that differ from
investing in U.S. markets. For a discussion of those risks see Foreign
investments in this Prospectus. A detailed discussion of how the FUND intends to
handle these risks appears in the SAI.
The FUND may invest its assets in the securities of issuers which have been in
continuous operation for less than three years. The securities of these
companies may have limited liquidity which can result in their being priced
lower than they may be otherwise. Investments in unseasoned companies are more
speculative and involve greater risk than do investments in companies with
established operating records.
For temporary defensive purposes when the ADVISOR or sub-advisor determines that
market conditions warrant, the FUND may invest up to 100% of its assets in money
market instruments, and may hold a portion of its assets in cash for liquidity
purposes. To the extent it is engaged in a temporary defensive position, the
FUND will not be pursuing its investment objective.
The FUND may invest in the following types of instruments or use the following
investment techniques:
CONVERTIBLE SECURITIES
The FUND may invest in securities that either have warrants or rights attached,
or are otherwise convertible. A convertible security is typically a fixed-income
security (a bond or preferred stock) that may be converted at a stated price
within a specified period of time into a
3
<PAGE>
specified number of shares of common stock of the same or a different issuer.
Convertible securities are generally senior to common stocks in a corporation's
capital structure but are usually subordinate to similar non-convertible
securities. Convertible securities provide a fixed-income stream which is
generally higher in yield than the income that can be derived from a common
stock, but lower than that afforded by a similar non-convertible security.
Because it can be converted into common stock, frequently a convertible security
will allow its holder to take advantage of increases in the market price of that
common stock. In general, the market value of a convertible security is at least
the higher of its investment value (that is, its value as a fixed-income
security) or its conversion value (that is, its value upon conversion into its
underlying common stock). While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
U.S. GOVERNMENT SECURITIES
The FUND may also invest in securities of the U.S. Government. Securities
guaranteed by the U.S. Government include: (1) direct obligations of the U.S.
Treasury (such as Treasury bills, notes and bonds) and (2) federal agency
obligations guaranteed as to principal and interest by the U.S. Treasury [such
as Government National Mortgage Association (GNMA) certificates and Federal
Housing Administration (FHA) debentures]. These securities are of the highest
possible credit quality, because the payment of principal and interest is
unconditionally guaranteed by the U.S. Government. They are subject to
variations in market value due to fluctuations in interest rates, but, if held
to maturity are deemed to be free of credit risk for the life of the investment.
Securities issued by U.S. Government instrumentalities and certain federal
agencies are neither direct obligations of, nor are they guaranteed by, the U.S.
Treasury. However, they do generally involve federal sponsorship in one way or
another. Some are backed by specific types of collateral. Some are supported by
the issuer's right to borrow from the U.S. Treasury. Some are supported by the
discretionary authority of the U.S. Treasury to purchase certain obligations of
the issuer. Others are supported only by the credit of the issuing government
agency or instrumentality. These agencies and instrumentalities include, but are
not limited to, Federal Land Banks, Farmers Home Administration, Central Bank
for Cooperatives, Federal Intermediate Credit Banks and Federal Home Loan Banks.
There is no guarantee that the government will support these types of
securities, and therefore they may involve more risk than other government
obligations.
U.S. Government securities may be acquired by the FUND in the form of
separately-traded principal and interest segments of selected securities issued
or guaranteed by the U.S. Treasury. These segments are traded independently
under the Separate Trading of Registered Interest and Principal Securities
(STRIPS) program. Under the STRIPS program, the principal and interest parts are
individually numbered and separately issued by the U.S. Treasury at the request
of depository financial institutions, which then trade the parts independently.
Obligations of the Resolution Funding Corp. are similarly divided into principal
and interest parts and maintained on the book entry records of the Federal
Reserve Banks.
The FUND may also invest in custodial receipts that evidence ownership of future
interest payments, principal payments, or both, on certain U.S. Treasury notes
or bonds in connection with programs sponsored by banks and brokerage firms.
Such notes and bonds are held in custody by a bank on behalf of the owners of
the receipts. These custodial receipts are known by various names, including
Treasury Receipts (TRs), Treasury Interest Guarantee Receipts (TIGRs), and
Certificates of Accrual on Treasury Securities (CATS) and may not be deemed U.S.
Government securities.
The FUND may invest occasionally in collective investment vehicles, the assets
of which consist principally of U.S. Government securities or other assets
substantially collateralized or supported by such securities, such as government
trust certificates.
In general, the U.S. Government securities in which the FUND invests do not have
as high a yield as do more speculative securities not supported by the U.S.
Government or its agencies or instrumentalities.
MONEY MARKET INSTRUMENTS
The FUND may invest in money market instruments without limit for temporary or
defensive purposes. These are shorter-term debt securities generally maturing in
one year or less. They include:
1. Commercial paper (short-term notes up to nine months duration issued by
corporations or government bodies);
2. Commercial bank obligations (certificates of deposit, interest-bearing time
deposits), bankers' acceptances (time drafts on a commercial bank where the
bank accepts an irrevocable obligation to pay at maturity), and documented
discount notes (corporate promissory discount notes accompanied by a
commercial bank guarantee to pay at maturity);
3. Corporate bonds and notes (corporate obligations that mature, or that may be
redeemed, in one year or less); and/or
4. Savings association obligations (certificates of deposit issued by mutual
savings banks or savings and loan associations).
4
<PAGE>
Even though certain floating or variable rate obligations (securities which have
a coupon rate that changes at least annually and generally more frequently) have
maturities in excess of one year, they are also considered to be short-term debt
securities.
SPECIAL SITUATIONS
At times, the FUND may invest in certain securities under special situations. A
special situation arises when, in the ADVISOR'S or sub-advisor's opinion, the
securities of a particular company will be recognized and will appreciate in
value due to a specific development at that company. Developments creating a
special situation might include a new product or process, a management change, a
technological breakthrough or another event considered significant. Investment
in special situations may carry an additional risk of loss in the event that the
anticipated development does not occur or does not attract the expected
attention. The impact of the strategy on the FUND will depend on the FUND'S size
and the extent of the holdings of the special situation company relative to its
total assets.
FOREIGN INVESTMENTS
There are certain risks involved in investing in foreign securities that do not
exist for domestic trading. One important risk is that of fluctuation in
currency exchange rates. When the ADVISOR or sub-advisor believes that a
currency in which a portfolio security or securities is denominated may suffer a
decline against the U.S. dollar, it may hedge that risk. It does so by entering
into a forward contract to sell an amount of foreign currency approximating the
value of some or all of the portfolio securities denominated in that foreign
currency.
For a discussion of other risks inherent in foreign investing, see Foreign
investments in the Appendix. A detailed discussion of how the FUND intends to
handle these risks appears in the SAI.
WHEN-ISSUED SECURITIES AND FIRM COMMITMENT AGREEMENTS
The FUND may purchase securities on a delayed delivery or when-issued basis and
enter into firm commitment agreements (transactions where the payment obligation
and interest rate are fixed at the time of the transaction but the settlement is
delayed). The transactions may involve either corporate or government
securities. The FUND, as purchaser, assumes the risk of any decline in value of
the security beginning on the date of the agreement or purchase. The FUND may
invest in when-issued securities in order to take advantage of securities that
may be especially under or over valued when trading on a when-issued basis.
The FUND will segregate liquid assets such as cash, U.S. Government securities,
or other appropriate high grade debt obligations in an amount sufficient to meet
its payment obligations in these transactions. Although these transactions will
not be entered into for leveraging purposes, to the extent the FUND'S aggregate
commitments under these transactions exceed its holdings of cash and securities
that do not fluctuate in value (such as money market instruments), the FUND
temporarily will be in a leveraged position (i.e., it will have an amount
greater than its net assets subject to market risk).
Should market values of the FUND'S portfolio securities decline while the FUND
is in a leveraged position, greater depreciation of its net assets would likely
occur than if it were not in such a position. The FUND will not borrow money to
settle these transactions. Instead, it will liquidate other portfolio securities
in advance of settlement, if necessary, to generate additional cash to meet its
obligations.
BORROWING
The FUND may borrow money for temporary or emergency purposes in amounts not
exceeding 25% of its total assets. If the FUND borrows money, its share price
may be subject to greater fluctuation until the amount borrowed is paid off.
Purchasing securities when the FUND has borrowed money may involve an element of
leverage. It will not purchase additional securities when the amount borrowed
exceeds 5% of its total assets.
ILLIQUID INVESTMENTS
Up to 15% of the FUND'S assets may be invested in securities or other
investments that are not readily marketable, including these:
1. Repurchase agreements with maturities greater than seven calendar days;
2. Time deposits maturing in more than seven calendar days;
3. To the extent a liquid secondary market does not exist for such instruments,
futures contracts and options on futures;
4. Certain over-the-counter options, as described in the SAI; and/or
5. Certain Rule 144A restricted securities (Rule 144A securities for which a
dealer or institutional market exists will not generally be considered
illiquid).
LOWER-RATED DEBT SECURITIES
The FUND has no pre-established minimum quality standards and may invest in debt
securities of any quality, including lower-rated bonds that may offer higher
yields because of the greater risk involved in those investments. It may invest
up to 15% of its assets in those securities, including junk bonds. Debt
securities rated below investment grade by the primary rating agencies (bonds
rated Ba or lower by Moody's Investors Service and BB or lower by Standard &
Poor's Corp.) constitute
5
<PAGE>
lower-rated securities. See the Appendix in the SAI for a description of these
ratings.
Securities rated below investment grade as well as unrated securities usually
are a greater risk (including the possibility of default or bankruptcy of the
issuers). They generally involve greater price volatility and risk of principal
and income, and may be less liquid than securities in higher-rated categories.
Both price volatility and illiquidity may make it difficult for the portfolio to
value these securities at certain times, and these securities may be difficult
to sell under certain market conditions. Prices for securities rated below
investment grade may be affected by legislation and regulatory developments.
SPECIAL RISK FACTORS
Investing in securities of smaller, lesser-known companies involves greater
risks than those normally associated with larger, more mature, well known firms,
including a risk of increasing potential portfolio price volatility. This is due
to the greater business risks of small size and limited product lines, markets,
distribution channels and financial and managerial resources. Historically,
small capitalization stocks and stocks of recently organized companies, in which
the FUND often invests, have been more volatile in price than the larger
capitalization stocks included in the S&P 500. Among the reasons for the greater
price volatility of these small company stocks are the less certain growth
prospects of smaller firms, the lower degree of liquidity in the markets for
such stocks, and the greater sensitivity of small companies to changing economic
conditions. The FUND may invest, without limitation, in Special situations
securities of small capitalization companies which may have experienced
financial difficulties.
The values of small company stocks may fluctuate independently of larger company
stock prices. Small company stocks may decline in price as large company stock
prices rise, or rise in price as large company stock prices decline. The
securities of companies with small stock market capitalizations may trade less
frequently and in limited volume. Investors therefore should expect that, to the
extent the FUND invests in stock of small-capitalization companies, the net
asset value of its shares may be more volatile than broad stock market indices
such as the S&P 500, and may fluctuate independently from those indices.
To the extent the FUND invests in fixed-income securities, the market value of
fixed-income obligations and, consequently, the FUND'S net asset value per
share, may vary inversely to changes in prevailing interest rates. You should
recognize that, in periods of declining interest rates, the yields of such
fixed-income securities will tend to be somewhat higher than prevailing market
rates. In periods of rising interest rates, the yields of those securities may
be somewhat lower.
PORTFOLIO TURNOVER
The FUND'S annual portfolio turnover rate is not expected to exceed 200% in any
particular year although market conditions could result in a greater degree of
market activity. (For example, a rate of portfolio turnover of 100% would occur
if all of the FUND'S portfolio were replaced in a period of one year.) High
turnover could result in additional brokerage commissions to be paid by the
FUND. During 1997 the FUND'S portfolio turnover was 105.07% and in 1996 it was
77.51%.
INVESTMENT RESTRICTIONS
The following investment restrictions have been adopted by the FUND as
fundamental policies. See General information in the Appendix. For purposes of
the following restrictions: (1) all percentage limitations apply immediately
after the making of an investment; and (2) any subsequent change in any
applicable percentage resulting from market fluctuations does not require
elimination of any security from the portfolio.
The FUND may not:
1. Purchase any security (other than securities issued or guaranteed by the
U.S. Government or its agencies or instrumentalities) if, immediately after
and as a result of such investment (a) more than 5% of the value of its
total assets would be invested in securities of the issuer, except that, as
to 25% of its total assets, up to 10% of its total assets may be invested in
securities issued or guaranteed as to payment of interest and principal by a
foreign government or its agencies or instrumentalities or by a
multinational agency, or (b) it would hold more than 10% of the voting
securities of the issuer, or (c) more than 25% of the value of its assets
would be invested in a single industry. Each of the electric utility,
natural gas distribution, natural gas pipeline, combined electric and
natural gas utility and telephone industries shall be considered as a
separate industry for this purpose and/or
2. Acquire securities subject to restrictions on disposition (except certain
restricted securities for which a dealer or institutional market exists) or
securities for which there is no readily available market, or enter into
repurchase agreements or purchase time deposits maturing in more than seven
days, if, immediately after and as a result, the value of such securities
would exceed, in the aggregate, 15% of its total assets.
A complete listing of all of the FUND'S fundamental and non-fundamental
restrictions can be found in the SAI.
6
<PAGE>
STRATEGIC PORTFOLIO TRANSACTIONS
The portfolio manager for the FUND has considerable discretion in the selection
of appropriate FUND investments. In the exercise of that discretion, the
portfolio manager may, at any given time, invest a portion of the FUND'S assets
in one or more strategic portfolio transactions which we define as derivative
transactions and cash enhancement transactions.
For your convenience, in the Appendix, we have included a basic discussion of
these special financial arrangement transactions and some of the risks
associated with them. Note also that the SAI booklet for the FUNDS contains
definitions of the more commonly used derivative transactions, technical
explanations of how these transactions will be used and the limits on their use.
You should consult your financial counselor if you have specific questions.
THE AGGRESSIVE GROWTH FUND IS AUTHORIZED:
a) for derivative transactions, to: buy and sell exchange-traded and
over-the-counter put and call options on stock and stock indices, on
fixed-income (interest rate) securities; on equity and fixed-income indices and
on other financial transactions; buy and sell futures contracts and options on
futures contracts; engage in swaps, caps, floors, collars and similar
interest-rate transactions; enter into currency forward contracts, currency
futures, currency swaps, options on currencies and options on currency futures.
The FUND will not enter into any futures contract or option on a futures
contract if, as a result, the sum of initial margin deposits on futures
contracts and related options and premiums paid for options on futures contracts
the FUND has purchased, after taking into account unrealized profits and losses
on such contracts, would exceed 5% of its total assets.
In addition to the above limitations, the FUND will not (1) sell futures
contracts, purchase put options, or write call options if, as a result, more
than 25% of its total assets would be hedged with futures and options under
normal conditions; (2) purchase futures contracts or write put options if, as a
result, its total obligations upon settlement or exercise of purchased futures
contracts and written put options would exceed 25% of its total assets; or (3)
purchase call options if, as a result, the current value of option premiums for
call options purchased by it would exceed 5% of its total assets. These
limitations do not apply to options attached to or acquired or traded together
with their underlying securities, and do not apply to securities that
incorporate features similar to options.
In addition, the value of all futures contracts sold will not exceed the total
market value of the FUND.
b) for cash enhancement transactions, to: lend portfolio securities; engage in
repurchase transactions. Collateral will be continually maintained at no less
than 102% of the value of the loaned securities or of the repurchase price, as
applicable.
7
<PAGE>
THIS PAGE WAS INTENTIONALLY LEFT BLANK.
8
<PAGE>
APPENDIX -- CONTAINS IMPORTANT INFORMATION FOR ALL FUNDS
This Appendix constitutes part of the Prospectuses of Lincoln National
Aggressive Growth Fund, Inc. (Aggressive Growth) and Lincoln National Social
Awareness Fund, Inc. (Social Awareness). Unless otherwise indicated, the
following information applies to each FUND.
NET ASSET VALUE
Each FUND'S net asset value per share is determined as of close of business
(currently 4:00 p.m., New York Time) on the New York Stock Exchange (NYSE) on
each day it is open for trading. The net asset value per share for each FUND is
determined by adding the values of all securities and other assets, subtracting
liabilities (including dividends payable) and dividing by the number of shares
outstanding. Debt securities and other assets of the FUND, other than equity
securities, for which market quotations are readily available, are valued at
their bid quotations.
