STATEMENT OF ADDITIONAL INFORMATION April 30, 1999
AQUINAS FIXED INCOME FUND
AQUINAS EQUITY INCOME FUND
AQUINAS EQUITY GROWTH FUND
AQUINAS BALANCED FUND
THE AQUINAS FUNDS, INC.
5310 Harvest Hill Road
Suite 248
Dallas, Texas 75230
Call 1-972-233-6655
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the Prospectus of The Aquinas Funds, Inc. dated
April 30, 1999. Requests for copies of the Prospectus should be made by writing
to The Aquinas Funds, Inc., 5310 Harvest Hill Road, Dallas, Texas 75230,
Attention: Corporate Secretary, or by calling 1-972-233-6655.
The following financial statements are incorporated by reference to the
Annual Report, dated December 31, 1998, of The Aquinas Funds, Inc. (File No.
811-8122) as filed with the Securities and Exchange Commission on February 26,
1999.
Report of Independent Public Accountants Schedule of
Investments at December 31, 1998 Statements of Assets and
Liabilities at December 31, 1998 Statements of Operations for
the year ended December 31, 1998
Statements of Changes in Net Assets for the years ended December 31,
1998 and December 31, 1997
Financial Highlights for the years ended December 31, 1998,
December 31, 1997, December 31, 1996, December 31, 1995 and
December 31, 1994
Notes to Financial Statements
Shareholders may obtain a copy of the Annual Report, without charge, by
calling 1-877-278-4627.
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THE AQUINAS FUNDS, INC.
TABLE OF CONTENTS
Page
FUND HISTORY AND CLASSIFICATION................................................1
INVESTMENT RESTRICTIONS........................................................1
INVESTMENT POLICIES AND TECHNIQUES.............................................3
DETERMINATION OF NET ASSET VALUE..............................................16
PURCHASE OF SHARES............................................................17
EXCHANGE PRIVILEGE............................................................17
DIRECTORS AND OFFICERS OF THE COMPANY.........................................17
INVESTMENT ADVISER, PORTFOLIO MANAGERS AND ADMINISTRATOR......................20
CUSTODIAN AND TRANSFER AGENT..................................................26
ALLOCATION OF PORTFOLIO BROKERAGE.............................................26
TAXES ........................................................................28
CAPITAL STRUCTURE.............................................................29
SHAREHOLDER MEETINGS..........................................................30
PERFORMANCE INFORMATION.......................................................31
DESCRIPTION OF SECURITIES RATINGS.............................................33
INDEPENDENT ACCOUNTANTS.......................................................39
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated April 30, 1999, and, if given or made, such
information or representations may not be relied upon as having been authorized
by The Aquinas Funds, Inc.
This Statement of Additional Information does not constitute an offer to
sell securities.
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FUND HISTORY AND CLASSIFICATION
The Aquinas Funds, Inc. (the "Company") is an open-end, diversified
management investment company, consisting of four separate diversified
portfolios: the Aquinas Fixed Income Fund (the "Fixed Income Fund"), the Aquinas
Equity Income Fund (the "Equity Income Fund"), the Aquinas Equity Growth Fund
(the "Equity Growth Fund") and the Aquinas Balanced Fund (the "Balanced Fund").
The Aquinas Funds, Inc. is registered under the Investment Company Act of 1940.
The Aquinas Funds, Inc. was incorporated as a Maryland corporation on October
20, 1993.
INVESTMENT RESTRICTIONS
Each of the Funds has adopted the following investment restrictions which
are matters of fundamental policy and cannot be changed without approval of the
holders of the lesser of: (i) 67% of the Fund's shares present or represented at
a stockholder's meeting at which the holders of more than 50% of such shares are
present or represented; or (ii) more than 50% of the outstanding shares of the
Fund.
1. Each of the Funds will diversify its assets in different companies and
will not purchase securities of any issuer if, as a result of such purchase, the
Fund would own more than 10% of the outstanding voting securities of such issuer
or more than 5% of the Fund's assets would be invested in securities of such
issuer (except that up to 25% of the value of the Fund's total assets may be
invested without regard to this limitation). This restriction does not apply to
obligations issued or guaranteed by the United States Government, its agencies
or instrumentalities.
2. None of the Funds will purchase securities on margin, participate in a
joint trading account or sell securities short (except for such short term
credits as are necessary for the clearance of transactions); provided, however,
that the Fixed Income Fund and the Balanced Fund may (i) enter into interest
rate swap transactions; (ii) purchase or sell futures contracts; (iii) make
initial and variation margin payments in connection with purchases or sales of
futures contracts or options on futures contracts; (iv) write or invest in put
or call options; and (v) enter into foreign currency exchange contracts.
3. None of the Funds will borrow money or issue senior securities, except
the Funds may borrow for temporary or emergency purposes, and then only from
banks, in an amount not exceeding 25% of the value of the Fund's total assets.
The Funds will not borrow money for the purpose of investing in securities, and
the Funds will not purchase any portfolio securities while any borrowed amounts
remain outstanding. Notwithstanding the foregoing, the Fixed Income Fund and the
Balanced Fund may enter into options, futures, options on futures, foreign
currency exchange contracts and interest rate swap transactions.
4. None of the Funds will pledge or hypothecate its assets, except to
secure borrowings for temporary or emergency purposes.
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5. None of the Funds will act as an underwriter or distributor of
securities other than shares of the applicable Fund (except to the extent that
the Fund may be deemed to be an underwriter within the meaning of the Securities
Act of 1933, as amended, in the disposition of restricted securities).
6. None of the Funds will make loans, except through (i) the acquisition
of debt securities from the issuer or others which are publicly distributed or
are of a type normally acquired by institutional investors; or (ii) repurchase
agreements and except that the Funds may make loans of portfolio securities to
unaffiliated persons who are deemed to be creditworthy if any such loans are
secured continuously by collateral at least equal to the market value of the
securities loaned in the form of cash and/or securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities and provided that no such
loan will be made if upon the making of that loan more than 30% of the value of
the lending Fund's total assets would be the subject of such loans.
7. None of the Funds will concentrate 25% or more of its total assets,
determined at the time an investment is made, in securities issued by companies
primarily engaged in the same industry. This restriction does not apply to
obligations issued or guaranteed by the United States Government, its agencies
or instrumentalities.
8. None of the Funds will purchase or sell real estate or real estate
mortgage loans and will not make any investments in real estate limited
partnerships but the Funds may purchase and sell securities that are backed by
real estate or issued by companies that invest in or deal in real estate.
Certain of the Funds may purchase mortgage-backed securities and similar
securities in accordance with their investment objectives and policies.
9. None of the Funds will purchase or sell any interest in any oil, gas
or other mineral exploration or development program, including any oil, gas or
mineral leases.
10. None of the Funds will purchase or sell commodities or commodities
contracts, except that the Fixed Income Fund and the Balanced Fund may enter
into futures contracts and options on futures contracts.
Each of the Funds has adopted certain other investment restrictions which
are not fundamental policies and which may be changed without stockholder
approval. These additional restrictions are as follows:
1. The Funds will not acquire or retain any security issued by a
company, an officer or director of which is an officer or director of the
Company or an officer, director or other affiliated person of the Funds'
investment adviser.
2. None of the Funds will invest more than 5% of its total assets
in securities of any issuer which has a record of less than three (3)
years of continuous operation, including the operation of any predecessor
business of a company which came into existence as a result of a merger,
consolidation,
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reorganization or purchase of substantially all of the assets of such
predecessor business.
3. None of the Funds will purchase securities of other investment
companies (as defined in the Investment Company Act of 1940 (the "1940
Act")), except as part of a plan of merger, consolidation, reorganization
or acquisition of assets.
4. No Fund's investments in illiquid securities will exceed 5% of
the total value of its net assets.
5. None of the Funds will make investments for the purpose of
exercising control or management of any company.
6. No Fund's investment in warrants, valued at the lower of cost
or market, will exceed 5% of the total value of the Fund's net assets.
Included within that amount, but not to exceed 2% of the total value of
the Fund's net assets, may be warrants that are not listed on the New
York Stock Exchange or the American Stock Exchange.
The aforementioned percentage restrictions on investment or utilization
of assets refer to the percentage at the time an investment is made. If these
restrictions are adhered to at the time an investment is made, and such
percentage subsequently changes as a result of changing market values or some
similar event, no violation of a Fund's fundamental restrictions will be deemed
to have occurred. Any changes in a Fund's investment restrictions made by the
Board of Directors will be communicated to shareholders prior to their
implementation.
INVESTMENT POLICIES AND TECHNIQUES
In addition to the policies described above and in the Prospectus, the
investment policies and techniques described below have been adopted by the
Funds as indicated.
Temporary Investments
For temporary defensive purposes, each Fund may invest up to 100% of its
total assets in cash and high-quality money market obligations. Money market
securities include short-term investment-grade fixed-income securities, bankers'
acceptances, commercial paper, commercial paper master notes and repurchase
agreements.
The Funds may invest in commercial paper and other cash equivalents rated
A-1 or A-2 by S&P or Prime-1 or Prime-2 by Moody's, commercial paper master
notes (which are demand instruments bearing interest at rates which are fixed to
known lending rates and automatically adjusted when such lending rates change)
of issuers whose commercial paper is rated A-1 or A-2 by S&P or Prime-1 or
Prime-2 by Moody's and unrated debt securities which are deemed by the portfolio
manager to be of comparable quality. Each Fund may also invest
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in United States Treasury bills and Notes, and certificates of deposit of
domestic branches of U.S. banks.
The Funds may invest in repurchase agreements issued by banks and certain
non-bank broker-dealers. In a repurchase agreement, a Fund buys an
interest-bearing security at one price and simultaneously agrees to sell it back
at a mutually agreed upon time and price. The repurchase price reflects an
agreed-upon interest rate during the time the Fund's money is invested in the
security. When entering into repurchase agreements, a Fund must hold an amount
of cash or government securities at least equal to the market value of the
securities that are part of the repurchase agreement. A repurchase agreement can
be considered as a loan collateralized by the security purchased. A repurchase
agreement involves the risk that a seller may declare bankruptcy or default. In
that event, a Fund may experience delays, increased costs and a possible loss.
Repurchase agreements will be acquired in accordance with procedures established
by the Funds' Board of Directors which are designed to evaluate the credit
worthiness of the other parties to the repurchase agreements.
Lending Portfolio Securities
Each of the Funds may lend a portion of its portfolio securities. Such
loans may not exceed 10% of the net assets of the lending Fund. Income may be
earned on collateral received to secure the loans. Cash collateral would be
invested in money market instruments. U.S. Government securities collateral
would yield interest or earn discount. Part of this income might be shared with
the borrower. Alternatively, the lending Fund could allow the borrower to
receive the income from the collateral and charge the borrower a fee. In either
event, the Fund would receive the amount of dividends or interest paid on the
loaned securities.
Usually these loans would be made to brokers, dealers or financial
institutions. Loans would be fully secured by collateral deposited with the
Fund's custodian in the form of cash and/or securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities. This collateral must be
increased within one business day in the event that its value shall become less
than the market value of the loaned securities. While there may be delays in
recovery or even loss of rights in the collateral should the borrower fail
financially, the loans will be made only to firms deemed by Aquinas Investment
Advisors, Inc., the Funds' investment adviser (the "Adviser") and the Funds'
portfolio managers, to be of good standing. Loans will not be made unless, in
the judgment of the Adviser, the consideration which can be earned from such
loans justifies the risk.
