<PAGE>
Preface/Directory
Preface to the Multi Fund(R) Prospectuses
Pages 21 and 22 are part of the Prospectus for each of the following funds:
Lincoln National Aggressive Growth Fund, Inc. (AG)
Lincoln National Bond Fund, Inc. (B)
Lincoln National Capital Appreciation Fund, Inc. (CA)
Lincoln National Equity-Income Fund, Inc. (E-I)
Lincoln National Global Asset Allocation Fund, Inc. (GAA)
Lincoln National Growth and Income Fund, Inc. (GI)
Lincoln National International Fund, Inc. (I)
Lincoln National Managed Fund, Inc. (M)
Lincoln National Money Market Fund, Inc. (MM)
Lincoln National Social Awareness Fund, Inc. (SA)
Lincoln National Special Opportunities Fund, Inc. (SO)
Shares of all the funds are sold to Lincoln National Life Insurance Co. (Lincoln
Life) for allocation to our Variable Annuity Account C (the variable annuity
account [VAA]) to fund variable annuity contracts and for allocation to our
Variable Life Account K to fund Variable Life Insurance Contracts.
To fund its variable life contracts, Variable Life Account D buys shares of the
Bond, Growth and Income, Managed, Money Market and Special Opportunities Funds.
To fund its variable life contracts, Variable Life Account G buys shares of the
Growth and Income and Special Opportunities Funds.
Each of these Variable Life and Annuity Accounts may be referred to as a
variable account. For each fund listed above, see Description of the fund in its
Prospectus, for a statement of that fund's investment objective. We refer to
each of these funds individually as a fund; collectively, the funds.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (SEC) NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THESE PROSPECTUSES. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
These Prospectuses set forth concisely the information about each fund that you
ought to know before investing. Please read and keep this Prospectus booklet for
future reference.
A separate Statement of Additional Information (SAI) for each fund has been
filed with the SEC. By this reference, each SAI, dated May 1, 1996, is
incorporated into the Prospectus of the fund with which it is registered. A free
copy will be provided upon request. Either write Kim Oakman, Lincoln National
Life Insurance Co., P.O. Box 2340, Fort Wayne, Indiana 46801 or call 1-800-348-
1212, Ext. 4912.
The Financial Highlights table of each fund contains per-share data calculated
on the basis of a share outstanding throughout the period, together with
financial ratios and other supplemental data. The Financial Highlights table is
incorporated by reference to the fund's 1995 Annual Report (see pages 47-49 of
the Annual Report). A copy of the Annual Report will be provided on request and
without charge. Please write or call Eric Jones, Lincoln National Life Insurance
Co., P.O. Box 2340, Fort Wayne, Indiana 46801; telephone: 1-800-348-1212, Ext.
6536.
NO DEALER, SALESPERSON, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THESE
PROSPECTUSES, IN CONNECTION WITH THE OFFERS CONTAINED IN THEM. IF ANY ARE GIVEN
OR MADE, THE INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE FUND(S) IN QUESTION. THESE PROSPECTUSES DO NOT CONSTITUTE
OFFERS BY THE FUNDS TO SELL, OR SOLICITATIONS OF ANY OFFERS TO BUY, ANY OF THE
SECURITIES OFFERED BY THEM IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL FOR THE FUNDS TO MAKE THOSE OFFERS.
Prospectuses dated May 1, 1996
21
<PAGE>
Directory for the fund prospectuses
Subject Page
- --------------------------------------------------------
Preface 21
Description of the fund
Aggressive Growth Fund 23
Bond Fund 29
Capital Appreciation Fund 33
Equity-Income Fund 37
Global Asset Allocation Fund 41
Growth and Income Fund 47
International Fund 49
Managed Fund 53
Money Market Fund 57
Social Awareness Fund 59
Special Opportunities Fund 61
- --------------------------------------------------------
Investment policies and techniques
Aggressive Growth Fund 23
Bond Fund 29
Capital Appreciation Fund 33
Equity-Income Fund 37
Global Asset Allocation Fund 41
Growth and Income Fund 47
International Fund 49
Managed Fund 53
Money Market Fund 57
Social Awareness Fund 59
Special Opportunities Fund 61
- --------------------------------------------------------
Investment restrictions
Aggressive Growth Fund 26
Bond Fund 30
Capital Appreciation Fund 35
Equity-Income Fund 39
Global Asset Allocation Fund 44
Growth and Income Fund 47
International Fund 51
Managed Fund 54
Money Market Fund 58
Social Awareness Fund 60
Special Opportunities Fund 62
- --------------------------------------------------------
Strategic portfolio transactions
Aggressive Growth Fund 26
Bond Fund 31
Capital Appreciation Fund 36
Equity-Income Fund 39
Global Asset Allocation Fund 45
Growth and Income Fund 48
International Fund 51
Managed Fund 55
Money Market Fund 58
Social Awareness Fund 60
Special Opportunities Fund 63
- --------------------------------------------------------
Appendix - contains important
information for all funds
Net asset value 65
Management of the funds 65
Purchase of securities being offered 67
Sale and redemption of shares 68
Distributions and federal income tax considerations 68
Management discussion of fund performance 68
Description of shares 68
Strategic portfolio transactions-
additional information 69
Foreign investments 71
General information 72
Statement of Additional Information
table of contents - 11 underlying funds 73
22
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EQUITY-
INCOME
-----------
LINCOLN NATIONAL EQUITY-INCOME FUND, INC.
DESCRIPTION OF THE FUND
The Equity-Income Fund (fund) was incorporated in Maryland in 1993. It is a
diversified open-end management investment company whose investment objective is
to seek reasonable income by investing primarily in income-producing equity
securities. In choosing these securities, the fund will also consider the
potential for capital appreciation. The fund pursues its objective through the
policies described in Investment policies and techniques. The principal risks of
this fund are those normally associated with investing in the common stock of a
broad range of companies, including but not limited to the fact that shares will
fluctuate in value. In addition, high-yielding, lower-quality securities held by
the fund present higher risks of untimely interest and principal payments,
defaults, and price volatility than do higher-quality securities, and may
present problems of liquidity and valuation. These and other risks are discussed
under Special risk factors. There is no assurance that the objective of the fund
will be achieved.
The fund's investment objective and certain investment policies are fundamental
and cannot be changed without the affirmative vote of a majority of the
outstanding voting securities of the fund. See General information in the
Appendix. All other investment policies are not fundamental, and may be changed
by a majority vote of the Board of Directors.
Fund management expects securities selection for the fund to closely parallel
that of an existing Fidelity retail fund, the Fidelity Equity-Income Fund, which
has a similar objective. However, there cannot be a precise correlation, and
performance of the fund is not expected to be the same as the performance of the
corresponding retail fund. Selection criteria for portfolio securities and the
relative weightings of the selections can differ based on asset size, timing,
cash flow, expenses and other factors. Portfolio selections will be made by
Fidelity Management Trust Co. (the sub-advisor), an affiliate of Fidelity
Management & Research Co. (Fidelity), which manages the Fidelity Equity-Income
Fund.
PORTFOLIO MANAGER
The portfolio manager for the fund is Stephen R. Petersen, Senior Vice-President
of Fidelity Management Trust Co. Petersen also serves as portfolio manager for
several separate institutional accounts of the sub-advisor as well as for the
Fidelity Equity-Income Fund. This mutual fund is advised by Fidelity Management
& Research Co., an affiliate of the sub-advisor. Petersen holds undergraduate
and Master's degrees from the University of Wisconsin.
INVESTMENT POLICIES AND TECHNIQUES
The fund's goal, through investing in income-producing equity securities, is to
achieve a yield which exceeds the composite yield on the securities comprising
the Standard & Poor's 500 Index (S&P 500). However, the fund will also consider
the potential for capital appreciation.
Normally, the fund will invest at least 65% of total assets in income-producing
common or preferred stock and debt convertible into common stock. The remainder
of the fund's assets will tend to be invested in debt obligations. It is
expected that the fund will invest, as is consistent with the objective, in
securities of varying quality, but it is not intended that the fund will invest
in securities of companies without proven earnings or credit.
Since capital appreciation is only a secondary consideration for the fund, the
fund's total return should not be expected to be comparable to funds that have
capital appreciation as a primary objective. The fund may be appropriate for you
if you can afford to ride out changes in the stock market, because it invests
primarily in common and preferred stock and debt convertible into common stock.
The fund can also make temporary investments in securities such as investment-
grade bonds, high-quality preferred stocks and short-term notes, for defensive
purposes when market conditions warrant.
The fund may invest in bonds rated in the lowest category of investment grade
debt (i.e., BBB-rated bonds). These bonds may have speculative characteristics,
and changes in economic conditions or other circumstances are more likely to
lead to a weakened ability of the issuer of such bonds to make principal and
interest payments than is the case with higher grade bonds. In addition, the
fund may invest in high-yielding, lower-rated debt securities (junk bonds) which
are subject to greater risk than investments in higher quality securities. For a
further discussion of lower-rated securities, please see Special risk factors.
The fund may engage in short-term trading when consistent with its objective. A
security may be sold and another of comparable quality simultaneously purchased
to take advantage of what the sub-advisor believes to be a temporary disparity
in the normal yield relationship of the two securities. The sub-advisor buys and
sells securities for the fund after considering a company's ability to repay,
future business conditions, interest rate levels and the availability of new
investments or higher relative yields.
37
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EQUITY-
INCOME
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The fund is authorized to invest in the following:
Credit enhancement agreements
Loans and other direct debt instruments
Warrants
Mortgaged-back securities
Stripped mortgage-backed securities
Asset-backed securities
Money market securities
Commercial paper
Certificates of deposit
Bankers' acceptances
Time deposits
U.S. Government obligations
Variable or floating rate instruments
Corporate obligations
Indexed securities
Zero coupon bonds
A brief description of these securities and other important information can be
found in the SAI. The fund is not limited to just these securities, however, and
may purchase other types of securities and enter into other types of
transactions if they are consistent with the fund's objective and policies. The
following paragraphs provide brief descriptions of some of the other securities
in which the fund may invest.
SHORT SALES
The fund may enter into short sales with respect to stocks underlying its
convertible security holdings. These transactions may help to hedge against the
effect of stock price declines, but may result in losses if a convertible
security's price does not track the price of its underlying equity. Convertible
securities hedged with short sales are not currently expected to exceed 15% of
the fund's total assets under normal conditions.
ILLIQUID INVESTMENTS
The fund may invest up to 10% of its assets in illiquid investments. Under the
supervision of the Board of Directors, the sub-advisor determines the liquidity
of the fund's investments. The absence of a trading market can make it difficult
to determine a market value for illiquid investments. Disposing of illiquid
investments may involve time-consuming negotiation and legal expenses, and it
may be difficult or impossible for the fund to sell them promptly at an
acceptable price.
RESTRICTED SECURITIES
The fund may also purchase securities which cannot be sold to the public without
registration under the Securities Act of 1933 (restricted securities). Unless
registered for sale, these securities can only be sold in privately negotiated
transactions or pursuant to an exemption from registration.
FOREIGN INVESTMENTS
The fund may invest up to 20% of its net assets in foreign securities, defined
as those which are denominated in a foreign currency and not publicly traded in
the United States. The 20% may be invested in just one country or in several
countries. The fund may have an additional 15% of its net assets invested in
securities of issuers located in any one of the following countries: Australia,
Canada, France, Japan, the United Kingdom or Germany.
Investing outside the United States involves different opportunities and
different risks from U.S. investments. The fund may invest a portion of its
assets in developing countries, or in countries with new or developing capital
markets; for example, nations in Eastern Europe. The risks noted above are
generally intensified for these investments. These countries may have relatively
unstable governments, economies based on only a few industries and securities
markets that trade a small number of securities. Securities of issuers located
in these countries tend to have volatile prices and may offer significant
potential for loss as well as gain. See Foreign investments in the Appendix for
a discussion of these risks, and the SAI for a discussion of how the fund
intends to handle them.
BORROWING
The fund may borrow money only from banks and will not purchase securities when
the amount borrowed exceeds 5% of its total assets. If the fund borrows money,
its share price may be subject to greater fluctuation until the amount borrowed
is paid off. Purchasing securities when the fund has borrowed money may involve
an element of leverage.
SPECIAL RISK FACTORS
Lower-rated debt securities are usually defined as securities rated Ba or lower
by Moody's Investors Service or BB or lower by Standard and Poor's Corp. Lower-
rated debt securities are considered speculative and involve greater risk of
loss than higher-rated debt securities, and are more sensitive to changes in the
issuer's capacity to pay. This is an aggressive approach to income investing.
The 1980s saw a dramatic increase in the use of lower-rated debt securities to
finance highly leveraged acquisitions and restructurings. Past experience may
not provide an accurate indication of the future performance of lower-rated debt
securities, especially during periods of economic recession. In fact, from 1989
to 1991, the percentage of lower-rated debt securities that defaulted rose
significantly above prior levels.
Lower-rated debt securities may be traded thinly, which can adversely affect the
prices at which these securities can be sold and can result in high transaction
costs. If market quotations are not available, lower-rated debt securities will
be valued in accordance with standards set by the Board of Directors, including
the use of outside pricing services. Judgment plays a greater role in valuing
lower-rated debt securities than securities for which more extensive quotations
and last sale information are available. Adverse publicity and changing investor
38
<PAGE>
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EQUITY-
INCOME
-----------
perceptions may affect the ability of outside pricing services to value
lower-rated debt securities, and the fund's ability to dispose of these
securities.
The market prices of lower-rated debt securities may decline significantly in
periods of general economic difficulty which may follow periods of rising
interest rates. During an economic downturn or a prolonged period of rising
interest rates, the ability of issuers of lower-rated debt to service their
payment obligations, meet projected goals, or obtain additional financing may be
impaired.
The fund may choose, at its expense or in conjunction with others, to pursue
litigation or otherwise to exercise its rights as a security holder to seek to
protect the interests of security holders if it determines this to be in the
interest of the fund's shareholders.
The considerations discussed previously for lower-rated debt securities also
apply to lower-quality, unrated debt instruments of all types, including loans
and other direct indebtedness of businesses with poor credit standing. Unrated
debt instruments are not necessarily of lower quality than rated instruments,
but they may not be attractive to as many buyers. The fund relies more on the
sub-advisor's credit analysis when investing in debt instruments that are
unrated.
Please refer to the SAI for a discussion of Moody's Investors Service and
Standard and Poor's Corp. ratings.
PORTFOLIO TURNOVER
The frequency of portfolio transactions the fund's portfolio turnover rate will
vary from year to year depending on market conditions. It is estimated that the
fund's portfolio turnover rate will not exceed 100%. (A rate of portfolio
turnover of 100% would occur if all of the fund's portfolio were replaced in a
period of one year.) Because a higher turnover rate increases transaction costs
and may have certain tax consequences, the sub-advisor carefully weighs the
anticipated benefits of short-term investment against these consequences. During
1995 the fund's portfolio turnover was 27.81% and in 1994 it was 33.40%.
INVESTMENT RESTRICTIONS
The following summarizes the fund's principal investment limitations. The
following limitations (except Item 3) and the policies discussed previously are
considered at the time of purchase; the sale of securities is not required in
the event of a subsequent change in circumstances:
1. The fund will not purchase a security if, as a result, with respect to 75% of
its total assets: (a) more than 5% of its total assets would be invested in
the securities of any single issuer; (b) it would hold more than 10% of the
outstanding voting securities of any issuer; or (c) more than 25% of its
total assets would be invested in a particular industry. Limitations (a)
through (c) do not apply to U.S. Government obligations;
2. A. The fund may engage in repurchase agreements and
B. no more than 10% of the fund's assets may be invested in illiquid
securities;
3. The fund may borrow money or engage in reverse repurchase agreements for
temporary or emergency purposes but not in an amount exceeding 25% of its net
assets; and/or
4. The fund may temporarily lend any security or make any other loan provided
that not more than 33 1/3% of the fund's total assets would be lent to other
parties.
Except for Items 1(a), 1(b), 1(c) and 4, the policies described in this
Prospectus are not fundamental, and can be changed at any time without your
consent. See General information in the Appendix for a discussion of fundamental
policies.
Additional investment restrictions can be found in the SAI.
DIVERSIFICATION
The fund qualifies as a diversified investment company under the Investment
Company Act of 1940 (1940 Act). As a fundamental policy, a diversified fund may
not purchase a security of any issuer (except cash items and U.S. Government
securities) if a) it would cause the fund to own more than 10% of the
outstanding voting securities of that issuer or b) if it would cause the fund's
holdings of that issuer to amount to more than 5% of the fund's total assets (as
applied to 75% of the fund's total assets). It may invest up to 25% of its total
assets in the securities of one issuer. The fund does not anticipate
concentrating its holdings in so few issuers unless the sub-advisor believes a
security has the potential for substantial income production consistent with the
fund's policies and goals. The fund does intend to take advantage of the ability
to invest more than 5% of its total assets in the securities of one issuer. To
the extent that it does so, its exposure to credit risks and/or market risks
associated with that issuer increases.
STRATEGIC PORTFOLIOTRANSACTIONS
The portfolio manager for the fund has considerable discretion in the selection
of appropriate fund investments. In the exercise of that discretion, the
portfolio manager may, at any given time, invest a portion of the fund's assets
in one or more strategic portfolio transactions which we define as derivative
transactions and cash enhancement transactions.
For your convenience, in the Appendix, we have included a basic discussion of
these special financial arrangement transactions and some of the risks
associated with them. Note also that the SAI booklet for
39
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EQUITY-
INCOME
-----------
the 11 funds contains definitions of the more commonly used derivative
transactions, technical explanations of how these transactions will be used and
the limits on their use. You should consult your financial counselor if you have
specific questions.
THE EQUITY-INCOME FUND IS AUTHORIZED:
a) for derivative transactions, to: buy and sell put and call options; buy and
sell futures contracts; engage in forward contracts; engage in interest rate
swaps, currency swaps, and other types of swap agreements such as caps, collars,
and floors.
The fund will not hedge more than 25% of its total assets by selling futures,
buying puts, and writing calls under normal conditions. In addition, the fund
will not buy futures or write puts whose underlying value exceeds 25% of its
total assets, and the fund will not buy calls with a value exceeding 5% of its
total assets.
b) for cash enhancement transactions, to: lend portfolio securities; engage in
repurchase and reverse repurchase transactions. Collateral will be continually
maintained at no less than 102% of the value of the loaned securities or of the
repurchase price, as applicable.
40
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APPENDIX
- --------------------------------------------------------------------------------
APPENDIX - CONTAINS IMPORTANT INFORMATION FOR ALL FUNDS
This Appendix constitutes part of the Prospectuses of Lincoln National
Aggressive Growth Fund, Inc. (Aggressive Growth Fund), Lincoln National Bond
Fund, Inc. (Bond Fund), Lincoln National Capital Appreciation Fund, Inc.
(Capital Appreciation Fund), Lincoln National Equity-Income Fund, Inc. (Equity-
Income Fund), Lincoln National Global Asset Allocation Fund, Inc. (Global Asset
Allocation Fund), Lincoln National Growth and Income Fund, Inc. (Growth and
Income Fund), Lincoln National International Fund, Inc. (International Fund),
Lincoln National Managed Fund, Inc. (Managed Fund), Lincoln National Money
Market Fund, Inc. (Money Market Fund), Lincoln National Social Awareness Fund,
Inc. (Social Awareness Fund), and Lincoln National Special Opportunities Fund,
Inc. (Special Opportunities Fund). Unless otherwise indicated, the following
information applies to each fund.