When market quotations are not readily available, debt securities and other
assets are valued at their fair value as determined in good faith. This
valuation is made by or under the authority of each FUND'S Board of Directors
and it may include the use of valuations furnished by outside sources, including
pricing services which utilize electronic data processing techniques for valuing
normal institutional-size trading units of debt securities. The value of equity
securities is based on the last sale prices of those securities on national
securities exchanges or over-the-counter, or in the absence of recorded sales,
at the average of readily available closing bid and asked prices on exchanges or
over-the-counter. In the absence of readily available closing bid and asked
prices, equity securities will be valued at fair value. See the SAI Appendix for
a discussion of the methodology utilized to value short-term investments,
options, futures and options thereon, and foreign securities.
MANAGEMENT OF THE FUNDS
The business and affairs of each FUND are managed under the direction of its
Board of Directors. The Board has the power to amend the bylaws of each FUND, to
declare and pay dividends and to exercise all the powers of the FUND except
those granted to the shareholder. LINCOLN LIFE and LLANY are the sole
shareholders of each FUND.
INVESTMENT ADVISOR. LINCOLN INVESTMENT is the INVESTMENT ADVISOR to the FUNDS
and is headquartered at 200 East Berry Street, Fort Wayne, Indiana 46802.
LINCOLN INVESTMENT (THE ADVISOR) is registered with the Securities and Exchange
Commission (the Commission or SEC) as an INVESTMENT ADVISOR and has acted as an
INVESTMENT ADVISOR to mutual funds for over 40 years. The ADVISOR also acts as
INVESTMENT ADVISOR to Lincoln National Convertible Securities Fund, Inc., and
Lincoln National Income Fund, Inc., closed-end investment companies, and also
acts as sub-adviser to two of the series of Delaware Group Adviser Funds, Inc.,
an open-end series investment company.
The ADVISOR is a wholly-owned subsidiary of Lincoln National Corp. (LNC), a
publicly-held insurance holding company organized under Indiana law. Through its
subsidiaries, LNC provides life insurance and annuities, property-casualty
insurance, reinsurance and financial services. Directors, officers and employees
of the ADVISOR and each FUND are permitted to engage in personal securities
transactions subject to restrictions and procedures set forth in the Code of
Ethics adopted by the ADVISOR and each FUND. Such restrictions and procedures
include substantially all of the recommendations of the Advisory Group of the
Investment Company Institute and comply with SEC rules and regulations.
Under advisory agreements described in the Prospectus for the VARIABLE ACCOUNT,
the ADVISOR provides portfolio management and investment advice to the FUNDS and
administers their other affairs, subject to the supervision of each FUND'S Board
of Directors.
As compensation for its services to each FUND, the advisor is paid a monthly
investment advisory fee at an annual rate based on the average daily net asset
value of each FUND, as shown in the following chart:
<TABLE>
<CAPTION>
FUND ...OF AVERAGE DAILY NET ASSET VALUE
- ----------------------------------------------------------------------------------------------------------
<S> <C>
Aggressive Growth .75 of 1% of the first $200 million; .70 of 1% of the next $200
million; .65 of 1% of the excess over $400 million
Social Awareness .48 of 1% of the first $200 million; .40 of 1% of the next $200
million; and .30 of 1% in excess over $400 million
</TABLE>
- --------------------------------------------------------------------------------
13
<PAGE>
FUND EXPENSES (see accompanying text below)
<TABLE>
<CAPTION>
1997 RATIO OF THE
ADVISOR'S
COMPENSATION TO 1997 RATIO OF TOTAL
AVERAGE EXPENSES
FUND NET ASSETS TO AVERAGE NET ASSETS
- -------------------------------------------------------------------------------------
<S> <C> <C>
Aggressive Growth .73% .81%
Social Awareness .36 .41
</TABLE>
Other expenses specifically assumed by each FUND include: compensation and
expenses of Directors of the FUND who are not interested persons of the FUND as
defined in the 1940 Act; registration, filing, printing, and other fees in
connection with filings with regulatory authorities, including the costs of
printing and mailing updated Prospectuses and SAIs provided to current CONTRACT
OWNERs; fees and expenses of independent auditors; the expenses of printing and
mailing proxy statements and shareholder reports; custodian and transfer agent
charges; brokerage commissions and securities and options transaction costs
incurred by the FUND; taxes and corporate fees; fees for accounting, valuation
and related services; legal fees incurred in connection with the affairs of the
FUND (other than legal services provided by personnel of the ADVISOR or its
affiliated companies); the fees of any trade association of which the FUND is a
member; and expenses of shareholder and Director meetings.
SUB-ADVISORS. As ADVISOR, LINCOLN INVESTMENT is primarily responsible for
investment decisions affecting each of the FUNDS. However, LINCOLN INVESTMENT
has entered into sub-advisory agreements with professional investment management
firms. These firms provide some or substantially all of the investment advisory
services required by the FUNDS, including day-to-day investment management of
those FUNDS' portfolios. Each sub-advisor makes investment decisions for its
respective fund in accordance with that FUND'S investment objectives and places
orders on behalf of that FUND to effect those decisions. See the following
tables for more information about the sub-advisors and their fees:
<TABLE>
<CAPTION>
DATE OF ANNUAL FEE RATE BASED ON AVERAGE DAILY NET ASSET
FUND SUB-ADVISOR AGREEMENT VALUE
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Lynch & Mayer 12/20/93 .50 of 1% of the first $150 million .35 of 1% of the
Growth 520 Madison Avenue excess over $150 million
New York, NY 10022
- -------------
<CAPTION>
ANNUAL FEE RATE BASED ON MARKET VALUE OF SECURITIES
HELD IN THE PORTFOLIO OF EACH RESPECTIVE CLIENT FUND
DATE OF AT THE CLOSE OF BUSINESS ON THE LAST TRADING DAY OF
FUND SUB-ADVISOR AGREEMENT EACH CALENDAR QUARTER
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Social Vantage Investment 4/30/88 .20 of 1%
Awareness Advisors
630 5th Avenue
New York, NY 10111
</TABLE>
No additional compensation from the assets of the FUNDS will be assessed as a
result of the sub-advisory agreements; the sub-advisors are paid by LINCOLN
INVESTMENT.
SERVICE MARKS. The service mark for the FUNDS and the name Lincoln National have
been adopted by the FUNDS with the permission of LNC, and their continued use is
subject to the right of LNC to withdraw this permission in the event the advisor
should not be the INVESTMENT ADVISOR of the FUNDS.
PURCHASE OF SECURITIES BEING OFFERED
Shares of the FUNDS' common stock ($0.01 par value) will be sold to LINCOLN LIFE
and LLANY for allocation to the VARIABLE ACCOUNTS, which have been established
for the purpose of funding VARIABLE ANNUITY CONTRACTS. Shares of each FUND are
sold and redeemed at their net asset value per share determined daily. See Sale
and redemption of shares. Also see Net asset value. The FUNDS' shares are sold
to LINCOLN LIFE and LLANY for the VARIABLE ACCOUNTS on a no-load basis -- that
is, without the imposition of a sales charge.
SALE AND REDEMPTION OF SHARES
The shares of each FUND are sold and redeemed by the FUND at their net asset
value per share next determined after receipt by LINCOLN LIFE or LLANY of a
purchase or redemption order in acceptable form. Redemption of
14
<PAGE>
FUND shares held by LINCOLN LIFE or LLANY for its own account will be effected
at the FUND'S net asset value per share next determined after receipt of the
redemption request by the FUND. The value of shares redeemed may be more or less
than original cost, depending upon the market value of the portfolio securities
at the time of redemption. Payment for shares redeemed will be made within seven
days after the redemption request is received in proper form by the FUNDS.
However, the right to redeem FUND shares may be suspended or payment postponed
for any period during which (1) trading on the NYSE is restricted as determined
by the Commission, or the NYSE is closed for other than weekends and holidays;
(2) an emergency exists, as determined by the Commission, as a result of which
(a) disposal by each FUND of securities owned by it is not reasonably
practicable, or (b) it is not reasonably practicable for each FUND to determine
fairly the value of its net assets; or (3) the Commission by order so permits
for the protection of shareholders of the FUNDS.
DISTRIBUTION AND FEDERAL INCOME TAX CONSIDERATIONS
Each FUND'S policy is to distribute, at least once a year, substantially all of
its net investment income. Net realized capital gains may only be distributed
annually. These distributions, when paid to LINCOLN LIFE or LLANY for the
VARIABLE ACCOUNTS, will be reinvested automatically in additional shares of that
FUND, at its net asset value per share.
Each FUND intends to qualify and has elected to be taxed as a regulated
investment company under the provisions of Subchapter M of the Internal Revenue
Code of 1986, as amended (the CODE). If a FUND qualifies as a regulated
investment company and complies with the provisions of the CODE relieving
regulated investment companies which distribute substantially all of their net
income (both ordinary income and capital gain) from Federal income tax and the
4% nondeductible Federal excise tax, the FUNDS will be relieved of those taxes
on the amounts distributed. See the SAI for a more complete discussion.
Each FUND is subject to asset diversification requirements under Section 817(h)
of the code and the related regulation that the United States Treasury
Department has adopted. Each FUND intends to comply with these diversification
requirements.
Since the sole shareholders of the FUNDS are LINCOLN LIFE and LLANY, there is no
discussion here about the Federal income tax consequences at the shareholder
level. For information concerning the Federal income tax consequences to holders
of annuity or life insurance contracts, including the failure of a FUND to
comply with the diversification requirements discussed above. See the Prospectus
for the VARIABLE ACCOUNT.
MANAGEMENT DISCUSSION OF FUND PERFORMANCE
In the Annual Report for the FUNDS, the portfolio manager for each FUND
discusses that FUND'S performance for the previous fiscal year and the factors
which affected that performance. We will send you a copy of the Annual Report
free upon request.
DESCRIPTION OF SHARES
The authorized capital stock of Aggressive Growth and Social Awareness consists
of 50 million and 150 million shares of common stock respectively, $0.01 par
value. As of March 1, 1998, each FUND had the following number of shares issued
and outstanding:
<TABLE>
<S> <C>
Aggressive Growth 24,053,290
Social Awareness 39,436,497
</TABLE>
FUND shares will be owned by LINCOLN LIFE and LLANY and will be held in the
VARIABLE ACCOUNTS. As sole shareholders of each FUND, LINCOLN LIFE and LLANY
each may be deemed to be a control person as that term is defined under the 1940
Act. However, as stated in the Prospectuses for the VARIABLE ACCOUNTS, LINCOLN
LIFE provides to CONTRACT OWNERS of the VARIABLE ACCOUNTS the right to direct
the voting of FUND shares at shareholder meetings, to the extent provided by
law. LINCOLN LIFE and LLANY will vote for or against any proposition, or will
abstain from voting, any FUND shares attributable to a contract for which no
timely voting instructions are received, and any FUND shares held for its own
account, in proportion to the voting instructions that it received with respect
to all contracts participating in that FUND. However, if the 1940 Act or any
regulation under it should change, and as a result LINCOLN LIFE or LLANY
determines it is permitted to vote FUND shares in its own right, it may elect to
do so.
All the shares of each FUND are of the same class with equal rights and
privileges. Each full share is entitled to one vote and each fractional share is
entitled to a proportionate fractional vote, on all matters subjected to a vote
of the shareholder. All shares, full and fractional, participate proportionately
in any dividends and capital gains distributions and, in the event of
liquidation, in that FUND'S net assets remaining after satisfaction of
outstanding liabilities.
When issued, each share is fully-paid and non-assessable and the shareholder has
no preemptive or conversion rights. FUND shares have non-cumulative voting
rights, which means that holders of more than 50% of
15
<PAGE>
the shares voting for the election of directors can elect 100% of the directors
if they choose to do so. In that event the holders of the remaining shares so
voting will not be able to elect any directors. Shares may be redeemed as set
forth under Sale and redemption of shares.
The Bylaws of the FUNDS allow them, in proper cases, to dispense with their
annual meetings of shareholders. Generally, this may be done as long as: (1) a
majority of the Directors then in office have at some point been elected by
shareholders and, if any vacancy is filled by vote of the Board of Directors,
then immediately after filling the vacancy at least two thirds of the Directors
shall have been elected by the shareholder; (2) there is no change in the
independent auditor of the FUNDS; (3) there is no material change to the
investment advisory and/or sub-advisory agreements and/or fundamental policies;
and (4) a shareholder vote is not required with respect to a distribution
agreement. In adopting this procedure for dispensing with annual meetings that
are a formality, the Directors of the FUNDS have undertaken to comply with the
requirements of Section 16(c) of the 1940 Act. That Section protects CONTRACT
OWNERS by providing a procedure by which they may require management to convene
a meeting of the shareholders to vote on removal of one or more Directors. The
Directors also have agreed to facilitate communication among CONTRACT OWNERS for
the purpose of calling those meetings. Further information about these
procedures is available from FUND management.
STRATEGIC PORTFOLIO TRANSACTIONS -- ADDITIONAL INFORMATION
Because of their different investment objectives and portfolio management
philosophies the FUNDS engage to varying degrees in strategic portfolio
transactions, in order to preserve or enhance the value of their assets. These
can be generally identified as either derivative transactions or cash
enhancement transactions. Derivative transactions are recognized by the
investment community as an acceptable way to seek to increase each FUND'S
overall value (or, depending on the condition of the securities markets, at
least to slow its decrease). Cash enhancement transactions are designed to make
some extra money for the FUND when it has excess cash, or to help the FUND
obtain some cash for temporary purposes when needed. See the Prospectus for each
FUND for a listing of the kinds of transactions in which each FUND may engage.
1. DERIVATIVE TRANSACTIONS
A. Introduction
A derivative transaction is a financial agreement the value of which is
dependent upon the values of one or more underlying assets or upon the
values of one or more indices of asset values. The following types are
currently in fairly common use in the investment community, although not
every FUND will use all of them:
1. Equity contracts: stock options and indexed options; equity swaps;
stock index futures and options on futures; swaptions;
2. Interest rate contracts: interest rate futures and options on them;
forward rate agreements (FRAs); interest rate swaps and their related
transactions (e.g., caps, floors, collars and corridors); and/or
3. Currency derivative contracts: currency forward contracts; currency
options; currency futures; currency swaps; cross-currency interest rate
swaps.
SIMPLIFIED DEFINITIONS FOR THESE TRANSACTIONS ARE PROVIDED IN THE SAI APPENDIX.
Although they may be structured in complex combinations, derivative transactions
in which the FUNDS engage generally fall into two broad categories: options
contracts or forward contracts. The combined forms are constantly evolving. In
fact, variations on the types listed previously may come into use after the date
of these Prospectuses. Therefore, where the Prospectus for a particular FUND
discloses the intent of that FUND to engage in any of the types listed, that
FUND hereby reserves the right to engage in related variations on those
transactions.
The FUNDS intend to engage in derivative transactions only defensively. Examples
of this defensive use might be: to hedge against a perceived decrease in a
FUND'S asset value; to control transaction costs associated with market timing
(E.G., by using futures on an unleveraged basis); and to lock in returns,
spreads, or currency exchange rates in anticipation of future cash market
transactions.
B. Risk factors commonly associated with derivative transactions.
There are certain risks associated with derivatives, and some derivatives
involve more of these risks than others. We briefly describe the most
common ones here; however, this is not an exhaustive list. Consult your
financial counselor if you have additional questions.
CREDIT RISK is the possibility that a counterparty to a transaction will
fail to perform according to the terms and conditions of the transaction,
causing the holder of the claim to suffer a loss.
CROSS-CURRENCY SETTLEMENT RISK (or Herstatt risk) is related to the
settlement of foreign
16
<PAGE>
exchange contracts. It arises when one of the counterparties to a contract
pays out one currency prior to receiving payment of the other. Herstatt
risk arises because the hours of operation of domestic interbank fund
transfer systems often do not overlap due to time zone differences. In the
interval between the time one counterparty has received payment in one
indicated currency and the time the other counterparty(ies) receive
payment in the others, those awaiting payment are exposed to credit risk
and market risk.
LEGAL RISK is the chance that a derivative transaction, which involves
highly complex financial arrangements, will be unenforceable in particular
jurisdictions or against a financially troubled entity; or will be subject
to regulation from unanticipated sources.
MARKET LIQUIDITY RISK is the risk that a FUND will be unable to control
its losses if a liquid secondary market for a financial instrument does
not exist. It is often considered as the risk that a (negotiable or
assignable) financial instrument cannot be sold quickly and at a price
close to its fundamental value.
MARKET RISK is the risk of a change in the price of a financial
instrument, which may depend on the price of an underlying asset.
OPERATING RISK is the potential of unexpected loss from inadequate
internal controls or procedures; human error; system (including data
processing system) failure; or employee dishonesty.
SETTLEMENT RISK between two counterparties is the possibility that a
counterparty to whom a firm has made a delivery of assets or money
defaults before the amounts due or assets have been received; or the risk
that technical difficulties interrupt delivery or settlement even if the
counterparties are able to perform. In the latter case, payment is likely
to be delayed but recoverable.