The borrower, upon notice, must redeliver the loaned securities within 3
business days. In the event that voting rights with respect to the loaned
securities pass to the borrower and a material proposal affecting the securities
arises, the loan may be called or the Fund will otherwise secure or be granted a
valid proxy in time for it to vote on the proposal.
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In making such loans, the Fund may utilize the services of a loan broker
and pay a fee therefor. The Fund may incur additional custodian fees for
services in connection with lending of securities.
When-Issued Securities
The Fixed Income Fund and the Balanced Fund may purchase securities on a
forward commitment or when-issued basis, which means that the price of the
securities is fixed at the time the commitment to purchase is made. Delivery of
and payment for these securities typically occur 15 to 90 days after the
commitment to purchase. Interest rates on debt securities at the time of
delivery may be higher or lower than those contracted for on the when-issued
security. The Funds will make commitments to purchase when-issued securities
only with the intention of actually acquiring the securities, but the Funds may
sell these securities before the settlement date if the portfolio manager deems
it advisable. The Funds will not accrue income in respect of a when-issued
security prior to its stated delivery date.
When the Funds purchase securities on a when-issued basis, they will
maintain in a segregated account with the Funds' custodian cash or liquid
securities having an aggregate value equal to the amount of its purchase
commitment until payment is made. The purpose and effect of such segregation is
to prevent the Fund from gaining investment leverage from when- issued
transactions. When-issued securities may decline or increase in value during the
period from the Fund's investment commitment to the settlement of the purchase.
Foreign Securities
Each of the Funds may invest up to 15% of its total assets in securities
of foreign issuers that are U.S. dollar-denominated and up to 5% of its total
assets in securities of foreign issuers denominated in foreign currencies.
Securities of foreign issuers in the form of American Depository Receipts
("ADRs") that are regularly traded on recognized U.S. exchanges or in the U.S.
over-the-counter market are not considered foreign securities for purposes of
these limitations. Each of the Funds, however, will not invest more than 10% of
its total assets in such ADRs and will only invest in ADRs that are issuer
sponsored. Investments in securities of foreign issuers involve risks which are
in addition to the usual risks inherent in domestic investments. The value of a
Fund's foreign investments may be significantly affected by changes in currency
exchange rates, and the Funds may incur certain costs in converting securities
denominated in foreign currencies to U.S. dollars. In many countries, there is
less publicly available information about issuers than is available in the
reports and ratings published about companies in the United States.
Additionally, foreign companies are not subject to uniform accounting, auditing
and financial reporting standards. Dividends and interest on foreign securities
may be subject to foreign withholding taxes which would reduce a Fund's income
without providing a tax credit for the Fund's shareholders. Although the Funds
intend to invest in securities of foreign issuers domiciled in nations in which
their respective portfolio managers consider as having stable and friendly
governments, there is a possibility of expropriation, confiscatory taxation,
currency blockage or political or social instability which could affect
investments in those nations.
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Mortgage-Backed and Asset-Backed Securities
The Fixed Income Fund and the Balanced Fund may invest in Mortgage-Backed
as well as other asset-backed Securities (i.e., securities backed by credit card
receivables, automobile loans or other assets). Mortgage-Backed Securities are
securities that directly or indirectly represent a participation in, or are
secured by and payable from, mortgage loans secured by real property.
Mortgage-Backed Securities include: (i) Guaranteed Government Agency
Mortgage-Backed Securities; (ii) Privately-Issued Mortgage-Backed Securities;
and (iii) collateralized mortgage obligations and multiclass pass-through
securities. These securities as well as other asset-backed securities are
described below.
Guaranteed Government Agency Mortgage-Backed Securities. Mortgage-Backed
Securities include Guaranteed Government Agency Mortgage-Backed Securities,
which represent participation interests in pools of residential mortgage loans
originated by United States governmental or private lenders and guaranteed, to
the extent provided in such securities, by the United States Government or one
of its agencies or instrumentalities. Such securities, with the exception of
collateralized mortgage obligations, are ownership interests in the underlying
mortgage loans and provide for monthly payments that are a "pass-through" of the
monthly interest and principal payments (including any prepayments) made by the
individual borrowers on the pooled mortgage loans, net of any fees paid to the
guarantor of such securities and the servicer of the underlying mortgage loans.
The Guaranteed Government Agency Mortgage-Backed Securities in which the
Fixed Income Fund and the Balanced Fund may invest will include those issued or
guaranteed by the Government National Mortgage Association ("Ginnie Mae"), the
Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan
Mortgage Corporation ("Freddie Mac"). As more fully described below, these
securities may include collateralized mortgage obligations, multiclass
pass-through securities and stripped mortgage-backed securities.
Ginnie Mae Certificates. Ginnie Mae is a wholly-owned corporate
instrumentality of the United States within the Department of Housing and Urban
Development. The National Housing Act of 1934, as amended (the "Housing Act"),
authorizes Ginnie Mae to guarantee the timely payment of the principal of and
interest on certificates that are based on and backed by a pool of mortgage
loans insured by the Federal Housing Administration Act, or Title V of the
Housing Act of 1949 ("FHA Loans"), or guaranteed by the Veterans' Administration
under the Servicemen's Readjustment Act of 1944, as amended ("VA Loans"), or by
pools of other eligible mortgage loans. The Housing Act provides that the full
faith and credit of the United States Government is pledged to the payment of
all amounts that may be required to be paid under any guarantee. To meet its
obligations under such guarantee, Ginnie Mae is authorized to borrow from the
United States Treasury with no limitations as to amount.
Fannie Mae Certificates. Fannie Mae is a federally chartered and
privately owned corporation organized and existing under the Federal National
Mortgage Association
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Charter Act. Fannie Mae was originally established in 1938 as a United States
Government agency to provide supplemental liquidity to the mortgage market and
was transformed into a stockholder owned and privately managed corporation by
legislation enacted in 1968. Fannie Mae provides funds to the mortgage market
primarily by purchasing home mortgage loans from local lenders, thereby
replenishing their funds for additional lending. Fannie Mae acquires funds to
purchase home mortgage loans from many capital market investors that ordinarily
may not invest in mortgage loans directly, thereby expanding the total amount of
funds available for housing.
Each Fannie Mae Certificate will entitle the registered holder thereof to
receive amounts representing such holder's pro rata interest in scheduled
principal payments and interest payments (at such Fannie Mae Certificate's
pass-through rate, which is net of any servicing and guarantee fees on the
underlying mortgage loans), and any principal prepayments, on the mortgage loans
in the pool represented by such Fannie Mae Certificate and such holder's
proportionate interest in the full principal amount of any foreclosed or
otherwise finally liquidated mortgage loan. The full and timely payment of
principal of and interest on each Fannie Mae Certificate will be guaranteed by
Fannie Mae, which guarantee is not backed by the full faith and credit of the
United States Government.
Freddie Mac Certificates. Freddie Mac is a corporate instrumentality of
the United States created pursuant to the Emergency Home Finance Act of 1970, as
amended (the "FHLMC Act"). Freddie Mac was established primarily for the purpose
of increasing the availability of mortgage credit for the financing of needed
housing. The principal activity of Freddie Mac currently consists of the
purchase of first lien, conventional, residential mortgage loans and
participation interests in such mortgage loans and the resale of the mortgage
loans so purchased in the form of mortgage securities, primarily Freddie Mac
Certificates.
Freddie Mac guarantees to each registered holder of a Freddie Mac
Certificate the timely payment of interest at the rate provided for by such
Freddie Mac Certificate, whether or not received. Freddie Mac also guarantees to
each registered holder of a Freddie Mac Certificate ultimate collection of all
principal of the related mortgage loans, without any offset or deduction, but,
generally, does not guarantee the timely payment of scheduled principal. Freddie
Mac may remit the amount due on account of its guarantee of collection of
principal at any time after default on an underlying mortgage loan, but not
later than 30 days following (i) foreclosure sale, (ii) payment of claim by any
mortgage insurer, or (iii) the expiration of any right of redemption, whichever
occurs later, but in any event no later than one year after demand has been made
upon the mortgagor for accelerated payment of principal. The obligations of
Freddie Mac under its guarantee are obligations solely of Freddie Mac and are
not backed by the full faith and credit of the United States Government.
Privately-Issued Mortgage-Backed Securities. Privately-Issued
Mortgage-Backed Securities are issued by private issuers and represent an
interest in or are collateralized by (i) Mortgage-Backed Securities issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities
("Privately-Issued Agency Mortgage-Backed Securities"), or (ii) whole mortgage
loans or non-Agency collateralized Mortgage-Backed Securities
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("Privately-Issued Non-Agency Mortgage-Backed Securities"). These securities are
structured similarly to the Ginnie Mae, Fannie Mae and Freddie Mac mortgage
pass-through securities described above and are issued by originators of and
investors in mortgage loans, including savings and loan associations, mortgage
banks, commercial banks, investment banks and special purpose subsidiaries of
the foregoing. Privately-Issued Agency Mortgage-Backed Securities usually are
backed by a pool of Ginnie Mae, Fannie Mae and Freddie Mac Certificates.
Privately-Issued Non-Agency Mortgage-Backed Securities usually are backed by a
pool of conventional fixed rate or adjustable rate mortgage loans that are not
guaranteed by an entity having the credit status of Ginnie Mae, Fannie Mae or
Freddie Mac, and generally are structured with one or more types of credit
enhancement. As more fully described below, these securities may include
collateralized mortgage obligations, multiclass pass-through securities and
stripped mortgage-backed securities.
Collateralized Mortgage Obligations and Multiclass Pass-Through
Securities. Mortgage-Backed Securities include collateralized mortgage
obligations or "CMOs," which are debt obligations collateralized by mortgage
loans or mortgage pass-through securities. Typically, CMOs are collateralized by
Ginnie Mae, Fannie Mae or Freddie Mac Certificates, but also may be
collateralized by other Mortgage-Backed Securities or whole loans (such
collateral collectively hereinafter referred to as "Mortgage Assets"). CMOs
include multiclass pass-through securities, which can be equity interests in a
trust composed of Mortgage Assets. Payments of principal of and interest on the
Mortgage Assets, and any reinvestment income thereon, provide the funds to pay
debt service on the CMOs or make scheduled distributions on the multiclass
pass-through securities. CMOs may be issued by agencies or instrumentalities of
the United States Government, or by private originators of, or investors in,
mortgage loans, including savings and loan associations, mortgage banks,
commercial banks, investment banks and special purpose subsidiaries of the
foregoing. The issuer of a series of CMOs may elect to be treated as a Real
Estate Mortgage Investment Conduit.
In a CMO, a series of bonds or certificates is issued in multiple
classes. Each class of CMOs, often referred to as a "tranche," is issued at a
specific fixed or floating coupon rate and has a stated maturity or final
distribution date. Principal prepayments on the Mortgage Assets may cause the
CMOs to be retired substantially earlier than their stated maturities or final
distribution dates. Interest is paid or accrues on classes of the CMOs on a
monthly, quarterly or semiannual basis. The principal of and interest on the
Mortgage Assets may be allocated among the several classes of a CMO series in
innumerable ways, some of which bear substantially more risk than others. In
particular, certain classes of CMO's and other types of mortgage pass-through
securities, including interest only classes, principal only classes, inverse
floaters, Z or accrual classes and companion classes, are designed to be highly
sensitive to changes in prepayment and interest rates and can subject the holder
to extreme reductions of yield and loss of principal. Neither the Fixed Income
Fund nor the Balanced Fund will invest in such high-risk derivative
mortgage-backed securities.