NET ASSET VALUE
Each fund's net asset value per share is determined as of close of business
(currently 4:00 p.m., New York Time) on the New York Stock Exchange (NYSE) on
each day it is open for trading. The net asset value per share for all funds
except the Money Market Fund is determined by adding the values of all
securities and other assets, subtracting liabilities (including dividends
payable) and dividing by the number of shares outstanding. Debt securities and
other assets of the fund, other than equity securities, for which market
quotations are readily available, are valued at their bid quotations.
When market quotations are not readily available, debt securities and other
assets are valued at their fair value as determined in good faith. This
valuation is made by or under the authority of the fund's Board of Directors and
it may include the use of valuations furnished by outside sources, including
pricing services which utilize electronic data processing techniques for valuing
normal institutional-size trading units of debt securities. The value of equity
securities is based on the last sale prices of those securities on national
securities exchanges or, in the absence of recorded sales, at the average of
readily available closing bid and asked prices on exchanges or over-the-counter.
In the absence of readily available closing bid and asked prices, equity
securities will be valued at fair value.
SHORT-TERM INVESTMENTS. For funds (other than the Money Market Fund) that trade
in short-term investments which mature in less than 60 days, these instruments
are valued at amortized cost; if these securities are acquired with a remaining
maturity of 61 days or more, the cost for purposes of valuation is deemed to be
the value on the sixty-first day prior to maturity.
OPTIONS TRADING. For those funds engaging in options trading, fund investments
underlying call options will be valued as described previously. Options are
valued at the last sale price or, if there has been no sale that day, at the
mean of the last bid and asked price on the principal exchange where the option
is traded, as of the close of trading on the NYSE. The fund's net asset value
will be increased or decreased by the difference between the premiums received
on writing options and the cost of liquidating those positions measured by the
closing price of those options on the exchange where traded.
FOREIGN SECURITIES. For funds investing in foreign securities, the value of a
foreign portfolio security held by a fund is determined based upon its closing
price or upon the mean of the closing bid and asked prices on the foreign
exchange or market on which it is traded and in the currency of that market, as
of the close of the appropriate exchange. As of the close of business on the
NYSE, that fund's portfolio securities which are quoted in foreign currencies
are converted into their U.S. dollar equivalents at the prevailing market rates,
as computed by the custodian of the fund's assets.
However, trading on foreign exchanges may take place on dates or at times of day
when the NYSE is not open; conversely, overseas trading may not take place on
dates or at times of day when the NYSE is open. Any of these circumstances could
affect the net asset value of fund shares on days when the investor has no
access to the fund. There are more detailed explanations of these circumstances
in the SAI for the various funds. See the Preface to this Prospectus booklet for
information about how to obtain a copy of the SAI booklet.
MONEY MARKET FUND. The net asset value per share of the Money Market Fund is
determined by the amortized cost method of valuation, under Rule 2a-7, as
amended (the Rule) of the Investment Company Act of 1940 (1940 Act). Under the
Rule, the fund's net asset value using the amortized cost method must fairly
reflect market value. The Board of Directors of the fund has established
procedures to assist fund management and the investment advisor in complying
with the requirements of the Rule, which imposes specific standards for the
maturity, quality and diversification of portfolio securities. The Rule also
assigns certain specific duties to fund management and the Board.
MANAGEMENT OF THE FUNDS
The business and affairs of each fund are managed under the direction of its
Board of Directors. The Board has the power to amend the bylaws of each fund, to
declare and pay dividends and to exercise all the powers of the fund except
those granted to the shareholder. Lincoln Life is the sole shareholder of each
fund.
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APPENDIX
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INVESTMENT ADVISOR. Lincoln Investment is the investment advisor to the funds
and is headquartered at 200 East Berry Street, Fort Wayne, Indiana 46802.
Lincoln Investment (the advisor) is registered with the Securities and Exchange
Commission (the Commission) [SEC] as an investment advisor and has acted as an
investment advisor to mutual funds for over 40 years. The advisor also acts as
investment advisor to Lincoln National Convertible Securities Fund, Inc., and
Lincoln National Income Fund, Inc., closed-end investment companies as well as
Lincoln Advisor Funds, Inc., an open-end series.
The advisor is a wholly-owned subsidiary of Lincoln National Corp. (LNC), a
publicly-held insurance holding company organized under Indiana law. Through its
subsidiaries, LNC provides life insurance and annuities, property-casualty
insurance, reinsurance and financial services.
Under advisory agreements described in the Prospectus for the variable account,
the advisor provides portfolio management and investment advice to the funds and
administers their other affairs, subject to the supervision of each fund's Board
of Directors.
As compensation for its services to each fund, the advisor is paid an investment
advisory fee at an annual rate based on the average daily net asset value of
each fund, as shown in the following chart:
<TABLE>
<CAPTION>
First Next In excess of
Fund $200 million $200 million $400 million
...Of average daily net asset value
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth .75 of 1% .70 of 1% .65 of 1%
Capital Appreciation .80 of 1 .80 of 1 .80 of 1
Equity-Income .95 of 1 .95 of 1 .95 of 1
Global Asset Allocation .75 of 1 .70 of 1 .68 of 1
International .90 of 1 .75 of 1 .60 of 1
All other funds .48 of 1 .40 of 1 .30 of 1
</TABLE>
The advisory fees for the Capital Appreciation, Equity-Income, and International
funds reflect the more extensive services and increased expense associated with
portfolios of securities issued outside the United States.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
FUND EXPENSES (see accompanying text below)
1995 ratio of the advisor's 1995 ratio of total expenses
compensation to average to average net assets
Fund net assets operational fund
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Aggressive Growth .75% .94%
Bond .47 .49
Capital Appreciation .80 1.07
Equity-Income .95 1.15
Global Asset Allocation .70 .92
Growth and Income .34 .35
International .84 1.27
Managed .41 .43
Money Market .48 .52
Social Awareness .47 .50
Special Opportunities .43 .45
</TABLE>
Expenses specifically assumed by each fund include: compensation and expenses of
Directors of the fund who are not interested persons of the fund as defined in
the 1940 Act; registration, filing, and other fees in connection with filings
with regulatory authorities, including the costs of printing and mailing
registration statements and updated Prospectuses provided to current contract
owners; fees and expenses of independent auditors; the expenses of printing and
mailing proxy statements and shareholder reports; custodian and transfer agent
charges; brokerage commissions and securities and options transaction costs
incurred by the fund; taxes and corporate fees; legal fees incurred in
connection with the affairs of the fund (other than legal services provided by
personnel of the advisor or its affiliated companies); the fees of any trade
association of which the fund is a member; and expenses of shareholder and
Director meetings.
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APPENDIX
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SUB-ADVISORS. As advisor, Lincoln Investment is primarily responsible for
investment decisions affecting each of the funds. However, Lincoln Investment
has entered into sub-advisory agreements with several professional investment
management firms. These firms provide some or substantially all of the
investment advisory services required by a number of the funds, including day-
to-day investment management of those funds' portfolios. Each sub-advisor makes
investment decisions for its respective fund in accordance with that fund's
investment objectives and places orders on behalf of that fund to effect those
decisions. See the following tables for more information about the sub-advisors
and their fees:
<TABLE>
<CAPTION>
Date of
Fund Sub-advisor agreement Annual fee rate based on average daily net asset value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive .50 of 1% of the first $150 million
Growth Lynch & Mayer 12/20/93 .35 of 1% of the excess over $150 million
Capital
Appreciation Janus 1/1/94 .60 of 1% of the first $100 million
.55 of 1% of the excess over $100 million
Equity-Income Fidelity 12/20/93 .75 of 1%
Global Asset the greater of (a) $40,000; or (b) .47 of 1% of the
Allocation Putnam 6/8/87 first $200 million; .42 of 1% of the next $200 million;
and .40 of 1% of any excess over $400 million
International Clay Finlay 11/19/90 .665 of 1% of the first $50 million; .475 of 1% of the
next $50 million; and .250 of 1% of any excess over $100
million
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Annual fee rate based on market value of securities held
in the portfolio of each respective client fund at the
Date of close of business on the last trading day of each
Fund Sub-advisor agreement calendar quarter
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Growth and
Income Vantage 8/21/85 .20 of 1%
Managed Vantage 8/21/85 .20 of 1%
(stock portfolio only)
Social
Awareness Vantage 4/30/88 .20 of 1%
Special
Opportunities Vantage 8/21/85 .20 of 1%
</TABLE>
No additional compensation from the assets of the funds will be assessed as a
result of the sub-advisory agreements; the sub-advisors are paid by Lincoln
Investment. (There is no sub-advisor for the Bond and Money Market Funds.)
SERVICE MARKS. The service mark for the funds and the name Lincoln National have
been adopted by the funds with the permission of LNC, and their continued use is
subject to the right of LNC to withdraw this permission in the event the advisor
should not be the investment advisor of the funds.
In the Prospectus and sales literature, the name Fidelity Investments will be
used with the Equity-Income Fund, Janus with the Capital Appreciation Fund and
Putnam with the Global Asset Allocation Fund. The continued use of these names
is subject to the right of the respective sub-advisor to withdraw its permission
in the event it ceases to be the sub-advisor to the particular fund it advises.
PURCHASE OF SECURITIES BEING OFFERED
Shares of the funds' common stock ($0.01 par value) will be sold to Lincoln Life
for allocation to the variable annuity account (VAA), which has been established
for the purpose of funding variable annuity contracts; shares in the funds will
also be sold to Lincoln Life for allocation to one or more of the variable life
accounts, which have been established for the purpose of funding variable life
insurance contracts. Shares of each fund are sold and redeemed at their net
asset value determined daily. See Sale and redemption of shares. Also see Net
asset value. The funds' shares are sold to Lincoln Life for the variable
accounts on a no-load basis-that is; without the imposition of a sales charge.
67
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APPENDIX
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SALE AND REDEMPTION OF SHARES
The shares of each fund are sold and redeemed by the fund at their net asset
value next determined after receipt of a purchase or redemption order in
acceptable form. The value of shares redeemed may be more or less than original
cost, depending upon the market value of the portfolio securities at the time of
redemption. Payment for shares redeemed will be made within seven days after the
redemption request is received in proper form by the funds. However, the right
to redeem fund shares may be suspended or payment postponed for any period
during which (1) trading on the NYSE is restricted as determined by the
Commission, or the NYSE is closed for other than weekends and holidays; (2) an
emergency exists, as determined by the Commission, as a result of which (a)
disposal by each fund of securities owned by it is not reasonably practicable,
or (b) it is not reasonably practicable for each fund to determine fairly the
value of its net assets; or (3) the Commission by order so permits for the
protection of shareholders of the funds.
DISTRIBUTION AND FEDERAL INCOME TAX CONSIDERATIONS
Each fund's policy is to distribute, at least once a year, substantially all of
its net investment income. Net realized capital gains may only be distributed
annually. These distributions, when paid to Lincoln Life for the variable
accounts, will be reinvested automatically in additional shares of that fund, at
its net asset value.
Each fund intends to qualify and has elected to be taxed as a regulated
investment company under the provisions of Subchapter M of the Internal Revenue
Code of 1986, as amended (the code). If a fund qualifies as a regulated
investment company and complies with the provisions of the code relieving
regulated investment companies which distribute substantially all of their net
income (both ordinary income and capital gain) from Federal income tax and the
4% nondeductible Federal excise tax, the funds will be relieved of those taxes
on the amounts distributed. See the SAI for a more complete discussion.
Since the sole shareholder of the funds is Lincoln Life, there is no discussion
here about the Federal income tax consequences at the shareholder level. For
information concerning the Federal income tax consequences to holders of annuity
or life insurance contracts, see the Prospectus for the variable account at the
front of this booklet.
MANAGEMENT DISCUSSION OF FUND PERFORMANCE
In the Annual Report for the funds, the portfolio manager for each fund
discusses that fund's performance for the previous fiscal year and the factors
which affected that performance. We will send you a copy of the Annual Report
free upon request.
DESCRIPTION OF SHARES
The authorized capital stock of each fund consists of 50 million shares of
common stock (100 million for the Growth and Income Fund), $0.01 par value. As
of April 1, 1996, each fund had the following number of shares issued and
outstanding:
Aggressive Growth 12,933,481
Bond 22,622,136
Capital Appreciation 12,115,745
Equity-Income 21,459,285
Global Asset Allocation 20,930,014
Growth and Income 69,131,710
International 28,134,844
Managed 41,694,836
Money Market 8,326,457
Social Awareness 15,887,303
Special Opportunities 20,963,247
Fund shares will be owned by Lincoln Life and will be held by it in the variable
accounts. As stated in the Prospectuses for the variable accounts, Lincoln Life
provides to contract owners of the variable accounts the right to direct the
voting of fund shares at shareholder meetings, to the extent provided by law.
However, if the 1940 Act or any regulation under it should change, and as a
result Lincoln Life determines it is permitted to vote fund shares in its own
right, it may elect to do so.
All the shares of each fund are of the same class with equal rights and
privileges. Each full share is entitled to one vote and each fractional share is
entitled to a proportionate fractional vote, on all matters subjected to a vote
of the shareholder. All shares, full and fractional, participate proportionately
in any dividends and capital gains distributions and, in the event of
liquidation, in that fund's net assets remaining after satisfaction of
outstanding liabilities.
When issued, each share is fully-paid and non-assessable and the shareholder has
no preemptive or conversion rights. Fund shares have non-cumulative voting
rights, which means that holders of more than 50% of the shares voting for the
election of directors can elect 100% of the directors if they choose to do so.
In that event the
68
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APPENDIX
- --------------------------------------------------------------------------------
holders of the remaining shares so voting will not be able to elect any
directors. Shares may be redeemed as set forth under Sale and redemption of
shares.
The Bylaws of the funds allow them, in proper cases, to dispense with their
annual meetings of the shareholder. Generally, this may be done as long as: (1)
a majority of the Directors then in office have at some point been elected by
the shareholder and, if any vacancy is filled by vote of the Board of Directors,
then immediately after filling the vacancy at least two thirds of the Directors
shall have been elected by the shareholder; (2) there is no change in the
independent auditor of the funds; (3) there is no material change to the
investment advisory and/or sub-advisory agreements; and (4) a shareholder vote
is not required with respect to a distribution agreement. In adopting this
procedure for dispensing with annual meetings that are a formality, the
Directors of the funds have undertaken to comply with the requirements of
Section 16(c) of the 1940 Act. That Section protects contract owners by
providing a procedure by which they may require management to convene a meeting
of the shareholder to vote on removal of one or more Directors. The Directors
also have agreed to facilitate communication among contract owners for the
purpose of calling those meetings. Further information about these procedures is
available from fund management.
STRATEGIC PORTFOLIO TRANSACTIONS-ADDITIONAL INFORMATION
Because of their different investment objectives and portfolio management
philosophies many of the funds engage to varying degrees in strategic portfolio
transactions, in order to preserve or enhance the value of their assets. These
can be generally identified as either derivative transactions or cash
enhancement transactions. Derivative transactions are recognized by the
investment community as an acceptable way to increase the fund's overall value
(or, depending on the condition of the securities markets, at least to slow its
decrease). Cash enhancement transactions are designed to make some extra money
for the fund when it has excess cash, or to help the fund obtain some cash for
temporary purposes when needed. SEE THE PROSPECTUS FOR EACH FUND FOR A LISTING
OF THE KINDS OF TRANSACTIONS IN WHICH EACH FUND MAY ENGAGE.
1. DERIVATIVE TRANSACTIONS
A. Introduction
A derivative transaction is a financial agreement the value of which is
dependent upon the values of one or more underlying assets or upon the
values of one or more indices of asset values. The following types are
currently in fairly common use in the investment community, although not
every fund will use all of them:
1. Equity contracts: stock options and indexed options; equity swaps;
stock index futures and options on futures; swaptions;
2. Interest rate contracts: interest rate futures and options on them;
forward rate agreements (FRAs); interest rate swaps and their related
transactions (e.g., caps, floors, collars and corridors); and/or
3. Currency derivative contracts: currency forward contracts; currency
options; currency futures; currency swaps; cross-currency interest rate
swaps.
SIMPLIFIED DEFINITIONS FOR THESE TRANSACTIONS ARE PROVIDED IN THE SAI APPENDIX.
Although they may be structured in complex combinations, derivative transactions
in which the funds engage generally fall into two broad categories: options
contracts or forward contracts. The combined forms are constantly evolving. In
fact, variations on the types listed previously may come into use after the date
of these Prospectuses. Therefore, where the Prospectus for a particular fund
discloses the intent of that fund to engage in any of the types listed, that
fund hereby reserves the right to engage in related variations on those
transactions.
The funds intend to engage in derivative transactions only defensively. Examples
of this defensive use might be: to hedge against a perceived decrease in a
fund's asset value; to control transaction costs associated with market timing
(e.g., by using futures on an unleveraged basis); and to lock in returns,
spreads, or currency exchange rates in anticipation of future cash market
transactions.
There is no discussion here of asset-backed or mortgage-backed securities (such
as collateralized mortgage obligations, structured notes, inverse floaters,
principal-only or interest-only securities, etc.). See the Prospectus and SAI
for the Capital Appreciation and Equity-Income funds, which are authorized to
engage in this kind of trading.
B. Risk factors commonly associated with derivative transactions.
There are certain risks associated with derivatives, and some derivatives
involve more of these risks than others. We briefly describe the most
common ones here; however, this is not an exhaustive list. Consult your
financial counselor if you have additional questions.
69
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APPENDIX
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CREDIT RISK is the possibility that a counterparty to a transaction will
fail to perform according to the terms and conditions of the transaction,
causing the holder of the claim to suffer a loss.
CROSS-CURRENCY SETTLEMENT RISK (or Herstatt risk) is related to the
settlement of foreign exchange contracts. It arises when one of the
counterparties to a contract pays out one currency prior to receiving
payment of the other. Herstatt risk arises because the hours of operation
of domestic interbank fund transfer systems often do not overlap due to
time zone differences. In the interval between the time one counterparty
has received payment in one indicated currency and the time the other
counterparty(ies) receive payment in the others, those awaiting payment
are exposed to credit risk and market risk.
LEGAL RISK is the chance that a derivative transaction, which involves
highly complex financial arrangements, will be unenforceable in particular
jurisdictions or against a financially troubled entity; or will be subject
to regulation from unanticipated sources.
MARKET LIQUIDITY RISK is the risk that a fund will be unable to control
its losses if a liquid secondary market for a financial instrument does
not exist. It is often considered as the risk that a (negotiable or
assignable) financial instrument cannot be sold quickly and at a price
close to its fundamental value.
MARKET RISK is the risk of a change in the price of a financial
instrument, which may depend on the price of an underlying asset.
OPERATING RISK is the potential of unexpected loss from inadequate
internal controls or procedures; human error; system (including data
processing system) failure; or employee dishonesty.