SYSTEMIC RISK is the uncertainty that a disruption (at a firm, in a market
segment, to a settlement system, etc.) might cause widespread difficulties
at other firms, in other market segments, or in the financial system as a
whole.
SPECIAL NOTE FOR OPTIONS AND FUTURES TRANSACTIONS: Gains and losses on
options and futures transactions depend on the portfolio manager's ability
to correctly predict the direction of stock prices and interest rates, and
other economic factors. Options and futures trading may fail as hedging
techniques in cases where the price movements of the securities underlying
the options and futures do not follow the price movements of the portfolio
securities subject to the hedge. The loss from investing in futures
transactions is potentially unlimited.
SOME OF THESE RISKS MAY BE PRESENT IN EACH TYPE OF TRANSACTION, WHILE
OTHERS MAY PERTAIN ONLY TO CERTAIN ONES. These risks are discussed here
only briefly. Before you invest in a particular fund, please consult your
financial counselor if you have questions about the risks associated with
that FUND'S use of derivatives.
C. Varying usage of derivative transactions
Subject to the terms of the Prospectus and SAI for each FUND, that FUND'S
portfolio manager decides which types of derivative transactions to
employ, at which times and under what circumstances. For a description of
the limits, risk factors and circumstances under which derivative
transactions will be used by each FUND, refer to the SAI booklet.
D. Increased government scrutiny
Derivative transactions are coming under increased scrutiny by Congress
and industry regulators (such as the SEC and the Office of the Comptroller
of the Currency), and by self-regulatory agencies (such as the NASD).
Should legislation or regulatory initiatives be enacted resulting in
additional restrictive requirements for derivative transactions, LINCOLN
LIFE, LLANY and the FUNDS reserve the right to make all necessary changes
in the CONTRACTS and the Registration Statements for the FUNDS,
respectively, to comply with those requirements.
2. CASH ENHANCEMENT TRANSACTIONS
Cash enhancement transactions also involve certain risks to the fund. They are
discussed more fully in the SAI.
A. Lending of portfolio securities
Any FUND authorized to do so may make secured loans of its portfolio
securities, in order to realize additional income. The loans are limited
to a maximum of a stipulated amount of the FUND'S total assets. As a
matter of policy, securities loans are made to broker/dealers under
agreements requiring that the loans be continuously secured by collateral
in cash or short-term debt obligations at least equal at all times to 102%
of the value of the securities lent.
The borrower pays the FUND an amount equal to any dividends or interest
received on securities lent. The FUND retains all or a portion of the
interest received on securities lent. The FUND also retains all or a
portion of the interest received on
17
<PAGE>
investment of the cash collateral, or receives a fee from the borrower.
With respect to the loaned securities, voting rights or rights to consent
pass to the borrower. However, the FUND retains the right to call in the
loans and have the loaned securities returned at any time with reasonable
notice. This is important when issuers of the securities ask holders of
those securities -- including the FUND -- to vote or consent on matters
which could materially affect the holders' investment. The FUND may also
call in the loaned securities in order to sell them. None of the FUNDS'
portfolio securities will be loaned to LINCOLN INVESTMENT, to any
sub-advisor, or to any of their respective affiliates. The FUND may pay
reasonable finder's fees to persons unaffiliated with it in connection
with the arrangement of the loans.
B. Repurchase (Repo) transactions
Repos. From time to time, the FUNDS may enter into Repo transactions. In a
typical Repo transaction, the FUND involved buys U.S. Government or other
money market securities from a financial institution (such as a bank,
broker, or savings and loan association). At the same time, as part of the
arrangement, the FUND obtains an agreement from the seller to repurchase
those same securities from the FUND at a specified price on a fixed future
date.
The repurchase date is normally not more than seven days from the date of
purchase. Repurchase agreements maturing in more than seven days will be
considered illiquid and subject to the FUNDS restriction on illiquid
securities.
FOREIGN INVESTMENTS
There are certain risks involved in investing in foreign securities, including
those resulting from fluctuations in currency exchange rates; devaluation of
currencies; political or economic developments including the possible imposition
of currency exchange blockages or other foreign governmental laws or
restrictions; reduced availability of public information concerning issuers; and
the fact that foreign companies are not generally subject to uniform accounting,
auditing, and financial reporting standards or to other regulatory practices and
requirements comparable to those applicable to domestic companies. With respect
to certain foreign countries, there is also the possibility of expropriation,
nationalization, confiscatory taxation, and limitations on the use or removal of
cash or other assets of a FUND, including the withholding of interest payments
or dividends. These risks may be particularly great in so-called developing or
undeveloped countries, sometimes referred to as Emerging Markets.
In addition, while the volume of transactions effected on foreign stock
exchanges has increased in recent years, in most cases it remains appreciably
below that of the NYSE. Accordingly, a FUND'S foreign investments may be less
liquid and their prices may be more volatile than comparable investments in
securities of U.S. companies. Moreover, the settlement periods for foreign
securities, which are often longer than those for securities of U.S. issuers,
may affect portfolio liquidity. The FUNDS will incur costs in converting foreign
currencies into U.S. dollars. Custody charges are generally higher for foreign
securities. In buying and selling securities on foreign exchanges, a FUND
normally pays fixed commissions that are generally higher than the negotiated
commissions charged in the United States. In addition, there is generally less
governmental supervision and regulation of securities exchanges, brokers and
issuers in foreign countries that in the United States. There may be difficulty
in enforcing legal rights outside the United States. For example, in the event
of default on any foreign debt obligations, it may be more difficult or
impossible for the FUND to obtain or to enforce a judgment against the issuers
of these securities. The ADVISOR or sub-advisor will take all these factors into
consideration in managing a FUND'S foreign investments.
Certain state insurance regulations impose additional restrictions on the extent
to which a FUND may invest in foreign securities. See the SAI.
The share price of a FUND that invests in foreign securities will reflect the
movements of both the prices of the portfolio securities and the currencies in
which those securities are denominated. Depending on the extent of a FUND'S
investments abroad, changes in a FUND'S share price may have a low correlation
with movements in the U.S. markets. Because most of the foreign securities in
which the FUND invests will be denominated in foreign currencies, or otherwise
will have values that depend on the performance of foreign currencies relative
to the U.S. dollar, the relative strength of the U.S. dollar may be an important
factor in the performance of the FUND.
FOREIGN CURRENCIES
The following only applies to Aggressive Growth. When the ADVISOR or sub-advisor
believes that a currency in which a portfolio security or securities is
denominated or exposed may suffer a decline against the U.S. dollar, it may
hedge that risk by entering into a forward contract to sell an amount of foreign
currency approximating the value of some or all of the portfolio securities
denominated in or exposed to that foreign currency.
Because foreign securities generally are denominated and pay dividends or
interest in foreign currencies, and a FUND may hold various foreign currencies,
the value of
18
<PAGE>
the net assets of that FUND as measured in U.S. dollars will be affected
favorably or unfavorably by changes in exchange rates. Generally, currency
exchange transactions will be conducted on a spot (i.e., cash) basis at the spot
rate prevailing in the currency exchange market. The cost of currency exchange
transactions will generally be the difference between the bid and offer spot
rate of the currency being purchased or sold. Some foreign currency values may
be volatile, and there is the possibility of government controls on currency
exchange or governmental intervention in currency markets which could adversely
affect the FUND.
Investors should be aware that exchange rate movements can be significant and
can endure for long periods of time. In order to protect against uncertainty in
the level of future foreign currency exchange rates, the FUND'S ADVISOR or
sub-advisor may attempt to manage exchange rate risk through active currency
management, including the use of certain foreign currency hedging transactions.
For example, it may hedge some or all of its investments denominated in a
foreign currency against a decline in the value of that currency relative to the
U.S. dollar by entering into contracts to exchange that currency for U.S.
dollars (not exceeding the value of the FUND'S assets denominated in or exposed
to that currency), or by participating in options or futures contracts with
respect to that currency. If the ADVISOR or sub-advisor believes that a
particular currency may decline relative to the U.S. dollar, the FUND may also
enter into contracts to sell that currency (up to the value of the FUND'S assets
denominated in or exposed to that currency) in exchange for another currency
that the ADVISOR or sub-advisor expects to remain stable or to appreciate
relative to the U.S. dollar. This technique is known as currency cross-hedging.
These strategies are intended to minimize the effect of currency appreciation as
well as depreciation, but do not protect against a decline in the underlying
value of the hedged security. In addition, these strategies may reduce or
eliminate the opportunity to profit from increases in the value of the original
currency and may adversely impact the FUND'S performance if the ADVISOR or
sub-advisor's projection of future exchange rates is inaccurate. See Strategic
portfolio transactions.
Additionally, several European countries are participating in the European
Economic and Monetary Union, which will establish a common European currency for
participating countries. This currency will commonly be known as the "Euro". It
is anticipated that each such participating country will replace its existing
currency with the Euro on January 1, 1999. Additional European countries may
elect to participate after that date. FUNDS investing in securities of
participating countries could be adversely affected if the computer systems used
by their major service providers are not properly prepared to handle both the
imminent implementation of this single currency and the prospect of the adoption
of the Euro by additional countries in the future. These FUNDS are taking steps
to obtain satisfactory assurances that their major service providers are, in
turn, taking steps reasonably designed to address these matters with respect to
the computer systems they use. There can be no assurances that these steps will
be sufficient to avoid any adverse impact on the business of any FUND.
GENERAL INFORMATION
Your inquiries should be directed to Lincoln National Life Insurance Co., at
P.O. Box 9740, Portland, Maine 04104 or call 1-800-341-0441. For Variable
Annuity contracts issued by LLANY, inquiries should be directed to Lincoln Life
& Annuity Company of New York, TDA Client Services, P.O. Box 1337, Syracuse, NY
13201-1337 or call 1-800-893-1337.
The FUNDS will issue unaudited semiannual reports showing current investments in
each FUND and other information; and annual financial statements audited by
their independent auditors. In 1998, in response to certain changes to the
federal securities laws, the Board of Directors of Social Awareness recommended,
and shareholders approved, changes to the fundamental policy of the FUND. The
Board of Directors of each FUND also changed or eliminated certain
non-fundamental policies of the FUNDS.
Under the 1940 Act a fundamental policy of a fund may not be changed without the
affirmative vote of a majority of the fund's outstanding shares.
As used in this Prospectus, the term majority of the FUND'S outstanding shares
means the vote of: (1) 67% or more of each FUND'S shares present at a meeting,
if the holders of more than 50% of the outstanding shares of each FUND are
present or represented by proxy, or (2) more than 50% of each FUND'S outstanding
shares, whichever is less.
These Prospectuses do not contain all the information included in their
Registration Statements filed with the Commission. The Registration Statements,
including the exhibits filed with them, may be examined at the office of the
Commission in Washington, D.C. Statements contained in the Prospectuses about
the contents of any CONTRACT or other document referred to in them are not
necessarily complete. In each instance, reference is made to the copy of that
CONTRACT or other document filed as an exhibit to the Registration Statement of
which the particular Prospectus forms a part, and each statement is qualified in
all respects by that reference.
Due to differences in redemption rates, tax treatment, or other considerations,
the interests of CONTRACT OWNERS under one VARIABLE ACCOUNT may conflict with
those of
19
<PAGE>
CONTRACT OWNERS under another variable account or other variable annuity
accounts. For example, violation of the federal tax laws by one VARIABLE ACCOUNT
investing in the FUNDS could cause the contracts and Policies funded through
another VARIABLE ACCOUNT to lose their tax-deferred status, unless remedial
action were taken. The Board of Directors of each FUND will monitor for any
material conflicts and determine what action, if any, should be taken.
Should any conflict arise which requires that a substantial amount of assets be
withdrawn from any of the FUNDS, orderly portfolio management could be
disrupted, to the detriment of those CONTRACT OWNERS still investing in that
FUND. Also, if that FUND believes that any portfolio has become so large as to
materially impair investment performance, then the FUND will examine other
investment options.
LINCOLN LIFE performs the dividend and transfer functions for the FUNDS.
PREPARING FOR YEAR 2000
THE 'YEAR 2000' ISSUE. Many existing computer programs use only two digits to
identify a year in the date field. These programs were designed and developed
without considering the impact of the upcoming change in the century. If not
corrected, many computer applications could fail or create erroneous results by
or at the year 2000. This 'year 2000 issue' affects virtually all companies and
organizations.
Lincoln Life is responsible, as part of its year 2000 updating process, for the
updating of FUND-related computer systems. An affiliate of Lincoln Life,
Delaware Service Company (Delaware), provides substantially all of the necessary
accounting and valuation services for the FUNDS. Delaware, for its part, is
responsible for updating all of its computer systems, including those which
serve the FUNDS, to accommodate the year 2000. Lincoln Life and Delaware have
begun formal discussions with each other to assess the requirements for their
respective systems to interface properly in order to facilitate the accurate and
orderly operation of the FUND beginning in the year 2000.
The year 2000 issue is pervasive and complex and affects virtually every aspect
of the businesses of Lincoln Life, Delaware, and the FUNDS (the Companies). The
computer systems of Lincoln Life and Delaware (including those computer systems
which serve the FUNDS) and their interfaces with the computer systems of
vendors, suppliers, customers and other business partners are particularly
vulnerable. The inability to properly recognize date-sensitive electronic
information and to transfer data between systems could cause errors or even
complete failure of systems, which would result in a temporary inability to
process transactions correctly and engage in normal business activities for the
FUNDS. Lincoln Life and Delaware, respectively, are redirecting significant
portions of their internal information technology efforts and are contracting,
as needed, with outside consultants to help update their systems to accommodate
the year 2000. Also, in addition to the discussions with each other noted above,
Lincoln Life and Delaware have respectively initiated formal discussions with
other critical parties that interface with their systems to gain an
understanding of the progress by those parties in addressing year 2000 issues.
While Lincoln Life and Delaware are making substantial efforts to address their
own systems (including those which serve the FUNDS) and the systems with which
they interface, it is not possible to provide assurance that operational
problems will not occur. Lincoln Life and Delaware presently believe that,
assuming the modification of existing computer systems, updates by vendors and
conversion to new software and hardware, the year 2000 issue will not pose
significant operations problems for their respective computer systems. In
addition, the Companies are incorporating potential issues surrounding year 2000
into their contingency planning process, in the event that, despite these
substantial efforts, there are unresolved year 2000 problems. If the remediation
efforts noted above are not completed timely or properly, the year 2000 issue
could have a material adverse impact on the operation of the businesses of
Lincoln Life, Delaware, the FUNDS, or all of them.
The cost of addressing year 2000 issues and the timeliness of completion will be
closely monitored by management for Lincoln Life, Delaware and the FUNDS.
Nevertheless, there can be no guarantee by Lincoln Life, by Delaware or by the
FUNDS that estimated costs will be achieved, and actual results could differ
significantly from those anticipated. Specific factors that might cause such
differences include, but are not limited to, the availability and cost of
personnel trained in this area, the ability to locate and correct all relevant
computer problems, and other uncertainties.
20
<PAGE>
STATEMENT OF ADDITIONAL
INFORMATION TABLE OF
CONTENTS
<TABLE>
<CAPTION>
ITEM ITEM
- ------------------------------------------------ ------------------------------------------------
<S> <C>
General Information and History Appendix
Investment objective Investment advisor and sub-advisor
Investment policies and techniques Directors and officers
Investment restrictions Investment policies and techniques
Portfolio transactions and brokerage (continued): options, futures, securities
Determination of net asset value valuation, securities lending, repurchase and
reverse repurchase agreements
Custodian
Independent auditors
Financial statements
Bond and commercial paper ratings
U.S. Government obligations
Taxes
State requirements
Derivative transactions -- definitions
*NOTE: THIS IS A GENERIC TABLE. THERE ARE
VARIATIONS IN THE CONTENTS OF THE SAI FROM FUND
TO FUND.
</TABLE>
- --------------------------------------------------------------------------------
Please send me a free copy of the current Statement of Additional Information
for the FUNDS
(Please Print)
Name: __________________________________________________________________________
Address: _______________________________________________________________________
City _________________________________ State ____________________ Zip __________
Mail to Lincoln National Life Insurance Co., P.O. Box 9740, Portland, Maine
04104 or Lincoln Life & Annuity Company of New York, TDA Client Services, P.O.
Box 1337, Syracuse, NY 13201-1337
21
<PAGE>
THIS PAGE WAS INTENTIONALLY LEFT BLANK.
22
<PAGE>
LINCOLN NATIONAL
AGGRESSIVE GROWTH FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
This SAI should be read in conjunction with the Prospectus
of Lincoln National Aggressive Growth Fund, Inc. (FUND)
dated May 1, 1998. You may obtain a copy of the FUND'S
Prospectus on request and without charge. Please write
Lincoln National Life Insurance Co., P.O. Box 2340, Fort
Wayne, Indiana 46801 or call 1-800-4LINCOLN (454-6265).