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Mortgage Dollar Rolls. The Fixed Income Fund and the Balanced Fund may
enter into mortgage "dollar rolls" in which the Fund sells Mortgage-Backed
Securities for delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type, coupon and maturity) securities on
a specified future date. During the roll period, the Fund foregoes principal and
interest paid on the Mortgage-Backed Securities. The Fund is compensated by the
difference between the current sales price and the lower forward price for the
future purchase (often referred to as the "drop") as well as by the interest
earned on the cash proceeds of the initial sale. A "covered roll" is a specific
type of dollar roll for which there is an offsetting cash position or a cash
equivalent security position which matures on or before the forward settlement
date of the dollar roll transaction. The Fixed Income Fund and the Balanced Fund
will only enter into covered rolls. Covered rolls are not treated as a borrowing
or other senior security and will be excluded from the calculation of the Funds'
borrowings and other senior securities.
Asset-Backed Securities. Asset-backed securities may involve certain
risks that are not presented by mortgage-backed securities arising primarily
from the nature of the underlying assets (i.e., credit card and automobile loan
receivables as opposed to real estate mortgages). Non-mortgage asset-backed
securities do not have the benefit of the same security interest in the
collateral as mortgage-backed securities. Credit card receivables are generally
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, many of which have given debtors the right to
reduce the balance due on the credit cards. Most issuers of automobile
receivables permit the servicers to retain possession of the underlying
obligations. If the servicer were to sell these obligations to another party,
there is the risk that the purchaser would acquire an interest superior to that
of the holders of related automobile receivables. In addition, because of the
large number of vehicles involved in a typical issuance and technical
requirements under state laws, the trustee for the holders of the automobile
receivables may not have an effective security interest in all of the
obligations backing such receivables. Therefore, there is a possibility that
payments on the receivables together with recoveries on repossessed collateral
may not, in some cases, be able to support payments on these securities.
Asset-backed securities may be subject to greater risk of default during
periods of economic downturn than other instruments. Also, while the secondary
market for asset-backed securities is ordinarily quite liquid, in times of
financial stress the secondary market may not be as liquid as the market for
other types of securities, which could cause the Fixed Income Fund or Balanced
Fund to experience difficulty in valuing or liquidating such securities.
Miscellaneous. The yield characteristics of Mortgage-Backed Securities
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
generally may be prepaid at any time. As a result, if a Fund purchases such a
security at a premium, a prepayment rate that is faster than
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expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing yield to maturity.
Conversely, if a Fund purchases these securities at a discount, faster than
expected prepayments will increase, while slower than expected prepayments will
reduce, yield to maturity. Certain classes of CMOs and other types of mortgage
pass-through securities, including those whose interest rates fluctuate based on
multiples of a stated index, are designed to be highly sensitive to changes in
prepayment and interest rates and can subject the holders thereof to extreme
reductions of yield and possibly loss of principal.
Prepayments on a pool of mortgage loans are influenced by a variety of
economic, geographic, social and other factors, including changes in the
mortgagors' housing needs, job transfers, unemployment, mortgagors' net equity
in the mortgaged properties and servicing decisions. Generally, however,
prepayments on fixed rate mortgage loans will increase during a period of
falling interest rates and decrease during a period of rising interest rates.
Accordingly, amounts available for reinvestment by a Fund are likely to be
greater during a period of declining interest rates and, as a result, likely to
be reinvested at lower interest rates than during a period of rising interest
rates. Mortgage-Backed Securities may decrease in value as a result of increases
in interest rates and may benefit less than other fixed income securities from
declining interest rates because of the risk of prepayment.
No assurance can be given as to the liquidity of the market for certain
Mortgage-Backed Securities, such as CMOs and multiclass pass-through securities.
Determination as to the liquidity of such securities will be made in accordance
with guidelines established by the Company's Board of Directors. In accordance
with such guidelines, the Adviser and the portfolio managers will monitor each
Fund's investments in such securities with particular regard to trading
activity, availability of reliable price information and other relevant
information.
Interest rates on variable rate Mortgage-Backed Securities are subject to
periodic adjustment based on changes or multiples of changes in an applicable
index. The One-Year Treasury Index and LIBOR are among the common interest rate
indexes. The One-Year Treasury Index is the figure derived from the average
weekly quoted yield on U.S. Treasury Securities adjusted to a constant maturity
of one year. LIBOR, the London interbank offered rate, is the interest rate that
the most creditworthy international banks dealing in U.S. dollar-denominated
deposits and loans charge each other for large dollar-denominated loans. LIBOR
is also usually the base rate for large dollar-denominated loans in the
international market. LIBOR is generally quoted for loans having rate
adjustments at one, three, six or twelve month intervals.
Illiquid Securities
Each of the Funds may invest in illiquid securities, which include
certain restricted securities (privately placed securities), repurchase
agreements maturing in more than seven days and other securities that are not
readily marketable. However, no Fund will acquire illiquid securities if, as a
result, they would comprise more than 5% of the value of the
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Fund's net assets. The Board of Directors of the Company or its delegate has the
ultimate authority to determine, to the extent permissible under the federal
securities laws, which securities are liquid or illiquid for purposes of this 5%
limitation. Securities eligible to be resold pursuant to Rule 144A under the
Securities Act may be considered liquid by the Board of Directors. Risks
associated with illiquid securities include the potential inability of a Fund to
promptly sell a portfolio security after its decision to sell.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is required,
a Fund may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time the Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions were
to develop, a Fund might obtain a less favorable price than prevailed when it
decided to sell. Restricted securities will be priced at fair value as
determined in good faith by the Board of Directors of the Company. If through
the appreciation of restricted securities or the depreciation of unrestricted
securities, a Fund should be in a position where more than 5% of the value of
its net assets are invested in illiquid assets, including restricted securities,
the Fund will take such steps as is deemed advisable, if any, to protect
liquidity.
U.S. Government Securities
Each of the Funds may invest in securities issued or guaranteed by the
U.S. Government or its agencies or instrumentalities which include Treasury
securities which differ only in their interest rates, maturities and times of
issuance. Treasury Bills have initial maturities of one year or less; Treasury
Notes have initial maturities of one to ten years; and Treasury Bonds generally
have initial maturities of greater than ten years. Some obligations issued or
guaranteed by U.S. Government agencies and instrumentalities, for example,
Ginnie Mae Certificates, are supported by the full faith and credit of the U.S.
Treasury; others, such as those of the Federal Home Loan Banks, by the right of
the issuer to borrow from the Treasury; others, such as those issued by Fannie
Mae, by discretionary authority of the U.S. Government to purchase certain
obligations of the agency or instrumentality; and others, such as those issued
by the Student Loan Marketing Association, only by the credit of the agency or
instrumentality. While the U.S. Government provides financial support to such
U.S. Government sponsored agencies or instrumentalities, no assurance can be
given that it will always do so since it is not so obligated by law.
Zero Coupon Securities
The Fixed Income Fund and the Balanced Fund may invest up to 10% of their
net assets in zero coupon U.S. Government and corporate debt securities, which
do not pay current interest, but are purchased at a discount from their face
values. The market prices of zero coupon securities generally are more volatile
than the prices of securities that pay interest periodically and in cash and are
likely to respond to changes in interest rates to a greater degree than to other
types of debt securities having similar maturities and credit qualities.
B-11
<PAGE>
Hedging Instruments
The Fixed Income Fund and the Balanced Fund may buy and sell futures
contracts on debt securities ("Debt Futures"). When the Funds buy a Debt Future,
they agree to take delivery of a specific type of debt security at a specific
future date for a fixed price; when they sell a Debt Future, they agree to
deliver a specific type of debt security at a specific future date for a fixed
price. Either obligation may be satisfied by the actual taking, delivering or
entering into an offsetting Debt Future to close out the futures position. The
Fixed Income Fund and the Balanced Fund may purchase puts but only if (i) the
investments to which the puts relate are Debt Futures; and (ii) the puts are
traded on a domestic commodities exchange. Such puts need not be protective
(i.e., the Funds need not own the related Debt Futures). The Funds may write
covered puts on Debt Futures. For a put to be covered, the Fund must maintain in
a segregated account cash or liquid securities equal to the option price. The
Funds may purchase calls and write calls but only if (i) the investments to
which the calls relate are Debt Futures; and (ii) the calls are traded on a
domestic commodities exchange.
Futures Contracts. When a Fund purchases a futures contract, it agrees to
purchase a specified underlying instrument at a specified future date. When a
Fund sells a futures contract, it agrees to sell the underlying instrument at a
specified future date. The price at which the purchase and sale will take place
is fixed when the Fund enters into the contract. Futures can be held until their
delivery dates, or can be closed out before then if a liquid secondary market is
available.
The value of a futures contract tends to increase and decrease in tandem
with the value of its underlying instrument. Therefore, purchasing futures
contracts will tend to increase a Fund's exposure to positive and negative price
fluctuations in the underlying instrument, much as if the Fund had purchased the
underlying instrument directly. When the Fund sells a futures contract, by
contrast, the value of its futures position will tend to move in a direction
contrary to the market. Selling futures contracts, therefore, will tend to
offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
Futures Margin Payments. The purchaser or seller of a futures contract is
not required to deliver or pay for the underlying instrument unless the contract
is held until the delivery date. However, both the purchaser and seller are
required to deposit "initial margin" with a futures broker known as a Futures
Commission Merchant (FCM), when the contract is entered into. Initial margin
deposits are equal to a percentage of the contract's value. If the value of a
party's position declines, that party will be required to make additional
"variation margin" payments to settle the change in value on a daily basis. The
party that has a gain may be entitled to receive all or a portion of this
amount. Initial and variation margin payments do not constitute purchasing
securities on margin for purposes of a Fund's investment limitations. In the
event of the bankruptcy of an FCM that holds margin on behalf of a Fund, the
Fund may be entitled to return of margin owed to it only in proportion to the
amount received by the FCM's other customers, potentially resulting in losses to
the Fund.
B-12
<PAGE>
Purchasing Put and Call Options. By purchasing a put option, a Fund
obtains the right (but not the obligation) to sell the option's underlying
instrument at a fixed strike price. In return for this right, the Fund pays the
current market price for the option (known as the option premium). A Fund may
purchase options on Debt Futures. The Fund may terminate its position in a put
option it has purchased by allowing it to expire or by exercising the option. If
the option is allowed to expire, the Fund will lose the entire premium it paid.
If the Fund exercises the option, it completes the sale of the underlying
instrument at the strike price. The Fund may also terminate a put option
position by closing it out in the secondary market at its current price, if a
liquid secondary market exists. The buyer of a put option can expect to realize
a gain if security prices fall substantially. However, if the underlying
instrument's price does not fall enough to offset the cost of purchasing the
option, a put buyer can expect to suffer a loss (limited to the amount of the
premium paid, plus related transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the underlying instrument at the option's strike
price. A call buyer attempts to participate in potential price increases of the
underlying instrument with risk limited to the cost of the option if security
prices fall. At the same time, the buyer can expect to suffer a loss if security
prices do not rise sufficiently to offset the cost of the option. Only exchange
listed options will be acquired.