SETTLEMENT RISK between two counterparties is the possibility that a
counterparty to whom a firm has made a delivery of assets or money
defaults before the amounts due or assets have been received; or the risk
that technical difficulties interrupt delivery or settlement even if the
counterparties are able to perform. In the latter case, payment is likely
to be delayed but recoverable.
SYSTEMIC RISK is the uncertainty that a disruption (at a firm, in a market
segment, to a settlement system, etc.) might cause widespread difficulties
at other firms, in other market segments, or in the financial system as a
whole.
SPECIAL NOTE FOR OPTIONS AND FUTURES TRANSACTIONS: Gains and losses on
options and futures transactions depend on the portfolio manager's ability
to correctly predict the direction of stock prices and interest rates, and
other economic factors. Options and futures trading may fail as hedging
techniques in cases where the price movements of the securities underlying
the options and futures do not follow the price movements of the portfolio
securities subject to the hedge. The loss from investing in futures
transactions is potentially unlimited.
SOME OF THESE RISKS MAY BE PRESENT IN EACH TYPE OF TRANSACTION, WHILE
OTHERS MAY PERTAIN ONLY TO CERTAIN ONES. These risks are discussed here
only briefly. Before you invest in a particular fund, please consult your
financial counselor if you have questions about the risks associated with
that fund's use of derivatives.
C. Varying usage of derivative transactions
Subject to the terms of the Prospectus and SAI for each fund, that fund's
portfolio manager decides which types of derivative transactions to
employ, at which times and under what circumstances. For a description of
the limits, risk factors and circumstances under which derivative
transactions will be used by each fund, refer to the SAI booklet.
D. Increased government scrutiny
Derivative transactions are coming under increased scrutiny by Congress
and industry regulators (such as the SEC and the Office of the Comptroller
of the Currency), and by self-regulatory agencies (such as the NASD).
Should legislation or regulatory initiatives be enacted resulting in
additional restrictive requirements for derivative transactions, we
reserve the right to make all necessary changes in the contracts and/or
the Registration Statements for the funds to comply with those
requirements.
2. CASH ENHANCEMENT TRANSACTIONS
Cash enhancement transactions also involve certain risks to the fund. They
are discussed more fully inthe SAI.
A. Lending of portfolio securities
Any fund authorized to do so may make secured loans of its portfolio
securities, in order to realize additional income. The loans are limited
to a maximum of a stipulated amount of the fund's total assets. As a
matter of policy, securities loans are made to broker/dealers under
agreements requiring that the loans be continuously secured by collateral
in cash or short-term debt obligations at least equal at all times to 102%
of the value of the securities lent.
The borrower pays the fund an amount equal to any dividends or interest
received on securities lent. The fund retains all or a portion of the
interest received on securities lent. The fund also retains all or a
portion of the interest received on investment of the cash collateral, or
receives a fee from the borrower.
70
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APPENDIX
- --------------------------------------------------------------------------------
With respect to the loaned securities, voting rights or rights to consent
pass to the borrower. However, the fund retains the right to call in the
loans and have the loaned securities returned at any time with reasonable
notice. This is important when issuers of the securities ask holders of
those securities-including the fund-to vote or consent on matters which
could materially affect the holders' investment. The fund may also call in
the loaned securities in order to sell them. None of the funds' portfolio
securities will be loaned to Lincoln Investment, to any sub-advisor, or to
any of their respective affiliates. The fund may pay reasonable finder's
fees to persons unaffiliated with it in connection with the arrangement of
the loans.
B. Repurchase (Repo) and reverse repurchase (Reverse Repo) transactions
1. Repos. From time to time, the funds may enter into Repo transactions.
In a typical Repo transaction, the fund involved buys U.S. Government
or other money market securities from a financial institution (such as
a bank, broker, or savings and loan association). At the same time, as
part of the arrangement, the fund obtains an agreement from the seller
to repurchase those same securities from the fund at a specified price
on a fixed future date.
The repurchase date is normally not more than seven days from the date
of purchase. Keeping the term under seven days is significant, because
the SEC considers Repo Agreements with maturities of more than seven
days to be illiquid assets of the fund, and the funds have strict
limitations on the percentage of their respective assets which may be
illiquid.
2. Reverse repos. A fund may also be authorized to enter into Reverse Repo
transactions. This simply means the fund is on the reverse side of a
Repo transaction. That is, the fund is the Seller of some of its
portfolio securities, subject to buying them back at a set price and
date.
Authorized funds will engage in Reverse Repos for temporary purposes,
such as for obtaining cash to fund redemptions; or for the purpose of
increasing the income of the fund by investing the cash proceeds at a
higher rate than the cost of the agreement. Entering into a reverse
repo transaction is considered to be the borrowing of money by the
fund. Funds authorized to engage in Repos as buyers are not necessarily
authorized to do Reverse Repos.
FOREIGN INVESTMENTS
There are certain risks involved in investing in foreign securities, including
those resulting from fluctuations in currency exchange rates; devaluation of
currencies; political or economic developments including the possible imposition
of currency exchange blockages or other foreign governmental laws or
restrictions; reduced availability of public information concerning issuers; and
the fact that foreign companies are not generally subject to uniform accounting,
auditing, and financial reporting standards or to other regulatory practices and
requirements comparable to those applicable to domestic companies. With respect
to certain foreign countries, there is also the possibility of expropriation,
nationalization, confiscatory taxation, and limitations on the use or removal of
cash or other assets of a fund, including the withholding of interest payments
or dividends. These risks may be particularly great in so-called developing or
undeveloped countries, sometimes referred to as Emerging Markets.
In addition, while the volume of transactions effected on foreign stock
exchanges has increased in recent years, in most cases it remains appreciably
below that of the NYSE. Accordingly, a fund's foreign investments may be less
liquid and their prices may be more volatile than comparable investments in
securities of U.S. companies. Moreover, the settlement periods for foreign
securities, which are often longer than those for securities of U.S. issuers,
may affect portfolio liquidity. The funds will incur costs in converting foreign
currencies into U.S. dollars. Custody charges are generally higher for foreign
securities. In buying and selling securities on foreign exchanges, a fund
normally pays fixed commissions that are generally higher than the negotiated
commissions charged in the United States. In addition, there is generally less
governmental supervision and regulation of securities exchanges, brokers and
issuers in foreign countries that in the United States. There may be difficulty
in enforcing legal rights outside the United States. For example, in the event
of default on any foreign debt obligations, it may be more difficult or
impossible for the fund to obtain or to enforce a judgment against the issuers
of these securities. The advisor or sub-advisor will take all these factors into
consideration in managing a fund's foreign investments.
Certain state insurance regulations impose additional restrictions on the extent
to which a fund may invest in foreign securities. See the SAI.
The share price of a fund that invests in foreign securities will reflect the
movements of both the prices of the portfolio securities and the currencies in
which those securities are denominated. Depending on the extent of a fund's
investments abroad, changes in a fund's share price may have a low correlation
with movements in the U.S. markets. Because most of the foreign securities in
which the fund invests will be denominated in foreign currencies, or otherwise
will have values that depend on the performance of foreign currencies relative
to the U.S. dollar, the relative strength of the U.S. dollar may be an important
factor in the performance of the fund.
71
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APPENDIX
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FOREIGN CURRENCIES
When an advisor or sub-advisor believes that a currency in which a portfolio
security or securities is denominated may suffer a decline against the U. S.
dollar, it may hedge that risk by entering into a forward contract to sell an
amount of foreign currency approximating the value of some or all of the
portfolio securities denominated in that foreign currency.
Because foreign securities generally are denominated and pay dividends or
interest in foreign currencies, and a fund may hold various foreign currencies,
the value of the net assets of that fund as measured in U. S. dollars will be
affected favorably or unfavorably by changes in exchange rates. Generally,
currency exchange transactions will be conducted on a spot (i.e., cash) basis at
the spot rate prevailing in the currency exchange market. The cost of currency
exchange transactions will generally be the difference between the bid and offer
spot rate of the currency being purchased or sold. Some foreign currency values
may be volatile, and there is the possibility of government controls on currency
exchange or governmental intervention in currency markets which could adversely
affect the fund.
Investors should be aware that exchange rate movements can be significant and
can endure for long periods of time. In order to protect against uncertainty in
the level of future foreign currency exchange rates, a fund's advisor or sub-
advisor may attempt to manage exchange rate risk through active currency
management, including the use of certain foreign currency hedging transactions.
For example, it may hedge some or all of its investments denominated in a
foreign currency against a decline in the value of that currency relative to the
U.S. dollar by entering into contracts to exchange that currency for U.S.
dollars (not exceeding the value of the fund's assets denominated in that
currency), or by participating in options or futures contracts with respect to
that currency. If the advisor or sub-advisor believes that a particular currency
may decline relative to the U.S. dollar, the fund may also enter into contracts
to sell that currency (up to the value of the fund's assets denominated in that
currency) in exchange for another currency that the advisor or sub-advisor
expects to remain stable or to appreciate relative to the U.S. dollar. This
technique is known as currency cross-hedging. Refer to the Prospectus for each
fund to determine which funds may engage in these transactions.
These strategies minimize the effect of currency appreciation as well as
depreciation, but do not protect against a decline in the underlying value of
the hedged security. In addition, these strategies may reduce or eliminate the
opportunity to profit from increases in the value of the original currency and
may adversely impact the fund's performance if the advisor or sub-advisor's
projection of future exchange rates is inaccurate. See Strategic portfolio
transactions.
GENERAL INFORMATION
Your inquiries should be directed to Lincoln National Life Insurance Co., at
P.O. Box 2340, Fort Wayne, Indiana 46801; or, you may call 1-800-348-1212.
The funds will issue unaudited semiannual reports showing current investments in
each fund and other information; and annual financial statements audited by
their independent auditors.
Under the 1940 Act a fundamental policy of a fund may not be changed without the
affirmative vote of a majority of the fund's outstanding shares.
As used in this Prospectus, the term majority of the fund's outstanding shares
means the vote of: (1) 67% or more of each fund's shares present at a meeting,
if the holders of more than 50% of the outstanding shares of each fund are
present or represented by proxy, or (2) more than 50% of each fund's outstanding
shares, whichever is less.
These Prospectuses do not contain all the information included in their
Registration Statements filed with the Commission. The Registration Statements,
including the exhibits filed with them, may be examined at the office of the
Commission in Washington, D.C. Statements contained in the Prospectuses about
the contents of any contract or other document referred to in them are not
necessarily complete. In each instance, reference is made to the copy of that
contract or other document filed as an exhibit to the Registration Statement of
which the particular Prospectus forms a part, and each statement is qualified in
all respects by that reference.
The use of funds by both variable annuity and variable life insurance separate
accounts is known as mixed funding. Due to differences in redemption rates, tax
treatment, or other considerations, the interests of contract owners under the
variable life accounts may conflict with those of contract owners under the
variable annuity account, in those cases where mixed funding occurs. The Board
of Directors of each fund will monitor for any material conflicts and determine
what action, if any, should be taken.
Should any conflict arise which requires that a substantial amount of assets be
withdrawn from any of the funds, orderly portfolio management could be
disrupted, to the detriment of those contract owners still investing in that
fund. Also, if that fund believes that any portfolio has become so large as to
materially impair investment performance, then the fund will examine other
investment options.
Lincoln Life performs the dividend and transfer functions for the funds.
72
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EQUITY-
INCOME
-----------
LINCOLN NATIONAL EQUITY-INCOME FUND, INC.
Statement of Additional Information (SAI)
This SAI should be read in conjunction with the Prospectus of Lincoln National
Equity-Income Fund, Inc. (fund) dated May 1, 1996. You may obtain a copy of the
fund's Prospectus on request and without charge. Please write Kim Oakman,
Lincoln National Life Insurance Co., P.O. Box 2340, Fort Wayne, Indiana 46801 or
call 1-800-348-1212, Ext. 4912.
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Page
- -----------------------------------------------------------------------------
<S> <C>
INVESTMENT OBJECTIVES E1- 2
- -----------------------------------------------------------------------------
INVESTMENT POLICIES AND LIMITATIONS (RESTRICTIONS) E1- 2
- -----------------------------------------------------------------------------
INVESTMENT TECHNIQUES E1- 3
- -----------------------------------------------------------------------------
PORTFOLIO TRANSACTIONS AND BROKERAGE E1-16
- -----------------------------------------------------------------------------
DETERMINATION OF NET ASSET VALUE E1-17
- -----------------------------------------------------------------------------
APPENDIX
Investment advisor and sub-advisor A- 1
- -----------------------------------------------------------------------------
Directors and officers A- 3
- -----------------------------------------------------------------------------
Investment policies and techniques (continued):
options, futures, securities lending, repurchase
and reverse repurchase agreements A- 4
- -----------------------------------------------------------------------------
Custodian A- 9
- -----------------------------------------------------------------------------
Independent auditors A-10
- -----------------------------------------------------------------------------
Financial statements A-10
- -----------------------------------------------------------------------------
Bond ratings A-10
- -----------------------------------------------------------------------------
Commercial paper ratings A-11
- -----------------------------------------------------------------------------
U.S. Government obligations A-11
- -----------------------------------------------------------------------------
Taxes A-11
- -----------------------------------------------------------------------------
State requirements A-12
- -----------------------------------------------------------------------------
Derivative transactions-definitions A-13
- -----------------------------------------------------------------------------
</TABLE>
THIS SAI IS NOT A PROSPECTUS.
The date of this SAI is May 1, 1996
EI-1
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EQUITY-
INCOME
-----------
INVESTMENT OBJECTIVES
The fund's investment objective is to obtain reasonable income by investing
primarily in income-producing equity securities. The fund's investment objective
and certain investment policies are fundamental and cannot be changed without
the affirmative vote of a majority of the outstanding voting securities of the
fund. See General information in the Appendix to the Prospectus. There can be no
assurance that the objective of the fund will be achieved.
The fund seeks to achieve its objective by actively managing income-producing
common and preferred stock and debt convertible into common stock. In choosing
securities, the fund will also consider the potential for capital appreciation.
The fund's goal is to achieve a yield which exceeds the composite yield on the
securities comprising the Standard & Poor's 500 Index (S&P 500).
INVESTMENT POLICIES AND LIMITATIONS (RESTRICTIONS)
The following policies and limitations supplement those set forth in the
Prospectus. Unless otherwise noted, whenever an investment policy or limitation
states a maximum percentage of the fund's assets that may be invested in any
security or other asset, or sets forth a policy regarding quality standards,
such standard or percentage limitation will be determined immediately after and
as a result of the fund's acquisition of such security or other asset.
Accordingly, any subsequent change in values, net assets or other circumstances
will not be considered when determining whether the investment complies with the
fund's investment policies and limitations.
The fund's fundamental investment policies and limitations cannot be changed
without approval by a majority of the outstanding voting securities of the fund.
However, except for the following fundamental investment limitations, the
investment policies and limitations described in this SAI are not fundamental
and may be changed without shareholder approval.
The following are the fund's fundamental investment limitations. The fund may
not:
1. with respect to 75% of the fund's total assets, purchase the securities of
any issuer (other than securities issued or guaranteed by the U.S. Government
or any of its agencies or instrumentalities) if, as a result, (a)more than 5%
of the fund's total assets would be invested in the securities of that
issuer, or (b)the fund would hold more than 10% of the outstanding voting
securities of that issuer;
2. issue senior securities, except as permitted under the Investment Company Act
of 1940, as amended ( 1940 Act);
3. borrow money, except that the fund (a)may borrow money for temporary or
emergency purposes (not for leveraging or investment) or (b)engage in reverse
repurchase agreements, provided that (a)and (b)in combination (borrowings) do
not exceed 33 1/3% of its total assets (including the amount borrowed) less
liabilities (other than borrowings). Any borrowings that come to exceed 33
1/3% of the value of the fund's total assets by reason of a decline in net
assets will be reduced within three days (exclusive of Sundays and holidays)
to the extent necessary to comply with the 33 1/3% limitation;
4. underwrite securities issued by others, except to the extent that the fund
may be considered an underwriter within the meaning of the Securities Act of
1933 in the disposition of restricted securities;
5. purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. Government or any of its agencies or
instrumentalities) if, as a result, more than 25% of its total assets would
be invested in the securities of companies whose principal business
activities are in the same industry;
6. purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments (but this shall not prevent the fund from
investing in securities or other instruments backed by real estate or
securities of companies engaged in the real estate business);
7. purchase or sell physical commodities unless acquired as a result of
ownership of securities or other instruments (but this shall not prevent the
fund from purchasing or selling options and futures contracts or from
investing in securities or other instruments backed by physical commodities);
or
8. lend any security or make any other loan if, as a result, more than 33 1/3%
of its total assets would be lent to other parties, but this limitation does
not apply to purchases of debt securities or to repurchase agreements.
EI-2
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EQUITY-
INCOME
-----------
The following investment limitations for the fund are not fundamental and may be
changed without shareholder notification.
1. The fund does not currently intend to sell securities short, unless it owns
or has the right to obtain securities equivalent in kind and amount to the
securities sold short, and provided that transactions in futures contracts
and options are not deemed to constitute selling securities short.
2. The fund does not currently intend to purchase securities on margin, except
that the fund may obtain such short-term credits as are necessary for the
clearance of transactions, and provided that margin payments in connection
with futures contracts and options on futures contracts shall not constitute
purchasing securities on margin.
3. The fund may borrow money only (a)from a bank or (b)by engaging in reverse
repurchase agreements with any party [reverse repurchase agreements are
treated as borrowings for purposes of fundamental investment limitation (3)].
The fund will not borrow money in excess of 25% of net assets so long as this
limitation is required for certification by certain state insurance
departments. Any borrowings that come to exceed this amount will be reduced
within seven days (not including Sundays and holidays) to the extent
necessary to comply with the 25% limitation. The fund will not purchase any
security while borrowings representing more than 5% of its total assets are
outstanding.
4. The fund does not currently intend to purchase any security if, as a result,
more than 10% of the fund's net assets would be invested in securities that
are deemed to be illiquid because they are subject to legal or contractual
restrictions on resale or because they cannot be sold or disposed of in the
ordinary course of business at approximately the prices at which they are
valued.
5. The fund does not currently intend to lend assets other than securities to
other parties, except by acquiring loans, loan participations, or other forms
of direct debt instruments and, in connection therewith, assuming any
associated unfunded commitments of the sellers. (This limitation does not
apply to purchases of debt securities or to repurchase agreements.)
6. The fund does not currently intend to (a)purchase securities of other
investment companies, except in the open market where no commission except
the ordinary broker's commission is paid, or (b)purchase or retain securities
issued by other open-end investment companies. Limitations (a)and (b)do not
apply to securities received as dividends, thr oug h offers of exchange, or
as a result of a reorganization, consolidation, or merger. (Due to certain
state insurance regulations, the fund does not currently intend to purchase
the securities of other investment companies.)
7. The fund does not currently intend to invest in oil, gas, or other mineral
exploration or development programs or leases.
For the fund's limitations on futures and options transactions, see Limitations
on futures and options transactions below. For the fund's limitations on short
sales, see Short sales.
In accordance with the fund's fundamental investment policies, there are no
limitations on the percentage of the fund's assets which may be invested in any
one type of instrument. Nor are there limitations (except those imposed by
certain state insurance regulations) on the percentage of the fund's assets
which may be invested in any foreign country. However, in order to comply with
diversification requirements under Section 817(h) of the Internal Revenue Code
of 1986, as amended, in connection with Fidelity Management Trust Co. serving as
sub-advisor, the fund has agreed to certain non-fundamental limitations. Please
refer to the Prospectus for the VAA for more information.