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
- -----------------------------------------------------
INVESTMENT OBJECTIVE AG- 2
- -----------------------------------------------------
INVESTMENT POLICIES AND TECHNIQUES AG- 2
- -----------------------------------------------------
INVESTMENT RESTRICTIONS AG- 9
- -----------------------------------------------------
PORTFOLIO TRANSACTIONS AND BROKERAGE AG-10
- -----------------------------------------------------
DETERMINATION OF NET ASSET VALUE AG-11
- -----------------------------------------------------
APPENDIX
Investment advisor and sub-advisor A- 1
- -----------------------------------------------------
Directors and officers A- 3
- -----------------------------------------------------
Investment policies and techniques
(continued): options, futures, securities
valuation, securities lending, repurchase
and reverse repurchase agreements A- 4
- -----------------------------------------------------
<CAPTION>
PAGE
- -----------------------------------------------------
<S> <C>
Custodian A- 9
- -----------------------------------------------------
Independent auditors A- 9
- -----------------------------------------------------
Financial statements A- 9
- -----------------------------------------------------
Bond and commercial paper ratings A- 9
- -----------------------------------------------------
U.S. Government obligations A-11
- -----------------------------------------------------
Taxes A-12
- -----------------------------------------------------
State requirements A-12
- -----------------------------------------------------
Derivative transactions-definitions A-12
- -----------------------------------------------------
</TABLE>
THIS SAI IS NOT A PROSPECTUS.
The date of this SAI is May 1, 1998.
AG-1
<PAGE>
INVESTMENT OBJECTIVE
Lincoln National Aggressive Growth Fund, Inc. (the FUND) was incorporated in
Maryland in 1993 as an open-end diversified management investment company whose
investment objective is to maximize capital appreciation. The FUND pursues its
investment objective by investing in a diversified portfolio of equity
securities of small and medium-sized companies with favorable growth prospects.
The FUND invests primarily in companies with market capitalizations of between
$250 million and $5 billion at the time of purchase. A company's market
capitalization is calculated by multiplying the total number of shares of its
common stock outstanding by the market price of the stock.
The principal risks of this FUND are those associated with investing in smaller,
lesser-known companies. Such companies involve greater risks than investing in
larger, more mature, better known issuers, including increasing the possibility
of portfolio price volatility. Additional risks are discussed under Special risk
factors in the Prospectus.
The FUND'S investment objective is 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 Appendix to the Prospectus.) There can be no
assurance that the objective of the FUND will be achieved. References to ADVISOR
in this SAI include both Lincoln Investment Management, Inc. (LINCOLN
INVESTMENT) and Lynch & Mayer, Inc.
INVESTMENT POLICIES AND TECHNIQUES
The Prospectus discusses the investment policies and techniques used to pursue
the FUND'S investment objective. The following discussion supplements the
description of the investment policies and techniques in the
Prospectus.(Italicized terms that are not defined herein are defined in the
FUND'S Prospectus.)
LOWER-RATED DEBT SECURITIES
Lower-rated debt securities are often considered speculative and involve
significantly higher risk of default on the payment of principal and interest or
are more likely to experience significant price fluctuation due to changes in
the issuer's creditworthiness. Market prices of these securities may fluctuate
more than higher-rated debt securities and may decline significantly in periods
of general economic difficulty which may follow periods of rising interest
rates. Accordingly, past experience may not provide an accurate indication of
future performance of the high yield bond market, especially during periods of
economic recession.
The market for lower-rated debt securities may be less active than that for
higher-rated debt securities, which can adversely affect the prices at which
these securities can be sold. If market quotations are not available, these
securities will be valued in accordance with procedures established by the Board
of Directors, including the use of outside pricing services. Judgment plays a
greater role in valuing lower-rated corporate debt securities than is the case
for securities for which more external sources for quotations and last-sale
information are available. Adverse publicity and changing investor perceptions
may affect the ability of outside pricing services used by the FUND to value its
portfolio securities and the FUND'S ability to dispose of these lower-rated debt
securities.
Since the risk of default is higher for lower-rated debt securities, the
ADVISOR'S and/or sub-advisor's research and credit analysis is an integral part
of managing any securities of this type held by the FUND. In considering
investments for the FUND, the ADVISOR and/or sub-advisor, if any, will attempt
to identify those issuers of high-yielding debt securities whose financial
condition is adequate to meet future obligations, has improved, or is expected
to improve in the future. The ADVISOR'S and/or sub-advisor's analysis focuses on
relative values based on such factors as interest or dividend coverage, asset
coverage, earnings prospects, and the experience and managerial strength of the
issuer. There can be no assurance that such analysis will prove accurate.
The FUND may choose, at its expense or in conjunction with others, to pursue
litigation or otherwise exercise its rights as security holder to seek to
protect the interests of security holders if it determines this to be in the
best interest of shareholders.
STRATEGIC PORTFOLIO TRANSACTIONS
GENERAL. The FUND may, but is not required to, utilize various other investment
strategies described in the Prospectus under Strategic portfolio transactions to
hedge various market risks (such as interest rates, currency exchange rates, and
broad or specific equity or fixed-income market movements), to manage the
effective maturity or duration of fixed-income securities in its portfolio or to
enhance potential gain. Such strategies are generally accepted as 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, the FUND may engage in the
derivative transactions described in the Prospectus. Strategic portfolio
transactions may be used to attempt to protect against possible changes in the
market value of securities held in or to be purchased for the FUND resulting
from securities markets or currency exchange rate fluctuations; to protect the
AG-2
<PAGE>
FUND'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 fixed-income securities; or to establish a position in
the derivatives markets as a temporary substitute for purchasing or selling
particular securities. Any or all of these investment techniques may be used at
any time and there is no particular strategy that dictates the use of one
technique rather than another, as use of any strategic transaction is a function
of numerous variables including market conditions. The ability of the FUND to
utilize these strategic transactions successfully will depend on the ADVISOR'S
or sub-advisor's ability to predict pertinent market movements, which cannot be
assured. The FUND will comply with applicable regulatory requirements when
implementing these strategies, techniques and instruments. Strategic
transactions involving financial futures and options thereon will be purchased,
sold or entered into only for a bona fide hedging, risk management or portfolio
management purposes and not for speculative purposes. Additional information
relating to certain financial instruments or strategies is set forth below. In
addition, see Special risks of strategic transactions below for a discussion of
certain risks.
LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS. The FUND 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 regulates trading in the futures markets, before
engaging in any purchases or sales of futures contracts or options on futures
contracts. Pursuant to Section 4.5 of the regulations under the Commodity
Exchange Act, each notice of eligibility will include the following
representations:
Normally the FUND expects to use futures contracts and related options solely
for bona fide hedging purposes, as that term is defined in CFTC regulations.
However, in addition, the FUND may take positions in futures contracts and
related options which do not come within the CFTC definition, as long as the
aggregate initial margin and premiums required to establish those positions does
not exceed 5% of the net asset value of the FUND (after taking into account
unrealized profits and unrealized losses on any such contracts into which it has
entered).
In addition to the above limitations, the FUND will not (a) sell futures
contracts, purchase put options or write call options if, as a result, more than
25% of its total assets would be hedged with futures and options under normal
conditions; (b) purchase futures contracts or write put options if, as a result,
its total obligations upon settlement or exercise of purchased futures contracts
and written put options would exceed 25% of its total assets; or (c) purchase
call options if, as a result, the current value of option premiums for call
options purchased by it would exceed 5% of its total assets. These limitations
do not apply to options attached to or acquired or traded together with their
underlying securities, and do not apply to securities that incorporate features
similar to options.
The limitations on the FUND'S investments in futures contracts and options, and
the FUND'S policies regarding futures contracts and options discussed elsewhere
are not fundamental policies and may be changed as regulatory agencies permit.
OPTIONS ON CURRENCIES AND SECURITIES
The FUND may purchase and sell (write) put and call options on securities,
although the present intent is to write only covered call options. These covered
call options must remain covered so long as the FUND is obligated as a writer. A
call option written by the FUND is covered if the FUND owns the security
underlying the option 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 the FUND'S custodian) upon
conversion or exchange of other securities held in its portfolio. A call option
is also covered if the FUND holds on a share-for-share basis a call on the same
security as the call written where the exercise price of the call held is equal
to or less than the exercise price of the call written or greater than the
exercise price of the call written if the difference is maintained by the FUND
in cash, treasury bills or other high grade, short-term debt obligations in a
segregated account with the FUND'S custodian. The premium paid by the purchaser
of an option will reflect, among other things, the relationship of the exercise
price to the market price and volatility of the underlying security, the
remaining term of the option, supply and demand and interest rates.
If the writer of an option wishes to terminate the obligation, it 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 it has been notified
of the exercise of an option. Similarly, 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
purchased. There is no guarantee that either a closing purchase or a closing
sale transaction can be effected. To secure the obligation to deliver the
underlying security in the case of a call option, the writer of the option
(whether an exchange-traded option or a NASDAQ option) is required to pledge for
the benefit of the broker the underlying security or other assets in accordance
with the rules of The Options Clearing Corp. (OCC), the Chicago Board of Trade
and the Chicago Mercantile Exchange, institutions which
AG-3
<PAGE>
interpose themselves between buyers and sellers of options. Technically, each of
these institutions assumes the other side of every purchase and sale transaction
on an exchange and, by doing so, guarantees the transaction.
An option position may be closed out only on an exchange, board of trade or
other trading facility which provides a secondary market for an option of the
same series. Although the FUND will generally purchase or write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market on an exchange or other trading
facility will exist for any particular option, or at any particular time, and
for some options no secondary market on an exchange or otherwise may exist. In
such event, it might not be possible to effect closing transactions in
particular options, with the result that the FUND would have to exercise its
options in order to realize any profit and would incur brokerage commissions
upon the exercise of call options and upon the subsequent disposition of
underlying securities acquired through the exercise of call options or upon the
purchase of underlying securities for the exercise of put options. If the FUND
as a covered call option writer 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 it delivers the underlying security upon
exercise.
Reasons for the absence of a liquid secondary market on an exchange include the
following: (1) there may be insufficient trading interest in certain options;
(2) restrictions may be imposed by an exchange on opening transactions or
closing transactions, or both; (3) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options or underlying securities; (4) unusual or unforeseen circumstances may
interrupt normal operations on an exchange, (e.g., the facilities of an exchange
or a clearing corporation may not at all times be adequate to handle current
trading volume); or (5) 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 the class or series of options) would
cease to exist, although outstanding options on that exchange that had been
issued by a clearing corporation as a result of trades in that exchange would
continue to be exercisable in accordance with their terms. There is no assurance
that higher than anticipated trading activity or other unforeseen events might
not, at times, render certain of the facilities of any of the clearing
corporations inadequate, and thereby result in the institution by an exchange of
special procedures which may interfere with the timely execution of customers'
orders. However, the OCC, based on forecasts provided by the U.S. exchanges,
believes that its facilities are adequate to handle the volume of reasonably
anticipated options transactions, and such exchanges have advised such clearing
corporation that they believe their facilities will also be adequate to handle
reasonably anticipated volume.
See Foreign currency options, for a discussion of the additional features
(including the risks thereon) of foreign currency option contracts.
OPTIONS ON STOCK INDICES
Options on stock indices are similar to options on stock except that, rather
than the right to take or make delivery of stock at a specified price an option
on a stock index gives the holder the right to receive, upon exercise of the
option, an amount of cash if the closing level of the stock index upon which the
option is based is greater than, in the case of a call, or less than, in the
case of a put, the exercise price of the option. This amount of cash is equal to
such difference between the closing price of the index and the exercise price of
the option expressed in dollars times a specified multiple (the multiplier). The
writer of the option is obligated, in return for the premium received, to make
delivery of this amount. Unlike stock options, all settlements are in cash.
The multiplier for an index option performs a function similar to the unit of
trading for a stock option. It determines the total dollar value per contract of
each point in the difference between the exercise price of an option and the
current level of the underlying index. A multiplier of 100 means that a
one-point difference will yield $100. Options on different indices may have
different multipliers.
Except as described later, the FUND will write call options on indices only if
on such date it holds a portfolio of securities at least equal to the value of
the index times the multiplier times the number of contracts. When the FUND
writes a call option on a broadly-based stock market index, it will segregate or
put into escrow with the custodian, or pledge to a broker as collateral for the
option, cash, cash equivalents or at least one qualified security with a market
value at the time the option is written of not less than 100% of the current
index value times the multiplier times the number of contracts. The FUND will
write call options on broadly-based stock market indices only if at the time of
writing it holds a diversified portfolio of stocks.
If the FUND has written an option on an industry or market segment index, it
will so segregate or put into escrow with its custodian or pledge to a broker as
collateral for the option, at least ten qualified securities, which are stocks
of an issuer in such industry or market segment, with a market value at the time
the option is written of not less than 100% of the current index value times the
multiplier times the number of contracts. Such stocks will include stocks which
represent
AG-4
<PAGE>
at least 50% of the FUND holdings in that industry or market segment. No
individual security will represent more than 15% of the amount so segregated,
pledged or escrowed in the case of broadly-based stock market index options or
25% of such amount in the case of industry or market segment index options.
If at the close of business, the market value of such qualified securities so
segregated, escrowed or pledged falls below 100% of the current index value
times the multiplier times the number of contracts, the FUND will segregate,
escrow or pledge an amount in cash Treasury bills or other high grade short-term
debt obligations equal in value to the difference. In addition, when the FUND
writes a call on an index which is in-the-money at the time the call is written,
it will segregate with its custodian or pledge to the broker as collateral,
cash, U.S. Government or other high grade short-term debt obligations equal in
value to the amount by which the call is in-the-money times the multiplier times
the number of contracts. Any amount segregated pursuant to the foregoing
sentence may be applied to the FUND'S obligation to segregate additional amounts
in the event that the market value of the qualified securities falls below 100%
of the current index value times the multiplier times the number of contracts.
However, if the FUND holds a call on the same index as the call written where
the exercise price of the call held is equal to or less than the exercise price
of the call written or greater than the exercise price of the call written if
the difference is maintained by the FUND in cash, Treasury bills or other high
grade short-term debt obligations in a segregated account with the FUND'S
custodian, it will not be subject to the requirements described in this
paragraph.
RISKS OF OPTIONS ON STOCK INDICES. Index prices may be distorted if trading of
certain securities included in the index is interrupted. Trading in the index
options also may be interrupted in certain circumstances, such as if trading
were halted in a substantial number of securities included in the index. If this
occurred, the FUND would not be able to close out options which it had purchased
or written and, if restrictions on exercise were imposed, may be unable to
exercise an option it holds, which could result in substantial losses to the
FUND. It is the FUND'S policy to purchase or write options only on indices which
include a number of securities sufficient to minimize the likelihood of a
trading halt in the index.
SPECIAL RISKS OF WRITING CALLS ON STOCK INDICES. Unless the FUND has other
liquid assets which are sufficient to satisfy the exercise of a call, it would
be required to liquidate portfolio securities in order to satisfy the exercise.
Because an exercise must be settled within hours after receiving the notice of
exercise, if the FUND fails to anticipate an exercise it may have to borrow from
a bank (in amounts not exceeding 20% of the value of its total assets) pending
settlement of the sale of securities in its portfolio and would incur interest
charges thereon.
When the FUND has written a call, there is also a risk that the market may
decline between the time it has a call exercised against it, at a price which is
fixed as of the closing level of the index on the date of exercise, and the time
it is able to sell securities in its portfolio. As with stock options, the FUND
will not learn that an index option has been exercised until the day following
the exercise date. Unlike a call on stock where the FUND would be able to
deliver the underlying securities in settlement, the FUND may have to sell part
of its portfolio in order to make settlement in cash and the price of such
securities might decline before they can be sold. This timing risk makes certain
strategies involving more than one option substantially more risky with index
options than with stock options. For example, even if an index call which the
FUND has written is covered by an index call held by the portfolio with the same
strike price, the FUND will bear the risk that the level of the index may
decline between the close of trading on the date the exercise notice is filed
with the cleaning corporation and the close of trading on the date the FUND
exercises the call it holds or the time the FUND sells the call, which in either
case would occur no earlier than the day following the day the exercise notice
was filed.
OVER-THE-COUNTER OPTIONS AND LIQUID SECURITIES. As indicated in the Prospectus
the FUND may deal in over-the-counter (OTC) options. The position of the staff
of the Securities and Exchange Commission is that purchased OTC options and the
assets used as cover for written OTC options are illiquid securities. The FUND,
the investment advisor, and the sub-advisors disagree with this position and
have found the dealers with which they engage in OTC options transactions
generally agreeable to and capable of entering into closing transactions. As
also indicated in the Prospectus, the FUND has adopted procedures for engaging
in OTC options for the purpose of reducing any potential adverse impact of such
transactions upon the liquidity of its portfolio.
