January 1, 2001
PAUZE FUNDS (TM)
----------------
PAUZE U.S. GOVERNMENT TOTAL RETURN BOND FUND(TM)
SUPPLEMENT TO PROSPECTUS
DATED JUNE 30, 2000
ABOUT THE FUNDS
---------------
The second and third paragraphs of the section titled "Principal
Strategies" on page 1 of the Prospectus are replaced with the following:
The TOTAL RETURN BOND FUND invests exclusively in U.S. government debt
securities and repurchase agreements backed by the U.S. government. U.S.
government debt securities may be issued by the U. S. government, or by an
agency of the U. S. government, and include zero-coupon securities. The
Total Return Bond Fund will limit its investment in zero-coupon securities
to 25% of the Fund's total net assets. The Fund invests in debt securities
of varying maturities, based upon the Fund's advisor's perception of market
conditions, with no stipulated average maturity.
The Fund's advisor seeks high total return by restructuring the
average duration of the Fund's portfolio securities to take advantage of
anticipated changes in interest rates. Under normal circumstances, the
Total Return Bond Fund will maintain an average duration of no more than
ten years. Duration is the time-weighted average of the discounted cash
flows thrown off by the bonds in the Fund's portfolio where each weight is
the actual time that the Fund would have to wait to receive that cash flow.
This Supplement and the Prospectus dated June 30, 2000 provide the
information a prospective investor ought to know before investing and should be
retained for future reference. A Statement of Additional Information has been
filed with the Securities and Exchange Commission dated June 30, 2000, which is
incorporated herein by reference and can be obtained without charge by calling
the Pauze Funds at 1-800-327-7170.
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STATEMENT OF ADDITIONAL INFORMATION
PAUZE FUNDS
PAUZE U.S. GOVERNMENT TOTAL RETURN BOND FUND
PAUZE U.S. GOVERNMENT INTERMEDIATE TERM BOND FUND
PAUZE U.S. GOVERNMENT SHORT TERM BOND FUND
This Statement of Additional Information ("SAI") is not a Prospectus. It
should be read in conjunction with the Prospectus of the Funds dated June 30,
2000. This SAI incorporates by reference the financial statements and
independent auditor's report from the Funds' Annual Report to Shareholders for
the fiscal year ended April 30, 2000 ("Annual Report"). A free copy of the
Prospectus and Annual Report can be obtained by writing the Funds at 14340
Torrey Chase, Suite 170, Houston, TX 77014-1024 or by calling the Funds at (800)
327-7170.
The date of this Statement of Additional Information is January 5, 2001.
TABLE OF CONTENTS
GENERAL INFORMATION ........................................................ 2
INVESTMENT OBJECTIVES AND POLICIES ......................................... 3
PORTFOLIO TURNOVER ......................................................... 8
PORTFOLIO TRANSACTIONS ..................................................... 9
MANAGEMENT OF THE TRUST .................................................... 9
PRINCIPAL HOLDERS OF SECURITIES ............................................ 11
INVESTMENT ADVISORY SERVICES ............................................... 13
ADMINISTRATOR SERVICES ..................................................... 14
TRANSFER AGENCY AND OTHER SERVICES 15
12b-1 PLAN OF DISTRIBUTION ................................................. 15
ADDITIONAL INFORMATION ON REDEMPTIONS 16
CALCULATION OF PERFORMANCE DATA ............................................ 16
TAX STATUS ................................................................. 18
CUSTODIAN .................................................................. 20
INDEPENDENT ACCOUNTANTS .................................................... 20
FINANCIAL STATEMENTS ....................................................... 20
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GENERAL INFORMATION
Pauze Funds (the "Trust") is an open-end management investment company and
is a voluntary association of the type known as a "business trust" organized on
October 15, 1993 under the laws of the Commonwealth of Massachusetts. The Board
of Trustees of the Trust has the power to create additional series, or divide
existing series into two or more classes, at any time, without a vote of
shareholders of the Trust. Each series is authorized to issue four classes of
shares. Each series represents a separate diversified portfolio of securities
(collectively referred to herein as the "Portfolios" or "Funds" and individually
as a "Portfolio" or "Fund").