INVESTMENT TECHNIQUES
The following paragraphs provide a brief description of securities in which the
fund may invest and transactions it may make. The fund is not limited by this
discussion, however, and may purchase other types of securities and enter into
other types of transactions if they are consistent with the fund's investment
objective and policies.
Fund management expects securities selection for the fund to closely parallel
that for an existing Fidelity retail fund, the Fidelity Equity-Income Fund,
which has a similar investment objective. However, there cannot be a precise
correlation, and performance of the fund is not expected to be the same as the
performance of the corresponding retail fund. Selection criteria for portfolio
securities and the relative weightings of the selections can differ based on
asset size, timing, cash flow, expenses and other factors. Portfolio selections
will be made by fund's sub-advisor, Fidelity Management Trust Co., which is an
affiliate of Fidelity Management & Research Co. (Fidelity), which manages the
Fidelity Equity-Income Fund.
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AFFILIATED BANK TRANSACTIONS. Pursuant to exemptive orders issued by the
Securities and Exchange Commission (SEC), the fund may engage in transactions
with banks that are, or may be considered to be, affiliated persons of the fund
under the 1940 Act. Such transactions may be entered into only pursuant to
procedures established and periodically reviewed by the Board of Directors.
These transactions may include repurchase agreements with custodian banks;
purchases, as principal, of short-term obligations of, and repurchase agreements
with, the 50 largest U.S. banks (measured by deposits); transactions in
municipal securities; and transactions in U.S. Government securities with
affiliated banks that are primary dealers in these securities.
FUND'S RIGHTS AS A SHAREHOLDER. The fund does not intend to direct or administer
the day-to-day operations of any company. The fund, however, may exercise its
rights as a shareholder and may communicate its views on important matters of
policy to management, the Board of Directors and shareholders of a company when
the sub-advisor determines that such matters could have a significant effect on
the value of the fund's investment in the company. The activities that the fund
may engage in, either individually or in conjunction with others, may include,
among others, supporting or opposing proposed changes in a company's corporate
structure or business activities; seeking changes in a company's directors or
management; seeking changes in a company's direction or policies; seeking the
sale or reorganization of the company or a portion of its assets; or supporting
or opposing third party takeover efforts. This area of corporate activity is
increasingly prone to litigation and it is possible that the fund could be
involved in lawsuits related to such activities. The sub-advisor will monitor
such activities with a view to mitigating, to the extent possible, the risk of
litigation against the fund and the risk of actual liability if the fund is
involved in litigation. No guarantee can be made, however, that litigation
against the fund will not be undertaken or liabilities incurred.
PERMITTED INSTRUMENTS
MONEY MARKET refers to the marketplace where short-term, high grade debt
securities are traded, and includes U.S. Government obligations, commercial
paper, certificates of deposit and bankers' acceptances, time deposits and
short-term corporate obligations. Money market instruments may carry fixed rates
of return or have variable or floating interest rates.
COMMERCIAL PAPER represents short-term obligations issued by banks, broker-
dealers, corporations and other entities for purposes such as financing their
current operations.
CERTIFICATES OF DEPOSIT represent a commercial bank's obligations to repay funds
deposited with it earning specified rates of interest over given periods.
BANKERS' ACCEPTANCES are obligations of a bank to pay a draft which has been
drawn on it by a customer. These obligations are backed by large banks and
usually backed by goods in international trade.
TIME DEPOSITS are non-negotiable deposits in a banking institution earning a
specified interest rate over a given period of time.
U.S. GOVERNMENT OBLIGATIONS are debt securities issued or guaranteed as to
principal and interest by the U.S. Treasury or by an agency or instrumentality
of the U.S. Government. Not all U.S. Government obligations are backed by the
full faith and credit of the United States. For example, securities issued by
the Federal Farm Credit Bank or by the Federal National Mortgage Association are
supported by the agency's right to borrow money from the U.S. Treasury under
certain circumstances. Securities issued by the Federal Home Loan Bank are
supported only by the credit of the agency. There is no guarantee that the
government will support these types of securities, and therefore they involve
more risk than other government obligations.
VARIABLE OR FLOATING RATE INSTRUMENTS (including notes purchased directly from
issuers) bear variable or floating interest rates and may carry rights that
permit holders to demand full payment from the issuers or certain financial
intermediaries. Floating rate securities have interest rates that change
whenever there is a change in a designated market-based interest rate, while
variable rate instruments provide for a specified periodic adjustment in the
interest rate. These formulas are designed to result in a market value for the
instrument that approximates its par value.
CREDIT ENHANCEMENT AGREEMENTS may be purchased simultaneously with a money
market instrument for guaranteeing principal and/or interest and may be
considered with the instrument for purposes of determining the quality of the
instruments. These include irrevocable note repurchase agreements or letters of
credit issued by banks and guarantees provided by creditworthy institutions. The
fund will purchase these agreements to enhance the creditworthiness of
instruments when
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the sub-advisor (through yield and credit analysis) feels it is in the fund's
best interest.
CORPORATE OBLIGATIONS are bonds and notes issued by corporations and other
business organizations in order to finance their long-term credit needs.
LOANS AND OTHER DIRECT DEBT INSTRUMENTS are interests in amounts owed by a
corporate, governmental or other borrower to another party. They may represent
amounts owed to lenders or lending syndicates (loans and loan participations),
to suppliers of goods or services (trade claims or other receivables), or to
other parties. Direct debt instruments purchased by the fund may have a maturity
of any number of days or years, may be secured or unsecured, and may be of any
credit quality. Direct debt instruments involve the risk of loss in case of
default or insolvency of the borrower. Direct debt instruments may offer less
legal protection to the fund in the event of fraud or misrepresentation. In
addition, loan participations involve a risk of insolvency of the lending bank
or other financial intermediary. Direct debt instruments also may include
standby financing commitments that obligate the fund to supply additional cash
to the borrower on demand at a time when the fund would not have otherwise done
so, even if the borrower's condition makes it unlikely that the amount ever will
be repaid.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities are securities issued by
government and non-government entities such as banks, mortgage lenders, or other
financial institutions. A mortgage-backed security may be an obligation of the
issuer backed by a mortgage or pool of mortgages or a direct interest in an
underlying pool of mortgages. Some mortgage-backed securities, such as
collateralized mortgage obligations or CMOs, make payments of both principal and
interest at a variety of intervals; others make semiannual interest payments at
a predetermined rate and repay principal at maturity (like a typical bond).
Mortgage-backed securities are based on different types of mortgages, including
those on commercial real estate or residential properties. Other types of
mortgage-backed securities will likely be developed in the future, and the fund
may invest in them if the sub-advisor determines they are consistent with the
fund's investment objective and policies.
The value of mortgage-backed securities may change due to shifts in the market's
perception of issuers. In addition, regulatory or tax changes may adversely
affect the mortgage securities market as a whole. Non-government mortgage-backed
securities may offer higher yields than those issued by government entities, but
also may be subject to greater price changes than government issues. Mortgage-
backed securities are subject to prepayment risk. Prepayment, which occurs when
unscheduled or early payments are made on the underlying mortgages, may shorten
the effective maturities of these securities and may lower their total returns.
STRIPPED MORTGAGE-BACKED SECURITIES are created when a U.S. Government agency or
a financial institution separates the interest and principal components of a
mortgage-backed security and sells them as individual securities. The holder of
the principal-only security (PO) receives the principal payments made by the
underlying mortgage-backed security, while the holder of the interest-only
security (IO) receives interest payments from the same underlying security.
The prices of stripped mortgage-backed securities may be particularly affected
by changes in interest rates. As interest rates fall, prepayment rates tend to
increase, which tends to reduce prices of IOs and increase prices of POs. Rising
interest rates can have the opposite effect.
ASSET-BACKED SECURITIES consist of undivided fractional interests in pools of
consumer loans (unrelated to mortgage loans) held in a trust. Payments of
principal and interest are passed through to certificate holders and are
typically supported by some form of credit enhancement, such as a letter of
credit, surety bond, limited guaranty or senior/subordination. The degree of
credit enhancement varies, but generally amounts to only a fraction of the
asset-backed security's par value until exhausted. Asset-backed securities are
ultimately dependent upon payment of consumer loans by individuals, and the
certificate holder generally has no recourse to the entity that originated the
loans. The underlying loans are subject to prepayments which shorten the
securities' weighted average life and may lower their return. (As prepayments
flow through at par, total returns would be affected by the prepayments; if a
security were trading at a premium, its total return would be lowered by
prepayments, and if a security were trading at a discount, its total return
would be increased by prepayments.) If the credit enhancement is exhausted,
certificate holders may experience losses or delays in payment if the required
payments of principal and interest are not made to the trust with respect to the
underlying loans. The value of these securities also may change because of
changes in the market's perception of the creditworthiness of the
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servicing agent for the loan pool, the originator of the loans, or the financial
institution providing the credit enhancement.
The sub-advisor believes that CMOs, asset-backed securities and mortgage-backed
securities are readily marketable based on the size of the market and the number
of trades transacted each day.
ZERO COUPON BONDS do not make interest payments; instead, they are sold at a
deep discount from their face value and are redeemed at face value when they
mature. Because zero coupon bonds do not pay current income, their prices can be
very volatile when interest rates change. In calculating its daily dividend, the
fund takes into account as income a portion of the difference between a zero
coupon bond's purchase price and its face value.
A broker-dealer creates a derivative zero by separating the interest and
principal components of a U.S. Treasury security and selling them as two
individual securities. Certificates of Accrual on Treasury Securities (CATS),
Treasury Investment Growth Receipts (TIGRs) and Treasury Receipts (TRs) are
examples of derivative zeros.
The Federal Reserve Bank creates Separate Trading of Registered Interest and
Principal of Securities (STRIPS) by separating the interest and principal
components of an outstanding U.S. Treasury bond and selling them as individual
securities. Bonds issued by the Resolution Funding Corp. (REFCORP) and the
Financing Corp. (FICO) can also be separated in this fashion. Original issue
zeros are zero coupon securities originally issued by the U.S. Government, a
government agency or a corporation in zero coupon form.
REPURCHASE AGREEMENTS. The fund may also make short-term investments in
repurchase agreements. A repurchase agreement typically involves the purchase by
the fund of securities (U.S. Government or other money market securities) from a
financial institution such as a bank, broker or savings and loan association,
coupled with an agreement by the seller to repurchase the same securities from
the fund at the specified price and at a fixed time in the future, usually not
more than seven days from the date of purchase. The difference between the
purchase price to the fund and the resale price to the seller represents the
interest earned by the fund which is unrelated to the coupon rate or maturity of
the purchased security. If the seller defaults, the fund may incur a loss if the
value of the collateral securing the repurchase agreement declines, or the fund
may incur disposition costs in connection with liquidating the collateral. If
bankruptcy proceedings are commenced with respect to the seller, realization
upon the collateral by the fund may be delayed or limited and a loss may be
incurred if the collateral securing the repurchase agreement declines in value
during the bankruptcy proceedings. However, repurchase agreements will be made
only with brokers or dealers deemed by the Board of Directors to be
creditworthy; they will be fully collateralized; and the collateral for each
transaction will be in the actual or constructive possession of the fund during
the term of the transaction, as provided in the agreement. Repurchase agreements
with a duration of more than seven days are considered illiquid securities and
are subject to the limit stated above. In a repurchase agreement, the fund
purchases a security and simultaneously commits to resell that security to the
seller at an agreed upon price on an agreed upon date within a number of days
(usually not more than seven) from the date of purchase. The resale price
reflects the purchase price plus an agreed upon incremental amount that is
unrelated to the coupon rate or maturity of the purchased security. A repurchase
agreement involves the obligation of the seller to pay the agreed upon price,
which obligation is in effect secured by the value (at least equal to the amount
of the agreed upon resale price and marked-to-market daily) of the underlying
security. The fund may engage in a repurchase agreement with respect to any
security in which it is authorized to invest. While it does not presently appear
possible to eliminate all risks from these transactions (particularly the
possibility of a decline in the market value of the underlying securities, as
well as delays and costs to the fund in the event of bankruptcy of the seller),
it is the policy of the fund to limit repurchase agreements to those parties
whose creditworthiness has been reviewed and found satisfactory by the advisor
or sub-advisor. In addition, the fund currently intends to invest only in
repurchase agreements collateralized by U.S. Government securities.
Pursuant to an Exemptive Order issued by the SEC, the fund, along with other
registered investment companies having management contracts with the sub-advisor
or an affiliate thereof, may invest in a pool of one or more large overnight
repurchase agreements. The repurchase agreements' underlying securities are U.S.
Government securities in which the fund is permitted to invest.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements are transactions
when the fund temporarily transfers possession of a portfolio instrument to
another party, such as a bank or bro-
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ker-dealer, in return for cash. At the same time, the fund agrees to repurchase
the instrument in an agreed-upon price and time. The fund expects that it will
engage in reverse repurchase agreements for temporary purposes such as to fund
redemptions or when it is able to invest the cash so acquired at a rate higher
than the cost of the agreement, which would increase the income earned by the
fund. Reverse repurchase agreements may increase the risk of fluctuation in the
market value of assets or in its yield. In a reverse repurchase agreement, the
fund sells a fund instrument to another party, such as a bank or broker-dealer,
in return for cash and agrees to repurchase the instrument at a particular price
and time. While a reverse repurchase agreement is outstanding, the fund will
maintain appropriate liquid assets in a segregated custodial account to cover
its obligation under the agreement. The fund will enter into reverse repurchase
agreements only with parties whose creditworthiness has been reviewed and found
satisfactory by the Board of Directors. Such transactions may increase
fluctuations in the market value of the fund's assets and may be viewed as a
form of leverage.
SECURITIES LENDING. The fund may from time to time lend securities from its
portfolio to brokers, dealers and financial institutions and receive collateral
from the borrower, in the form of cash (which may be invested in short-term
securities), U.S. Government obligations or certificates of deposit. Such
collateral will be maintained at all times in an amount equal to at least 100%
of the current market value of the loaned securities, and will be in the actual
or constructive possession of the fund during the term of the loan. The fund
will retain the incidents of ownership of the loaned securities and will be
entitled to the interest or dividends payable on the loaned securities. In
addition, the fund will receive interest on the amount of the loan. The loans
will be terminable by the fund at any time and will not be made to any
affiliates of the fund or the advisor or sub-advisor. The fund may pay
reasonable finder's fees to persons unaffiliated with it in connection with the
arrangement of the loans.
As with any extensions of credit, there are risks of delay in recovery and, in
some cases, even loss of rights in the collateral or the loaned securities
should the borrower of securities fail financially. However, loans of portfolio
securities will be made only to firms deemed by the Board of Directors to be
creditworthy. As a fundamental policy, the fund will not lend securities if, as
a result, more than 25% of its total assets would be lent to other parties.
ILLIQUID INVESTMENTS are investments that cannot be sold or disposed of in the
ordinary course of business at approximately the prices at which they are
valued. Under the supervision of the Board of Directors, the sub-advisor
determines the liquidity of the fund's investments and, through reports from the
sub-advisor, the Board monitors investments in illiquid instruments. In
determining the liquidity of the fund's investments, the sub-advisor may
consider various factors, including (1) the frequency of trades and quotations,
(2) the number of dealers and prospective purchasers in the marketplace, (3)
dealer undertakings to make a market, (4) the nature of the security (including
any demand or tender features), and (5) the nature of the marketplace for trades
(including the ability to assign or offset the fund's rights and obligations
relating to the investment).
Investments currently considered by the fund to be illiquid include repurchase
agreements not entitling the holder to payment of principal and interest within
seven days, loans and other direct debt instruments, over-the-counter options,
non-government stripped fixed-rate mortgage-backed securities, and restricted
securities, government-stripped fixed-rate mortgage-backed securities and swap
agreements determined by the sub-advisor to be illiquid. However, with respect
to over-the-counter options the fund writes, all or a portion of the value of
the underlying instrument may be illiquid depending on the assets held to cover
the option and the nature and terms of any agreement the fund may have to close
out the option before expiration.
In the absence of market quotations, illiquid investments are valued at fair
value as determined in good faith by a committee appointed by the Board of
Directors of the fund. If through a change in values, net assets, or other
circumstances, the fund were in a position where more than 10% of net assets
were invested in illiquid securities, it would seek to take appropriate steps to
protect liquidity.
RESTRICTED SECURITIES generally can be sold in privately negotiated
transactions, pursuant to an exemption from registration under the Securities
Act of 1933, or in a registered public offering. Where registration is required,
the fund may be obligated to pay all or part of the registration expense and a
considerable period may elapse between the time it decides to seek registration
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, the fund might obtain a less favorable
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price than prevailed when it decided to seek registration of the security.
SWAP AGREEMENTS. As one way of managing its exposure to different types of
investments, the fund may enter into interest rate swaps, currency swaps, and
other types of swap agreements such as caps, collars and floors. In a typical
interest rate swap, one party agrees to make regular payments equal to a
floating interest rate multiplied by a notional principal amount, in return for
payments equal to a fixed rate multiplied by the same amount, for a specified
period of time. If a swap agreement provides for payments in different
currencies, the parties might agree to exchange the notional principal amount as
well. Swaps may also depend on other prices or rates, such as the value of an
index or mortgage prepayment rates.
In a typical cap or floor agreement, one party agrees to make payments only
under specified circumstances, usually in return for payment of a fee by the
other party. For example, the buyer of an interest rate cap obtains the right to
receive payments to the extent that a specified interest rate exceeds an
agreed-upon level, while the seller of an interest rate floor is obligated to
make payments to the extent that a specified interest rate falls below an
agreed-upon level. An interest rate collar combines elements of buying a cap and
selling a floor.
Swap agreements will tend to shift the fund's investment exposure from one type
of investment to another. For example, if the fund agreed to exchange payments
in dollars for payments in foreign currency, the swap agreement would tend to
decrease the fund's exposure to U.S. interest rates and increase its exposure to
foreign currency and interest rates. Caps and floors have an effect similar to
buying or writing options. Depending on how they are used, swap agreements may
increase or decrease the overall volatility of the fund's investments and its
share price and yield.
Swap agreements are sophisticated hedging instruments that typically involve a
small investment of cash relative to the magnitude of risks assumed. As a
result, swaps can be highly volatile and may have a considerable impact on the
fund's performance. Swap agreements are subject to risks related to the
counterparty's ability to perform, and may decline in value if the
counterparty's creditworthiness deteriorates. The fund may also suffer losses if
it is unable to terminate outstanding swap agreements or reduce its exposure
through offsetting transactions.
Swap agreements can be individually negotiated and structured to include
exposure to a variety of different types of investments or market factors.
Depending on their structure, swap agreements may increase or decrease the
fund's exposure to long or short-term interest rates (in the U.S. or abroad),
foreign currency values, mortgage securities, corporate borrowing rates, or
other factors such as security prices or inflation rates. Swap agreements can
take many different forms and are known by a variety of names. The fund is not
limited to any particular form of swap agreement if the sub-advisor determines
it is consistent with the fund's investment objective and policies.