As part of these procedures the FUND will engage in OTC options transactions
only with primary dealers that have been specifically approved by the Board of
Directors of the FUND. The FUND and the INVESTMENT ADVISOR and/or sub-advisor
believe that the approved dealers should be agreeable and able to enter into
closing transactions if necessary and, therefore, present minimal credit risks
to the FUND. The FUND anticipates entering into written agreements with those
dealers to whom it may sell OTC options, pursuant to which it would have the
absolute right to repurchase the OTC options from such dealers at any time at a
price determined pursuant to a formula set forth in certain no-action letters
published by the Securities and Exchange Commission staff. The FUND will not
engage in OTC options transactions if the amount invested by it in OTC options
plus, with respect to OTC options written by it, the amounts required to be
AG-5
<PAGE>
treated as illiquid pursuant to the terms of such letters (and the value of the
assets used as cover with respect to OTC option sales which are not within the
scope of such letters), plus the amount invested by the FUND in illiquid
securities, would exceed 15% of its total assets. OTC options on securities
other than U.S. Government securities may not be within the scope of such
letters and, accordingly, the amount invested by the FUND in OTC options on such
other securities and the value of the assets used as cover with respect to OTC
option sales regarding such non-U.S. Government securities will be treated as
illiquid and subject to the 15% limitation on assets that may be invested in
illiquid securities. See Illiquid investments.
FUTURES CONTRACTS AND OPTIONS THEREON
A futures contract is an agreement in which the writer (or seller) of the
contract agrees to deliver to the buyer an amount of cash or securities equal to
a specific dollar amount times the difference between the value of a specific
fixed-income security or index at the close of the last trading day of the
contract and the price at which the agreement is made. No physical delivery of
the underlying securities is made. When the futures contract is entered into,
each party deposits with a broker or in a segregated custodial account
approximately 5% of the contract amount, called the initial margin. Subsequent
payments to and from the broker, called variation margin, will be made on a
daily basis as the price of the underlying security or index fluctuates, making
the long and short positions in the fixtures contracts more or less valuable, a
process known as marking-to-market. In the case of options on futures contracts,
the holder of the option pays a premium and receives the right, upon exercise of
the option at a specified price during the option period, to assume a position
in the futures contract (a long position if the option is a call and a short
position if the option is a put). If the option is exercised by the holder
before the last trading day during the option period, the option writer delivers
the futures position, as well as any balance in the writer's futures margin
account. If it is exercised on the last trading day, the option writer delivers
to the option holder cash in an amount equal to the difference between the
option exercise price and the closing level of the relevant security or index on
the date the option expires.
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS. There are several risks in
connection with the use of futures contracts as a hedging device. Successful use
of futures contracts is subject to the ability of the INVESTMENT ADVISOR or
sub-advisor to correctly predict movements in the direction of interest rates or
changes in market conditions. These predictions involve skills and techniques
that may be different from those involved in the management of the portfolio
being hedged. In addition, there can be no assurance that there will be a
correlation between movements in the price of the underlying index or securities
and movements in the price of the securities which are the subject of the hedge.
A decision of whether, when and how to hedge involves the exercise of skill and
judgment, and even a well-conceived hedge may be unsuccessful to some degree
because of market behavior or unexpected trends in interest rates.
Although the FUND will purchase or sell futures contracts only on exchanges
where there appears to be an adequate secondary market, there is no assurance
that a liquid secondary market on an exchange will exist for any particular
contract or at any particular time. Accordingly, there can be no assurance that
it will be possible, at any particular time, to close a fixtures position. In
the event the FUND could not close a fixtures position and the value of such
position declined, the FUND would be required to continue to make daily cash
payments of variation margin. However, in the event futures contracts have been
used to hedge portfolio securities, such securities will partially or completely
offset losses on the futures contract. However, there is no guarantee that the
price movements of the securities will, in fact, correlate with the price
movements in the futures contract and thus provide an offset to losses on a
futures contract.
Under regulations of the Commodity Exchange Act, investment companies registered
under the Investment Company Act of 1940 (1940 Act) are exempted from the
definition of commodity pool operator, subject to compliance with certain
conditions. The exemption is conditioned upon a requirement that all of the
investment company's futures transactions constitute bona fide hedging
transactions or other permitted transactions within the meaning of the
regulations of the CFTC.
The hours of trading of futures contracts may not conform to the hours during
which the FUND may trade the underlying securities. To the extent that the
futures markets close before the securities markets, significant price and rate
movements can take place in the securities markets that cannot be reflected in
the futures market.
FOREIGN CURRENCY TRANSACTIONS
The FUND 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.
AG-6
<PAGE>
FOREIGN CURRENCY CONVERSION. Although foreign exchange dealers do not charge a
fee for currency conversion, they do realize a profit based on the difference
(the spread) between prices at which they are buying and selling various
currencies. Thus, a dealer may offer to sell a foreign currency to the FUND at
one rate, while offering a lesser rate of exchange should the FUND desire to
resell that currency to the dealer.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. The FUND may enter into these
contracts to protect the value of its portfolio against future changes in the
level of currency exchange rates. The FUND'S dealings in forward contracts will
be limited to hedging involving either specific transactions or portfolio
positions. Transaction hedging is the purchase or sale of forward contracts with
respect to specific receivables or payables of the FUND generally arising in
connection with the purchase or sale of its portfolio securities and accruals of
interest or dividends receivable and FUND expenses. Position hedging is the sale
of a foreign currency with respect to portfolio security positions denominated
or quoted in that currency. The FUND may not position hedge with respect to a
particular currency for an amount greater than the aggregate market value
(determined at the time of making any sale of a forward contract) of securities
held in its portfolio denominated or quoted in, or currently convertible into,
such currency.
When the FUND enters into a contract for the purchase or sale of a security
denominated in a foreign currency, or when the FUND anticipates the receipt in a
foreign currency of dividends or interest payments on a security which it holds,
it may desire to lock in the U.S. dollar price of the security or the U.S.
dollar equivalent of such dividend or interest payment as the case may be. By
entering into a forward contract for a fixed amount of dollars for the purchase
or sale of the amount of foreign currency involved in the underlying
transactions, it will be able to protect itself against a possible loss
resulting from an adverse change in the relationship between the U.S. dollar and
the subject foreign currency during the period between the date on which the
security is purchased or sold, or on which the dividend or interest payment is
declared, and the date on which such payments are made or received.
Additionally, when the INVESTMENT ADVISOR and/or sub-advisor believe that the
currency of a particular foreign country may suffer a substantial decline
against the U.S. dollar, the FUND may enter into a forward contract for a fixed
amount of dollars, to sell the amount of foreign currency approximating the
value of some or all of the securities it holds denominated in such foreign
currency.
The FUND 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.
In connection with purchases and sales of securities denominated in foreign
currencies, the FUND 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.
The INVESTMENT ADVISOR and/or sub-advisor expect to enter into settlement hedges
in the normal course of managing foreign investments. The FUND 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 the INVESTMENT ADVISOR
and/or sub-advisor.
The FUND may also use forward contracts to hedge against a decline in the value
of existing investments denominated in foreign currency. For example, if it
owned securities denominated in pounds sterling, the FUND 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. The FUND 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 Deutschemarks 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 will 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, Commission guidelines require investment companies to
set aside cash and appropriate liquid assets in a segregated custodian account
to cover currency forward contracts. As required by Commission guidelines, the
FUND will segregate assets to cover currency forward contracts, if any, whose
purpose is essentially speculative. The FUND will not segregate assets to cover
forward contracts, including settlement hedges, position hedges, and proxy
hedges. Successful use of forward currency contracts will depend on the
INVESTMENT ADVISOR'S and/or sub-advisor's skill in analyzing and predicting
currency values. Forward contracts may substantially change the FUND'S
investment exposure to changes in currency exchange rates, and could result in
losses to the FUND if currencies do not perform as the INVESTMENT ADVISOR and/or
sub-advisor anticipate. For example, if a currency's value rose at a time when
the INVESTMENT ADVISOR and/or sub-advisor had hedged by selling that currency in
exchange for dollars, the FUND would be unable
AG-7
<PAGE>
to participate in the currency's appreciation. If the INVESTMENT ADVISOR and/or
sub-advisor hedge currency exposure through proxy hedges, the FUND 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 the INVESTMENT ADVISOR
and/or sub-advisor increases the FUND'S exposure to a foreign currency, and that
currency's value declines, the FUND will realize a loss.
There is no assurance that the use of forward currency contracts will be
advantageous to the FUND or that it will hedge at an appropriate time.
FOREIGN CURRENCY OPTIONS. The FUND may purchase U.S. exchange-listed call and
put options on foreign currencies. Such options on foreign currencies operate
similarly to options on securities. Options on foreign currencies are affected
by all of those factors which influence foreign exchange rates and investments
generally.
The value of a foreign currency option is dependent upon the value of the
foreign currency and the U.S. dollar, and may have no relationship to the
investment merits of a foreign security. Because foreign currency transactions
occurring in the interbank market involve substantially larger amounts than
those that may be involved in the use of foreign currency options, investors may
be disadvantaged by having to deal in an odd lot market (generally consisting of
transactions of less than $1 million) for the underlying foreign currencies at
prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign currencies
and there is no regulatory requirement that quotations available through dealer
or other market sources be firm or revised on a timely basis. Available
quotation information is generally representative of very large transactions in
the interbank market and thus may not reflect relatively smaller transactions
(less than $1 million) where rates may be less favorable. The interbank market
in foreign currencies is a global, around-the-clock market. To the extent that
the U.S. options markets are closed while the markets for the underlying
currencies remain open, significant price and rate movements may take place in
the underlying markets that cannot be reflected in the options market.
LENDING OF PORTFOLIO SECURITIES
As discussed in the Prospectus, the FUND may lend securities from its portfolio
to brokers, dealers and other financial organizations. Such loans, if and when
made, may not exceed one-third of its total assets. The FUND may not lend its
portfolio securities to Lincoln Life or its affiliates unless it has applied for
and received specific authority from the Commission. Loans of securities will be
collateralized by cash, letters of credit or securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities (U.S. Government
securities), which will be maintained at all times in an amount equal to at
least 102% of the current market value of the loaned securities. From time to
time, the FUND may return a part of the interest earned from the investment of
collateral received for securities loaned to the borrower and/or a third party,
which is unaffiliated with the FUND or with Lincoln Life, and which is acting as
a finder.
In lending its portfolio securities, the FUND can increase its income by
continuing to receive interest on the loaned securities as well as by either
investing the cash collateral in short-term instruments or obtaining yield in
the form of interest paid by the borrower when government securities are used as
collateral. Requirements of the Commission, which may be subject to future
modifications, currently provide that the following conditions must be met
whenever portfolio securities are loaned: (a) the FUND must receive at least
100% cash collateral or equivalent securities from the borrower; (b) the
borrower must increase such collateral whenever the market value of the loaned
securities rises above the level of such collateral; (c) the FUND must be able
to terminate the loan at any time; (d) the FUND must receive reasonable interest
on the loan, as well as an amount equal to any dividends, interest or other
distributions on the loaned securities, and any increase in market value; (e)
the FUND may pay only reasonable custodian fees in connection with the loan; and
(f) voting rights on the loaned securities may pass to the borrower; however, if
a material event adversely affecting the investment occurs, the FUND'S Board of
Directors must terminate the loan and regain the right to vote the securities.
The risks in lending portfolio securities, as with other extensions of secured
credit, consist of possible delay in receiving additional collateral or in the
recovery of the securities or possible loss of rights in the collateral should
the borrower fail financially.
WHEN-ISSUED SECURITIES
As discussed in the Prospectus, the FUND may purchase securities on a
when-issued basis. When it agrees to purchase securities, the custodian will set
aside cash or liquid portfolio securities equal to the amount of the commitment
in a separate account. Normally, the custodian will set aside portfolio
securities to satisfy a purchase commitment. In such a case, the FUND may be
required subsequently to place additional assets in the separate account in
order to assure that the value of the account remains equal to the amount of the
FUND'S commitment. It may be expected that the FUND'S net assets will fluctuate
to a greater degree when it sets aside portfolio securities to cover such
purchase commitments than when it sets aside cash. The FUND does not intend to
purchase when-issued securities for speculative purposes but only in furtherance
of its investment objective. Because it will set aside cash or liquid portfolio
securities to satisfy its purchase commitments in the
AG-8
<PAGE>
manner described, the FUND'S liquidity and the ability of the INVESTMENT ADVISOR
and sub-advisor to manage it might be affected in the event its commitments to
purchase when-issued securities ever exceeded 25% of the value of its total
assets.
When the FUND engages in when-issued transactions, it relies on the seller to
consummate the trade. Failure of the seller to do so may result in the FUND'S
incurring a loss or missing the opportunity to obtain a price considered to be
advantageous.
ILLIQUID INVESTMENTS
Illiquid investments are investments that cannot be sold or disposed of in the
ordinary course of business at approximately the prices at which they are valued
under the supervision of the Board of Directors. The INVESTMENT ADVISOR and/or
sub-advisor determine the liquidity of the FUND'S investments and monitors
trading activity in illiquid investments. In determining the liquidity of
investments, the INVESTMENT ADVISOR and/or sub-advisor may consider various
factors including (1) the frequency of trades and quotations, (2) the number of
dealers and prospective purchasers in the marketplace, (3) dealer undertakings
to make a market, (4) the nature of the security (including any demand or tender
features), and (5) the nature of the marketplace for trades (including the
ability to assign or offset the FUND'S rights and obligations relating to the
investment). Investments currently considered to be illiquid include repurchase
agreements not entitling the holder to payments of principal and interest within
seven days, loans and other direct debt instruments, over-the-counter options,
non-government stripped fixed-rate mortgage-backed securities, and certain
restricted securities and government-stripped fixed-rate mortgage backed
securities determined by the INVESTMENT ADVISOR and/or sub-advisor to be
illiquid. Rule 144A securities for which a market exists will not be considered
illiquid securities. In the absence of market quotations, illiquid investments
are priced at fair value as determined in good faith by the Pricing Committee of
the Board of Directors.
REPURCHASE AGREEMENTS
The FUND may additionally engage in repurchase agreement transactions. Under the
terms of a typical repurchase agreement, the FUND would acquire an underlying
debt obligation for a relatively short period (usually not more than one week)
subject to an obligation of the seller to repurchase, and the FUND to resell,
the obligation at an agreed-upon price and time, thereby determining the yield
during the FUND'S holding period. This arrangement results in a fixed rate of
return that is not subject to market fluctuations during the FUND'S holding
period. The FUND will enter into repurchase agreements with respect to their
portfolio securities with member banks of the Federal Reserve System or primary
government securities dealers recognized by the Federal Reserve Bank of New
York. Under each repurchase agreement, the selling institution will be required
to maintain the value of the securities subject to the repurchase agreement at
not less than their repurchase price, including accrued interest earned on the
underlying securities.
Repurchase agreements could involve certain risks in the event of default or
insolvency of the other party, including possible delays or restrictions upon
the FUND'S ability to dispose of the underlying securities. The INVESTMENT
ADVISOR and/or sub-advisor, acting under the supervision of the FUND'S Board of
Directors, review the creditworthiness of those banks and dealers with which the
FUND enter into repurchase agreements to evaluate these risks, and monitors on
an ongoing basis the value of the securities subject to repurchase agreements to
ensure that the collateral is maintained at the required level.
INVESTMENT RESTRICTIONS
The FUND has adopted policies and investment restrictions. The investment
restrictions numbered 1 through 8 below may not be changed without a majority
vote of its outstanding shares, and are considered fundamental. Such majority is
defined in the 1940 Act as the vote of the lesser of (1) 67% or more of the
outstanding voting securities present at a meeting, if the holders of more than
50% of the outstanding voting securities are present in person or by proxy, or
(2) more than 50% of the outstanding voting securities. All percentage
limitations expressed in the following investment restrictions are measured
immediately after and giving effect to the relevant transaction. Investment
restrictions 9 and 10 may be changed by the vote of a majority of the Board of
Directors.