The assets received by the Trust from the issue or sale of shares of each
Portfolio, and all income, earnings, profits and proceeds thereof, subject only
to the rights of creditors, are allocated to the Portfolio. They constitute the
underlying assets of the Portfolio, are required to be segregated on the books
of accounts, and are to be charged with the expenses with respect to the
Portfolio. In the event additional portfolios are created, any general expenses
of the Trust, not readily identifiable as belonging to the Portfolio, shall be
allocated by or under the direction of the Board of Trustees (the "Trustees") in
such manner as the Trustees determine to be fair and equitable. Shares represent
a proportionate interest in the Portfolio. Shares of each Portfolio have been
divided into classes with respect to which the Trustees have adopted allocation
plans regarding expenses specifically attributable to a particular class of
shares. Subject to such an allocation, all shares are entitled to such dividends
and distributions, out of the income belonging to the Portfolio, as are declared
by the Trustees. Upon liquidation of the Trust, shareholders of the Portfolio
are entitled to share pro rata, adjusted for expenses attributable to a
particular class of shares, in the net assets belonging to the Portfolio
available for distribution.
Under the Trust's Master Trust Agreement, no annual or regular meeting of
shareholders is required; however, the Trustees may call meetings to take action
on matters which require shareholder vote and other matters which Trustees
determine shareholder vote is necessary or desirable. Whether appointed by prior
Trustees or elected by shareholders, an "Independent" Trustee serves as Trustee
of the Trust for a period of six years. However, the Trustees' terms are
staggered so that the terms of at least 25% of the Board of Trustees will expire
every three years. A Trustee whose term is expiring may be re-elected. Thus,
shareholder meetings will ordinarily be held only once every three years unless
otherwise required by the Investment Company Act of 1940 (the "1940 Act").
On any matter submitted to shareholders, the holder of each share is
entitled to one vote per share (with proportionate voting for fractional shares)
irrespective of the relative net asset values of each Portfolio's shares. On
matters affecting an individual Portfolio, a separate vote of shareholders of
the Portfolio is required. On matters affecting an individual class of shares, a
separate vote of shareholders of the class is required.
Shares do not have cumulative voting rights, which means that in situations
in which shareholders elect Trustees, holders of more than 50% of the shares
voting for the election of Trustees can elect 100% of the Trust's Trustees, and
the holders of less than 50% of the shares voting for the election of Trustees
will not be able to elect any person as a Trustee.
Shares are fully paid and non-assessable by the Trust, have no preemptive
or subscription rights and are fully transferable. There are no conversion
rights.
Under Massachusetts law, the shareholders of the Trust could, under certain
circumstances, be held personally liable for the obligations of the Trust.
However, the Master Trust Agreement disclaims shareholder liability for acts or
obligations of the Trust and requires that notice of such disclaimer be given in
each agreement, obligation or instrument entered into or executed by the Trust
or the Trustees. The Master Trust Agreement provides for indemnification out of
the Trust's property for all losses and expenses of any shareholder held
personally liable for the obligations of the Trust. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Trust itself would be unable to meet its
obligations.
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INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of the Funds'
investment objectives and policies in the Funds' Prospectus.
INVESTMENT RESTRICTIONS
A Fund will not change any of the following investment restrictions,
without, in either case, the affirmative vote of a majority of the outstanding
voting securities of the Fund, which, as used herein, means the lesser of (1)
67% of the Fund's outstanding shares present at a meeting at which more than 50%
of the outstanding shares of the Fund are represented either in person or by
proxy, or (2) more than 50% of the Fund's outstanding shares.
The Funds may not:
(1) Issue senior securities.
(2) Borrow money, except that the Fund may borrow not in excess of 33 1/3%
of the total assets of the Fund from banks as a temporary measure for
extraordinary purposes.