The most significant factor in the performance of swap agreements is the change
in the specific interest rate, currency, or other factors that determine the
amounts of payments due to and from the fund. If a swap agreement calls for
payments by the fund, it must be prepared to make such payments when due. In
addition, if the counterparty's creditworthiness declined, the value of a swap
agreement would be likely to decline, potentially resulting in losses. The fund
expects to be able to eliminate its exposure under swap agreements either by
assignment or other disposition, or by entering into an offsetting swap
agreement with the same party or a similarly creditworthy party.
The fund will maintain appropriate liquid assets in a segregated custodial
account to cover its current obligations under swap agreements. If the fund
enters into a swap agreement on a net basis, it will segregate assets with a
daily value at least equal to the excess, if any, of its accrued obligations
under the swap agreement over the accrued amount it is entitled to receive under
the agreement. If the fund enters into a swap agreement on other than a net
basis, it will segregate assets with a value equal to the full amount of its
accrued obligations under the agreement.
INDEXED SECURITIES. The fund may purchase securities whose prices are indexed to
the prices of other securities, securities indices, currencies, precious metals
or other commodities, or other financial indicators. Indexed securities
typically, but not always, are debt securities or deposits whose value at
maturity or coupon rate is determined by reference to a specific instrument or
statistic. Gold-indexed securities, for example, typically provide for a
maturity value that depends on the price of gold, resulting in a security whose
price tends to rise and fall together with gold prices. Currency-indexed
securities typically are short-term to intermediate-term debt securities whose
maturity values
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interest rates are determined by reference to the values of one or more
specified foreign currencies, and may offer higher yields than U.S.
dollar-denominated securities of equivalent issuers. Currency-indexed securities
may be positively or negatively indexed; that is, their maturity value may
increase when the specified currency value increases, resulting in a security
that performs similarly to a foreign-denominated instrument, or their maturity
value may decline when foreign currencies increase, resulting in a security
whose price characteristics are similar to a put on the underlying currency.
Currency-indexed securities may also have prices that depend on the values of a
number of different foreign currencies relative to each other.
The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers of
indexed securities have included banks, corporations, and certain U.S.
Government agencies.
WARRANTS. Warrants are securities that give the fund the right to purchase
equity securities from the issuer at a specific price (the strike price) for a
limited period of time. The strike price of warrants typically is much lower
than the current market price of the underlying securities, yet they are subject
to similar price fluctuations. As a result, warrants may be more volatile
investments than the underlying securities and may offer greater potential for
capital appreciation as well as capital loss.
Warrants do not entitle a holder to dividends or voting rights with respect to
the underlying securities and do not represent any rights in the assets of the
issuing company. Also, the value of the warrant does not necessarily change with
the value of the underlying securities and a warrant ceases to have value if it
is not exercised before the expiration date. These factors can make warrants
more speculative than other types of investments.
LOANS AND OTHER DIRECT DEBT INSTRUMENTS. Direct debt instruments are interests
in amounts owed by a corporate, governmental, or other borrower to lenders or
lending syndicates (loans and loan participations), to suppliers of goods or
services (trade claims or other receivables) or to other parties. Direct debt
instruments are subject to the fund's policies regarding the quality of debt
securities.
Purchasers of loans and other forms of direct indebtedness depend primarily upon
the creditworthiness of the borrower for payment of principal and interest.
Direct debt instruments may not be rated by any nationally recognized rating
service. If the fund does not receive scheduled interest or principal payments
on such indebtedness, the fund's share price and yield could be adversely
affected. Loans that are fully secured offer the fund more protections than an
unsecured loan in the event of non-payment of scheduled interest or principal.
However, there is no assurance that the liquidation of collateral from a secured
loan would satisfy the borrower's obligation, or that the collateral can be
liquidated. Indebtedness of borrowers whose creditworthiness is poor involves
substantially greater risks, and may be highly speculative. Borrowers that are
in bankruptcy or restructuring may never pay off their indebtedness, or may pay
only a small fraction of the amount owed. Direct indebtedness of developing
countries will also involve a risk that the governmental entities responsible
for the repayment of the debt may be unable, or unwilling, to pay interest and
repay principal when due.
Investments in loans through direct assignment of a financial institution's
interests with respect to a loan may involve additional risks to the fund. For
example, if a loan is foreclosed, the fund could become part owner of any
collateral, and would bear the costs and liabilities associated with owning and
disposing of the collateral. In addition, it is conceivable that under emerging
legal theories of lender liability, the fund could be held liable as a co-
lender. Direct debt instruments may also involve a risk of insolvency of the
lending bank or other intermediary. Direct debt instruments that are not in the
form of securities may offer less legal protection to the fund in the event of
fraud or misrepresentation. In the absence of definitive regulatory guidance,
the fund relies on the sub-advisor's research in an attempt to avoid situations
where fraud or misrepresentation could adversely affect the fund.
A loan is often administered by a bank or other financial institution that acts
as agent for all holders. The agent administers the terms of the loan, as
specified in the loan agreement. Unless, under the terms of the loan or other
indebtedness, the fund has direct recourse against the borrower, it may have to
rely on the agent to apply appropriate credit remedies against a borrower. If
assets held by the agent for the benefit of the fund were determined to be
subject to the claims of the agent's general creditors, the fund might incur
certain costs and
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delays in realizing payment on the loan or loan participation and could suffer a
loss of principal or interest.
Direct indebtedness purchased by the fund may include letters of credit,
revolving credit facilities or other standby financing commitments obligating
the fund to pay additional cash on demand. These commitments may have the effect
of requiring the fund to increase its investment in a borrower at a time when it
would not otherwise have done so, even if the company's condition makes it
unlikely that the amount will ever be repaid. The fund will set aside
appropriate liquid assets in a segregated custodial account to cover its
potential obligations under standby financing commitments.
The fund limits the amount of total assets that it will invest in any one issuer
or in issuers within the same industry (see limitations (1) and (5) for the
fund). For purposes of these limitations, the fund generally will treat the
borrower as the issuer of indebtedness held by the fund. In the case of loan
participants where a bank or other lending institution serves as financial
intermediary between the fund and the borrower, if the participation does not
shift to the fund the direct debtor-creditor relationship with the borrower, SEC
interpretations require the fund, in appropriate circumstances, to treat both
the lending bank or other lending institution and the borrower as issuers for
the purposes of determining whether the fund has invested more than 5% of its
total assets in a single issuer. Treating a financial intermediary as an issuer
of indebtedness may restrict the fund's ability to invest in indebtedness
related to a single financial intermediary, or a group of intermediaries engaged
in the same industry, even if the underlying borrowers represent many different
companies and industries.
FOREIGN INVESTMENTS. Foreign investments can involve significant risks in
addition to the risks inherent in U.S. investments. The value of securities
denominated in or indexed to foreign currencies, and of dividends and interest
from such securities, can change significantly when foreign currencies
strengthen or weaken relative to the U.S. dollar. Foreign securities markets
generally have less trading volume and less liquidity than U.S. markets, and
prices on some foreign markets can be highly volatile. Many foreign countries
lack uniform accounting and disclosure standards comparable to those applicable
to U.S. companies, and it may be more difficult to obtain reliable information
regarding an issuer's financial condition and operations. In addition, the costs
of foreign investing, including withholding taxes, brokerage commissions and
custodial costs, are generally higher than for U.S. investments.
Foreign markets may offer less protection to investors than U.S. markets.
Foreign issuers, brokers, and securities markets may be subject to less
government supervision. Foreign security trading practices, including those
involving the release of assets in advance of payment, may involve increased
risks in the event of a failed trade or the insolvency of a broker-dealer, and
may involve substantial delays. It may also be difficult to enforce legal rights
in foreign countries.
Investing abroad also involves different political and economic risks. Foreign
investments may be affected by actions of foreign governments adverse to the
interests of U.S. investors, including the possibility of expropriation or
nationalization of assets, confiscatory taxation, restrictions on U.S.
investment or on the ability to repatriate assets or convert currency into U.S.
dollars or other government intervention. There may be a greater possibility of
default by foreign governments or foreign government-sponsored enterprises.
Investments in foreign countries also involve a risk of local political,
economic or social instability, military action or unrest or adverse diplomatic
developments. There is no assurance that the sub-advisor will be able to
anticipate these potential events or counter their effects.
The considerations noted previously generally are intensified for investments in
developing countries. Developing countries may have relatively unstable
governments, economies based on only a few industries and securities markets
that trade a small number of securities.
The fund may invest in foreign securities that impose restrictions on transfer
within the United States or to U.S. persons. Although securities subject to
transfer restrictions may be marketable abroad, they may be less liquid than
foreign securities of the same class that are not subject to such restrictions.
American Depositary Receipts and European Depositary Receipts (ADRs and EDRs)
are certificates evidencing ownership of shares of a foreign-based issuer held
in trust by a bank or similar financial institution. Designed for use in U.S.
and European securities markets, respectively, ADRs and EDRs are alternatives to
the purchase of the underlying securities in their national markets and
currencies.
FOREIGN CURRENCY TRANSACTIONS. The fund may conduct foreign currency
transactions on a spot (i.e., cash) basis or by entering into forward contracts
to purchase or sell foreign currencies at a
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future date and price. The fund will convert currency on a spot basis from time
to time, and investors should be aware of the costs of currency conversion.
Although foreign exchange dealers generally do not charge a fee for conversion,
they do realize a profit based on the difference between the prices at which
they are buying and selling various currencies. Thus, a dealer may offer to sell
a foreign currency to the fund at one rate, while offering a lesser rate of
exchange should the fund desire to resell that currency to the dealer. Forward
contracts are generally traded in an interbank market conducted directly between
currency traders (usually large commercial banks) and their customers. The
parties to a forward contract may agree to offset or terminate the contract
before its maturity, or may hold the contract to maturity and complete the
contemplated currency exchange.
The fund may use currency forward contracts for any purpose consistent with its
investment objective. The following discussion summarizes some, but not all, of
the possible currency management strategies involving forward contracts that
could be used by the fund. The fund may also use options and futures contracts
relating to foreign currencies for the same purposes.
When the fund agrees to buy or sell a security denominated in a foreign
currency, it may desire to lock in the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale, for a fixed amount of
U.S. dollars, of the amount of foreign currency involved in the underlying
security transaction, the fund will be able to protect itself against an adverse
change in foreign currency values between the date the security is purchased or
sold and the date on which payment is made or received. This technique is
sometimes referred to as a settlement hedge or transaction hedge. The fund may
also enter into forward contracts to purchase or sell a foreign currency in
anticipation of future purchases or sales of securities denominated in foreign
currency, even if the specific investments have not yet been selected by the
sub-advisor.
The fund may also use forward contracts to hedge against a decline in the value
of existing investments denominated in foreign currency. For example, if the
fund owned securities denominated in pounds sterling, the fund could enter into
a forward contract to sell pounds sterling in return for U.S. dollars to hedge
against possible declines in the pound's value. Such a hedge, sometimes referred
to as a position hedge, would tend to offset both positive and negative currency
fluctuations, but would not offset changes in security values caused by other
factors. The fund could also hedge the position by selling another currency
expected to perform similarly to the pound sterling-for example, by entering
into a forward contract to sell Deutschemarks or European Currency Units in
return for U.S. dollars.This type of hedge, sometimes referred to as a proxy
hedge, could offer advantages in terms of cost, yield or efficiency, but
generally will not hedge currency exposure as effectively as a simple hedge into
U.S. dollars. Proxy hedges may result in losses if the currency used to hedge
does not perform similarly to the currency in which the hedged securities are
denominated.
The fund may enter into forward contracts to shift its investment exposure from
one currency into another currency that is expected to perform better relative
to the U.S. dollar. For example, if the fund held investments denominated in
Deutschemarks, the fund could enter into forward contracts to sell Deutschemarks
and purchase Swiss Francs. This type of strategy, sometimes known as a
cross-hedge, will tend to reduce or eliminate exposure to the currency that is
sold, and increase exposure to the currency that is purchased, much as if the
fund had sold a security denominated in one currency and purchased an equivalent
security denominated in another. Cross-hedges protect against losses resulting
from a decline in the hedged currency, but will cause the fund to assume the
risk of fluctuations in the value of the currency it purchases.
Under certain conditions, SEC guidelines require mutual funds to set aside
appropriate liquid assets in a segregated custodial account to cover currency
forward contracts. As required by SEC guidelines, the fund will segregate assets
to cover currency forward contracts, if any, whose purpose is essentially
speculative. The fund will not segregate assets to cover forward contracts
entered into for hedging purposes, including settlement hedges, position hedges
and proxy hedges.
Successful use of currency forward contracts will depend on the sub-advisor's
skill in analyzing and predicting currency values. Forward contracts may
substantially change the fund's investment exposure to changes in currency
exchange rates, and could result in losses to the fund if currencies do not
perform as the sub-advisor anticipates. For example, if a currency's value rose
at a time when the sub-advisor had hedged the fund by selling that currency in
exchange for dollars, the fund would be unable to participate in the currency's
appreciation. If the sub-advisor hedges currency exposure through proxy hedges,
the fund could realize cur-
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rency losses from the hedge and the security position at the same time if the
two currencies do not move in tandem. Similarly, if the sub-advisor increases
the fund's exposure to a foreign currency, and that currency's value declines,
the fund will realize a loss. There is no assurance that the sub-advisor's use
of currency forward contracts will be advantageous to the fund or that they will
hedge at an appropriate time. The policies described in this section are non-
fundamental policies of the fund.
OPTIONS AND FUTURES CONTRACTS are a way for the fund to manage its exposure to
changing interest rates, security prices, and currency exchange rates. Some
options and futures strategies, including selling futures, buying puts, and
writing calls, tend to hedge the fund's investments against price fluctuations.
Other strategies, including buying futures, writing puts, and buying calls, tend
to increase market exposure. Options and futures may be combined with each other
or with forward contracts in order to adjust the risk and return characteristics
of the overall strategy. The fund may invest in options and futures based on any
type of security, index, or currency, including options and futures traded on
foreign exchanges and options not traded on exchanges.
Options and futures can be volatile investments, and involve certain risks. If
the sub-advisor applies a hedge at an inappropriate time or judges market
conditions incorrectly, options and futures strategies may lower the options and
futures positions were poorly correlated with its other investments, or if it
could not close out its positions because of an illiquid secondary market.
The fund will not hedge more than 25% of its total assets by selling futures,
buying puts and writing calls under normal conditions. In addition, the fund
will not buy futures or write puts whose underlying value exceeds 25% of its
total assets, and the fund will not buy calls with a value exceeding 5% of its
total assets.
LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS. The fund has filed a notice of
eligibility for exclusion from the definition of the term commodity pool
operator with the Commodity Futures Trading Commission (CFTC) and the National
Futures Association, which regulate trading in the futures markets. The fund
intends to comply with Section 4.5 of the regulations under the Commodity
Exchange Act, which limits the extent to which the fund can commit assets to
initial margin deposits and option premiums.
a. 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 long positions in futures contracts and related options that do
not fall within the definition of bona fide hedging transactions if the
positions are used as part of a fund management strategy and are incidental
to the fund's activities in the cash market, and the underlying commodity
value of the positions at all times will not exceed the sum of (1) cash or
money market instruments set aside in an identifiable manner, plus margin
deposits, (2) cash proceeds from existing investments due in 30 days, and (3)
accrued profits on the positions held by a futures commission merchant; and
b. The fund will not enter into any futures contract or option on a futures
contract if, as a result, the sum of initial margin deposits on futures
contracts and related options and premiums paid for options on futures
contracts the fund has purchased, after taking into account unrealized
profits and losses on such contracts, would exceed 5% of the fund's total
assets.
In addition, the fund will not: (a) sell futures contracts, purchase put options
or write call options if, as a result, more than 25% of the fund's total assets
would be hedged with futures and options under normal conditions; (b) purchase
futures contracts or write put options if, as a result, the fund's total
obligations upon settlement or exercise of purchased futures contracts and
written put options would exceed 25% of its total assets; or (c) purchase call
options if, as a result, the current value of option premiums for call options
purchased by the fund would exceed 5% of the fund's total assets. These
limitations do not apply to options attached to or acquired or traded together
with their underlying securities, and do not apply to securities that
incorporate features similar to options.
FUTURES CONTRACTS. When the fund purchases a futures contract, it agrees to
purchase a specified underlying instrument at a specified future date. When the
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. Some currently available
futures contracts are based on specific securities, such as U.S. Treasury bonds
or notes, and some are based on indices of securities prices, such as the S&P
500) and the Bond Buyer Index of municipal bonds. Futures can be held until
their delivery dates, or can be closed out before then if a liquid secondary
market is available.
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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 the fund's exposure to positive and negative price
fluctuations in the underlying instrument, much as if it 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 typically equal to a percentage of the contract's value. If the
value of either party's position declines, that party will be required to make
additional variation margin payments to settle the change in value on a daily
basis. The party that has a gain may be entitled to receive all or a portion of
this amount. Initial and variation margin payments do not constitute purchasing
securities on margin for purposes of the fund's investment limitations. In the
event of the bankruptcy of an FCM that holds margin on behalf of the 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.
PURCHASING PUT AND CALL OPTIONS. By purchasing a put option, the 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). Options have various types
of underlying instruments, including specific securities, indices of securities
prices, and futures contracts. 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 typical put option can expect to realize a gain if security
prices fall substantially. However, if the underlying instrument's price does
not fall enough to offset the cost of purchasing the option, a put buyer can
expect to suffer a loss (limited to the amount of the premium paid, plus related
transaction costs).
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 stake price. A call buyer
typically attempts to participate in potential price increases of the underlying
instrument with risk limited to the cost of the option if security prices fall.
At the same time, the buyer can expect to suffer a loss if security prices do
not rise sufficiently to offset the cost of the option.
WRITING PUT AND CALL OPTIONS. When the fund writes a put option, it takes the
opposite side of the transaction from the option's purchaser. In return for
receipt of the 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. 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. The fund may seek to terminate its position in a put option it writes
before exercise by closing out the option in the secondary market at its current
price. If the secondary market is not liquid for a put option the fund has
written, however, the fund must continue to be prepared to pay the strike price
while the option is outstanding, regardless of price changes, and must continue
to set aside assets to cover its position.
If security prices rise, a put writer would generally expect to profit, although
its gain would be limited to the amount of the premium it received. If security
prices remain the same over time, it is likely that the writer will also profit,
because it should be able to close out the option at a lower price. If security
prices fall, the put writer would expect to suffer a loss. This loss should be
less than the loss from purchasing the underlying instrument directly, however,
because the premium received for writing the option should mitigate the effects
of the decline.
Writing a call option obligates the fund to sell or deliver the option's
underlying instrument, in return for the strike price, upon exercise of the
option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. Through receipt of
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the option premium, a call writer mitigates the effects of a price decline. At
the same time, because a call writer must be prepared to deliver the underlying
instrument in return for the strike price, even if its current value is greater,
a call writer gives up some ability to participate in security price increases.
COMBINED POSITIONS. The fund may purchase and write options in combination with
each other, or in combination with futures or forward contracts, to adjust the
risk and return characteristics of the overall position. For example, 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 positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
CORRELATION OF PRICE CHANGES. Because there are a limited number of types of
exchange-traded options and futures contracts, it is likely that the
standardized contracts available will not match the fund's current or
anticipated investments exactly. The fund may invest in options and futures
contracts based on securities with different issuers, maturities or other
characteristics from the securities in which it typically invests, which
involves a risk that the options or futures position will not track the
performance of the fund's other 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 the 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. The 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
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.
LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS. There is no assurance that a liquid
secondary market will exist for any particular options or futures contract at
any particular time. Options may have relatively low trading volume and
liquidity if their strike prices are not close to the underlying instrument's
current price. In addition, exchanges may establish daily price fluctuation
limits for options and futures contracts, and may halt trading if a contract's
price moves upward or downward more than the limit in a given day. On volatile
trading days when the price fluctuation limit is reached or a trading halt is
imposed, it may be impossible for the 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 the 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.
OVER THE COUNTER (OTC) OPTIONS. Unlike exchange-traded options, which are
standardized with respect to the underlying instrument, expiration date,
contract size and strike price, the terms of OTC options (options not traded on
exchanges) generally are established through negotiation with the other party to
the option contract. While this type of arrangement allows the fund greater
flexibility to tailor an option to its needs, OTC options generally involve
greater credit risk than exchange-traded options, which are guaranteed by the
clearing organization of the exchanges where they are traded.
OPTIONS AND FUTURES RELATING TO FOREIGN CURRENCIES. Currency futures contracts
are similar to forward currency exchange contracts, except that they are traded
on exchanges (and have margin requirements) and are standardized as to contract
size and delivery date. Most currency futures contracts call for payment or
delivery in U.S. dollars. The underlying instrument of a currency option may be
a foreign currency, which generally is purchased or delivered in exchange for
U.S. dollars, or may be a futures contract. The purchaser of a currency call
obtains the right to purchase the underlying currency, and the purchaser of a
currency put obtains the right to sell the underlying currency.
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The uses and risks of currency options and futures are similar to options and
futures relating to securities or indices, as discussed previously. The fund may
purchase and sell currency futures and may purchase and write currency options
to increase or decrease its exposure to different foreign currencies. The fund
may also purchase and write currency options in conjunction with each other or
with currency futures or forward contracts. Currency futures and options values
can be expected to correlate with exchange rates, but may not reflect other
factors that affect the value of the fund's investments. A currency hedge, for
example, should protect a Yen-denominated security from a decline in the Yen,
but will not protect the fund against a price decline resulting from
deterioration in the issuer's creditworthiness. Because the value of the fund's
foreign-denominated investments changes in response to many factors other than
exchange rates, it may not be possible to match the amount of currency options
and futures to the value of the fund's investments exactly over time.
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS. The fund will comply with
guidelines established by the SEC with respect to coverage of options and
futures strategies by mutual funds, and if the guidelines so require will set
aside appropriate liquid assets in a segregated custodial account in the amount
prescribed. Securities held in a segregated account cannot be sold while the
futures or option strategy is outstanding, unless they are replaced with other
suitable assets. As a result, there is a possibility that segregation of a large
percentage of the fund's assets could impede portfolio management or the fund's
ability to meet redemption requests or other current obligations.
SHORT SALES. The fund may enter into short sales with respect to stocks
underlying its convertible security holdings. For example, if the sub-advisor
anticipates a decline in the price of the stock underlying a convertible
security the fund holds, it may sell the stock short. If the stock price
subsequently declines, the proceeds of the short sale could be expected to
offset all or a portion of the effect of the stock's decline on the value of the
convertible security. The fund currently intends to hedge no more than 15% of
its total assets with short sales on equity securities underlying its
convertible security holdings under normal circumstances.
When the fund enters into a short sale, it will be required to set aside
securities equivalent in kind and amount to those sold short (or securities
convertible or exchangeable into such securities) and will be required to
continue to hold them while the short sale is outstanding. The fund will incur
transaction costs, including interest expense, in connection with opening,
maintaining, and closing short sales.
LOWER-RATED DEBT INSTRUMENTS
Lower-rated debt securities are usually defined as securities rated Ba or lower
by Moody's or BB or lower by Standard & Poor's Corp. Lower-rated debt securities
are considered speculative and involve greater risk of loss than higher-rated
debt securities, and are more sensitive to changes in the issuer's capacity to
pay. This is an aggressive approach to income investing.
The 1980s saw a dramatic increase in the use of lower-rated debt securities to
finance highly leveraged acquisitions and restructurings. Past experience may
not provide an accurate indication of the future performance of lower-rated debt
securities, especially during periods of economic recession. In fact, from 1989
to 1991, the percentage of lower-rated debt securities that defaulted rose
significantly above prior levels.
Lower-rated debt securities may be thinly traded, which can adversely affect the
prices at which these securities can be sold and can result in high transaction
costs. If market quotations are not available, lower-rated debt securities will
be valued in accordance with standards set by the Board of Directors, including
the use of outside pricing services. Judgment plays a greater role in valuing
lower-rated debt securities than securities for which more extensive quotations
and last sale information are available. Adverse publicity and changing investor
perceptions may affect the ability of outside pricing services to value
lower-rated debt securities, and the fund's ability to dispose of these
securities.
The market prices of lower-rated debt securities may decline significantly in
periods of general economic difficulty which may follow periods of rising
interest rates. During an economic downturn or a prolonged period of rising
interest rates, the ability of issuers of lower-rated debt to service their
payment obligations, meet projected goals, or obtain additional financing may be
impaired.
The fund may choose, at its expense or in conjunction with others, to pursue
litigation or otherwise to exercise its rights as a security holder to seek to
protect the interests of security holders if it determines this to be in the
interest of the fund's shareholders.
The considerations discussed previously for lower-rated debt securities also
apply to lower-quality, unrated debt instruments of all types, including loans
and other direct indebtedness of businesses
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with poor credit standing. Unrated debt instruments are not necessarily of lower
quality than rated instruments, but they may not be attractive to as many
buyers. The fund relies more on the sub-advisor's credit analysis when investing
in debt instruments that are unrated.
Please refer to the Appendix for a discussion of Moody's and Standard & Poor's
Corp. ratings.
PORTFOLIO TRANSACTIONS AND BROKERAGE
All orders for the purchase or sale of fund securities are placed on behalf of
the fund by the sub-advisor (either directly or through affiliated advisors or
sub-advisors) pursuant to authority contained in the fund's sub-advisory
agreement. The sub-advisor may also be responsible for the placement of
transaction orders for other investment companies and accounts for which it or
its affiliates act as investment advisor or sub-advisor. Money market securities
purchased and sold by the fund generally will be traded on a net basis (i.e.,
without commission). In selecting broker-dealers, subject to applicable
limitations of the federal securities laws, the sub-advisor will consider
various relevant factors, including, but not limited to, the size and type of
the transaction; the nature and character of the markets for the security to be
purchased or sold; the execution efficiency, settlement capability and financial
condition of the broker-dealer firm; the broker-dealer's execution services
rendered on a continuing basis; and the reasonableness of any commissions.
Commissions for foreign investments traded on foreign exchanges will generally
be higher than for U.S. investments and may not be subject to negotiation.
The fund may execute portfolio transactions with broker-dealers who provide
research and execution services to the fund and/or other accounts over which the
sub-advisor or its affiliates exercise investment discretion. Such services may
include advice concerning the value of securities; the advisability of investing
in, purchasing or selling securities; the availability of securities or the
purchasers or sellers of securities; furnishing analyses and reports concerning
issuers, industries, securities, economic factors and trends, fund strategy and
performance of accounts; and effecting securities transactions and performing
functions incidental thereto (such as clearance and settlement). The sub-advisor
maintains a listing of broker-dealers who provide such services on a regular
basis. However, as many transactions on behalf of the fund's money market
securities are placed with dealers (including broker-dealers on the list)
without regard to the furnishing of such services, it is not possible to
estimate the proportion of such transactions directed to such dealers solely
because such services were provided. The selection of such broker-dealers is
generally made by the sub-advisor (to the extent possible consistent with
execution considerations) in accordance with a ranking of broker-dealers
determined periodically by the sub-advisor's investment staff based upon the
quality of research and execution services provided.
The receipt of research from broker-dealers that execute transactions on behalf
of the fund may be useful to the sub-advisor in rendering investment management
services to the fund and/or other clients, and conversely, such information
provided by broker-dealers who have executed transaction orders on behalf of
other sub-advisor clients may be useful to the sub-advisor in carrying out its
obligations to the fund. The receipt of such research has not reduced the
sub-advisor's normal independent research activities; however, it enables the
sub-advisor to avoid additional expenses that could be incurred if the
sub-advisor tried to develop comparable information through its own efforts.
Subject to applicable limitations of the federal securities laws, broker dealers
may receive commissions for agency transactions that are in excess of the amount
of commissions charged by other broker dealers in recognition of their research
and/or execution services. In order to cause the fund to pay such higher
commissions, the sub-advisor must determine in good faith that such commissions
are reasonable in relation to the value of the brokerage and research services
provided by such executing broker-dealers viewed in terms of a particular
transaction or the sub-advisor's overall responsibilities to the fund and its
other clients. In reaching this determination, the sub-advisor will not attempt
to place a specific dollar value on the brokerage and research services provided
or to determine what portion of the compensation should be related to those
services.
The sub-advisor is authorized to use research services provided by and to place
portfolio transactions with brokerage firms that have provided assistance in the
distribution of shares of the fund or shares of other Fidelity funds to the
extent permitted by law. The sub-advisor may use research services provided by
and place agency transactions with Fidelity Brokerage Services, Inc. (FBSI) and
Fidelity Brokerage Services, Ltd. (FBSL), subsidiaries of FMR Corp., if the
commissions are fair, reasonable,
EI-16
<PAGE>
-----------
EQUITY-
INCOME
-----------
and comparable to commissions charged by non-affiliated, qualified brokerage
firms for similar services. Before September 4, 1992, FBSL operated under the
name Fidelity Portfolio Services, Ltd. (FPSL) as a owned subsidiary of Fidelity
International Limited (FIL). Edward C. Johnson 3d is Chairman of FIL. Mr.
Johnson 3d, together with various trusts for the benefit of Johnson family
members, owns directly or indirectly more than 25% of the voting common stock of
FIL.
The fund's Board of Directors periodically reviews the sub-advisor's performance
of its responsibilities in connection with the placement of fund transactions on
behalf of the fund and reviews the commissions, if any, paid by the fund over
representative periods of time to determine if they are reasonable in relation
to the benefits to the fund.
BROKERAGE COMMISSIONS. Of the commissions paid to brokerage firms which provided
research services, the providing of such services is not necessarily a factor in
the placement of all business with such firms. The fund pays both commissions
and spreads in connection with the placement of fund transactions.
From time to time the fund's Directors will review whether the recapture for the
benefit of the fund of some portion of the brokerage commissions or similar fees
paid by the fund on fund transactions is legally permissible and advisable. The
fund seeks to recapture soliciting broker-dealer fees on the tender of portfolio
securities, but at present no other recapture arrangements are in effect. The
Directors intend to continue to review whether recapture opportunities are
available and are legally permissible and, if so, to determine in the exercise
of their business judgment whether it would be advisable for the fund to seek
such recapture.
Although the sub-advisor or its affiliates also manage other funds, investment
decisions for the fund are made independently from those of other funds managed
by sub-advisor or accounts managed by affiliates of the sub-advisor. It
sometimes happens that the same security is held in the portfolio of more than
one of these funds or accounts. Simultaneous transactions are inevitable when
several funds are managed by the same investment advisor, particularly when the
same security is suitable for the investment objective of more than one fund.
When two or more funds, or portfolios, are simultaneously engaged in the
purchase or sale of the same security, the prices and amounts are allocated in
accordance with a formula considered by the officers of the funds or portfolios
involved to be equitable to each fund or portfolio. In some cases this system
could have a detrimental effect on the price or volume of the security as far as
the fund is concerned. In other cases, however, the ability of the fund or
portfolio to participate in volume transactions will produce better executions
and prices for the fund. It is the current opinion of the Board of Directors
that the desirability of retaining the sub-advisor as sub-investment advisor to
the fund outweighs any disadvantages that may be said to exist from exposure to
simultaneous transactions.
DETERMINATION OF NET ASSET VALUE
The fund's securities are appraised by various methods depending on the market
or exchange on which they trade. Securities traded on the New York Stock
Exchange (NYSE) or the American Stock Exchange are appraised at the last sale
price, or if no sale has occurred, at the closing bid price. Securities traded
on other exchanges are appraised, to the extent possible, in the same manner.
Securities and other assets for which exchange quotations are not readily
available are valued using closing over-the-counter bid prices, if available, or
at their fair value as determined in good faith under consistently applied
procedures generally supervised by the Board of Directors. Short-term securities
are valued either at amortized cost or at original cost plus accrued interest,
both of which approximate their current value. Securities pricing services may
be utilized by the fund.
The fund is open for business and its NAV is calculated each day the NYSE is
open for trading. The NYSE has designated the following holiday closings for
1996: New Year's Day, January 1; President's Day, February 19; Good Friday,
April 5; Memorial Day, May 27; Independence Day, July 4; Labor Day, September 2;
Thanksgiving Day, November 28; and Christmas Day, December 25. It may also be
closed on other days. Although the Directors expect the same holiday schedule to
be observed in the future, the NYSE may modify its holiday schedule at any time.
On any day that the NYSE closes early, the right is reserved to advance the time
on that day by which purchase and redemption orders must be received. To the
extent that the fund's securities are traded in other markets on days when the
NYSE is closed, the fund's NAV may be affected on days when investors do not
have access to the fund to purchase or redeem shares.
EI-17
<PAGE>
-----------
EQUITY-
INCOME
-----------
If, in the opinion of the Directors, conditions exist that make cash payment
undesirable, redemption payments may be made in whole or in part in securities
or other property, valued for this purpose as they are valued in computing the
NAV of the fund. Shareholders receiving any such securities or other property on
redemption will incur any costs of selling a domestic or foreign security as
well as the associated inconveniences.
EI-18
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION TABLE OFCONTENTS-11 UNDERLYING FUNDS*
Item
- --------------------------------------------------------------------------------
General Information and History
Investment objective
Investment policies and techniques
Investment restrictions
Portfolio transactions and brokerage
Determination of net asset value
Item
- --------------------------------------------------------------------------------
Appendix
Investment advisor and sub-advisor
Directors and officers
Investment policies and techniques (continued): options, futures, securities
lending, repurchase and reverse repurchase agreements
Custodian
Independent auditors
Financial statements
Bond ratings
Commercial paper ratings
U.S. Government obligations
Taxes
State requirements
Derivative transactions - definitions
*Note: This is a generic table. There are variations in the contents of the SAI
from fund to fund.
- --------------------------------------------------------------------------------
Please send me a free copy of the current Statement of Additional Information
for Lincoln National Life Insurance Co. Variable Annuity Account C:
(Please Print)
Name:___________________________________________________________________________
Address:________________________________________________________________________
City ___________________________________State ____________________Zip __________
Mail to Kim Oakman, Lincoln National Life Insurance Co., P.O. Box 2340, Fort
Wayne, Indiana 46801
73
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This page was intentionally left blank.
74
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
APPENDIX
(Note: This is uniform information for the 11 Funds. See each Fund's SAI for
information specific to that Fund.)
THIS APPENDIX CONSTITUTES PART OF THE SAIS OF LINCOLN NATIONAL AGGRESSIVE GROWTH
FUND, INC. (AGGRESSIVE GROWTH FUND), LINCOLN NATIONAL BOND FUND, INC. (BOND
FUND), LINCOLN NATIONAL CAPITAL APPRECIATION FUND, INC. (CAPITAL APPRECIATION
FUND), LINCOLN NATIONAL EQUITY-INCOME FUND, INC. (EQUITY-INCOME FUND), LINCOLN
NATIONAL GLOBAL ASSET ALLOCATION FUND, INC. (GLOBAL ASSET ALLOCATION FUND),
LINCOLN NATIONAL GROWTH AND INCOME FUND, INC. (GROWTH AND INCOME FUND), LINCOLN
NATIONAL INTERNATIONAL FUND, INC. (INTERNATIONAL FUND), LINCOLN NATIONAL MANAGED
FUND, INC. (MANAGED FUND), LINCOLN NATIONAL MONEY MARKET FUND, INC. (MONEY
MARKET FUND), LINCOLN NATIONAL SOCIAL AWARENESS FUND, INC. (SOCIAL AWARENESS
FUND), AND LINCOLN NATIONAL SPECIAL OPPORTUNITIES FUND, INC. (SPECIAL
OPPORTUNITIES FUND). UNLESS OTHERWISE INDICATED, THE FOLLOWING INFORMATION
APPLIES TO EACH FUND.
INVESTMENT ADVISOR AND SUB-ADVISOR
Lincoln Investment Management, Inc. (Lincoln Investment) is the investment
advisor to the funds and is headquartered at 200 E. Berry Street, Fort Wayne,
Indiana 46802. Lincoln Investment (the advisor) is a subsidiary of Lincoln
National Corp. (LNC), a publicly-held insurance holding company organized under
Indiana law. Through its subsidiaries, LNC provides, on a national basis,
insurance and financial services. Lincoln Investment is registered with the
Securities and Exchange Commission (SEC) as an investment advisor and has acted
as an investment advisor to mutual funds for over 40 years. The advisor also
acts as investment advisor to Lincoln National Income Fund, Inc. (a closed-end
investment company whose investment objective is to provide a high level of
current income from interest on fixed-income securities) and Lincoln National
Convertible Securities Fund, Inc. (a closed-end investment company whose
investment objective is a high level of total return on its assets through a
combination of capital appreciation and current income), Lincoln Advisor Funds,
Inc. (a retail mutual fund complex) and to other clients.
Under Advisory Agreements with the funds, the advisor provides portfolio
management and investment advice to the funds and administers its other affairs,
subject to the supervision of the funds' Board of Directors. The advisor, at its
expense, will provide office space to the funds and all necessary office
facilities, equipment and personnel and will make its officers and employees
available to the funds as appropriate. In addition, the advisor will pay all
expenses incurred by it or by the funds in connection with the management of
each fund's assets or the administration of its affairs, other than those
assumed by the funds, as described later. Lincoln Life has paid the
organizational expenses of all the funds. The rates of compensation to the
advisor and the sub-advisor are set forth in the Appendix to the Prospectus.
During the last three years, the advisor received the following amounts for
investment advisory services:
<TABLE>
<CAPTION>
1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $ 725,544 $ 232,000 N/A
Bond Fund 1,061,701 999,397 $ 978,266
Capital Appreciation Fund 726,011 211,773 N/A
Equity-Income Fund 1,457,623 348,255 N/A
Global Asset Allocation Fund 1,570,876 1,381,059 901,004
Growth and Income Fund 5,077,981 3,896,902 3,293,315
International Fund 2,770,197 2,262,664 759,801
Managed Fund 2,120,656 1,919,150 1,756,544
Money Market Fund 385,019 404,441 449,374
Social Awareness Fund 1,048,366 736,602 542,142
Special Opportunities Fund 1,809,514 1,351,374 1,052,967
</TABLE>
A-1
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX
- --------------------------------------------------------------------------------
Expenses specifically assumed by the funds include: compensation and expenses of
directors of the funds who are not interested persons of the funds as defined in
the Investment Company Act of 1940 (1940 Act); registration, filing and other
fees in connection with filings with regulatory authorities, including the costs
of printing and mailing registration statements and updated prospectuses
provided to current shareholders; fees and expenses of independent auditors; the
expenses of printing and mailing proxy statement and shareholder reports;
custodian charges; brokerage commissions and securities transaction costs
incurred by the funds; taxes and corporate fees; legal fees incurred in
connection with the affairs of the funds (other than legal services provided by
personnel of the advisor or its affiliated companies); the fees of any trade
association of which the funds are members; and expenses of shareholder and
director meetings.