The FUND may not:
1. Purchase any security (other than securities issued or guaranteed by the
U.S. Government or its agencies or instrumentalities) if, immediately after
and as a result of such investment (a) more than 5% of the value of its
total assets would be invested in securities of the issuer, except that, as
to 25% of its total assets, up to 10% of its total assets may be invested in
securities issued or guaranteed as to payment of interest and principal by a
foreign government or its agencies or instrumentalities or by a
multinational agency, or (b) it would hold more than 10% of the voting
securities of the issuer, or (c) more than 25% of the value of its assets
would be invested in a single industry. Each of the electric utility,
natural gas distribution, natural gas pipeline, combined electric and
natural gas utility, and telephone industries shall be considered as a
separate industry for this purpose;
AG-9
<PAGE>
2. Buy or sell real estate or commodities or commodity contracts; however, it
may invest in debt securities secured by real estate or interests therein,
or issued by companies which invest in real estate or interests therein,
including real estate investment trusts, and may purchase or sell currencies
(including forward currency contracts) and financial futures contracts and
options thereon;
3. Acquire securities subject to restrictions on disposition or securities for
which there is no readily available market, or enter into repurchase
agreements or purchase time deposits maturing in more than seven days, if,
immediately after and as a result, the value of such securities would
exceed, in the aggregate, 15% of its total assets;
4. Engage in the business of underwriting securities of other issuers, except
to the extent that the disposal of an investment position may technically
cause the FUND to be considered an underwriter as that term is defined under
the Securities Act of 1933, as amended;
5. Make loans in an aggregate amount in excess of one-third of its total
assets, taken at the time any loan is made, provided that entering into
certain repurchase agreements and purchasing debt securities shall not be
deemed loans for the purposes of this restriction;
6. Make short sales of securities or maintain a short position if, when added
together more than 25% of the value of its net assets would be (a) deposited
as collateral for the obligation to replace securities borrowed to effect
short sales and (b) allocated to segregated accounts in connection with
short sales;
7. Borrow money, except from banks for temporary or emergency purposes not in
excess of one-third of the value of its total assets;
8. Invest in securities of other investment companies except as may be acquired
as part of a merger, consolidation, reorganization or acquisition of assets
and except that it may invest up to 5% of its total assets in the securities
of any one investment company, but may not own more than 3% of the
securities of any investment company or invest more than 10% of its total
assets in the securities of other investment companies;
9. Enter into repurchase agreements with maturities in excess of seven days if
such investment, together with other investments which are not readily
marketable, exceed 15% of its total assets. This restriction shall not apply
to securities eligible for resale to institutional buyers under Rule 144A of
the Securities Act of 1933;
10. Make investments for the purpose of exercising control or management.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The ADVISOR and sub-advisor are responsible for decisions to buy and sell
securities and other investments for the FUND, the selection of brokers, dealers
and futures commission merchants to effect the transactions, and the negotiation
of brokerage commissions, if any. In this section, the term ADVISOR includes the
sub-advisor. Purchases and sales of securities on a stock exchange are effected
through brokers who charge a commission for their services. Broker-dealers may
also receive commissions in connection with options and futures transactions
including the purchase and sale of underlying securities upon the exercise of
options. Orders may be directed to any broker or futures commission merchant.
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 ADVISOR currently provides investment advice to a number of other clients.
See Management of the FUND in the Appendix to the Prospectus. It will be the
practice of the ADVISOR 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. Securities of the
same issuer may be purchased, held, or sold at the same time by the FUND or
other accounts or companies for which the ADVISOR provides investment advice
(including affiliates of the ADVISOR). On occasions when the ADVISOR deems the
purchase or sale of a security to be in the best interest of the FUND, as well
as the other clients of the ADVISOR, the ADVISOR, to the extent permitted by
applicable laws and regulations, may aggregate such securities to be sold or
purchased for the FUND with those to be sold or purchased for other clients in
order to obtain best execution and lower brokerage commissions, if any. In such
event, allocation of the securities so purchased or sold, as well as the
expenses incurred in the transaction, will be made by the ADVISOR in the manner
it considers to be equitable and consistent with its fiduciary obligations to
all such clients, including the FUND. In some instances,
AG-10
<PAGE>
the procedures may impact the price and size of the position obtainable for the
FUND. FUND securities are not purchased from or sold to the ADVISOR or any
affiliated person (as defined in the 1940 Act) of the ADVISOR.
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, commission rates charged by some
brokers may be greater than the amounts other brokers might charge. The ADVISOR
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 ADVISOR and published data
concerning transaction costs incurred by institutional investors generally. The
nature of the research services provided to the ADVISOR by brokerage firms
varies from time to time but generally includes current and historical financial
data concerning particular companies and their 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 ADVISOR regards as a useful
supplement to its own internal research capabilities. The ADVISOR may from time
to time direct trades to brokers which have provided specific brokerage or
research services for the benefit of the ADVISOR'S clients; in addition the
ADVISOR may allocate trades among brokers that generally provide superior
brokerage and research services. During 1997, the ADVISOR directed transactions
totaling approximately $17,989,306 million to these brokers and paid commissions
of approximately $47,000 in connection with these transactions. Research
services furnished by brokers are used for the benefit of some or all of the
ADVISOR'S clients and not solely or necessarily for the benefit of the FUND. The
ADVISOR 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 ADVISOR by any amount that might be attributable to the
value of such services. The aggregate amount of brokerage commissions paid by
the FUND during 1997 was $677,335, for 1996 it was $332,924, and for 1995 it was
$251,854.
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 the advisor. 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 SAI, these
limits (which are subject to change) are 2,000 options (200,000 shares) in each
class of puts or calls.
Under the sub-advisory agreement between the ADVISOR and the sub-advisor, the
sub-advisor may perform some, or substantially all, of the investment advisory
services required by the FUND, even though the ADVISOR remains primarily
responsible for investment decisions affecting the FUND. The sub-advisor will
follow the same procedures and policies which are followed by the ADVISOR as
described previously. The sub-advisor currently provides investment advice to a
number of other clients.
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 1998 it will be closed
on New Year's Day, Martin Luther King Day, President's Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
It may also be closed on other days. Although the Directors expect the same
holiday schedule to be observed in the future, the NYSE may modify its holiday
schedule at any time. To the extent that the FUND'S securities are traded in
other markets on days when the NYSE is closed, the FUND'S NAV may be affected on
days when investors do not have access to the FUND to purchase or redeem shares.
AG-11
<PAGE>
APPENDIX
(NOTE: THIS IS UNIFORM INFORMATION FOR THE 11 FUNDS. SEE EACH FUND'S SAI FOR
INFORMATION SPECIFIC TO THAT FUND.)
THIS APPENDIX CONSTITUTES PART OF THE SAIS OF LINCOLN NATIONAL AGGRESSIVE GROWTH
FUND, INC. (AGGRESSIVE GROWTH FUND), LINCOLN NATIONAL BOND FUND, INC. (BOND
FUND), LINCOLN NATIONAL CAPITAL APPRECIATION FUND, INC. (CAPITAL APPRECIATION
FUND), LINCOLN NATIONAL EQUITY-INCOME FUND, INC. (EQUITY-INCOME FUND), LINCOLN
NATIONAL GLOBAL ASSET ALLOCATION FUND, INC. (GLOBAL ASSET ALLOCATION FUND),
LINCOLN NATIONAL GROWTH AND INCOME FUND, INC. (GROWTH AND INCOME FUND), LINCOLN
NATIONAL INTERNATIONAL FUND, INC. (INTERNATIONAL FUND), LINCOLN NATIONAL MANAGED
FUND, INC. (MANAGED FUND), LINCOLN NATIONAL MONEY MARKET FUND, INC. (MONEY
MARKET FUND), LINCOLN NATIONAL SOCIAL AWARENESS FUND, INC. (SOCIAL AWARENESS
FUND), AND LINCOLN NATIONAL SPECIAL OPPORTUNITIES FUND, INC. (SPECIAL
OPPORTUNITIES FUND). UNLESS OTHERWISE INDICATED, THE FOLLOWING INFORMATION
APPLIES TO EACH FUND.
INVESTMENT ADVISOR AND SUB-ADVISOR
LINCOLN INVESTMENT Management, Inc. (LINCOLN INVESTMENT) is the investment
ADVISOR to the FUNDS and is headquartered at 200 E. Berry Street, Fort Wayne,
Indiana 46802. LINCOLN INVESTMENT (THE ADVISOR) is a subsidiary of Lincoln
National Corp. (LNC), a publicly-held insurance holding company organized under
Indiana law. Through its subsidiaries, LNC provides, on a national basis,
insurance and financial services. LINCOLN INVESTMENT is registered with the
Securities and Exchange Commission (SEC) as an INVESTMENT ADVISOR and has acted
as an INVESTMENT ADVISOR to mutual funds for over 40 years. The ADVISOR also
acts as INVESTMENT ADVISOR to Lincoln National Income Fund, Inc. (a closed-end
investment company whose investment objective is to provide a high level of
current income from interest on fixed-income securities) and Lincoln National
Convertible Securities Fund, Inc. (a closed-end investment company whose
investment objective is a high level of total return on its assets through a
combination of capital appreciation and current income) and to other clients,
and also acts as sub-adviser to two of the series of Delaware Group Adviser
Funds, Inc. (the Corporate Income Fund and the Federal Bond Fund of that retail
mutual fund complex).
Under Advisory Agreements with the FUNDS, the ADVISOR provides portfolio
management and investment advice to the FUNDS and administers its other affairs,
subject to the supervision of the funds' Board of Directors. The advisor, at its
expense, will provide office space to the FUNDS and all necessary office
facilities, equipment and personnel and will make its officers and employees
available to the FUNDS as appropriate. In addition, the ADVISOR will pay all
expenses incurred by it or by the FUNDS in connection with the management of
each FUND'S assets or the administration of its affairs, other than those
assumed by the FUNDS, as described in the Appendix to the Prospectus. LINCOLN
LIFE has paid the organizational expenses of all the FUNDS. The rates of
compensation to the ADVISOR and the sub-advisors are set forth in the Appendix
to the Prospectus.
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $2,109,952 $1,428,803 $ 725,544
Bond Fund 1,221,295 1,188,030 1,061,701
Capital Appreciation Fund 2,940,632 1,549,656 726,011
Equity-Income Fund 6,053,404 3,303,336 1,457,623
Global Asset Allocation Fund 2,808,358 2,072,722 1,570,876
Growth and Income Fund 9,714,765 7,063,276 5,077,981
International Fund 3,741,563 3,319,701 2,770,197
Managed Fund 2,873,786 2,480,524 2,120,656
Money Market Fund 451,243 417,468 385,019
Social Awareness Fund 3,355,544 1,877,030 1,048,366
Special Opportunities Fund 2,824,015 2,274,229 1,809,514
</TABLE>
A-1
<PAGE>
During the last three years, the ADVISOR received the amounts, as mentioned
above, for investment advisory services. If total expenses of the FUNDS
(excluding taxes, interest, portfolio brokerage commissions and fees, and
expenses of an extraordinary and non-recurring nature, but including the
investment advisory fee) exceed 1 1/2% per annum of the average daily net assets
of each FUND (2% for the International Fund), the ADVISOR will pay such excess
by offsetting it against the advisory fee. If such offset is insufficient to
cover the excess, any balance remaining will be paid directly by the ADVISOR to
each FUND.
The current advisory agreements between the ADVISOR and the FUNDS will remain in
effect from year to year if approved annually by: (1) the Board of Directors of
each FUND or by the vote of a majority of the outstanding voting securities of
each FUND, and (2) a vote of a majority of the directors who are not interested
persons of the FUNDS or the advisor, cast in person at a meeting called for the
purpose of voting on such approval. The advisory agreement may be terminated
without penalty at any time, on 60 days' written notice by: (1) the Board of
Directors of each FUND, (2) vote of a majority of the outstanding voting
securities of each FUND or (3) the advisor. The advisory agreement terminates
automatically in the event of assignment.
In like manner, the current sub-advisory agreement will remain in effect from
year to year if approved annually by the Board of Directors of the applicable
FUNDS or by the vote of a majority of the outstanding voting securities of those
FUNDS. The sub-advisory agreements may be terminated without penalty at any
time, on 60 days' written notice, by: (1) the Board of Directors of the
applicable FUND, (2) vote of the majority of the outstanding voting securities
of the applicable FUND, (3) the sub-advisor, or (4) the advisor. The
sub-advisory agreements terminate automatically in the event of assignment.
During the last three years each SUB-ADVISOR received the following amounts for
investment sub-advisory services. LINCOLN INVESTMENT, not the FUND, pays all
sub-advisory fees owed.
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $1,229,800 $ 893,059 $ 483,982
Bond Fund N/A N/A N/A
Capital Appreciation Fund 2,072,388 1,117,383 545,800
Equity-Income Fund 4,781,931 2,612,405 1,152,337
Global Asset Allocation Fund 1,724,369 1,284,185 1,034,321
Growth and Income Fund 6,155,225 4,440,325 3,108,208
International Fund 1,503,294 1,326,484 1,146,153
Managed Fund 974,080 820,633 672,474
Money Market Fund N/A N/A N/A
Social Awareness Fund 1,901,560 923,516 462,593
Special Opportunities Fund 1,519,961 1,168,134 868,019
</TABLE>
A-2
<PAGE>
DIRECTORS AND OFFICERS
The directors and executive officers of each FUND, their business addresses,
positions with FUND, age and their principal occupations during the past five
years are as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
* KELLY D. CLEVENGER Vice President, Lincoln National Life Insurance Co.
CHAIRMAN OF THE BOARD,
PRESIDENT AND DIRECTOR, age
45
1300 S. Clinton Street
Fort Wayne, IN 46802
- ------------------------------------------------------------------------------------------------------------------
JOHN B. BORSCH, JR. Retired, formerly Associate Vice President--Investments, Northwestern
DIRECTOR, age 64 University
1776 Sherwood Road
Des Plaines, IL 60016
- ------------------------------------------------------------------------------------------------------------------
NANCY L. FRISBY, CPA Regional Vice President/Chief Financial Officer (formerly Vice
DIRECTOR, age 56 President--Finance; Regional Controller of Finance), St. Joseph Medical
700 Broadway Center, Fort Wayne, Indiana
Fort Wayne, IN 46802
- ------------------------------------------------------------------------------------------------------------------
* BARBARA S. KOWALCZYK Senior Vice President and Director, Corporate Planning and Development,
DIRECTOR, age 46 Lincoln National Corporation; Director, Lincoln Life and Annuity Company
1300 S. Clinton St. of New York (formerly Executive Vice President, LINCOLN INVESTMENT
Fort Wayne, IN 46802 Management, Inc.)
- ------------------------------------------------------------------------------------------------------------------
KENNETH G. STELLA President, Indiana Hospital and Health Association
DIRECTOR, age 54
One America Square
Indianapolis, IN 46282
- ------------------------------------------------------------------------------------------------------------------
* JANET C. WHITNEY Vice President and Treasurer, Lincoln National Corp. (formerly Vice
TREASURER, age 49 President and General Auditor)
200 East Berry Street
Fort Wayne, IN 46802
- ------------------------------------------------------------------------------------------------------------------
* CYNTHIA A. ROSE Assistant Secretary, Lincoln National Life Insurance Co.
SECRETARY, age 43
200 East Berry Street
Fort Wayne, IN 46802
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
* Interested persons of the FUNDS, as defined in the 1940 Act. Directors' fees
of $250 per meeting are paid by each FUND to each director who is not an
interested person of the FUND. During 1997, each FUND paid $1,000 in director's
fees to each such director, plus out of pocket expenses to attend meetings.
During 1997, the FUND complex paid each of these directors aggregate fees of
$11,000. Mr. Stanley R. Nelson, a director who retired in 1997, received $750 in
director fees from each FUND and aggregate fees of $8,250 from the FUND complex.
Mr. Stella became a director in 1998 and thus received no fees during 1997.
A-3
<PAGE>
INVESTMENT POLICIES AND TECHNIQUES
OPTIONS AND FINANCIAL FUTURES TRADING
This discussion relates to the Bond, Growth and Income, Managed, Social
Awareness and Special Opportunities Funds. Neither the International Fund nor
the Money Market Fund has sought the authority to engage either in options or in
futures trading. (NOTE: The Aggressive Growth, Capital Appreciation,
Equity-Income and Global Asset Allocation Funds have their own respective
discussions of the strategic portfolio transactions in which they may engage.)
OPTIONS TRADING
The FUND may purchase or write (sell) options on financial instruments as a
means of achieving additional return or hedging the value of the FUND'S
portfolio. The FUND may not purchase or write put or covered call options in an
aggregate cost exceeding 30% of the value of its total assets. The FUND would
invest in options in standard contracts which may be quoted on NASDAQ, or on
national securities exchanges. Currently options are traded on numerous
securities and indices including, without limitation, the Standard and Poor's
100 Index (S&P 100), the Standard and Poor's 500 Index (S&P 500), and the NYSE
Beta Index.
A. In General. Put and call options are generally short-term contracts with
durations of nine months or less. The INVESTMENT ADVISOR will generally
write covered call options when it anticipates declines in the market value
of the portfolio securities and the premiums received may offset to some
extent the decline in the FUND'S net asset value. On the other hand, writing
put options may be a useful portfolio investment strategy when the FUND has
cash or other reserves and it intends to purchase securities but expects
prices to increase.