Writing Call and Put Options. When a Fund writes a call option, it
receives a premium and agrees to sell the related investments to a purchaser of
the call during the call period (usually not more than nine months) at a fixed
exercise price (which may differ from the market price of the related
investments) regardless of market price changes during the call period. If the
call is exercised, the Fund forgoes any gain from an increase in the market
price over the exercise price. When writing an option on a futures contract the
Fund will be required to make margin payments to an FCM as described above for
futures contracts.
To terminate its obligation on a call which it has written, the Fund may
purchase a call in a "closing purchase transaction." (As discussed above, the
Fund may also purchase calls other than as part of such closing transactions.) A
profit or loss will be realized depending on the amount of option transaction
costs and whether the premium previously received is more or less than the price
of the call purchased. A profit may also be realized if the call lapses
unexercised, because the Fund retains the premium received. Any profits realized
from the premiums received on options which expire unexercised are considered
short-term gains for federal income tax purposes and, when distributed, are
taxable as ordinary income.
Writing calls generally is a profitable strategy if prices remain the
same or fall. Through receipt of the option premium, a call writer mitigates the
effects of a price decline. At the same time, because a call writer must be
prepared to deliver the underlying instrument in return for the strike price,
even if its current value is greater, a call writer gives up some ability to
participate in security price increases.
B-13
<PAGE>
When a Fund writes a put option, it takes the opposite side of the
transaction from the option's purchaser. In return for receipt of a premium, the
Fund assumes the obligation to pay the strike price for the option's underlying
instrument if the other party to the option chooses to exercise it. The Funds
may only write covered puts. For a put to be covered, the Fund must maintain in
a segregated account cash or liquid securities equal to the option price. A
profit or loss will be realized depending on the amount of option transaction
costs and whether the premium previously received is more or less than the put
purchased in a closing purchase transaction. A profit may also be realized if
the put lapses unexercised because the Fund retains the premium received. Any
profits realized from the premiums received on options which expire unexercised
are considered short-term gains for federal income tax purposes and, when
distributed, are taxable as ordinary income.
Combined Option Positions. The Funds may purchase and write options
(subject to the limitations discussed above) in combination with each other to
adjust the risk and return characteristics of the overall position. For example,
the Fund may purchase a put option and write a call option on the same
underlying instrument, in order to construct a combined position whose risk and
return characteristics are similar to selling a futures contract. Another
possible combined position would involve writing a call option at one strike
price and buying a call option at a lower price, in order to reduce the risk of
the written call option in the event of a substantial price increase. Because
combined options involve multiple trades, they result in higher transaction
costs and may be more difficult to open and close out.
Correlation of Price Changes. Because there are a limited number of types
of exchange-traded options and futures contracts, it is likely that the
standardized contracts available will not match a Fund's current or anticipated
investments. A Fund may invest in options and futures contracts based on
securities which differ from the securities in which it typically invests. This
involves a risk that the options or futures position will not track the
performance of the Fund's investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match the Fund's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. A Fund may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
historical volatility between the contract and the securities, although this may
not be successful in all cases. If price changes in the Fund's options or
futures positions are poorly correlated with its other investments, the
positions may fail to produce anticipated gains or result in losses that are not
offset by gains in other investments. Successful use of these techniques
requires skills different from those needed to select portfolio securities.
B-14
<PAGE>
Liquidity of Options and Futures Contracts. There is no assurance a
liquid secondary market will exist for any particular options or futures
contract at any particular time. Options may have relatively low trading volume
and liquidity if their strike prices are not close to the underlying
instruments' current price. In addition, exchanges may establish daily price
fluctuation limits for options and futures contracts, and may halt trading if a
contract's price moves upward or downward more than the limit in a given day. On
volatile trading days when the price fluctuation limit is reached or a trading
halt is imposed, it may be impossible for a Fund to enter into new positions or
close out existing positions. If the secondary market for a contract is not
liquid because of price fluctuation limits or otherwise, it could prevent prompt
liquidation of unfavorable positions, and potentially could require a Fund to
continue to hold a position until delivery or expiration regardless of changes
in its value. As a result, the Fund's access to other assets held to cover its
options or futures positions could also be impaired.
Asset Coverage for Futures and Options Positions. The Funds will comply
with guidelines established by the Securities and Exchange Commission with
respect to coverage of options and futures strategies by mutual funds, and if
the guidelines so require will set aside U.S. Government securities, cash or
liquid securities in a segregated custodial account in the amount prescribed.
Securities held in a segregated account cannot be sold while the futures or
option strategy is outstanding, unless they are replaced with other suitable
assets. As a result, there is a possibility that segregation of a large
percentage of the Fund's assets could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
Limitations on Futures and Options Transactions. The Fixed Income Fund
and the Balanced Fund filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the Commodity Futures
Trading Commission (CFTC) and the National Futures Association, which regulate
trading in the futures markets, before engaging in any purchases or sales of
futures contracts or options on futures contracts. Pursuant to Section 4.5 of
the regulations under the Commodity Exchange Act, the notice of eligibility
included the following representations:
(1) The Fund will use futures contracts and related options solely
for bona fide hedging purposes within the meaning of CFTC regulations;
provided that the Fund may hold positions in futures contracts or options
that do not fall within the definition of bona fide hedging transactions
if the aggregate initial margin and premiums required to establish such
positions will not exceed 5% of the liquidation value of the Fund's
assets, after taking into account unrealized profits and losses on any
such contracts (subject to limited exclusions for options that are
in-the-money at the time of purchase); and
(2) The Fund will not market participations to the public as or in
a commodity pool or otherwise as or in a vehicle for trading in the
commodities futures or commodity option markets.
B-15
<PAGE>
Special Risks of Hedging and Income Enhancement Strategies. Participation
in the options or futures markets involves investment risks and transactions
costs to which the Fixed Income Fund and the Balanced Fund would not be subject
absent the use of these strategies. If a Fund's portfolio manager(s)' prediction
of movements in the direction of the securities and interest rate markets are
inaccurate, the adverse consequences to the Fund may leave the Fund in a worse
position than if such strategies were not used. Risks inherent in the use of
Debt Futures and options on Debt Futures include (i) dependence on the portfolio
manager(s)' ability to predict correctly movements in the direction of interest
rates, securities prices and currency markets; (ii) imperfect correlation
between the price of options and Debt Futures and options thereon and movements
in the prices of the securities being hedged; (iii) the fact that skills needed
to use these strategies are different from those needed to select portfolio
securities; (iv) the possible absence of a liquid secondary market for any
particular instrument at any time; and (v) the possible need to defer closing
out certain hedged positions to avoid adverse tax consequences.
DETERMINATION OF NET ASSET VALUE
As set forth in the Prospectus under the caption "DETERMINATION OF NET
ASSET VALUE," the net asset value of each of the Funds will be determined as of
the close of regular trading (currently 4:00 p.m. Eastern time) on each day the
New York Stock Exchange is open for trading. The New York Stock Exchange is open
for trading Monday through Friday except New Year's Day, Dr. Martin Luther King,
Jr. Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day. Additionally, if any of the
aforementioned holidays falls on a Saturday, the New York Stock Exchange will
not be open for trading on the preceding Friday and when any such holiday falls
on a Sunday, the New York Stock Exchange will not be open for trading on the
succeeding Monday, unless unusual business conditions exist, such as the ending
of a monthly or the yearly accounting period. The New York Stock Exchange also
may be closed on national days of mourning. This determination is applicable to
all transactions in shares of the Fund prior to that time and after the previous
time as of which net asset value was determined.
Securities which are traded on a recognized stock exchange or the Nasdaq
Stock Market are valued at the last sale price on the securities exchange on
which such securities are primarily traded or at the last sale price on the
national securities market. Exchange-traded securities for which there were no
transactions are valued at the current bid prices. Securities traded on only
over-the-counter markets are valued on the basis of closing over-the-counter bid
prices. Debt securities (other than short-term instruments) are valued at prices
furnished by a pricing service, subject to review and possible revision by the
Funds' Adviser. Any modification of the price of a debt security furnished by a
pricing service is made under the supervision of and will be the ultimate
responsibility of the Company's Board of Directors. Debt instruments maturing
within 60 days are valued by the amortized cost method. Any securities for which
market quotations are not readily available are valued at their fair value as
determined in good faith by the Adviser under the supervision of the Company's
Board of
B-16
<PAGE>
Directors, although such day-to-day determinations are made by the Adviser under
the supervision of or pursuant to guidelines established by the Company's Board
of Directors.
PURCHASE OF SHARES
Each of the Funds has adopted procedures pursuant to Rule 17a-7 under the
1940 Act pursuant to which a Fund may effect a purchase and sale transaction
with an affiliated person of the Fund (or an affiliated person of such an
affiliated person) in which the Fund issues its shares in exchange for
securities of a character which is a permitted investment for the Fund. For
purposes of determining the number of shares to be issued, the securities to be
exchanged will be valued in the manner required by Rule 17a-7.
EXCHANGE PRIVILEGE
Investors may exchange shares of a Fund having a value of $500 or more
for shares of any other Fund. In addition, effective July 1, 1998, shareholders
of the Funds may exchange shares of a Fund for shares of the PlanAhead Class of
American AAdvantage Money Market Fund. Investors who are interested in
exercising the exchange privilege should first contact the Funds to obtain
instructions and any necessary forms.
The exchange privilege will not be available if the proceeds from a
redemption of shares of the Funds are paid directly to the investor or at his or
her discretion to any persons other than the Funds. There is currently no
limitation on the number of exchanges an investor may make. The exchange
privilege may be terminated by the Funds upon at least 60 days prior notice to
investors.
For federal income tax purposes, a redemption of shares of the Funds
pursuant to the exchange privilege will result in a capital gain if the proceeds
received exceed the investor's tax-cost basis of the shares of Common Stock
redeemed. Such a redemption may also be taxed under state and local tax laws,
which may differ from the Code.
DIRECTORS AND OFFICERS OF THE COMPANY
As a Maryland corporation, the business and affairs of the Company are
managed by its officers under the direction of the Board of Directors. The name,
address, age, position(s) with the Company, principal occupation(s) during the
past five years, and certain other information with respect to each of the
directors and officers of the Company are as follows:
FRANK A. RAUSCHER, 55, President and Treasurer.
5310 Harvest Hill Road
Suite 248
Dallas, Texas 75230
B-17
<PAGE>
Mr. Rauscher has been the Chief Operating Officer of Aquinas Investment
Advisers, Inc. since August 1994. Prior thereto he was President and Chief
Executive Officer of American Federal Bank.
MICHAEL R. CORBOY, 68, Director.
#7 Kings Gate
Dallas, Texas 75225
Mr. Corboy is President of Corboy Investment Company, a private
investment company.
SISTER IMELDA GONZALEZ, CDP, 58, Director.
c/o NATRI
8824 Cameron Street
Silver Spring, Maryland 20910
Sister Gonzalez has been a member of the staff of the National
Association of Treasurers of Religious Institutions, Silver Spring, Maryland,
since April 1997. Prior thereto, Sister Gonzalez was the Treasurer General and
Chief Financial Officer of the Congregation of Divine Providence of San Antonio,
Texas.
THOMAS J. MARQUEZ, 61, Director.
8300 Douglas Avenue,
Suite 800
Dallas, Texas 75225
Mr. Marquez has been a self-employed private investor
since 1990.
CHARLES CLARK*, 60, Director.