(3) Underwrite the securities of other issuers.
(4) Purchase or sell real property (including limited partnership
interests, but excluding readily marketable interests in real estate
investment trusts or readily marketable securities or companies which
invest in real estate).
(5) Engage in the purchase or sale of commodities or commodity contracts;
except that each of the Intermediate Term Fund and the Short Term Fund
may invest in bond futures contracts and options on bond futures
contracts for bona fide hedging purposes.
(6) Lend its assets, except that purchases of debt securities in
furtherance of the Fund's investment objectives will not constitute
lending of assets and except that the Fund may lend portfolio
securities with an aggregate market value of not more than one-third
of the Fund's total net assets.(Accounts receivable for shares
purchased by telephone shall not be deemed loans.)
(7) Purchase any security on margin, except that it may obtain such
short-term credits as are necessary for clearance of securities
transactions. This restriction does not apply to bona fide hedging
activity in the Intermediate Term Fund and Short Term Fund utilizing
financial futures and related options.
(8) Make short sales.
(9) Invest more than 25% of its total assets in securities of companies
principally engaged in any one industry, except that this restriction
does not apply to debt obligations of the United States Government
which are protected by the full faith and credit of the United States
Government.
(10) (a) Invest more than 5% of the value of its total assets in
securities of any one issuer, except such limitation shall not apply
to obligations issued or guaranteed by the United States Government,
its agencies or instrumentalities, or (b) acquire more than 10% of the
voting securities of any one issuer.
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The following investment restrictions may be changed by the Board of
Trustees without a shareholder vote.
The Fund may not:
(11) Invest in warrants to purchase common stock.
(12) Invest in companies for the purpose of exercising control or
management
(13) Hypothecate, pledge, or mortgage any of its assets, except to secure
loans as a temporary measure for extraordinary purposes and except as
may be required to collateralize letters of credit to secure state
surety bonds.
(14) Participate on a joint or joint and several basis in any trading
account.
(15) Invest in any foreign securities.
(16) Invest more than 15% of its total net assets in illiquid securities.
(17) Invest in oil, gas or other mineral leases.
(18) In connection with bona fide hedging activities, invest more than 2.5%
of their assets as initial margin deposits or premiums for futures
contracts and provided that said Funds may enter into futures
contracts and option transactions only to the extent that obligations
under such contracts or transactions represent not more than 100% of a
Fund's assets.
If a percentage restriction is adhered to at the time of investment, a
later increase or decrease in percentage, resulting from a change in values of
portfolio securities or amount of net assets, will not be considered a violation
of any of the foregoing restrictions.
The following discussion of the investment objectives, policies and risks
associated with the Fund supplements the discussion in the prospectus.
ZERO COUPON BONDS
Each Fund may invest in bonds that are "zero coupon" United States
Government securities (which have been stripped of their unmatured interest
coupons and receipts). The Fund will only invest in "zeros" which are issued by
the United States Treasury or United States government agencies, and not those
issued by broker-dealers or banks. The Fund will not invest in Interest Only or
Principal Only ("IOs" or "POs") mortgage-backed securities or derivative
products. Zero coupon securities tend to be more sensitive to changes in
interest rates than other types of United States Government securities. As a
result, a rise or fall in interest rates will have a more significant impact on
the market value of these securities. Although zero coupon securities pay no
interest to holders prior to maturity, interest on these securities is accrued
as income to the Fund and distributed to its shareholders. These distributions
must be made from the Fund's cash assets, or, if necessary, from the proceeds of
sales of portfolio securities.
REPURCHASE AGREEMENTS
Each Fund may invest a portion of its assets in repurchase agreements with
domestic broker-dealers, banks and other financial institutions, provided the
Fund's custodian always has possession of securities serving as collateral or
has evidence of book entry receipt of such securities. In a repurchase
agreement, a fund purchases securities subject to the seller's agreement to
repurchase such securities at a specified time (normally one day) and price. The
repurchase price reflects an agreed-upon interest rate during the time of
investment. All repurchase agreements must be collateralized by
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United States Government or government agency securities, the market values of
which equal or exceed 102% of the principal amount of the repurchase obligation.