Generally, the risk to the FUND in writing options is that the investment
ADVISOR'S assumption about the price trend of the underlying security may prove
inaccurate. If the FUND wrote a put, expecting the price of a security to
increase, and it decreases, or if the FUND wrote a call, expecting the price to
decrease but it increased, the FUND could suffer a loss if the premium received
in each case did not equal the difference between the exercise price and the
market price.
B. Call Options. The FUND may write only call options which are covered,
meaning that the FUND either owns the underlying security or has an absolute
and immediate right to acquire that security, without additional cash
consideration, upon conversion or exchange of other securities currently
held in its portfolio. In addition, the FUND will not, before the expiration
of a call option, permit the call to become uncovered. If the FUND writes a
call option, the purchaser of the option has the right to buy (and the FUND
has the obligation to sell) the underlying security at the exercise price
throughout the term of the option. The amount paid to the FUND by the
purchaser of the option is the premium. The FUND'S obligation to deliver the
underlying security against payment of the exercise price would terminate
either upon expiration of the option or earlier if the FUND were to effect a
closing purchase transaction through the purchase of an equivalent option on
an exchange. The FUND would not be able to effect a closing purchase
transaction after it had received notice of exercise.
In order to write a call option, the FUND is required to deposit in escrow the
underlying security or other assets in accordance with the rules of The Options
Clearing Corp. (OCC) and the various exchanges. The FUND may not purchase call
options except in connection with a closing purchase transaction. It is possible
that the cost of effecting a closing purchase transaction may be greater than
the premium received by the FUND for writing the option.
Generally, the INVESTMENT ADVISOR (THE ADVISOR) intends to write listed covered
calls during periods when it anticipates declines in the market values of
portfolio securities and the premiums received (net of transaction costs) may
offset to some extent the decline in the FUND'S net asset value occasioned by
such declines in market value. The ADVISOR will generally not write listed
covered call options when it anticipates that the market value of the FUND'S
portfolio securities will increase.
If the ADVISOR decides that at a price higher than the current value a portfolio
security would be overvalued and should be sold, the FUND may write a call
option on the security at that price. Should the security subsequently reach
that price and the option be exercised, the FUND would, in effect, have
increased the selling price of that security, which it would have sold at that
price in any event, by the amount of the premium. In the event the market price
of the security declined and the option were not exercised, the premium would
offset all or some portion of that decline. It is possible, of course, that the
price of the security could increase beyond the exercise price; in that event,
the FUND would forego the opportunity to sell the security at that higher price.
In addition, call options may be used as part of a different strategy in
connection with sales of portfolio securities. If, in the judgment of the
advisor, the market price of a security is overvalued and it should be sold, the
FUND may elect to write a call with an exercise price substantially below the
current market price. So long as the value of the underlying security remains
above the exercise price during the term of the option, the option will be
exercised, and the FUND will be required to sell
A-4
<PAGE>
the security at the exercise price. If the sum of the premium and the exercise
price exceeds the market price of the security at the time the call is written,
the FUND would, in effect, have increased the selling price of the security. The
FUND would not write a call under these circumstances if the sum of the premium
and the exercise price were less than the current market price of the security.
In summary, a principal reason for writing calls on a securities portfolio is to
attempt to realize, through the receipt of premium income, a greater return than
would be earned on the securities alone. A covered call writer, such as the
FUND, which owns the underlying security has, in return for the premium, given
up the opportunity for profit from a price increase in the underlying security
above the exercise price, but has retained the risk of loss should the price of
the security decline. Unlike one who owns securities not subject to a call, the
FUND as a call writer may be required to hold such securities until the
expiration of the call option or until the FUND engages in a closing purchase
transaction at a price that may be below the prevailing market.
C. Put Options. The FUND may also write put options. If the FUND writes a put
option, it is obligated to purchase a given security at a specified price at
any time during the term of the option. The rules regarding the writing of
put options are generally comparable to those described above with respect
to call options.
Writing put options may be a useful portfolio investment strategy when the FUND
has cash or other reserves available for investment as a result of sales of FUND
shares or because the ADVISOR believes a more defensive and less fully invested
position is desirable in light of market conditions. If the FUND wishes to
invest its cash or reserves in a particular security at a price lower than
current market value, it may write a put option on that security at an exercise
price which reflects the lower price it is willing to pay. The buyer of the put
option generally will not exercise the option unless the market price of the
underlying security declines to a price near or below the exercise price. If the
FUND writes a put option, the price of the underlying security declines and the
option is exercised, the premium, net of transaction charges, will reduce the
purchase price paid by the FUND for the security. Of course, the price of the
security may continue to decline after exercise of the put options, in which
event the FUND would have foregone an opportunity to purchase the security at a
lower price, or the option might never be exercised.
If, before the exercise of a put, the ADVISOR determines that it no longer
wishes to invest in the security on which the put has been written, the FUND may
be able to effect a closing purchase transaction on an exchange by purchasing a
put of the same series as the one which it has previously written. The cost of
effecting a closing purchase transaction may be greater than the premium
received on writing the put option, and there is no guarantee that a closing
purchase transaction can be effected. The FUND may purchase put options only in
connection with a closing transaction.
As with the writer of a call, a put writer generally hopes to realize premium
income. The risk position of the FUND as a put writer is similar to that of a
covered call writer which owns the underlying securities. Like the covered call
writer (who must bear the risk of the position in the underlying security), the
FUND as a put writer stands to incur a loss if and to the extent the price of
the underlying security falls below the exercise price plus premium.
At the time a put option is written, the FUND will be required to establish, and
will maintain until the put is exercised or has expired, a segregated account
with its custodian consisting of cash or short-term U.S. Government securities
equal in value to the amount which the FUND will be obligated to pay upon
exercise of the put. Principal factors affecting the market value of a put or
call option include supply and demand, interest rates, the current market price
and price volatility of the underlying security and the time remaining until the
expiration date. In addition, there is no assurance that the FUND will be able
to effect a closing transaction at a favorable price. If the FUND cannot enter
into such a transaction, it may be required to hold a security that it might
otherwise have sold, in which case it would continue to be at market risk on the
security. If a substantial number of covered options written by the FUND are
exercised, the FUND'S rate of portfolio turnover could exceed historic levels.
This could result in higher transaction costs, including brokerage commissions.
The FUND will pay brokerage commissions in connection with the writing and
purchasing of options to close out previously written options. Such brokerage
commissions are normally higher than those applicable to purchases and sales of
portfolio securities.
FUTURES CONTRACTS AND OPTIONS THEREON
A. In General. The FUND may buy and sell financial futures contracts (futures
contracts) and related options thereon solely for hedging purposes. The FUND
may sell a futures contract or purchase a put option on that futures
contract to protect the value of the FUND'S portfolio in the event the
INVESTMENT ADVISOR anticipates declining security prices. Similarly, if
security prices are expected to rise, the FUND may purchase a futures
contract or a call option thereon. (For certain limited purposes, as
explained later, the FUND is also authorized to buy futures contracts on an
unleveraged basis and not as an anticipatory hedge.)
A-5
<PAGE>
The FUND will not invest in futures contracts and options thereon if immediately
thereafter the amount committed to margins plus the amount paid or option
premiums exceeds 5% of the FUND'S total assets. In addition the FUND will not
hedge more than 1/3 of its net assets.
B. Futures contracts. The FUND may purchase and sell financial futures
contracts (futures contracts) as a hedge against fluctuations in the value
of securities which are held in the FUND'S portfolio or which the FUND
intends to purchase. The FUND will engage in such transactions consistent
with the FUND'S investment objective. Currently, futures contracts are
available on Treasury bills, notes, and bonds as well as interest-rate and
stock market indexes.
There are a number of reasons why entering into futures contracts for hedging
purposes can be beneficial to the FUND. First, futures markets may be more
liquid than the corresponding cash markets on the underlying securities. Such
enhanced liquidity results from the standardization of the futures contracts and
the large transaction volumes. Greater liquidity permits a portfolio manager to
effect a desired hedge both more quickly and in greater volume than would be
possible in the cash market. Second, a desired sale and subsequent purchase can
generally be accomplished in the futures market for a fraction of the
transaction costs that might be incurred in the cash market.
The purpose of selling a futures contract is to protect the FUND'S portfolio
from fluctuation in asset value resulting from security price changes. Selling a
futures contract has an effect similar to selling a portion of the FUND'S
portfolio securities. If security prices were to decline, the value of the
FUND'S futures contracts would increase, thereby keeping the net asset value of
the FUND from declining as much as it otherwise might have. In this way, selling
futures contracts acts as a hedge against the effects of declining prices.
However, an increase in the value of portfolio securities tends to be offset by
a decrease in the value of corresponding futures contracts.
Similarly, when security prices are expected to rise, futures contracts may be
purchased to hedge against anticipated subsequent purchases of portfolio
securities at higher prices. By buying futures, the FUND could effectively hedge
against an increase in the price of the securities it intends to purchase at a
later date in order to permit the purchase to be effected in an orderly manner.
At that time, the futures contracts could be liquidated at a profit if prices
had increased as expected, and the FUND'S cash position could be used to
purchase securities.
When a purchase or sale of a futures contract occurs, a deposit of high-quality,
liquid securities called initial margin is made by both buyer and seller with a
custodian for the benefit of the broker. Unlike other types of margin, a futures
margin account does not involve any loan or borrowing but is merely a good faith
deposit that must be maintained in a minimum amount of cash or U.S. Treasury
bills. All futures positions, both long and short, are marked-to-market daily,
with cash payments called variation margin being made by buyers and sellers to
the custodian, and passed through to the sellers and buyers, to reflect daily
changes in the contract values.
Most futures contracts are typically canceled or closed out before the scheduled
settlement date. The closing is accomplished by purchasing (or selling) an
identical futures contract to offset a short (or long) position. Such an
offsetting transaction cancels the contractual obligations established by the
original futures transaction. Other financial futures contracts call for cash
settlements rather than delivery of securities.
If the price of an offsetting futures transaction varies from the price of the
original futures transaction, the hedger will realize a gain or loss
corresponding to the difference. That gain or loss will tend to offset the
realized loss or gain on the hedged securities position, but may not always or
completely do so.
The FUND will not enter into any futures contract if, immediately thereafter,
the aggregate initial margin for all existing futures contracts and options
thereon and for premiums paid for related options would exceed 5% of the FUND'S
total assets. The FUND will not purchase or sell futures contracts or related
options if immediately thereafter more than 1/3 of its net assets would be
hedged.
C. Risks and limitations involved in futures hedging. There are a number of
risks associated with futures hedging. Changes in the price of a futures
contract generally parallel but do not necessarily equal changes in the
prices of the securities being hedged. The risk of imperfect correlation
increases as the composition of the FUND'S securities portfolio diverges
from the securities that are the subject of the futures contract. Because
the change in the price of the futures contract may be more or less than the
change in the prices of the underlying securities, even a correct forecast
of price changes may not result in a successful hedging transaction. Another
risk is that the INVESTMENT ADVISOR could be incorrect in its expectation as
to the direction or extent of various market trends or the time period
within which the trends are to take place.
The FUND intends to purchase and sell futures contracts only on exchanges where
there appears to be a market in such futures sufficiently active to accommodate
the volume of its trading activity. There can be no assurance that a liquid
market will always exist for any particular contract at any particular time.
Accordingly, there can be no assurance that it will always be possible to close
a futures position when such closing is desired and, in the event of adverse
price movements, the FUND would
A-6
<PAGE>
continue to be required to make daily cash payments of variation margin.
However, in the event futures contracts have been sold to hedge portfolio
securities, such securities will not be sold until the offsetting futures
contracts can be executed. Similarly, in the event futures have been bought to
hedge anticipated securities purchases, such purchases will not be executed
until the offsetting futures contracts can be sold.
Successful use of futures contracts by the FUND is also subject to the ability
of the INVESTMENT ADVISOR to predict correctly movements in the direction of
interest rates and other factors affecting markets for securities. For example,
if the FUND has hedged against the possibility of an increase in interest rates
that would adversely affect the price of securities in its portfolio and prices
of such securities increase instead, the FUND will lose part or all of the
benefit of the increased value of its securities because it will have offsetting
losses in its futures positions. In addition, in such situations, if the FUND
has insufficient cash to meet daily variation margin requirements, it may have
to sell securities to meet such requirements. Such sale of securities may be,
but will not necessarily be, at increased prices that reflect the rising market.
The FUND may have to sell securities at a time when it is disadvantageous to do
so. Where futures are purchased to hedge against a possible increase in the
price of securities before the FUND is able to invest its cash in an orderly
fashion, it is possible that the market may decline instead; if the FUND then
concludes not to invest in securities at that time because of concern as to
possible further market decline or for other reasons, the FUND will realize a
loss on the futures contract that is not offset by a reduction in the price of
the securities purchased.
The selling of futures contracts by the FUND and use of related transactions in
options on futures contracts (discussed later) are subject to position limits,
which are affected by the activities of the investment advisor.
The hours of trading of futures contracts may not conform to the hours during
which the FUND may trade securities. To the extent that the futures markets
close before the securities markets, significant price and rate movements can
take place in the securities markets that cannot be reflected in the futures
markets.
Pursuant to Rule 4.5 under the Commodity Exchange Act, investment companies
registered under the 1940 Act are exempted from the definition of commodity pool
operator in the Commodity Exchange Act, subject to compliance with certain
conditions. The exemption is conditioned upon a requirement that all of the
investment company's commodity futures transactions constitute bona fide hedging
transactions (except on an unleveraged basis, as described in (F.) With respect
to long positions assumed by the FUND, the FUND will segregate with its
custodian an amount of cash and other assets permitted by Commodity Futures
Trading Commission (CFTC) regulations equal to the market value of the futures
contracts and thereby insure that the use of futures contracts is unleveraged.
The FUND will use futures in a manner consistent with these requirements.
D. Options on futures contracts. The FUND only intends to engage in options on
futures contracts for bona fide hedging purposes in compliance with CFTC
regulations. An option on a futures contract gives the purchaser the right,
but not the obligation, to assume a position in a futures contract (which
position may be a long or short position) at a specified exercise price at
any time during the option exercise period. The writer of the option is
required upon exercise to assume an offsetting futures position (which
position may be a long or short position). Upon exercise of the option, the
assumption of offsetting futures positions by the writer and holder of the
option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account that represents the amount by which the
market price of the futures contract, at exercise, exceeds, in the case of a
call, or is less than, in the case of a put, the exercise price of the
option on the futures contract.
The holder or writer of an option may terminate its position by selling or
purchasing an option of the same series. There is no guarantee that such closing
transactions can be effected.
The FUND will be required to deposit initial and variation margin with respect
to put and call options on futures contracts written by it pursuant to the
FUND'S futures commissions merchants' requirements similar to those applicable
to the futures contracts themselves, described previously.
E. Risks of futures transactions. The FUND'S successful use of futures
contracts and options thereon depends upon the ability of its investment
ADVISOR to predict movements in the securities markets and other factors
affecting markets for securities and upon the degree of correlation between
the prices of the futures contracts and the prices of the securities being
hedged. As a result, even a correct forecast of price changes may not result
in a successful hedging transaction. Although futures contracts and options
thereon may limit the FUND'S exposure to loss, they may also limit the
FUND'S potential for capital gains. For example, if the FUND has hedged
against the possibility of decrease in prices which would adversely affect
the price of securities in its portfolio and prices of such securities
increase instead, the FUND will lose part or all of the benefit of the
increased value of its securities because it will have offsetting losses in
its futures positions. Although the FUND will enter into futures contracts
only where there appears to be a liquid market,
A-7
<PAGE>
there can be no assurance that such liquidity will always exist.
F. The FUND also is authorized, subject to the limitations set out in the
Prospectus, to purchase futures contracts on an unleveraged basis, when not
intended as an anticipatory hedge. When a contract is purchased on this
basis the investment company establishes a segregated account, composed of
cash and/or cash equivalents, equal to the total value of the contract (less
margin on deposit). As with other futures trading, these purchases must not
be for speculative purposes.
The ability to engage in these purchases on an unleveraged basis can
significantly decrease transaction costs to the FUNDS in certain instances. For
example, if an inordinately large deposit should occur on a single day, the
sheer volume of securities purchases required for that day may place the FUND at
a market disadvantage by requiring it to purchase particular securities in such
volume that its own buying activity could cause prices to increase. In addition,
if this deposit had involved market-timing and as a result there subsequently
were an oversized withdrawal, the FUND could again suffer market disadvantage,
this time because the volume of sales could, for the same reason, force prices
of particular securities to decrease. The FUND, by buying a futures contract
(followed by the appropriate closing transaction) instead of purchasing
securities could achieve considerable savings in transaction costs without
departing from FUND objectives. Furthermore, as stated in (C.), price changes in
a futures contract generally parallel price changes in the securities that the
FUND might otherwise have purchased. Thus, purchase of a futures contract on an
unleveraged basis allows the FUND to comply with its objective while at the same
time achieving these lower transaction costs.