2420 Butler
Dallas, Texas 75235
Mr. Clark is President of Olmsted-Kirk Paper Company. Mr. Clark has been
Secretary, Treasurer and a Director of the Adviser since April 29, 1997.
- ------------
* Messrs. Clark and Strauss are directors who are "interested persons" of
the Company as that term is defined in the 1940 Act.
B-18
<PAGE>
JOHN L. STRAUSS*, 59, Director.
4601 Christopher Place
Dallas, Texas 75204
Mr. Strauss was a principal of Barrow, Hanley, Mewhinney & Strauss, an
investment advisory firm from 1980 until his retirement in January 1998. Mr.
Strauss is a director of the Adviser.
JOHN J. KICKHAM*, 57, Vice President.
5310 Harvest Hill Road
Suite 245
Dallas, Texas 75230
Mr. Kickham has been the President of Quarterdeck of Texas, Inc., a
mortgage banking firm, since March 1994. From November 1994 through November
1995, he was President of Wing Industries, a door manufacturer. Mr. Kickham has
been Chairman of the Kickham Group, Inc., a private investment company, since
March 1985.
The following table sets forth information on the compensation paid to
directors for services as directors of the Company during the fiscal year ended
December 31, 1998.
<TABLE>
<CAPTION>
Total
Pension or Compensation
Retirement From
Aggregate Benefits Accrued Estimated Annual Company and
Compensation as Part of Fund Benefits Upon Fund Complex
Name of Person from Company Expenses Retirement Paid to Directors
-------------- ------------ -------- ---------- -----------------
<S> <C> <C> <C> <C>
Charles Clark $ 0 0 0 $ 0
Michael R. Corboy 1,000 0 0 1,000
Imelda Gonzalez, CDP 1,500 0 0 1,500
Thomas J. Marquez 2,000 0 0 2,000
John L. Strauss 0 0 0 0
</TABLE>
The Company compensates each disinterested director $500 for each meeting
of the Board of Directors attended. The Company may also reimburse directors for
travel expenses incurred in order to attend meetings of the Board of Directors.
During the fiscal year ended December 31, 1998, there were reimbursements of
$1,272.50 for travel expenses. Sister Gonzalez has assigned all directors fees
that she receives to her religious order.
As of January 31, 1999, the officers and directors of the Fund as a group
owned less than 1% of the outstanding securities of each Fund. At January 31,
1999, The Catholic Foundation, 5310 Harvest Hill Road, Suite 248, Dallas, Texas
75230, owned 3,447,919 shares
B-19
<PAGE>
(78.8% of the outstanding) of the Fixed Income Fund, of which 1,934,606 shares
(44.2%) were owned as trustee and 1,513,313 shares (34.6%) were beneficially
owned; 3,154,952 shares (65.3% of the outstanding) of the Equity Income Fund, of
which 1,902,205 shares (39.4%) were owned as trustee and 1,252,747 shares
(25.9%) were beneficially owned; 1,589,348 shares (58.2% of the outstanding) of
the Equity Growth Fund, of which 710,435 shares (26.0%) were owned as trustee
and 878,913 shares (32.2%) were beneficially owned; and 1,807,535 shares (83.1%
of the outstanding) of the Balanced Fund, of which 327,410 shares (15.0%) were
owned as trustee and 1,480,125 shares (68.0%) were beneficially owned. The Lay
Employees of the Roman Catholic Diocese of Dallas 403(b)(7) plan, P.O. Box
190507, Dallas, Texas 75219, owned 134,025 shares (6.2% of the outstanding of
the Balanced Fund; and the Bishop Charles V. Grahmann Trust, P.O. Box 190507,
Dallas, Texas 75219, owned 237,789 shares (5.4% of the outstanding) of the Fixed
Income Fund. No other person owns of record or beneficially 5% or more of the
outstanding securities of any Fund. By virtue of its stock ownership, The
Catholic Foundation is deemed to "control," as that term is defined in the
Investment Company Act of 1940, each of the Funds and the Company.
INVESTMENT ADVISER, PORTFOLIO MANAGERS AND ADMINISTRATOR
The Board of Directors of the Company supervises the management,
activities and affairs of the Funds and has approved contracts with the
following business organizations to provide, among other services, day-to-day
management required by the Funds.
Investment Adviser. The investment adviser to the Funds is Aquinas
Investment Advisers, Inc., 5310 Harvest Hill, Suite 248, Dallas, Texas 75230
(the "Adviser"). The Adviser is a wholly-owned subsidiary of The Catholic
Foundation and was organized to become the investment adviser to the Funds.
Pursuant to investment advisory agreements entered into between each of the
Funds and the Adviser (the "Management Agreements"), the Adviser provides
consulting, investment and administrative services to the Funds. For its
services to the Funds, the Adviser receives a monthly fee based on the average
daily net assets of each Fund at the annual rate of 0.60% for the Fixed Income
Fund, 1.00% for the Equity Income Fund, 1.00% for the Equity Growth Fund and
1.00% for the Balanced Fund. The specific investments for each Fund are made by
portfolio managers selected for the Funds by the Adviser. The Adviser pays the
fees of each portfolio manager. The Adviser (i) provides or oversees the
provision of all general management and administration, investment advisory and
portfolio management, and distribution services for the Funds; (ii) provides the
Funds with office space, equipment and personnel necessary to operate and
administer the Funds' business, and to supervise provision of services by third
parties such as the portfolio managers and custodian; (iii) develops the
investment programs, selects portfolio managers, allocates assets among
portfolio managers and monitors the portfolio managers' investment programs and
results; and (iv) is authorized to select or hire portfolio managers to select
individual portfolio securities held in the Funds. The Adviser bears the
expenses it incurs in providing these services as well as the costs of preparing
and distributing explanatory materials concerning the Funds. The Adviser also
provides asset management consulting services - including the objective-setting
and asset-allocation technology, and portfolio manager research and evaluation
assistance.
B-20
<PAGE>
The Funds pay all of their own expenses, including, without limitation,
the cost of preparing and printing their registration statements required under
the Securities Act of 1933 and the Investment Company Act of 1940 and any
amendments thereto, the expense of registering their shares with the Securities
and Exchange Commission and in the various states, the printing and distribution
costs of prospectuses mailed to existing investors, reports to investors,
reports to government authorities and proxy statements, fees paid to directors
who are not interested persons of the Adviser, interest charges, taxes, legal
expenses, association membership dues, auditing services, insurance premiums,
brokerage commissions and expenses in connection with portfolio transactions,
fees and expenses of the custodian of the Funds' assets, printing and mailing
expenses and charges and expenses of dividend disbursing agents, accounting
services agents, registrars and stock transfer agents.
The Adviser has undertaken to waive its advisory fees with respect to
each of the Funds to the extent that the aggregate annual operating expenses,
including the investment advisory fee and the administration fee but excluding
interest, taxes, brokerage commissions and other costs incurred in connection
with the purchase or sale of portfolio securities, and extraordinary items,
exceeded that percentage of the average net assets of the Fund for such year, as
determined by valuations made as of the close of each business day of the year,
which is the most restrictive percentage provided by the state laws of the
various states in which the shares of the Funds are qualified for sale. As of
the date of this Statement of Additional Information, the shares of the Funds
are not qualified for sale in any state which imposes an expense limitation.
Additionally, the Adviser voluntarily has agreed to reimburse each Fund to the
extent aggregate annual operating expenses as described above exceed 1.50% of
the average daily net assets of a Fund (1.00% for the Fixed Income Fund). The
Adviser may voluntarily continue to waive all or a portion of the advisory fees
otherwise payable by the Funds. Such a waiver may be terminated at any time in
the Adviser's discretion. Each Fund monitors its expense ratio on a monthly
basis. If the accrued amount of the expenses of the Fund exceeds the expense
limitation, the Fund creates an account receivable from the Adviser for the
amount of such excess. In such a situation the monthly payment of the Adviser's
fee is reduced by the amount of such excess, subject to adjustment month by
month during the balance of the Fund's fiscal year if accrued expenses
thereafter fall below this limit.
For the fiscal years ended December 31, 1998, December 31, 1997 and
December 31, 1996, the fees paid to the Adviser for management and investment
advisory services were $222,321 (net of waivers of $10,042), $209,779 (net of
waivers of $22,939) and $203,761 (net of waivers of $10,507), respectively, for
the Fixed Income Fund, $653,479, $633,726 and $479,210, respectively, for the
Equity Income Fund, $396,047, $291,466 and $181,345 (net of waivers of $7,841),
respectively, for the Equity Growth Fund and $290,593, $289,730 and $278,719,
respectively, for the Balanced Fund.
Each Management Agreement will remain in effect as long as its
continuance is specifically approved at least annually (i) by the Board of
Directors of the Company or by the vote of a majority (as defined in the 1940
Act) of the outstanding shares of the applicable Fund, and (ii) by the vote of a
majority of the directors of the Company who are not parties to the Management
Agreement or interested persons of the Adviser, cast in person at a meeting
B-21
<PAGE>
called for the purpose of voting on such approval. Each Management Agreement
provides that it may be terminated at any time without the payment of any
penalty, by the Board of Directors of the Company or by vote of the majority of
the applicable Fund's shareholders on sixty (60) days' written notice to the
Adviser, and by the Adviser on the same notice to the Fund, and that it shall be
automatically terminated if it is assigned.
Portfolio Managers. Each portfolio manager makes specific portfolio
investments for that segment of the assets of a Fund under its management in
accordance with the particular Fund's investment objective and the portfolio
manager's investment approach and strategies.
Portfolio managers are employed or terminated by the Adviser subject to
prior approval by the Board of Directors of the Company. The Funds and the
Adviser have obtained an order of exemption from the SEC that permits the
Adviser to enter into and materially amend portfolio management agreements with
nonaffiliated portfolio managers without obtaining shareholder approval. The
Funds will notify shareholders of any change in portfolio managers. Selection
and retention criteria for portfolio managers include (i) their historical
performance records; (ii) an investment approach that is distinct in relation to
the approaches of each of the Funds' other portfolio managers; (iii) consistent
performance in the context of the markets and preservation of capital in
declining markets; (iv) organizational stability and reputation; (v) the quality
and depth of investment personnel; and (vi) the ability of the portfolio manager
to apply its approach consistently. Each portfolio manager will not necessarily
exhibit all of the criteria to the same degree. Portfolio managers are paid by
the Adviser (not the Funds).
In general, the policy of the Adviser with respect to each Fund is to
allocate assets approximately equally among the portfolio managers of each Fund
and to maintain such an equal allocation at regular intervals. Ordinarily,
assets will not be allocated from a portfolio manager whose performance is less
than that of the other portfolio managers of the Fund. The assets of each Fund
are reallocated at least quarterly but may be reallocated more frequently at the
discretion of the Adviser depending on cash flow and the evaluation of each
portfolio manager's performance. The allocation among portfolio managers within
a Fund may be temporarily unequal when portfolio managers are added to or
removed from a Fund or in the event of a net redemption. A portfolio manager may
purchase a particular security for the Fund at the same time another portfolio
manager is selling the same security for the Fund.
The portfolio managers' activities are subject to general supervision by
the Adviser and the Board of Directors of the Company. Although the Adviser and
Board do not evaluate the investment merits of the portfolio managers' specific
securities selections, they do review the performance of each portfolio manager
relative to the selection criteria.