If an institution enters insolvency proceedings, the resulting delay in
liquidation of securities serving as collateral could cause the Fund some loss
if the value of the securities declines prior to liquidation. To minimize the
risk of loss, each Fund will enter into repurchase agreements only with
institutions and dealers which are considered creditworthy.
INTERMEDIATE TERM FUND AND SHORT TERM FUND USE OF FUTURES CONTRACTS AND OPTIONS
ON FUTURES CONTRACTS
Futures contracts and options may be used for several reasons: to hedge
securities held to effectively reduce the average weighted maturity; to maintain
cash reserves while remaining fully invested; to facilitate trading; to reduce
transaction costs; or to seek higher investment returns when a futures contract
is priced more attractively than the underlying security or index. Neither Fund
may use futures contracts or options transactions to leverage assets.
The Intermediate Term and Short Term Funds may purchase or sell options on
individual securities, and may enter into trading in options on futures
contracts, may purchase put or call options on futures contracts, and may sell
such options in closing transactions.
The primary risks associated with the use of futures contracts and options
are: (i) imperfect correlation between the change in market value of the U.S.
Government securities held by a Fund and the prices of futures contracts and
options; and (ii) possible lack of a liquid secondary market for a futures
contract and the resulting inability to close a futures position prior to its
maturity date. The risk of imperfect correlation will be minimized by investing
only in those contracts whose price fluctuations are expected to resemble those
of a Fund's underlying securities. The risk that a Fund will be unable to close
out a futures position will be minimized by entering into such transactions on a
national exchange with an active and liquid secondary market.
An option will not be purchased for a Fund if, as a result, the aggregate
initial margins and the premiums paid for all options and futures contracts that
a Fund owns would exceed 2.5% of its net assets at the time of such purchase.
Futures contracts provide for the future sale by one party and purchase by
another party of a specified amount of a specific security at a specified future
time and at a specified price. Futures contracts which are standardized as to
maturity date and underlying financial instrument are traded on national futures
exchanges. Futures exchanges and trading are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a U.S.
Government Agency.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold" or "selling" a contract previously
"purchased") in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin
deposits which may range upward from less than 5% of the value of the contract
being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes, then to the
extent that the margin on deposit does not satisfy margin requirements, payment
of additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
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from the futures broker for as long as the contract remains open. The Funds
expect to earn interest income on their margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators". Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the prices of underlying securities. The Funds intend to use futures contracts
only for bona fide hedging purposes.
Regulations of the CFTC, as applicable to a Fund, require that all of its
futures transactions constitute bona fide hedging transactions. A Fund will only
sell futures contracts to protect securities it owns against price declines or
purchase contracts to protect against an increase in the price of securities it
intends to purchase. As evidence of this hedging interest, it is expected that
approximately 75% of its futures contract purchases will be "completed", that
is, equivalent amounts of related securities will have been purchased or are
being purchased by the Fund upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Fund's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
a Fund will incur commission expenses in both opening and closing out futures
positions, these costs usually are lower than transaction costs incurred in the
purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
A Fund will not enter into futures contract transaction to the extent that,
immediately thereafter, the sum of its initial margin deposits on open contracts
and premiums paid for all options and futures contracts exceed 2.5% of its net
assets at the time of the transaction. In addition, a Fund will not enter into
futures contracts to the extent that its outstanding obligations to purchase
securities under these contracts would exceed 100% of the Fund's total assets.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an Exchange which
provides a secondary market for such futures. However, there can be no assurance
that a liquid secondary market will exist for any particular futures contract at
any specific time. Thus, it may not be possible to close a futures position. In
the event of adverse price movements, the Fund would continue to be required to
make daily cash payments to maintain its required margin. In such situations, if
the Fund has insufficient cash, it may have to sell portfolio securities to meet
daily margin requirements at a time when it may be disadvantageous to do so. In
addition, the Fund may be required to make delivery of the instruments
underlying futures contracts it holds. The inability to close options and
futures positions also could have an adverse impact on the ability to
effectively hedge it.