If total expenses of the funds (excluding taxes, interest, portfolio brokerage
commissions and fees, and expenses of an extraordinary and non-recurring nature,
but including the investment advisory fee) exceed 1 1/2% per annum of the
average daily net assets of each fund (2% for the International Fund), the
advisor will pay such excess by offsetting it against the advisory fee. If such
offset is insufficient to cover the excess, any balance remaining will be paid
directly by the advisor to each fund.
The current advisory agreements between the advisor and the funds will remain in
effect from year to year if approved annually by: (1) the Board of Directors of
each fund or by the vote of a majority of the outstanding voting securities of
each fund, and (2) a vote of a majority of the directors who are not interested
persons of the funds or the advisor, cast in person at a meeting called for the
purpose of voting on such approval. The advisory agreement may be terminated
without penalty at any time, on 60 days' written notice by: (1) the Board of
Directors of each fund, (2) vote of a majority of the outstanding voting
securities of each fund or (3) the advisor. The advisory agreement terminates
automatically in the event of assignment.
In like manner, the current sub-advisory agreement will remain in effect from
year to year if approved annually by the Board of Directors of the applicable
funds or by the vote of a majority of the outstanding voting securities of those
funds. The sub-advisory agreements may be terminated without penalty at any
time, on 60 days' written notice, by: (1) the Board of Directors of the
applicable fund, (2) vote of the majority of the outstanding voting securities
of the applicable fund, (3) the sub-advisor, or (4) the advisor. The sub-
advisory agreements terminate automatically in the event of assignment.
A-2
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
DIRECTORS AND OFFICERS
The directors and executive officers of each fund, their business
addresses, positions with fund and their principal occupations during the past
five years areas follows:
- --------------------------------------------------------------------------------
* KELLY D. CLEVENGER Vice President, Lincoln National Life Insurance Co.
Chairman of the Board,
President and Director
1300 S. Clinton Street
Fort Wayne, IN 46802
- --------------------------------------------------------------------------------
JOHN B. BORSCH, JR. Retired, formerly Associate Vice President-
Director Investments,Northwestern University
1776 Sherwood Road Northwestern University
Des Planes, IL 60016
- --------------------------------------------------------------------------------
NANCY L. FRISBY, CPA Regional Vice President/Chief Financial Officer
Director (formerly Vice President -- Finance; Regional
700 Broadway Controller of Finance), St. Joseph Medical Center,
Fort Wayne, IN 46802 Fort Wayne, Indiana
- --------------------------------------------------------------------------------
* BARBARA S. KOWALCZYK Executive Vice President, Lincoln Investment
Director Management, Inc. (formerly Senior Vice President);
1300 S. Clinton St. Vice President, Lincoln National Life Insurance Co.
Fort Wayne, IN 46802
- --------------------------------------------------------------------------------
STANLEY R. NELSON Executive in Residence Program in Health Services
Director Administration, University of Minnesota,
420 Delaware St., S.E. Minneapolis, Minnesota, (formerly President, Henry
Minneapolis, MN 55455 Ford Health Care Corp., Detroit, Michigan)
- --------------------------------------------------------------------------------
* JANET C. WHITNEY Vice President and Treasurer, Lincoln National
200 East Berry Street Corp. (formerly Vice President and General Auditor)
Fort Wayne, IN 46802
- --------------------------------------------------------------------------------
* CYNTHIA A. ROSE Assistant Secretary, Lincoln National Life
200 East Berry Street Insurance Co.
Fort Wayne, IN 46802
- --------------------------------------------------------------------------------
* Interested persons of the funds, as defined in the 1940 Act. Directors' fees
of $250 per meeting are paid by each fund to each director who is not an
interested person of the fund.
A-3
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
INVESTMENT POLICIES AND TECHNIQUES (CONTINUED) OPTIONS AND FINANCIAL FUTURES
TRADING
This discussion relates to the Bond, Growth and Income, Managed, Social
Awareness and Special Opportunities Funds. Neither the International Fund nor
the Money Market Fund has sought the authority to engage either in options or in
futures trading. (NOTE: The Aggressive Growth, Capital Appreciation, Equity-
Income and Global Asset Allocation Funds have their own respective discussions
of the strategic portfolio transactions in which they may engage).
OPTIONS TRADING
The fund may purchase or write (sell) options on financial instruments as a
means of achieving additional return or hedging the value of the fund's
portfolio. The fund may not write put or covered call options in an amount
exceeding 30% of the value of its total assets. The fund would invest in options
in standard contracts which may be quoted on NASDAQ, or on national securities
exchanges. Currently options are traded on numerous securities and indices
including, without limitation, the Standard and Poor's 100 Index (S&P 100), the
Standard and Poor's 500 Index (S&P 500), and the NYSE Beta Index.
A) In General. Put and call options are generally short-term contracts with
durations of nine months or less. The investment advisor will generally write
covered call options when it anticipates declines in the market value of the
portfolio securities and the premiums received may offset to some extent the
decline in the fund's net asset value. On the other hand, writing put options
is a useful portfolio investment strategy when the fund has cash or other
reserves and it intends to purchase securities but expects prices to decline.
Generally, the risk to the fund in writing options is that the investment
advisor's assumption about the price trend of the underlying security may prove
inaccurate. If, as a result, the fund wrote a put, expecting the price of a
security to increase, and it decreases, or if the fund wrote a call, expecting
the price to decrease but it increased, the fund could suffer a loss if the
premium received in each case did not equal the difference between the exercise
price and the market price.
B) Call Options. The fund may write only call options which are covered, meaning
that the fund either owns the underlying security or has an absolute and
immediate right to acquire that security, without additional cash
consideration, upon conversion or exchange of other securities currently held
in its portfolio. In addition, the fund will not, before the expiration of a
call option, permit the call to become uncovered. If the fund writes a call
option, the purchaser of the option has the right to buy (and the fund has
the obligation to sell) the underlying security at the exercise price
throughout the term of the option. The amount paid to the fund by the
purchaser of the option is the premium. The fund's obligation to deliver the
underlying security against payment of the exercise price would terminate
either upon expiration of the option or earlier if the fund were to effect a
closing purchase transaction through the purchase of an equivalent option on
an exchange. The fund would not be able to effect a closing purchase
transaction after it had received notice of exercise.
In order to write a call option, the fund is required to deposit in escrow the
underlying security or other assets in accordance with the rules of The Options
Clearing Corp. (OCC) and the various exchanges. The fund may not purchase call
options except in connection with a closing purchase transaction. It is possible
that the cost of effecting a closing purchase transaction may be greater than
the premium received by the fund for writing the option.
Generally, the investment advisor (the advisor) intends to write listed covered
calls during periods when it anticipates declines in the market values of
portfolio securities and the premiums received (net of transaction costs) may
offset to some extent the decline in the fund's net asset value occasioned by
such declines in market value. The advisor will generally not write listed
covered call options when it anticipates that the market value of the fund's
portfolio securities will increase.
If the advisor decides that at a price higher than the current value a portfolio
security would be overvalued and should be sold, the fund may write an option on
the security at that price. Should the security subsequently reach that price
and the option be exercised, the fund would, in effect, have increased the
selling price of that security, which it would have sold at that price in any
event, by the amount of the premium. In the event the market price of the
security declined and the option were not exercised, the premium would offset
all or some portion of that decline. It is possible, of
A-4
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
course, that the price of the security could increase beyond the exercise price;
in that event, the fund would forego the opportunity to sell the security at
that higher price.
In addition, call options may be used as part of a different strategy in
connection with sales of portfolio securities. If, in the judgment of the
advisor, the market price of a security is overvalued and it should be sold, the
fund may elect to write a call with an exercise price substantially below the
current market price. So long as the value of the underlying security remains
above the exercise price during the term of the option, the option will be
exercised, and the fund will be required to sell the security at the exercise
price. If the sum of the premium and the exercise price exceeds the market price
of the security at the time the call is written, the fund would, in effect, have
increased the selling price of the security. The fund would not write a call
under these circumstances if the sum of the premium and the exercise price were
less than the current market price of the security.
In summary, a principal reason for writing calls on a securities portfolio is to
attempt to realize, through the receipt of premium income, a greater return than
would be earned on the securities alone. A covered call writer, such as the
fund, which owns the underlying security has, in return for the premium, given
up the opportunity for profit from a price increase in the underlying security
above the exercise price, but has retained the risk of loss should the price of
the security decline. Unlike one who owns securities not subject to a call, the
fund as a call writer may be required to hold such securities until the
expiration of the call option or until the fund engages in a closing purchase
transaction at a price that may be below the prevailing market.
C) Put Options. The fund may also write put options. If the fund writes a put
option, it is obligated to purchase a given security at a specified price at
any time during the term of the option. The rules regarding the writing of
put options are generally comparable to those described above with respect to
call options.
Writing put options is a useful portfolio investment strategy when the fund has
cash or other reserves available for investment as a result of sales of fund
shares or because the advisor believes a more defensive and less fully invested
position is desirable in light of market conditions. If the fund wishes to
invest its cash or reserves in a particular security at a price lower than
current market value, it may write a put option on that security at an exercise
price which reflects the lower price it is willing to pay. The buyer of the put
option generally will not exercise the option unless the market price of the
underlying security declines to a price near or below the exercise price. If the
fund writes a put option, the price of the underlying security declines and the
option is exercised, the premium, net of transaction charges, will reduce the
purchase price paid by the fund for the security. Of course, the price of the
security may continue to decline after exercise of the put options, in which
event the fund would have foregone an opportunity to purchase the security at a
lower price, or the option might never be exercised.
If, before the exercise of a put, the advisor determines that it no longer
wishes to invest in the security on which the put has been written, the fund may
be able to effect a closing purchase transaction on an exchange by purchasing a
put of the same series as the one which it has previously written. The cost of
effecting a closing purchase transaction may be greater than the premium
received on writing the put option, and there is no guarantee that a closing
purchase transaction can be effected. The fund may purchase put options only in
connection with a closing transaction.
As with the writer of a call, a put writer generally hopes to realize premium
income. The risk position of the fund as a put writer is similar to that of a
covered call writer which owns the underlying securities. Like the covered call
writer (who must bear the risk of the position in the underlying security), the
fund as a put writer stands to incur a loss if and to the extent the price of
the underlying security falls below the exercise price plus premium.
At the time a put option is written, the fund will be required to establish, and
will maintain until the put is exercised or has expired, a segregated account
with its custodian consisting of cash or short-term U.S. Government securities
equal in value to the amount which the fund will be obligated to pay upon
exercise of the put. Principal factors affecting the market value of a put or
call option include supply and demand, interest rates, the current market price
and price volatility of the underlying security and the time remaining until the
expiration date. In addition, there is no assurance that the fund will be able
to effect a closing transaction at a favorable price. If the fund cannot enter
into such a transaction, it may be required to hold a security that it might
otherwise have sold, in which case it would continue to be at market risk on the
security. If a substantial number of covered options
A-5
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
written by the fund are exercised, the fund's rate of portfolio turnover could
exceed historic levels. This could result in higher transaction costs, including
brokerage commissions. The fund will pay brokerage commissions in connection
with the writing and purchasing of options to close out previously written
options. Such brokerage commissions are normally higher than those applicable to
purchases and sales of portfolio securities.
FUTURES CONTRACTS AND OPTIONS THEREON
A. Generally, the fund may buy and sell financial futures contracts (futures
contracts) and related options thereon solely for hedging purposes. The fund
may sell a futures contract or purchase a put option on that futures contract
to protect the value of the fund's portfolio in the event the investment
advisor anticipates declining security prices. Similarly, if security prices
are expected to rise, the fund may purchase a futures contract or a call
option thereon. (For certain limited purposes, as explained later, the fund
is also authorized to buy futures contracts on an unleveraged basis and not
as an anticipatory hedge.)
The fund will not invest in futures contracts and options thereon if immediately
thereafter the amount committed to margins plus the amount paid or option
premiums exceeds 5% of the fund's total assets. In addition the fund will not
hedge more than 1/3 of its net assets.
B. Futures contracts. The fund may purchase and sell financial futures contracts
(futures contracts) as a hedge against fluctuations in the value of
securities which are held in the fund's portfolio or which the fund intends
to purchase. The fund will engage in such transactions consistent with the
fund's investment objective. Currently, futures contracts are available on
Treasury bills, notes, and bonds.
There are a number of reasons why entering into futures contracts for hedging
purposes can be beneficial to the fund. First, futures markets may be more
liquid than the corresponding cash markets on the underlying securities. Such
enhanced liquidity results from the standardization of the futures contracts and
the large transaction volumes. Greater liquidity permits a portfolio manager to
effect a desired hedge both more quickly and in greater volume than would be
possible in the cash market. Second, a desired sale and subsequent purchase can
generally be accomplished in the futures market for a fraction of the
transaction costs that might be incurred in the cash market.
The purpose of selling a futures contract is to protect the fund's portfolio
from fluctuation in asset value resulting from stock price changes. Selling a
futures contract has an effect similar to selling a portion of the fund's
portfolio securities. If stock prices were to decline, the value of the fund's
futures contracts would increase, thereby keeping the net asset value of the
fund from declining as much as it otherwise might have. In this way, selling
futures contracts acts as a hedge against the effects of declining stock prices.
However, an increase in the value of portfolio securities tends to be offset by
a decrease in the value of corresponding futures contracts.
Similarly, when stock prices are expected to rise, futures contracts may be
purchased to hedge against anticipated subsequent purchases of portfolio
securities at higher prices. By buying futures, the fund could effectively hedge
against an increase in the price of the securities it intends to purchase at a
later date in order to permit the purchase to be effected in an orderly manner.
At that time, the futures contracts could be liquidated at a profit if stock
prices had increased as expected, and the fund's cash position could be used to
purchase securities.
When a purchase or sale of a futures contract occurs, a deposit of high-quality,
liquid securities called initial margin is made by both buyer and seller with a
custodian for the benefit of the broker. Unlike other types of margin, a futures
margin account does not involve any loan or borrowing but is merely a good faith
deposit that must be maintained in a minimum amount of cash or U.S. Treasury
bills. All futures positions, both long and short, are marked-to-market daily,
with cash payments called variation margin being made by buyers and sellers to
the custodian, and passed through to the sellers and buyers, to reflect daily
changes in the contract values.
Most futures contracts are typically canceled or closed out before the scheduled
settlement date. The closing is accomplished by purchasing (or selling) an
identical futures contract to offset a short (or long) position. Such an
offsetting transaction cancels the contractual obligations established by the
original futures transaction. Other financial futures contracts call for cash
settlements rather than delivery of securities.
If the price of an offsetting futures transaction varies from the price of the
original futures transaction, the hedger will realize a gain or loss
corresponding to the difference. That gain or loss will tend to offset the
unrealized loss or gain on the
A-6
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
hedged securities position, but may not always or completely do so.
The fund will not enter into any futures contract if, immediately thereafter,
the aggregate initial margin for all existing futures contracts and options
thereon and for premiums paid for related options would exceed 5% of the fund's
total assets. The fund will not purchase or sell futures contracts or related
options if immediately thereafter more than 1/3 of its net assets would be
hedged.
C. Risks and limitations involved in futures hedging. There are a number of
risks associated with futures hedging. Changes in the price of a futures
contract generally parallel but do not necessarily equal changes in the
prices of the securities being hedged. The risk of imperfect correlation
increases as the composition of the fund's securities portfolio diverges from
the securities that are the subject of the futures contract. Because the
change in the price of the futures contract may be more or less than the
change in the prices of the underlying securities, even a correct forecast of
stock price changes may not result in a successful hedging transaction.
Another risk is that the investment advisor could be incorrect in its
expectation as to the direction or extent of various market trends or the
time period within which the trends are to take place.
The fund intends to purchase and sell futures contracts only on exchanges where
there appears to be a market in such futures sufficiently active to accommodate
the volume of its trading activity. There can be no assurance that a liquid
market will always exist for any particular contract at any particular time.
Accordingly, there can be no assurance that it will always be possible to close
a futures position when such closing is desired and, in the event of adverse
price movements, the fund would continue to be required to make daily cash
payments of variation margin. However, in the event futures contracts have been
sold to hedge portfolio securities, such securities will not be sold until the
offsetting futures contracts can be executed. Similarly, in the event futures
have been bought to hedge anticipated securities purchases, such purchases will
not be executed until the offsetting futures contracts can be sold.
Successful use of futures contracts by the fund is also subject to the ability
of the investment advisor to predict correctly movements in the direction of
interest rates and other factors affecting markets for securities. For example,
if the fund has hedged against the possibility of an increase in interest rates
that would adversely affect the price of securities in its portfolio and prices
of such securities increase instead, the fund will lose part or all of the
benefit of the increased value of its securities because it will have offsetting
losses in its futures positions. In addition, in such situations, if the fund
has insufficient cash to meet daily variation margin requirements, it may have
to sell securities to meet such requirements. Such sale of securities may be,
but will not necessarily be, at increased prices that reflect the rising market.
The fund may have to sell securities at a time when it is disadvantageous to do
so. Where futures are purchased to hedge against a possible increase in the
price of securities before the fund is able to invest its cash in an orderly
fashion, it is possible that the market may decline instead; if the fund then
concludes not to invest in securities at that time because of concern as to
possible further market decline or for other reasons, the fund will realize a
loss on the futures contract that is not offset by a reduction in the price of
the securities purchased.
The selling of futures contracts by the fund and use of related transactions in
options on futures contracts (discussed later) are subject to position limits,
which are affected by the activities of the investment advisor.
The hours of trading of futures contracts may not conform to the hours during
which the fund may trade equity securities. To the extent that the futures
markets close before the equity securities markets, significant price and rate
movements can take place in the equity securities markets that cannot be
reflected in the futures markets.
Pursuant to Rule 4.5 under the Commodity Exchange Act, investment companies
registered under the 1940 Act are exempted from the definition of commodity pool
operator in the Commodity Exchange Act, subject to compliance with certain
conditions. The exemption is conditioned upon a requirement that all of the
investment company's commodity futures transactions constitute bona fide hedging
transactions (except on an unleveraged basis, as described in E.). With respect
to long positions assumed by the fund, the fund will segregate with its
custodian, an amount of cash and other assets permitted by Commodity Futures
Trading Commission (CFTC) regulations equal to the market value of the futures
contracts and thereby insure that the use of futures contracts is unleveraged.
The fund will use futures in a manner consistent with these requirements.
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D. Options on futures contracts. The fund only intends to engage in options on
futures contracts for bona fide hedging purposes in compliance with CFTC
regulations. An option on a futures contract gives the purchaser the right,
but not the obligation, to assume a position in a futures contract (which
position may be a long or short position) at a specified exercise price at
any time during the option exercise period. The writer of the option is
required upon exercise to assume an offsetting futures position (which
position may be a long or short position). Upon exercise of the option, the
assumption of offsetting futures positions by the writer and holder of the
option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account that represents the amount by which the
market price of the futures contract, at exercise, exceeds, in the case of a
call, or is less than, in the case of a put, the exercise price of the option
on the futures contract.