Atlantic Asset Management Partners, L.L.C. ("AAM") is a portfolio manager
for the Fixed Income Fund and the Balanced Fund. Effective September 1, 1997,
for its services to the Fixed Income Fund and the Balanced Fund, AAM receives a
fee computed daily and payable monthly, paid by the Adviser (not the Funds)
determined by multiplying the
B-22
<PAGE>
average daily net assets of each of the Fixed Income Fund and the Balanced Fund
during the month by 1/12 of the Performance Fee Rate. The Performance Fee Rate
is determined by applying the following formula:
Performance Fee Rate = 0.30% + [0.20 x (Excess Return - 1.20%)]
Notwithstanding the above formula, the Performance Fee Rate will not be
lower than 0.10% and will not be higher than 0.50%. "Excess Return" is equal to
AAM's Total Return less the Benchmark Total Return for the twelve month period
beginning on the first day of the eleventh month prior to the month for which
the Performance Fee Rate is calculated and ending on the last day of such month
(e.g. the Performance Fee Rate for August 1998 is based on total returns for the
period beginning September 1, 1997 and ending August 31, 1998). The "Benchmark
Total Return" is the change in the level of the Lehman Brothers Aggregate Bond
Index during the measuring period. "AAM's Total Return" is the change in value
of assets of the Fixed Income Fund and the Balanced Fund under the management of
AAM plus any interest paid or accrued on such assets less brokerage commissions
paid on the acquisition or disposition of such assets during the measuring
period. AAM's Total Return is adjusted on a time-weighted basis for any assets
added to or withdrawn from the assets under the management of AAM. Since the fee
is received by AAM from the Adviser is based in part on AAM's performance, there
exists the risk that AAM might take undue risks to increase its investment
performance.
Prior to September 1, 1997, for its services to the Funds, AAM received a
fee, computed daily and payable monthly, paid by the Adviser (not the Funds), at
the following annual rate based on average daily net assets under its
management:
Assets Fee Rate
------ --------
0 to $15 million..................................................... 0.380%
$15 million to $45 million........................................... 0.300%
$45 million to $100 million.......................................... 0.200%
Over $100 million.................................................... 0.100%
Income Research & Management, Inc. ("IRM") serves as a portfolio manager
to the Fixed Income Fund and the Balanced Fund. For its services to the Funds,
the Adviser (not the Funds) pays IRM a fee, computed daily and payable monthly,
at the following annual rate based on average daily net assets under its
management:
Assets Fee Rate
------ --------
0 to $10 million..................................................... 0.400%
$10 million to $20 million........................................... 0.300%
$20 million to $60 million........................................... 0.250%
$60 million to $100 million.......................................... 0.200%
Over $100 million.................................................... 0.150%
B-23
<PAGE>
Beutel, Goodman Capital Management ("BGCM") is a portfolio manager for
the Equity Income Fund and the Balanced Fund. For its services to the Funds, the
Adviser (not the Funds) pays BCGM a fee, computed daily and payable monthly, at
the following annual rate based on average daily net assets under its
management:
Assets Fee Rate
------ --------
0 to $25 million..................................................... 0.450%
Over $25 million..................................................... 0.315%
NFJ Investment Group ("NFJ") serves as a portfolio manager for the Equity
Income Fund and the Balanced Fund. For its services to the Funds, the Adviser
(not the Funds) pays NFJ a fee, computed daily and payable monthly, at the
following annual rate based on average daily net assets under its management:
Assets Fee Rate
------ --------
0 to $25 million..................................................... 0.450%
Over $25 million..................................................... 0.315%
John McStay Investment Counsel, ("JMIC") is a portfolio manager for the
Equity Growth Fund and the Balanced Fund. For services to the Funds, the Adviser
(not the Funds) pays JMIC a fee, computed daily and payable monthly, equal to
0.8% of the average daily net assets under its management.
Sirach Capital Management, Inc. ("Sirach") is a portfolio manager for the
Equity Growth Fund and the Balanced Fund. For its services to the Fund, the
Adviser (not the Funds) pays Sirach a fee, computed daily and payable monthly,
at the following annual rate based on average daily net assets under its
management:
Assets Fee Rate
------ --------
0 to $10 million..................................................... 0.600%
$10 million to $30 million........................................... 0.500%
$30 million to $50 million........................................... 0.350%
Over $50 million..................................................... 0.250%
Administrator. Pursuant to an Administration and Fund Accounting
Agreement (the "Administration Agreement"), Sunstone Financial Group, Inc. (the
"Administrator"), 207 East Buffalo Street, Suite 400, Milwaukee, Wisconsin
53202, calculates the daily net asset value of the Funds, prepares and files all
federal income and excise tax returns and state income tax returns (other than
those required to be made by the Funds' custodian or the Transfer Agent),
oversees the Funds' insurance relationships, participates in the preparation of
the Funds' registration statement, proxy statements and reports, prepares
compliance filings relating to the registration of the securities of the Funds
pursuant to state securities laws, compiles data for and prepares notices to the
Securities and Exchange Commission, prepares
B-24
<PAGE>
the financial statements for the annual and semi-annual reports to the
Securities and Exchange Commission and current investors, monitors the Funds'
expense accruals and performs securities valuations, monitors the Funds' status
as a registered investment company under Subchapter M of the Internal Revenue
Code of 1986, as amended (the "Code") and monitors compliance with the Funds'
investment policies and restrictions, from time to time, and generally assists
in the Funds' administrative operations. The Administrator, at its own expense
and without reimbursement from the Funds, furnishes office space and all
necessary office facilities, equipment, supplies and clerical and executive
personnel for performing the services required to be performed by it under the
Administration Agreement. For the foregoing, the Administrator receives from the
Funds a fee, computed daily and payable monthly, based on the Funds' aggregate
average net assets at the annual rate of .23 of 1% on the first $50 million of
average net assets, .20 of 1% on the next $50 million of average net assets, .10
of 1% of the next $150 million, and .075 of 1% on average net assets in excess
of $250 million, subject to an annual aggregate minimum of $185,000, plus
out-of-pocket expenses. For the fiscal years ended December 31, 1998, December
31, 1997 and December 31, 1996, the fees paid to the Administrator were $64,510,
$66,698 and $67,228, respectively, for the Fixed Income Fund, $108,853, $108,782
and $90,155, respectively, for the Equity Income Fund, $65,971, $49,986 and
$35,579, respectively, for the Equity Growth Fund and $33,880 (net of voluntary
waivers of $14,525), $30,627 (net of voluntary waivers of $19,189) and $38,524
(net of voluntary waivers of $13,936), respectively, for the Balanced Fund.
The Administration Agreement will remain in effect as long as its
continuance is specifically approved at least annually (i) by the Board of
Directors of the Company or by the vote of a majority (as defined in the 1940
Act) of the outstanding shares of the Company, and (ii) by a vote of a majority
of the directors of the Company who are not interested persons (as defined in
the 1940 Act) of any party to the Administration Agreement, cast in person at a
meeting called for the purpose of voting on such approval. The Administration
Agreement may be terminated with respect to any one or more particular Funds
without penalty upon mutual consent of the Company and the Administrator or by
either party upon not less than 60 days' written notice to the other party.
The Management Agreements, agreements with the portfolio managers and the
Administration Agreement provide that the Adviser, the portfolio managers and
the Administrator, as the case may be, shall not be liable to the Funds or their
shareholders for anything other than willful misfeasance, bad faith, gross
negligence or reckless disregard of its obligations or duties. The Management
Agreements, agreements with the portfolio managers and the Administration
Agreement also provide that the Adviser, the portfolio managers and the
Administrator, as the case may be, and their officers, directors and employees
may engage in other businesses, devote time and attention to any other business
whether of a similar or dissimilar nature, and render services to others.
B-25
<PAGE>
CUSTODIAN AND TRANSFER AGENT
UMB Bank, n.a. ("UMB"), P.O. Box 419226, Kansas City, Missouri 64141,
acts as custodian for the Funds. As such, UMB holds all securities and cash of
the Funds, delivers and receives payment for securities sold, receives and pays
for securities purchased, collects income from investments and performs other
duties, all as directed by officers of the Funds. UMB does not exercise any
supervisory function over the management of the Funds, the purchase and sale of
securities or the payment of distributions to shareholders.
DST Systems, Inc., 1004 Baltimore, Kansas City, Missouri 64105-1807, acts
as the Funds' transfer agent and dividend disbursing agent.
ALLOCATION OF PORTFOLIO BROKERAGE
The Funds' securities trading and brokerage policies and procedures are
reviewed by and subject to the supervision of the Company's Board of Directors.
Decisions to buy and sell securities for the Funds are made by the portfolio
managers subject to review by the Adviser and the Company's Board of Directors.
In placing purchase and sale orders for portfolio securities for a Fund, it is
the policy of the portfolio managers to seek the best execution of orders at the
most favorable price in light of the overall quality of brokerage and research
services provided, as described in this and the following paragraph. Many of
these transactions involve payment of a brokerage commission by a Fund. In some
cases, transactions are with firms who act as principals for their own accounts.
In selecting brokers to effect portfolio transactions, the determination of what
is expected to result in best execution at the most favorable price involves a
number of largely judgmental considerations. Among these are the portfolio
manager's evaluation of the broker's efficiency in executing and clearing
transactions, block trading capability (including the broker's willingness to
position securities) and the broker's reputation, financial strength and
stability. The most favorable price to a Fund means the best net price without
regard to the mix between purchase or sale price and commission, if any.
Over-the-counter securities are generally purchased and sold directly with
principal market makers who retain the difference in their cost in the security
and its selling price (i.e. "markups" when the market maker sells a security and
"markdowns" when the market maker buys a security). In some instances, the
portfolio managers may determine that better prices are available from
non-principal market makers who are paid commissions directly. Although the
Funds do not intend to market their shares through intermediary broker-dealers,
a Fund may place portfolio orders with broker-dealers who recommend the purchase
of Fund shares to clients (if the portfolio managers believe the commissions and
transaction quality are comparable to that available from other brokers) and may
allocate portfolio brokerage on that basis.
In allocating brokerage business for a Fund, the portfolio managers also
take into consideration the research, analytical, statistical and other
information and services provided by the broker, such as general economic
reports and information, computer hardware and software, market quotations,
reports or analyses of particular companies or industry groups, market timing
and technical information, and the availability of the brokerage firm's
B-26
<PAGE>
analysts for consultation. While the portfolio managers believe these services
have substantial value, they are considered supplemental to their own efforts in
the performance of their duties. Other clients of the portfolio managers may
indirectly benefit from the availability of these services to the portfolio
managers, and the Fund may indirectly benefit from services available to the
portfolio managers as a result of transactions for other clients. Each of the
portfolio managers may cause a Fund to pay a broker which provides brokerage and
research services to the portfolio manager a commission for effecting a
securities transaction in excess of the amount another broker would have charged
for effecting the transaction, if the portfolio manager determines in good faith
that such amount of commission is reasonable in relation to the value of
brokerage and research services provided by the executing broker viewed in terms
of either the particular transaction or the portfolio manager's overall
responsibilities with respect to the Fund and the other accounts as to which he
exercises investment discretion.