VALUATION OF PORTFOLIO SECURITIES
SHORT-TERM INVESTMENTS. For FUNDS (other than the Money Market FUND) that own
short-term investments which mature in less than 60 days, these instruments are
valued at amortized cost. Such securities acquired with a remaining maturity of
61 days or more are valued at their fair value until the sixty-first day prior
to maturity; thereafter, their cost for valuation purposes is deemed to be their
fair value on such sixty-first day.
OPTIONS TRADING. For those FUNDS engaging in options trading, FUND investments
underlying call options will be valued as described previously. Options are
valued at the last sale price or, if there has been no sale that day, at the
mean of the last bid and asked price on the principal exchange where the option
is traded, as of the close of trading on the NYSE. The FUND'S net asset value
will be increased or decreased by the difference between the premiums received
on writing options and the cost of liquidating those positions measured by the
closing price of those options on the exchange where traded.
FUTURES CONTRACTS AND OPTIONS THEREON. For those FUNDS buying and selling
futures contracts and related options thereon, the futures contracts and options
are valued at their daily settlement price.
FOREIGN SECURITIES. For FUNDS investing in foreign securities, the value of a
foreign portfolio security held by a FUND is determined based upon its closing
price or upon the mean of the closing bid and asked prices on the foreign
exchange or market on which it is traded and in the currency of that market, as
of the close of the appropriate exchange. As of the close of business on the
NYSE, that FUND'S portfolio securities which are quoted in foreign currencies
are converted into their U.S. dollar equivalents at the prevailing market rates,
as computed by the custodian of the FUND'S assets.
However, trading on foreign exchanges may take place on dates or at times of day
when the NYSE is not open; conversely, overseas trading may not take place on
dates or at times of day when the NYSE is open. Any of these circumstances could
affect the net asset value of FUND shares on days when the investor has no
access to the FUND. There are more detailed explanations of these circumstances
in the SAI for the various FUNDS. See the Preface to this Prospectus booklet for
information about how to obtain a copy of the SAI booklet.
LENDING OF PORTFOLIO SECURITIES
As described in the Prospectus, the FUNDS may from time to time lend securities
from their portfolios 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 particular FUND during the term of the
loan. The FUND will maintain the incidents of ownership of the loaned securities
and will continue to be entitled to the interest or dividends payable on the
loaned securities. In addition, the FUND will receive 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 advisor. The FUND may pay reasonable
finder's fees to persons unaffiliated with it in connection with the arrangement
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 to firms deemed by the ADVISOR to be creditworthy.
A-8
<PAGE>
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
The FUNDS may make short-term investments in 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 purchase 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. The Board of Directors of the FUNDS or its delegate will
evaluate the creditworthiness of all entities, including banks and
broker-dealers, with which they propose to enter into repurchase agreements.
These transactions will be fully collateralized; and the collateral for each
transaction will be in the actual or constructive possession of the particular
FUND during the terms of the transaction, as provided in the agreement.
In a reverse repurchase agreement, the FUND involved 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 FUNDS 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 ADVISOR or sub-advisor deems creditworthy.
Reverse repurchase agreements are considered to be borrowing transactions, and
thus are subject to the FUND'S limitation on borrowing. Not every FUND is
authorized to enter into reverse repurchase agreements.
CUSTODIAN
All securities, cash and other similar assets of the Bond, Growth and Income,
Managed, Money Market, Social Awareness and Special Opportunities Funds are
currently held in custody by The Chase Manhattan Bank, N.A., 4 Chase MetroTech
Center, Brooklyn, NY 11245. Chase Manhattan agreed to act as custodian for each
FUND pursuant to a Custodian Agreement dated March 30, 1998.
All securities, cash and other similar assets of the Aggressive Growth, Capital
Appreciation, Equity-Income, Global Asset Allocation and International Funds are
held in custody by State Street Bank and Trust Co., 225 Franklin Street, Boston,
Massachusetts 02110. State Street agreed to act as custodian for these FUNDS
pursuant to Custodian Contracts effective July 21, 1987 for the Global Asset
Allocation Fund, April 29, 1991 for the International Fund, and December 6, 1993
for the other three FUNDS.
Under these Agreements, the respective custodians shall (1) receive and disburse
money; (2) receive and hold securities; (3) transfer, exchange, or deliver
securities; (4) present for payment coupons and other income items, collect
interest and cash dividends received, hold stock dividends, etc.; (5) cause
escrow and deposit receipts to be executed; (6) register securities; and (7)
deliver to the FUNDS proxies, proxy statements, etc.
INDEPENDENT AUDITORS
Each FUND'S Board of Directors has engaged Ernst & Young LLP, Two Commerce
Square, Suite 4000, 2001 Market Street, Philadelphia, PA 19103, to be the
independent auditors for the FUND. In addition to the audit of the 1997
financial statements of the FUNDS, other services provided include review and
consultation connected with filings of annual reports and registration
statements with the Securities and Exchange Commission (SEC); consultation on
financial accounting and reporting matters; and meetings with the Audit
Committee.
FINANCIAL STATEMENTS
The audited financial statements and the report of Ernst & Young LLP,
Independent Auditors, for the FUNDS are incorporated by reference to the FUNDS'
1997 Annual Report. We will provide a copy of the Annual Report on request and
without charge. Either write Lincoln National Life Insurance Co., P.O. Box 2340,
Fort Wayne, Indiana 46801 or call: 1-800-4LINCOLN (452-6265).
BOND AND COMMERCIAL PAPER RATINGS
Certain of the funds' investment policies and restrictions include references to
bond and commercial paper ratings. The following is a discussion of the rating
categories of Moody's Investors Service, Inc. and Standard & Poor's Corp.
A-9
<PAGE>
MOODY'S INVESTORS SERVICE, INC.
Aaa -- Bonds which are rated Aaa are judged to be of the best quality and carry
the smallest degree of investment risk. Interest payments are protected by a
large or by an exceptionally stable margin, and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of such
issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa -- Bonds which are rated Baa are considered as 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 both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa -- Bonds which are 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 which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
STANDARD & POOR'S CORP.
AAA -- This is the highest rating assigned by Standard & Poor's Corp. to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA -- Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong, and in the majority of instances they
differ from AAA issues only in small degree.
A -- Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB -- Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas these bonds normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest than for
bonds in the A category and higher.
BB-B-CCC-CC -- Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and C the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
MOODY'S INVESTORS SERVICE, INC.
Moody's Commercial Paper ratings are opinions of the ability of issuers to repay
punctually promissory obligations not having an original maturity in excess of
nine months. Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime 1 -- Highest Quality;
Prime 2 -- Higher Quality;
Prime 3 -- High Quality.
(The FUND will not invest in commercial paper rated Prime 3).
STANDARD & POOR'S CORP.
A Standard & Poor's Corp. commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. The FUND will invest in commercial paper rated in the A Categories, as
follows:
A -- Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are further refined with
the designation 1, 2, and 3 to indicate the relative degree of safety. (The FUND
will not invest in commercial paper rated A-3).
A-10
<PAGE>
A -- 1 this designation indicates that the degree of safety regarding timely
payment is very strong.
A -- 2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not overwhelming as for issues
designated A-1.
U.S. GOVERNMENT
OBLIGATIONS
Securities issued or guaranteed as to principal and interest by the U.S.
Government include a variety of Treasury securities, which differ only in their
interest rates, maturities and times of issuance. Treasury bills have a maturity
of one year or less. Treasury notes have maturities of two to ten years and
Treasury bonds generally have a maturity of greater than ten years.
Various agencies of the U.S. Government issue obligations. Some of these
securities are supported by the full faith and credit of the U.S. Treasury (for
example those issued by Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Government National Mortgage
Association, Maritime Administration, Small Business Administration and The
Tennessee Valley Authority).
Obligations of instrumentalities of the U.S. Government are supported by the
right of the issuer to borrow from the Treasury (for example, those issued by
Federal Farm Credit Banks, Federal Home Loan Bank, Federal Home Loan Mortgage
Corp., Federal Intermediate Credit Banks, Federal Land Bank and the U.S. Postal
Service). Obligations supported by the credit of the instrumentality include
securities issued by government-sponsored corporations whose stock is publicly
held (for example, the Federal National Mortgage Association, and the Student
Loan Marketing Association). There is no guarantee that the government will
support these types of securities, and therefore they may involve more risk than
other government obligations.
TAXES
Each FUND intends to qualify and has elected to be taxed as a regulated
investment company under certain provisions of the Internal Revenue Code of
1986, as amended (the CODE). If a FUND qualifies as a regulated investment
company and complies with the provisions of the CODE relieving regulated
investment companies which distribute substantially all of their net income
(both net ordinary income and net capital gain) from Federal income tax, it will
be relieved from such tax on the part of its net ordinary income and net
realized capital gain which it distributes to its shareholders. To qualify for
treatment as a regulated investment company, each FUND must, among other things,
derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock or securities or foreign currencies (subject to the
authority of the Secretary of the Treasury to exclude foreign currency gains
which are not directly related to the FUND'S principal business of investing in
stock or securities or options and futures with respect to such stock or
securities), or other income (including but not limited to gains from options,
futures, or forward contracts) derived with respect to its investing in such
stocks, securities, or currencies.
The Federal tax laws impose a 4% nondeductible excise tax on each regulated
investment company with respect to an amount, if any, by which such company does
not meet distribution requirements specified in such tax laws, unless certain
exceptions apply. Each FUND intends to comply with such distribution
requirements or qualify under one or more exceptions, and thus does not expect
to incur the 4% nondeductible excise tax.
Since the sole shareholder of each FUND will be LINCOLN LIFE, no discussion is
stated herein as to the Federal income tax consequences at the shareholder
level.
The discussion of Federal income tax considerations in the Prospectus, in
conjunction with the foregoing, is a general and abbreviated summary of the
applicable provisions of the CODE and Treasury Regulations currently in effect
as interpreted by the Courts and the Internal Revenue Service (IRS). These
interpretations can be changed at any time. The above discussion covers only
Federal tax considerations with respect to the FUND. State and local taxes vary.
STATE REQUIREMENTS
The California Department of Insurance has established the following guidelines
for an underlying portfolio of a VARIABLE ACCOUNT. The FUNDS intend to comply
with these guidelines:
BORROWING
The borrowing limit for any FUND is 33 1/3 percent of total assets. Entering
into a reverse repurchase agreement shall be considered "borrowing" as that term
is used herein.
FOREIGN INVESTMENTS -- DIVERSIFICATION
The diversification guidelines to be followed by international and global FUNDS
are as follows:
a. An international FUND or a global FUND is sufficiently diversified if it is
invested in a minimum of three different countries at all times, and has
invested no more than 50 percent of total assets in any one second-tier
country and no more than 25 percent of total assets in any one third-tier
country. First-tier countries are: Germany, the United Kingdom,
A-11
<PAGE>
Japan, the United States, France, Canada, and Australia. Second-tier
countries are all countries not in the first or third tier. Third-tier
countries are countries identified as "emerging" or "developing" by the
International Bank for Reconstruction and Development ("World Bank") or
International Finance Corporation.
b. A regional FUND is sufficiently diversified if it is invested in a minimum
of three countries. The name of the FUND must accurately describe the FUND.
c. The name of a single country FUND must accurately describe the FUND.
d. An index FUND must substantially mirror the index.
DERIVATIVE TRANSACTIONS-
DEFINITIONS
The Prospectus for each FUND and the uniform Appendix for the Prospectus booklet
discuss the type of derivative transactions in which the FUNDS may engage and
the risks typically associated with many derivative transactions. Here are some
definitions for the derivatives listed in the Appendix:
OPTION. A contract which gives the FUND the right, but not the obligation, to
buy or sell specified securities at a fixed price before or at a designated
future date. If the contract allows the FUND to buy securities, it is a call
option; if to sell, it is a put option. It is common practice in options trading
to terminate an outstanding option contract by entering into an offsetting
transaction known as a closing transaction; as a result of which the FUND would
either pay out or receive a cash settlement. This is discussed below.
CURRENCY OPTION. Discussed later.
FIXED INCOME OPTION. One based on a fixed-income security, such as a corporate
or government bond.
INDEX OPTION. One based on the value of an index which measures the fluctuating
value of a basket of pre-selected securities.
STOCK (EQUITY) OPTION. One based on the shares of stock of a particular company.
OPTION ON A FUTURES CONTRACT. Discussed later.
SWAP. A financial transaction in which the FUND and another party agree to
exchange streams of payments at periodic intervals under a predetermined set of
occurrences related to the price, level, performance or value of one or more
underlying securities, and pegged to a reference amount known as the notional
amount. A swap is normally used to change the market risk associated with a loan
or bond borrowing from one interest rate base (fixed term or floating rate) or
currency of one denomination to another.
EQUITY SWAP. One which allows the FUND to exchange the rate of return (or some
portion of the rate) on its portfolio stocks (an individual share, a basket or
index) for the rate of return on another equity or non-equity investment.
INTEREST RATE SWAP. One in which the FUND and another party exchange different
types of interest payment streams, pegged to an underlying notional principal
amount. The three main types of interest rate swaps are coupon swaps (fixed rate
to floating rate in the same currency); basis swaps (one floating rate index to
another floating rate index in the same currency); and cross-currency interest
rate swaps (fixed rate in one currency to floating rate in another).
Related transactions to interest rate swaps:
a. Cap. A contract for which the buyer pays a fee, or premium, to obtain
protection against a rise in a particular interest rate above a certain
level. For example, an interest rate cap may cover a specified principal
amount of a loan over a designated time period, such as a calendar quarter.
If the covered interest rate rises above the rate ceiling, the seller of the
rate cap pays the purchaser an amount of money equal to the average rate
differential times the principal amount times one-quarter.
b. Floor. A contract in which the seller agrees to pay to the purchaser, in
return for the payment of a premium, the difference between current interest
rates and an agreed (strike) rate times the notional amount, should interest
rates fall below the agreed level (the floor). A floor contract has the
effect of a string of interest rate guarantees.
c. Collar. An arrangement to simultaneously purchase a cap and sell a floor, in
order to maintain interest rates within a defined range. The premium income
from the sale of the floor reduces or offsets the cost of buying the cap.
d. Corridor. An agreement to buy a cap at one interest rate and sell a cap at a
higher rate.
SWAPTION. An option to enter into, extend, or cancel a swap.
FUTURES CONTRACT. A contract which commits the FUND to buy or sell a specified
amount of a financial instrument at a fixed price on a fixed date in the future.
Futures contracts are normally traded on an exchange and their terms are
standardized, which makes it easier to buy and sell them.
INTEREST RATE FUTURES (AND OPTIONS ON THEM). Futures contracts pegged to U.S.
and foreign fixed-income securities, debt indices and reference rates.
STOCK INDEX FUTURES. Futures contracts based on an index of pre-selected stocks,
with prices based on a composite of the changes to the prices of the individual
securities in the index (e.g., S&P 500).
A-12
<PAGE>
OPTION ON A FUTURES CONTRACT. An option taken on a futures position.
FORWARD CONTRACT. An over-the-counter, individually-tailored futures contract.
FORWARD RATE AGREEMENT (FRA). A contract in which the FUND and another party
agree on the interest rate to be paid on a notional deposit of specified
maturity at a specific future time. Normally, no exchange of principal is
involved; the difference between the contracted rate and the prevailing rate is
settled in cash.
CURRENCY CONTRACT. A contract entered into for the purpose of reducing or
eliminating an anticipated rise or drop in currency exchange rates over time.
CURRENCY FUTURES. Futures contracts on foreign currencies. Used to hedge the
purchase or sale of foreign securities.
CURRENCY OPTION. An option taken on foreign currency.
CURRENCY SWAP. A swap involving the exchange of cash flows and principal in one
currency for those in another, with an agreement to reverse the principal swap
at a future date.
CROSS-CURRENCY INTEREST RATE SWAP. A swap involving the exchange of streams of
interest rate payments (but not necessarily principal payments) in different
currencies and often on different interest bases (e.g., fixed Deutsche Mark
against floating dollar, but also fixed Deutsche Mark against fixed dollar).
FORWARD CURRENCY CONTRACT. A contract to lock in a currency exchange rate at a
future date, to eliminate risk of currency fluctuation when the time comes to
convert from one currency to another.
A-13
<PAGE>
THIS PAGE WAS INTENTIONALLY LEFT BLANK.
A-14