A Fund will minimize the risk that it will be unable to close out a futures
contract by only entering into futures which are traded on national futures
exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of the Fund are engaged in only for hedging purposes, Pauze Swanson
Capital Management Co., the Funds' Investment Advisor, does not believe that the
Funds are subject to the risks of loss frequently associated with leveraged
futures transactions. The
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Fund would presumably have sustained comparable losses if, instead of the
futures contract, it had invested in the underlying financial instrument and
sold it after the decline.
Utilization of futures transactions by a Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that a Fund could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by a Fund of margin deposits in the event of bankruptcy of a broker
with whom the Fund has an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of future positions and subjecting some futures
traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS
Except for transactions a Fund has identified as hedging transactions, the
Fund is required for Federal income tax purposes to recognize as income for each
taxable year its net unrealized gains and losses on certain futures contracts
held as of the end of the year as well as those actually realized during the
year. In most cases, any gain or loss recognized with respect to a futures
contract is considered to be 60% long-term capital gain or loss and 40%
short-term capital gain or loss, without regard to the holding period of the
contract. Furthermore, sales of futures contracts which are intended to hedge
against a change in the value of securities held by the Fund may affect the
holding period of such securities and, consequently, the nature of the gain or
loss on such securities upon disposition.
In order for a Fund to continue to qualify for Federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income; i.e., dividends, interest,
income derived from loans of securities, gains from the sale of securities or
other income derived with respect to the Fund's business of investment in
securities or currencies. In addition, with respect to tax years commencing
before August 5, 1997, gains realized on the sale or other disposition of
securities held for less than three months must be limited to less than 30% of
the Fund's annual gross income, provided, however, that for purposes of the 30%
test, the Internal Revenue Code of 1986, as amended, provides that losses on
securities underlying an option or a futures contract may be offset against any
gains realized on the disposition of the option or futures contract. It is
anticipated that any net gain realized from the closing out of futures contracts
will be considered gain from the sale of securities and therefore be qualifying
income for purposes of the 90% requirement. It is anticipated that unrealized
gains on futures contracts which have been open for less than three months as of
the end of a Fund's fiscal year and which are recognized for tax purposes will
not be considered gains on sales of securities held less than three months for
the purpose of the 30% test.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including unrealized
gains at the end of the Fund's fiscal year) on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Fund's other investments and shareholders will be advised on the nature of
the transactions.
SEGREGATED ASSETS AND COVERED POSITIONS
When purchasing futures contracts, selling an uncovered call option, or
purchasing securities on a when-issued or delayed delivery basis, the Funds will
restrict cash, which may be invested in repurchase obligations or liquid
securities. When purchasing a stock index futures contract, the amount of
restricted cash or liquid securities, when
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added to the amount deposited with the broker as margin, will be at least equal
to the market value of the futures contract and not less than the market price
at which the futures contract was established. When selling an uncovered call
option, the amount of restricted cash or liquid securities, when added to the
amount deposited with the broker as margin, will be at least equal to the value
of securities underlying the call option and not less than the strike price of
the call option. When purchasing securities on a when-issued or delayed delivery
basis, the amount of restricted cash or liquid securities will be at least equal
to the Fund's when-issued or delayed delivery commitments.
The restricted cash or liquid securities will either be identified as being
restricted in the Fund's accounting records or physically segregated in a
separate account at the Trust's custodian. For the purpose of determining the
adequacy of the liquid securities which have been restricted, the securities
will be valued at market or fair value. If the market or fair value of such
securities declines, additional cash or liquid securities will be restricted on
a daily basis so that the value of the restricted cash or liquid securities,
when added to the amount deposited with the broker as margin, equals the amount
of such commitments by a Fund.