For the fiscal year ended December 31, 1998, the Equity Income Fund paid
brokerage commissions of $119,657 on total transactions of $88,427,853; the
Equity Growth Fund paid brokerage commissions of $89,896 on total transactions
of $50,591,288; and the Balanced Fund paid brokerage commissions of $37,849 on
total transactions of $23,781,232. For the fiscal year ended December 31, 1997,
the Equity Income Fund paid brokerage commissions of $67,306 on total
transactions of $49,959,809; the Equity Growth Fund paid brokerage commissions
of $67,248 on total transactions of $40,480,115; and the Balanced Fund paid
brokerage commissions of $36,448 on total transactions of $22,830,609. For the
fiscal year ended December 31, 1996, the Equity Income Fund paid brokerage
commissions of $49,913 on total transactions of $32,976,854; the Equity Growth
Fund paid brokerage commissions of $53,405 on total transactions of $29,932,376;
and the Balanced Fund paid brokerage commissions of $39,127 on total
transactions of $20,257,052. For the fiscal year ended December 31, 1998 the
Fixed Income Fund paid brokerage commissions of $1,551 on total transactions of
$3,316,350. The Fixed Income Fund did not pay any brokerage commissions during
the two-year period ended December 31, 1997. During the fiscal year ended
December 31, 1998, the Equity Income Fund paid brokerage commissions of $113,580
on transactions of $84,779,088 to brokers who provided research; the Equity
Growth Fund paid brokerage commissions of $53,611 on transactions of $29,021,044
to brokers who provided research; the Balanced Fund paid brokerage commissions
of $29,128 on transactions of $18,835,190 to brokers who provided research; and
the Fixed Income Fund paid brokerage commissions of $1,551 on transactions of
$3,316,350 to brokers who provided research.
Any commission, fee or other remuneration paid to a portfolio manager who
causes a Fund to pay an affiliated broker-dealer is paid in compliance with
procedures adopted in accordance with Rule 17e-1 under the Investment Company
Act of 1940. The Funds do not expect that a significant portion of any Fund's
total brokerage business will be effected with broker-dealers affiliated with
portfolio managers. However, a portfolio manager may effect portfolio
transactions for the segments of a Fund's portfolio assigned to it with a
broker-dealer affiliated with the portfolio manager, as well as with
broker-dealers affiliated with other portfolio managers. No such fees were paid
to affiliated broker-dealers for the fiscal years ended December 31, 1998, 1997
and 1996.
B-27
<PAGE>
TAXES
Each Fund intends to qualify annually for and elect tax treatment
applicable to a regulated investment company under Subchapter M of the Code. The
discussion that follows is not intended to be a full discussion of present or
proposed federal income tax laws and the effect of such laws on an investor.
Investors are urged to consult with their respective tax advisers for a complete
review of the tax ramifications of an investment in a Fund.
If a Fund fails to qualify as a regulated investment company under
Subchapter M in any fiscal year, it will be treated as a corporation for federal
income tax purposes. As such the Fund would be required to pay income taxes on
its net investment income and net realized capital gains, if any, at the rates
generally applicable to corporations. Shareholders of a Fund that did not
qualify as a regulated investment company under Subchapter M would not be liable
for income tax on the Fund's net investment income or net realized capital gains
in their individual capacities. Distributions to shareholders, whether from the
Fund's net investment income or net realized capital gains, would be treated as
taxable dividends to the extent of current or accumulated earnings and profits
of the Fund.
Dividends from a Fund's net investment income, including short-term
capital gains, are taxable to shareholders as ordinary income, while
distributions of net long-term capital gain are taxable as long-term capital
gain regardless of the shareholder's holding period for the shares. Such
dividends and distributions are taxable to shareholders whether received in cash
or in additional shares. A portion of the Funds' income distributions may be
eligible for the 70% dividends-received deduction for domestic corporate
shareholders.
Any dividend or capital gain distribution paid shortly after a purchase
of shares of a Fund will have the effect of reducing the per share net asset
value of such shares by the amount of the dividend or distribution. Furthermore,
if the net asset value of the shares of such Fund immediately after a dividend
or distribution is less than the cost of such shares to the investor, the
dividend or distribution will be taxable to the investor even though it results
in a return of capital to him.
Redemption of shares will generally result in a capital gain or loss for
income tax purposes. Such capital gain or loss will be long term or short term,
depending upon the shareholders' holding period for the shares. However, if a
loss is realized on shares held for six months or less, and the investor
received a capital gain distribution during that period, then such loss is
treated as a long-term capital loss to the extent of the capital gain
distribution received.
Investors may also be subject to state and local taxes.
Each Fund may be required to withhold federal income tax at a rate of 31%
("backup withholding") from dividend payments and redemption and exchange
proceeds if an investor fails to furnish the Fund with his social security
number or other tax identification number or fails to certify under penalty of
perjury that such number is correct or that he is not subject to backup
withholding due to the underreporting of income. The certification form is
B-28
<PAGE>
included as part of the share purchase application and should be completed when
the account is opened.
CAPITAL STRUCTURE
The Funds constitute a single corporation (the Company) that was
organized as a Maryland corporation on October 20, 1993. The Company's
authorized capital consists of a single class of 500,000,000 shares of Common
Stock, $0.0001 par value. The Common Stock is divisible into an unlimited number
of "series," each of which is a separate Fund. Each share of a Fund represents
an equal proportionate interest in that Fund. Shareholders are entitled: (i) to
one vote per full share of Common Stock; (ii) to such distributions as may be
legally declared by the Company's Board of Directors; and (iii) upon
liquidation, to share in the assets available for distribution. There are no
conversion or sinking fund provisions applicable to the shares, and shareholders
have no preemptive rights and may not cumulate their votes in the election of
directors. Consequently the holders of more than 50% of the shares of Common
Stock voting for the election of directors can elect the entire Board of
Directors, and in such event, the holders of the remaining shares voting for the
election of directors will not be able to elect any person or persons to the
Board of Directors. Unless it is required by the Investment Company Act of 1940,
it will not be necessary for the Funds to hold annual meetings of shareholders.
As a result, shareholders may not consider each year the election of directors
or the appointment of auditors. The Company, however, has adopted provisions in
its Bylaws for the removal of directors by the shareholders. See "Shareholder
Meetings."
Shares of Common Stock are redeemable and are transferable. All shares
issued and sold by the Funds will be fully paid and nonassessable. Fractional
shares of Common Stock entitle the holder to the same rights as whole shares of
Common Stock. The Funds will not issue certificates evidencing shares of Common
Stock purchased. Instead, a shareholder's account will be credited with the
number of shares purchased, relieving the shareholder of responsibility for
safekeeping of certificates and the need to deliver them upon redemption. The
Transfer Agent will issue written confirmations for all purchases of Common
Stock.
The Board of Directors may classify or reclassify any unissued shares of
the Funds and may designate or redesignate the name of any outstanding class of
shares of the Funds. As a general matter, shares are voted in the aggregate and
not by class, except where class voting would be required by Maryland law or the
Investment Company Act of 1940 (e.g., a change in investment policy or approval
of an investment advisory agreement). All consideration received from the sale
of shares of any class of the Funds' shares, together with all income, earnings,
profits and proceeds thereof, would belong to that class and would be charged
with the liabilities in respect of that class and of that class's share of the
general liabilities of the Funds in the proportion that the total net assets of
the class bear to the total net assets of all classes of the Funds' shares. The
net asset value of a share of any class would be based on the assets belonging
to that class less the liabilities charged to that class, and dividends could be
paid on shares of any class of Common Stock only out of lawfully available
assets belonging to that class. In the event of liquidation or dissolution of
the Funds, the
B-29
<PAGE>
holders of each class would be entitled, out of the assets of the Funds
available for distribution, to the assets belonging to that class.
SHAREHOLDER MEETINGS
The Maryland General Corporation Law permits registered investment
companies, such as the Company, to operate without an annual meeting of
shareholders under specified circumstances if an annual meeting is not required
by the 1940 Act. The Company has adopted the appropriate provisions in its
Bylaws and may, at its discretion, not hold an annual meeting in any year in
which the election of directors is not required to be acted on by shareholders
under said Act.
The Company's Bylaws also contain procedures for the removal of directors
by its shareholders. At any meeting of shareholders, duly called and at which a
quorum is present, the shareholders may, by the affirmative vote of the holders
of a majority of the votes entitled to be cast thereon, remove any director or
directors from office and may elect a successor or successors to fill any
resulting vacancies for the unexpired terms of removed directors.
Upon the written request of the holders of shares entitled to not less
than ten percent (10%) of all the votes entitled to be cast at such meeting, the
Secretary of the Company shall promptly call a special meeting of shareholders
for the purpose of voting upon the question of removal of any director. Whenever
ten or more shareholders of record who have been such for at least six months
preceding the date of application, and who hold in the aggregate either shares
having a net asset value of at least $25,000 or at least one percent (1%) of the
total outstanding shares, whichever is less, shall apply to the Company's
Secretary in writing, stating that they wish to communicate with other
shareholders with a view to obtaining signatures to a request for a meeting as
described above and accompanied by a form of communication and request which
they wish to transmit, the Secretary shall within five business days after such
application either: (i) afford to such applicants access to a list of the names
and addresses of all shareholders as recorded on the books of the Company; or
(ii) inform such applicants as to the approximate number of shareholders of
record and the approximate cost of mailing to them the proposed communication
and form of request.
If the Secretary elects to follow the course specified in clause (ii) of
the last sentence of the preceding paragraph, the Secretary, upon the written
request of such applicants, accompanied by a tender of the material to be mailed
and of the reasonable expenses of mailing, shall, with reasonable promptness,
mail such material to all shareholders of record at their addresses as recorded
on the books unless within five business days after such tender the Secretary
shall mail to such applicants and file with the Securities and Exchange
Commission, together with a copy of the material to be mailed, a written
statement signed by at least a majority of the Board of Directors to the effect
that in their opinion either such material contains untrue statements of fact or
omits to state facts necessary to make the statements contained therein not
misleading, or would be in violation of applicable law, and specifying the basis
of such opinion.
B-30
<PAGE>
After opportunity for hearing upon the objections specified in the
written statement so filed, the Securities and Exchange Commission may, and if
demanded by the Board of Directors or by such applicants shall, enter an order
either sustaining one or more of such objections or refusing to sustain any of
them. If the Securities and Exchange Commission shall enter an order refusing to
sustain any of such objections, or if, after the entry of an order sustaining
one or more of such objections, the Securities and Exchange Commission shall
find, after notice and opportunity for hearing, that all objections so sustained
have been met, and shall enter an order so declaring, the Secretary shall mail
copies of such material to all shareholders with reasonable promptness after the
entry of such order and the renewal of such tender.
PERFORMANCE INFORMATION
From time to time, the Funds may advertise several types of performance
information. The Funds may advertise "yield," "average annual total return,"
"total return" and "cumulative total return." The Funds may occasionally cite
statistics to reflect volatility or risk. Each of these figures is based upon
historical results and is not necessarily representative of the future
performance of the Funds.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in a Fund for the
stated period, assuming the reinvestment of all dividends. Thus, these figures
reflect the change in the value of an investment in a Fund during a specific
period. Average annual total return will be quoted for at least the one, five
and ten year periods ending on a recent calendar quarter (or if such periods
have not elapsed, at the end of the shorter period corresponding to the life of
the Fund). Average annual total return figures are annualized and, therefore,
represent the average annual percentage change over the period in question.
Total return figures are not annualized and represent the aggregate percentage
or dollar value change over the period in question. Cumulative total return
reflects a Fund's performance over a stated period of time.