The holder or writer of an option may terminate its position by selling or
purchasing an option of the same series. There is no guarantee that such closing
transactions can be effected.
The fund will be required to deposit initial and variation margin with respect
to put and call options on futures contracts written by it pursuant to the
fund's futures commissions merchants' requirements similar to those applicable
to the futures contracts themselves, described previously.
E. Risks of futures transactions. The fund's successful use of futures contracts
and options thereon depends upon the ability of its investment advisor to
predict movements in the stock market and other factors affecting markets for
securities and upon the degree of correlation between the prices of the
futures contracts and the prices of the securities being hedged. As a result,
even a correct forecast of stock price changes may not result in a successful
hedging transaction. Although futures contracts and options thereon may limit
the fund's exposure to loss, they may also limit the fund's potential for
capital gains. For example, if the fund has hedged against the possibility of
decrease in stock prices which would adversely affect the price of securities
in its portfolio and prices of such securities increase instead, the fund
will lose part or all of the benefit of the increased value of its securities
because it will have offsetting losses in its futures positions. Although the
fund will enter into futures contracts only where there appears to be a
liquid market, there can be no assurance that such liquidity will always
exist.
F. The fund also is authorized, subject to the limitations set out in the
Prospectus, to purchase futures contracts on an unleveraged basis, when not
intended as an anticipatory hedge. When a contract is purchased on this basis
the investment company establishes a segregated account, composed of cash
and/or cash equivalents, equal to the total value of the contract (less
margin on deposit). As with other futures trading, these purchases must not
be for speculative purposes.
The ability to engage in these purchases on an unleveraged basis can
significantly decrease transaction costs to the funds in certain instances. For
example, if an inordinately large deposit should occur on a single day, the
sheer volume of securities purchases required for that day may place the fund at
a market disadvantage by requiring it to purchase particular securities in such
volume that its own buying activity could cause prices to increase. In addition,
if this deposit had involved `market-timing' and as a result there subsequently
were an oversized withdrawal, the fund could again suffer market disadvantage,
this time because the volume of sales could, for the same reason, force prices
of particular securities to decrease. The fund, by buying a futures contract
(followed by the appropriate closing transaction) instead of purchasing
securities could achieve considerable savings in transaction costs without
departing from fund objectives. Furthermore, as stated in (B.), price changes in
a futures contract generally parallel price changes in the securities that the
fund might otherwise have purchased. Thus, purchase of a futures contract on an
unleveraged basis allows the fund to comply with its objective while at the same
time achieving these lower transaction costs.
LENDING OF PORTFOLIO SECURITIES
As described in the Prospectus, the funds may from time to time lend securities
from their portfolios to brokers, dealers and financial institutions and receive
collateral from the borrower, in the form of cash (which may be invested in
short-term securities), U.S. Government obligations or certificates of deposit.
Such collateral will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities, and will be in the
actual or constructive possession of the particular fund during the term of the
loan. The
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APPENDIX
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fund will maintain the incidents of ownership of the loaned securities and will
continue to be entitled to the interest or dividends payable on the loaned
securities. In addition, the fund will receive interest on the amount of the
loan. The loans will be terminable by the fund at any time and will not be made
to any affiliates of the fund or the advisor. The fund may pay reasonable
finder's fees to persons unaffiliated with it in connection with the arrangement
of the loans.
As with any extensions of credit, there are risks of delay in recovery and, in
some cases, even loss of rights in the collateral or the loaned securities
should the borrower of securities fail financially. However, loans of portfolio
securities will be made to firms deemed by the advisor to be creditworthy.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
The funds may make short-term investments in repurchase agreements. A repurchase
agreement typically involves the purchase by the fund of securities (U.S.
Government or other money market securities) from a financial institution such
as a bank, broker or savings and loan association, coupled with an agreement by
the seller to repurchase the same securities from the fund at the specified
price and at a fixed time in the future, usually not more than seven days from
the date of purchase. The difference between the purchase price to the fund and
the resale price to the seller represents the interest earned by the fund which
is unrelated to the coupon rate or maturity of the purchased security. If the
seller defaults, the fund may incur a loss if the value of the collateral
securing the repurchase agreement declines, or the fund may incur disposition
costs in connection with liquidating the collateral. If bankruptcy proceedings
are commenced with respect to the seller, realization upon the collateral by the
fund may be delayed or limited and a loss may be incurred if the collateral
securing the repurchase agreement declines in value during the bankruptcy
proceedings. The Board of Directors of the fund will evaluate the
creditworthiness of all entities, including banks and broker-dealers, with which
they propose to enter into repurchase agreements. These transactions will be
fully collateralized; and the collateral for each transaction will be in the
actual or constructive possession of the particular fund during the terms of the
transaction, as provided in the agreement.
In a reverse repurchase agreement, the fund involved sells a portfolio security
to another party, such as a bank or broker-dealer, in return for cash and agrees
to repurchase the instrument at a particular price and time. While a reverse
repurchase agreement is outstanding, the fund will maintain cash and appropriate
liquid assets in a segregated custodial account to cover its obligation under
the agreement. The fund will enter into reverse repurchase agreements only with
parties that the advisor or sub-advisor deems creditworthy. Reverse repurchase
agreements and considered to be borrowing transactions, and thus are subject to
the fund's limitation on borrowing. Not every fund is authorized to enter into
reverse repurchase agreements.
CUSTODIAN
All securities, cash and other similar assets of the Bond, Growth and Income,
Managed, Money Market, Social Awareness and Special Opportunities Funds are
currently held in custody by Bankers Trust Co., 14 Wall Street, 4th Floor, New
York, New York 10005. Bankers Trust agreed to act as custodian for each fund
pursuant to a Custodian Agreement dated June 17, 1985 (March 10, 1986 for the
Social Awareness Fund).
All securities, cash and other similar assets of the Aggressive Growth, Capital
Appreciation, Equity-Income, Global Asset Allocation and International Funds are
held in custody by State Street Bank and Trust Co., 225 Franklin Street, Boston,
Massachusetts 02110. State Street agreed to act as custodian for these funds
pursuant to Custodian Contracts effective July 21, 1987 for the Global Asset
Allocation Fund, April 29, 1991 for the International Fund, and December 6, 1993
for the other three funds.
Under these Agreements, the respective custodians shall (1) receive and disburse
money; (2) receive and hold securities; (3) transfer, exchange, or deliver
securities; (4) present for payment coupons and other income items, collect
interest and cash dividends received, hold stock dividends, etc.; (5) cause
escrow and deposit receipts to be executed; (6) register securities; and (7)
deliver to the funds proxies, proxy statements, etc.
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APPENDIX
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INDEPENDENT AUDITORS
Each fund's Board of Directors has engaged Ernst & Young LLP, 2300 Fort Wayne
National Bank Building, Fort Wayne, Indiana 46802, to be the independent
auditors for the fund. In addition to the audit of the 1995 financial statements
of the funds, other services provided include review and consultation connected
with filings of annual reports and registration statements with the Securities
and Exchange Commission (SEC); consultation on financial accounting and
reporting matters; and meetings with the Audit Committee.
FINANCIAL STATEMENTS
The financial statements for the funds are incorporated by reference to the
funds' 1995 Annual Report (see Pages 36-49 for all funds; and Pages 10-11,
Aggressive Growth; and Pages 11-13, Bond Fund; Pages 13-14, Capital Appreciation
Fund; Page 14-18, Equity-Income Fund; Pages 18-24, Global Asset Allocation Fund;
Pages 24-25, Growth and Income Fund; Pages 26-27, International Fund; Pages 27-
31, Managed Fund; Pages 31-32, Money Market Fund; Pages 32-33, Social Awareness
Fund; and Pages 33-35, Special Opportunities Fund). We will provide a copy of
the Annual Report on request and without charge. Please write or call Eric
Jones, Lincoln National Life Insurance Co., P.O. Box 2340, Fort Wayne, Indiana
46801; telephone: 1-800-348-1212, Ext. 6536.
BOND RATINGS
MOODY'S INVESTORS SERVICE, INC.
Aaa -- Bonds which are rated Aaa are judged to be of the best quality and carry
the smallest degree of investment risk. Interest payments are protected by a
large or by an exceptionally stable margin, and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of such
issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa -- Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba -- Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa -- Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca -- Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
STANDARD & POOR'S CORP.
AAA -- This is the highest rating assigned by Standard & Poor's Corp. to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA -- Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong, and in the majority of instances they
differ from AAA issues only in small degree.
A -- Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
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BBB -- Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas these bonds normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest than for
bonds in the A category and higher.
BB-B-CCC-CC -- Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and C the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
COMMERCIAL PAPER RATINGS
MOODY'S INVESTORS SERVICE, INC.
Moody's Commercial Paper ratings are opinions of the ability of issuers to repay
punctually promissory obligations not having an original maturity in excess of
nine months. Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime 1 -- Highest Quality;
Prime 2 -- Higher Quality;
Prime 3 -- High Quality.
(The fund will not invest in commercial paper rated Prime 3).
STANDARD & POOR'S CORP.
A Standard & Poor's Corp. commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. The fund will invest in commercial paper rated in the A Categories, as
follows:
A Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are further refined
with the designation 1, 2, and 3 to indicate the relative degree of
safety. (The fund will not invest in commercial paper rated A-3).
A - 1 This designation indicates that the degree of safety regarding timely
payment is very strong.
A - 2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not overwhelming as for
issues designated A-1.
U.S. GOVERNMENT OBLIGATIONS
Securities issued or guaranteed as to principal and interest by the U.S.
Government include a variety of Treasury securities, which differ only in their
interest rates, maturities and times of issuance. Treasury bills have a maturity
of one year or less. Treasury notes have maturities of one to seven years and
Treasury bonds generally have a maturity of greater than five years.
Various agencies of the U.S. Government issue obligations. Some of these
securities are supported by the full faith and credit of the U.S. Treasury (for
example those issued by Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Government National Mortgage
Association, Maritime Administration, Small Business Administration and The
Tennessee Valley Authority). Obligations of instrumentalities of the U.S.
Government are supported by the right of the issuer to borrow from the Treasury
(for example, those issued by Federal Farm Credit Banks, Federal Home Loan Bank,
Federal Home Loan Mortgage Corp., Federal Intermediate Credit Banks, Federal
Land Bank and the U.S. Postal Service). Obligations supported by the credit of
the instrumentality include securities issued by government sponsored
corporations whose stock is publicly held (for example, the Federal National
Mortgage Association, and the Student Loan Marketing Association).
TAXES
Each fund intends to qualify and has elected to be taxed as a regulated
investment company under certain provisions of the Internal Revenue Code of
1986, as amended (the code). If a fund qualifies as a regulated investment
company and complies with the provisions of the code relieving regulated
investment companies which distribute substantially all of their net income
(both net ordinary income and net capital gain) from Federal income tax, it will
be relieved from such tax on the part of its net ordinary income and net
realized capital gain which it distributes to its shareholders. To qualify for
treatment as a regulated investment company, each fund must, among other things,
derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock or securities or foreign currencies (subject to the
authority of the Secretary
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APPENDIX
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of the Treasury to exclude foreign currency gains which are not directly related
to the fund's principal business of investing in stock or securities or options
and futures with respect to such stock or securities), or other income
(including but not limited to gains from options, futures, or forward contracts)
derived with respect to its investing in such stocks, securities, or currencies.
In addition, to qualify as a regulated investment company each fund must derive
less than 30% of its gross income from the sale or other disposition of
securities held for less than three months. In order to meet these requirements,
a fund may be required to defer disposing of certain futures contracts and
underlying securities beyond the time when it might otherwise be advantageous to
do so. Specifically, these requirements may limit a fund's ability to (a) sell
securities held for less than three months; (b) effect closing transactions on
futures contracts entered into less than three months previously; (c) enter into
futures contracts for a period of less than three months; and (d) enter into
futures contracts on securities held for less than the long-term capital gains
holding period. Further, for purposes of the 30% test, increases (and decreases)
in the value of positions that are part of a designated hedge (as defined in the
code) are netted.
The Federal tax laws impose a 4% nondeductible excise tax on each regulated
investment company with respect to an amount, if any, by which such company does
not meet distribution requirements specified in such tax laws, unless certain
exceptions apply. Each fund intends to comply with such distribution
requirements or qualify under one or more exceptions, and thus does not expect
to incur the 4% nondeductible excise tax.
Since the sole shareholder of each fund will be Lincoln Life, no discussion is
stated herein as to the Federal income tax consequences at the shareholder
level.
The discussion of Federal income tax considerations in the Prospectus, in
conjunction with the foregoing, is a general and abbreviated summary of the
applicable provisions of the code and Treasury Regulations currently in effect
as interpreted by the Courts and the Internal Revenue Service (IRS). These
interpretations can be changed at any time. The above discussion covers only
Federal tax considerations with respect to the fund. State and local taxes vary.
STATE REQUIREMENTS
The California Department of Insurance has established the following guidelines
for an underlying portfolio of a Separate Account. The funds intend to comply
with these guidelines:
BORROWING
The borrowing limits for any variable contract separate account portfolio are
(1) 10% of net asset value when borrowing for any general purpose and (2) 25% of
net asset value when borrowing as a temporary measure to facilitate redemptions.
Net asset value of a portfolio is the market value of all investments or assets
owned less outstanding liabilities of the portfolio at the time that any new or
additional borrowing is undertaken.
FOREIGN INVESTMENTS -- DIVERSIFICATION
The foreign country diversification guidelines to be followed by the funds are
as follows:
1. A portfolio will be invested in a minimum of five different foreign countries
at all times. However, this minimum is reduced to four when foreign country
investments comprise less than 80% of the portfolio's net asset value; to
three when less than 60% of such value; to two when less than 40%; and to one
when less than 20%.
2. Except as set forth in items 3 and 4, a portfolio will have no more than 20%
of its net asset value invested in securities of issuers located in any one
country.
3. A portfolio may have an additional 15% of its value invested in securities of
issuers located in any one of the following countries: Australia, Canada,
France, Japan, the United Kingdom or West Germany.
4. A portfolio's investments in United States issuers are not subject to the
foreign country diversification guidelines.
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DERIVATIVE TRANSACTIONS-DEFINITIONS
The Prospectus for each fund and the uniform Appendix for the Prospectus booklet
discuss the type of derivative transactions in which the funds may engage and
the risks typically associated with many derivative transactions. Here are some
definitions for the derivatives listed in the Appendix:
Option. A contract which gives the fund the right, but not the obligation, to
buy or sell specified securities at a fixed price before or at a designated
future date. If the contract allows the fund to buy securities, it is a call
option; if to sell, it is a put option. It is common practice in options trading
to terminate an outstanding option contract by entering into an offsetting
transaction known as a closing transaction; as a result of which the fund would
either pay out or receive a cash settlement. This is discussed below.
CURRENCY OPTION. Discussed later.
FIXED INCOME OPTION. One based on a fixed-income security, such as a corporate
or government bond.
INDEXED OPTION. One based on the value of an index which measures the
fluctuating value of a basket of pre-selected securities.
STOCK (EQUITY) OPTION. One based on the shares of stock of a particular company.
OPTION ON A FUTURES CONTRACT. Discussed later.
SWAP. A financial transaction in which the fund and another party agree to
exchange streams of payments at periodic intervals under a predetermined set of
occurrences related to the price, level, performance or value of one or more
underlying securities, and pegged to a reference amount known as the notional
amount. A swap is normally used to change the market risk associated with a loan
or bond borrowing from one interest rate base (fixed term or floating rate) or
currency of one denomination to another.
EQUITY SWAP. One which allows the fund to exchange the rate of return (or some
portion of the rate) on its portfolio stocks (an individual share, a basket or
index) for the rate of return on another equity or non-equity investment.
INTEREST RATE SWAP. One in which the fund and another party exchange different
types of interest payment streams, pegged to an underlying notional principal
amount. The three main types of interest rate swaps are coupon swaps (fixed rate
to floating rate in the same currency); basis swaps (one floating rate index to
another floating rate index in the same currency); and cross-currency interest
rate swaps (fixed rate in one currency to floating rate in another).
Related transactions to interest rate swaps:
a. Cap. A contract for which the buyer pays a fee, or premium, to obtain
protection against a rise in a particular interest rate above a certain
level. For example, an interest rate cap may cover a specified principal
amount of a loan over a designated time period, such as a calendar quarter.
If the covered interest rate rises above the rate ceiling, the seller of the
rate cap pays the purchaser an amount of money equal to the average rate
differential times the principal amount times one-quarter.
b. Floor. A contract in which the seller agrees to pay to the purchaser, in
return for the payment of a premium, the difference between current interest
rates and an agreed (strike) rate times the notional amount, should interest
rates fall below the agreed level (the floor). A floor contract has the
effect of a string of interest rate guarantees.
c. Collar. An arrangement to simultaneously purchase a cap and sell a floor, in
order to maintain interest rates within a defined range. The premium income
from the sale of the floor reduces or offsets the cost of buying the cap.
d. Corridor. An agreement to buy a cap at one interest rate and sell a cap at a
higher rate.
SWAPTION. An option to enter into, extend, or cancel a swap.
FUTURES CONTRACT. A contract which commits the fund to buy or sell a specified
amount of a financial instrument at a fixed price on a fixed date in the future.
Futures contracts are normally traded on an exchange and their terms are
standardized, which makes it easier to buy and sell them.
INTEREST RATE FUTURES (AND OPTIONS ON THEM). Futures contracts pegged to U.S.
and foreign fixed-income securities, debt indices and reference rates.
STOCK INDEX FUTURES. Futures contracts based on an index of pre-selected stocks,
with prices based on a composite of the changes to the prices of the individual
securities in the index (e.g., S&P 500).
OPTION ON A FUTURES CONTRACT. An option taken on a futures position.
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FORWARD CONTRACT. An over-the-counter, individually-tailored futures contract.
FORWARD RATE AGREEMENT (FRA). A contract in which the fund and another party
agree on the interest rate to be paid on a notional deposit of specified
maturity at a specific future time. Normally, no exchange of principal is
involved; the difference between the contracted rate and the prevailing rate is
settled in cash.
CURRENCY CONTRACT. A contract entered into for the purpose of reducing or
eliminating an anticipated rise or drop in currency exchange rates over time.
CURRENCY FUTURES. Futures contracts on foreign currencies. Used to hedge the
purchase or sale of foreign securities.
CURRENCY OPTION. An option taken on foreign currency.
CURRENCY SWAP. A swap involving the exchange of cash flows and principal in one
currency for those in another, with an agreement to reverse the principal swap
at a future date.
CROSS-CURRENCY INTEREST RATE SWAP. A swap involving the exchange of streams of
interest rate payments (but not necessarily principal payments) in different
currencies and often on different interest bases (e.g., fixed Deutsche Mark
against floating dollar, but also fixed Deutsche Mark against fixed dollar).
FORWARD CURRENCY CONTRACT. A contract to lock in a currency exchange rate at a
future date, to eliminate risk of currency fluctuation when the time comes to
convert from one currency to another.
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