Fund assets need not be segregated if the Fund "covers" the futures
contract or call option sold. For example, the Fund could cover a futures or
forward contract which it has sold short by owning the securities or currency
underlying the contract. The Fund may also cover this position by holding a call
option permitting the Fund to purchase the same futures or forward contract at a
price no higher than the price at which the sell position was established.
A Fund could cover a call option which it has sold by holding the same
security underlying the call option. A Fund may also cover by holding a separate
call option of the same security or stock index with a strike price no higher
than the strike price of the call option sold by the Fund. The Fund could cover
a call option which it has sold on a futures contract by entering into a long
position in the same futures contract at a price no higher than the strike price
of the call option or by owning the securities or currency underlying the
futures contract. The Fund could also cover a call option which it has sold by
holding a separate call option permitting it to purchase the same futures
contract at a price no higher than the strike price of the call option sold by
the Fund.
BORROWING
Each Fund may borrow from a bank up to 33 1/3% of its total assets (reduced
by the amount of all liabilities and indebtedness other than such borrowings) as
a temporary measure for extraordinary purposes. To the extent that a Fund
borrows money, the Fund will be leveraged; at such times, the Fund may
appreciate or depreciate in value more rapidly than its benchmark index. Each
Fund will repay any money borrowed in excess of 33 1/3% of the value of its
total assets prior to purchasing additional portfolio securities.
PORTFOLIO TURNOVER
Pauze Funds' Investment Advisor buys and sells securities for the Fund to
accomplish its investment objectives. The Funds' investment policies may lead to
frequent changes in investments, particularly in periods of rapidly fluctuating
interest rates. The Funds' investments may also be traded to take advantage of
perceived short-term disparities in market values or yields among securities of
comparable quality and maturity.
A change in the securities held by a Fund is known as "portfolio turnover."
Portfolio turnover rates are set forth in the "Financial Highlights" portion of
the prospectus. High portfolio turnover in any given year indicates a
substantial amount of short-term trading, which will result in payment by the
Fund from capital of above-average amounts of markups to dealers and could
result in the payment by shareholders of above-average amounts of taxes on
realized investment gain. Any short-term gain realized on securities will be
taxed to shareholders as ordinary income. See "Tax Status."
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PORTFOLIO TRANSACTIONS
Applicable law requires that the Advisor, in executing portfolio
transactions and selecting brokers or dealers, seek the best overall terms
available. In assessing the terms of a transaction, consideration may be given
to various factors, including the breadth of the market in the security, the
price of the security and the financial condition and execution capability of
the broker or dealer (for a specified transaction and on a continuing basis).
When transactions are executed in the over-the-counter market, it is intended
generally to seek first to deal with the primary market makers. However, the
services of brokers will be utilized if it is anticipated that the best overall
terms can thereby be obtained. Purchases of newly issued securities for the Fund
usually are placed with those dealers from which it appears that the best price
or execution will be obtained. Those dealers may be acting as either agents or
principals.
As all portfolio securities transactions were executed with principals,
none of the Funds paid brokerage fees for the fiscal years ended April 30, 1998
through April 30, 2000.
MANAGEMENT OF THE TRUST
The business and affairs of the Funds are managed by the Trust's Board of
Trustees. The Trustees establish policies, as well as review and approve
contracts and their continuance. The Trustees also elect the officers of the
Trust The Trustees and Officers of the Trust, and their principal occupations
during the past five years are set forth below, along with their business
address, 14340 Torrey Chase Blvd., Houston, Texas 77014.
<TABLE>
<CAPTION>
NAME, ADDRESS & AGE TRUST POSITION PRINCIPAL OCCUPATION
------------------- -------------- --------------------
<S> <C> <C>
Philip C. Pauze ** President and President of Pauze, Swanson & Associates
14340 Torrey Chase Blvd. Trustee Investment Advisors, Inc., d/b/a Pauze
Suite 170 Swanson Capital Management Co., an asset
Houston, Texas 77014 management firm specializing in
Year of Birth: 1941 management of fixed income portfolios since April 1993.