Each Fund's average annual total return figures are computed in
accordance with the standardized method prescribed by the Securities and
Exchange Commission by determining the average annual compounded rates of return
over the periods indicated, that would equate the initial amount invested to the
ending redeemable value, according to the following formula:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value at the end of the
period of a hypothetical $1,000 payment made
at the beginning of such period
B-31
<PAGE>
This calculation (i) assumes all dividends and distributions are reinvested at
net asset value or the appropriate reinvestment dates as described in the
Prospectus, and (ii) deducts all recurring fees, such as advisory fees, charged
as expenses to all investor accounts.
Total return is the cumulative rate of investment growth which assumes
that income dividends and capital gains are reinvested. It is determined by
assuming a hypothetical investment at the net asset value at the beginning of
the period, adding in the reinvestment of all income dividends and capital
gains, calculating the ending value of the investment at the net asset value as
of the end of the specified time period, subtracting the amount of the original
investment, and dividing this amount by the amount of the original investment.
This calculated amount is then expressed as a percentage by multiplying by 100.
The average annual total return for the one year period ended December
31, 1998 was 7.17% for the Fixed Income Fund, 5.50% for the Equity Income Fund,
21.95% for the Equity Growth Fund and 8.46% for the Balanced Fund. The average
annual compounded return for the period from January 3, 1994 (commencement of
operations) through December 31, 1998 was 6.15% for the Fixed Income Fund,
16.44% for the Equity Income Fund, 18.63% for the Equity Growth Fund and 12.36%
for the Balanced Fund.
The Fixed Income Fund's yield is computed in accordance with a
standardized method prescribed by the rules of the Securities and Exchange
Commission. Under that method, the current yield quotation for the Fixed Income
Fund is based on a one month or 30-day period. Yield is an annualized figure,
which means that it is assumed that the Fund generates the same level of net
investment income over a one-year period. Net investment income is assumed to be
compounded semiannually when it is annualized.
The Fixed Income Fund's yield is computed by dividing the net
investment income per share earned during the 30-day or one month period by the
maximum offering price per share on the last day of the period, according to the
following formula:
YIELD = 2 [(a-b +1)6 -1]
---
cd
Where a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = the maximum offering price per share on the last day
of the period.
The Fixed Income Fund's SEC 30-day yield for the period from December 1,
1998 through December 31, 1998 was 4.75%. Absent fee waivers, the yield would
have been 4.72%.
B-32
<PAGE>
Yield fluctuations may reflect changes in the Fixed Income Fund's net
income, and portfolio changes resulting from net purchases or net redemptions of
the Fixed Income Fund's shares may affect the yield. Accordingly, the Fixed
Income Fund's yield may vary from day to day, and the yield stated for a
particular past period is not necessarily representative of its future yield.
The Fixed Income Fund's yield is not guaranteed and its principal is not
insured.
In reports or other communications to investors and in advertising
material, the Funds may compare their performance to the Consumer Price Index,
the Dow Jones Industrial Average, the Standard & Poor's 500 Composite Stock
Index, the Lehman Brothers Aggregate Bond Index, the Lehman Brothers
Intermediate Government/Corporate Bond Index, the Lehman Brothers
Government/Corporate Bond Index and the Russell 3000, and to the performance of
mutual fund indexes as reported by Lipper Analytical Services, Inc. ("Lipper"),
CDA Investment Technologies, Inc. ("CDA"), or Morningstar, Inc. ("Morningstar"),
three widely recognized independent mutual fund reporting services. Lipper, CDA
and Morningstar performance calculations include reinvestment of all capital
gain and income dividends for the periods covered by the calculations. The
Consumer Price Index is generally considered to be a measure of inflation. The
Dow Jones Industrial Average, the Standard & Poor's 500 Stock Index and the
Russell 3000 Index are unmanaged indices of common stocks which are considered
to be generally representative of the United States stock market or segments
thereof. The marked prices and yields of these stocks will fluctuate. The
securities represented in the Lehman Brothers Intermediate Government/Corporate
Bond Index and Government/Corporate Bond Index include fixed-rate U.S. Treasury,
U.S. Government agency and U.S. corporate debt and dollar-denominated debt of
certain foreign, sovereign or supranational entities. The Funds also may quote
performance information from publications such as Inc., The Wall Street Journal,
Money Magazine, Forbes, Barron's, Chicago Tribune and USA Today.
DESCRIPTION OF SECURITIES RATINGS
The Fixed Income Fund and the Balanced Fund may invest in bonds and
debentures assigned one of the four highest ratings by at least one of the
following: Standard & Poor's Corporation ("Standard & Poor's"), Moody's
Investors Service, Inc. ("Moody's"), Duff & Phelps, Inc. or Fitch IBCA, Inc.
("Fitch"). As also set forth therein, each Fund may invest in commercial paper
and commercial paper master notes rated A-2 or better by Standard & Poor's or
Prime-2 or better by Moody's. A brief description of the ratings symbols and
their meanings follows.
Standard & Poor's Debt Ratings. A Standard & Poor's corporate or
municipal debt rating is a current assessment of the creditworthiness of an
obligor with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers or lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
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The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources it considers reliable. Standard
& Poor's does not perform any audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended or withdrawn as a result of changes in, or unavailability of, such
information, or for other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
I. Likelihood of default - capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in
accordance with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded by, and relative position of the obligation in
the event of bankruptcy, reorganization or other arrangement under
the laws of bankruptcy and other laws affecting creditors' rights;
AAA - Debt rated AAA has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in the higher rated
categories.
BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debts in this category than in higher rated categories.
BB, B, CCC, CC, C - Debt rated BB, B, CCC, CC and C is regarded, on
balance, as predominantly speculative with respect to 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 debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
Moody's Bond Ratings.
Aaa - Bonds which are rated Aaa are judged to be the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large, or by an exceptionally
stable margin and principal is secure.
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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 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 sometime in the future.
Baa - Bonds which are rated Baa are considered to be 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.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's bond rating symbols may contain numerical modifiers of a generic
rating classification. The modifier 1 indicates that the company ranks in the
higher end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the company ranks in the lower end of
its generic rating category.
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Fitch IBCA, Inc. Bond Ratings. The Fitch Bond Rating provides a guide to
investors in determining the investment risk associated with a particular
security. The rating represents its assessment of the issuer's ability to meet
the obligations of a specific debt issue or class of debt in a timely manner.
Fitch bond ratings are not recommendations to buy, sell or hold securities since
they incorporate no information on market price or yield relative to other debt
instruments.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the record of the issuer and of
any guarantor, as well as the political and economic environment that might
affect the future financial strength and credit quality of the issuer.
Bonds which have the same rating are of similar but not necessarily
identical investment quality since the limited number of rating categories
cannot fully reflect small differences in the degree of risk. Moreover, the
character of the risk factor varies from industry and between corporate, health
care and municipal obligations.
In assessing credit risk, Fitch IBCA, Inc. relies on current information
furnished by the issuer and/or guarantor and other sources which it considers
reliable. Fitch does not perform an audit of the financial statements used in
assigning a rating.
Ratings may be changed, withdrawn or suspended at any time to reflect
changes in the financial condition of the issuer, the status of the issue
relative to other debt of the issuer, or any other circumstances that Fitch
considers to have a material effect on the credit of the obligor.
AAA rated bonds are considered to be investment grade and of
the highest credit quality. The obligor has an
exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably
foreseeable events.
AA rated bonds are considered to be investment grade and of
very high credit quality. The obligor's ability to pay
interest and repay principal, while very strong, is
somewhat less than for AAA rated securities or more subject
to possible change over the term of the issue.
A rated bonds are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest
and repay principal is considered to be strong, but may be
more vulnerable to adverse changes in economic conditions
and circumstances than bonds with higher ratings.
BBB rated bonds are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay
interest and repay principal is considered to be adequate.
Adverse changes in economic conditions
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and circumstances, however, are more likely to weaken this
ability than bonds with higher ratings.
Duff & Phelps, Inc. Long-Term Ratings. These ratings represent a summary
opinion of the issuer's long-term fundamental quality. Rating determination is
based on qualitative and quantitative factors which may vary according to the
basic economic and financial characteristics of each industry and each issuer.
Important considerations are vulnerability to economic cycles as well as risks
related to such factors as competition, government action, regulation,
technological obsolescence, demand shifts, cost structure, and management depth
and expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of security (e.g.,
first mortgage bonds, subordinated debt, preferred stock, etc.). The extent of
rating dispersion among the various classes of securities is determined by
several factors including relative weightings of the different security classes
in the capital structure, the overall credit strength of the issuer and the
nature of covenant protection. Review of indenture restrictions is important to
the analysis of a company's operating and financial constraints.
The Credit Rating Committee formally reviews all ratings once per quarter
(more frequently, if necessary).
AAA Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA High credit quality. Protection factors are strong. Risk is modest, but
may vary slightly from time to time because of economic conditions
A Protection factors are average but adequate. However, risk factors are
more variable and greater in periods of economic stress.
BBB Below average protection factors but still considered sufficient for
prudent investment. Considerable variability in risk during economic
cycles.
Standard & Poor's Commercial Paper Ratings. A Standard & Poor's
commercial paper rating is a current assessment of the likelihood of timely
payment of debt considered short-term in the relevant market. Ratings are graded
into several categories, ranging from A-1 for the highest quality obligations to
D for the lowest. These categories are as follows:
A-1. This highest category indicates that the degree of safety regarding
timely payment is strong. Those issuers determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
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A-2. Capacity for timely payment on issues with this designation is
satisfactory. However the relative degree of safety is not as high as for
issuers designed "A-1".
A-3. Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designation.
Moody's Short-Term Debt Ratings. Moody's short-term debt ratings are
opinions of the ability of issuers to repay punctually senior debt obligations
which have an original maturity not exceeding one year. Obligations relying upon
support mechanisms such as letters-of-credit and bonds of indemnity are excluded
unless explicitly rated.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
Prime-1. Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics:
o Leading market positions in well-established industries.
o High rates of return on funds employed.
o Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
o Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
o Well-established access to a range of financial markets and assured
sources of alternate liquidity.
Prime-2. Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Prime-3. Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Fitch IBCA, Inc. Short-Term Ratings. Fitch's short-term ratings apply to
debt obligations that are payable on demand or have original maturities of
generally up to three
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years, including commercial paper, certificates of deposit, medium-term notes
and municipal and investment notes. Although the credit analysis is similar to
Fitch's bond rating analysis, the short-term rating places greater emphasis on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner. Relative strength or weakness of the degree of assurance for
timely payment determine whether the issuer's short-term debt is rated Fitch-1,
Fitch-2 or Fitch-3.
Duff & Phelps, Inc. Short-Term Ratings. Duff & Phelps' short-term ratings
are consistent with the rating criteria utilized by money market participants.
The ratings apply to all obligations with maturities of under one year,
including commercial paper, the uninsured portion of certificates of deposit,
unsecured bank loans, master notes, bankers acceptances, irrevocable letters of
credit and current maturities of long-term debt. Asset-backed commercial paper
is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis. Relative
differences in these factors determine whether the issuer's short-term debt is
rated Duff 1, Duff 2 or Duff 3.
INDEPENDENT ACCOUNTANTS
Arthur Andersen LLP, 100 East Wisconsin Avenue, Milwaukee, Wisconsin
53202, serves as the independent accountants for each of the Funds.