Owner of Philip C. Pauze & Associates, a management
consulting firm since April 1993. Vice President and
Registered Representative with Shearson Lehman Brothers
from 1988 to 1993. Financial Consultant to California
Master Trust since 1986.
Nancy Szidlowski Treasurer, Treasurer and Chief Accounting Officer of Pauze, Swanson
14340 Torrey Chase Chief & Associates Investment Advisors, Inc. since January 2001.
Houston, TX 77014 Accounting Accountant in the mutual fund accounting department at
Year of Birth: 1951 Officer American General Financial Group, an insurance company,
from April 1999 through December 2000. Lead Accountant
of the mutual fund accounting department at Van Kampen
Investments, a mutual fund company, from March 1994
through April 1999.
Patricia S. Dobson** Trustee and Vice President of Pauze, Swanson &
14340 Torrey Chase Secretary Associates Investment Advisors, Inc., since
Houston, TX 77014 1996. Assistant Vice President of Pauze
Year of Birth: 1943 Swanson from 1995 to 1996. Administrator
of Pauze Swanson from 1993 to 1995. Vice President of
Champion Fund Services since March 1999.
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Paul J. Hilbert Trustee Attorney with the firm of Paul J. Hilbert &
2301 FM 1960 West Associates, Houston, Texas, practicing civil Houston, TX
Houston, TX 77068 law since 1975. Legislator, Texas House of
Year of Birth: 1949 Representatives since 1982.
Gordon Anderson Trustee Consultant with the Texas Education
1806 Elk River Rd. Agency, Region 4 Education Service Center,
Houston, TX 77090 School Board and Superintendent
Year of Birth: 1935 Development Program since March 1998. President, RAJ
Development Corporation: investor, developer and home
builder from 1997 to 1998. Retired (July 1997)
Superintendent of Spring Independent School District,
Houston, Texas.
Wayne F. Collins Trustee Retired. From September 1991 to February
32 Autumn Crescent 1994 was Vice President of Worldwide
The Woodlands, TX 77381 Business Planning of the Compaq Computer
Year of Birth: 1941 Corporation. Served Compaq Computer Corporation as Vice
President of Materials Operations from September 1988 to
September 1991; Vice President, Materials and Resources
from April 1985 to September 1991; Vice President,
Corporate Resources from June 1983 to September 1988.
Robert J. Pierce Trustee Richard Pierce Funeral Service since 1967,
1791 #2 Silverado Trail serving in such capacities as President and
Napa, CA 94558 General Manager. In addition, in June 1997,
Year of Birth: 1945 became Vice President (Western Division) and Chief
Operating Officer (Northern California Region) of Stewart
Enterprises, Inc.
</TABLE>
** This Trustee may be deemed an "interested person" of the Trust as
defined in the Investment Company Act of 1940.
Trustee fees are Trust expenses and each portfolio pays a portion of the
Trustee fees. The compensation paid to the Trustees of the Trust for the fiscal
year ended April 30, 2000 is set forth below.
AGGREGATE COMPENSATION
FROM TRUST (THE TRUST IS
NAME NOT IN A FUND COMPLEX) TOTAL COMPENSATION
---- ---------------------- ------------------
Philip C. Pauze $0 $0
Patricia S. Dobson $0 $0
Paul J. Hilbert $12,500 $12,500
Wayne F. Collins $12,500 $12,500
Gordon Anderson $12,500 $12,500
Robert J. Pierce $12,500 $12,500
10
<PAGE>
PRINCIPAL HOLDERS OF SECURITIES
Other than indicated below, as of June 15, 2000, the Officers and Trustees of
the Trust, as a group, owned less than 1% of the outstanding shares of the Pauze
Funds(TM). The Trust is aware of the following persons who owned of record, or
beneficially, more than 5% of the outstanding shares of the Pauze Funds(TM) as
of June 15, 2000:
CLASS NAME & ADDRESS OF OWNER % OWNED TYPE OF OWNERSHIP
----- ----------------------- ------- -----------------
PAUZE U. S. GOVERNMENT TOTAL RETURN BOND FUND
No Load Norwest Bank Minnesota, NA 6.14% Record
FBO: TX Prepaid Funeral Fund N-G
P O Box 1533
Minneapolis, MN 55480
No Load Donaldson Lufkin & Jenrette 6.34% Record
Securities Corp.
P O Box 2052
Jersey City, NJ 07303-9998
No Load Mechanics Bank of Richmond, TTEE 83.91% Record
FBO California Master Trust
3170 Hilltop Mall Road
Richmond, CA 94806
Class B SEI Trust Company 9.79% Record
FBO 601 Banks
One Freedom Valley Dr.
Oaks, PA 19456
Class B Donaldson Lufkin & Jenrette 90.22% Record
Securities Corp.
P O Box 2052
Jersey City, NJ 07303-9998
Class C Comerica Bank Escrow Agent 47.77% Record
FBO MMC Grantor Escrow Account
411 W. Lafayette
Detroit, MI 48226
Class C Comerica Bank Escrow Agent 48.19% Record
FBO MMC Non-Grantor Escrow Account
411 W. Lafayette
Detroit, MI 48226
11
<PAGE>
PAUZE U. S. GOVERNMENT INTERMEDIATE TERM BOND FUND
No Load Donaldson Lufkin & Jenrette 6.61% Record
Securitites Corp.
P O Box 2052
Jersey City, NJ 07303-9998
No Load Norwest Bank Minnesota, NA 14.87% Record
FBO: TX Prepaid Funeral Fund G
P O Box 1533
Minneapolis, MN 55480
No Load Strafe & Co. F/A/O Cooper Agency 17.34% Record
P O Box 160
Westerville, OH 43086-0160
No Load Norwest Bank Minnesota, NA 53.97% Record
FBO: TX Prepaid Funeral Fund N-G
P O Box 1533
Minneapolis, MN 55480
Class B SEI Trust Company 30.67% Record
FBO 601 Banks
One Freedom Valley Drive
Oaks, PA 19456
Class B Donaldson Lufkin & Jenrette 63.56% Record
Securities Corp.
P O Box 2052
Jersey City, NJ 07303
PAUZE U. S. GOVERNMENT SHORT TERM BOND FUND
No Load CFTOC, Nominee
Community First Trust Co, TTEE 5.43% Record
FBO Hamilton Funeral Service Centers
dba Fitzhenry's Funeral Home and
Crematory
P O Box 1410
Ruston, LA 71273
No Load Mechanics Bank of Richmond, TTEE 5.95% Record
FBO California Master Trust
3170 Hilltop Mall Road
Richmond, CA 94806
No Load Strafe & Co. F/A/O Cooper Agency 8.82% Record
P O Box 160
Westerville, OH 43086-0160
12
<PAGE>
No Load Norwest Bank Minnesota, NA 17.09% Record
FBO: TX Prepaid Funeral Fund G
P O Box 1533
Minneapolis, MN 55480
No Load Norwest Bank Minnesota, NA 58.53% Record
FBO: TX Prepaid Funeral Fund N-G
P O Box 1533
Minneapolis, MN 55480
Class B Donaldson Lufkin & Jenrette 100% Record
Securitites Corp.
P O Box 2052
Jersey City, NJ 07303-9998
Class C Comerica Bank Escrow Agent 47.89% Record
FBO MMC Grantor Escrow Account
411 W. Lafayette
Detroit, MI 48226
Class C Comerica Bank Escrow Agent 49.31% Record
FBO MMC Non-Grantor Escrow Account
411 W. Lafayette
Detroit, MI 48226
As of June 15, 2000, as a result of the beneficial ownership described above,
Mechanics Bank of Richmond, TTEE FBO: California Master Trust may be deemed to
control the Total Return Fund (it beneficially owns 81% of the Fund) and Norwest
Bank of Minnesota, NA FBO: TX Prepaid Funeral Fund N-G, may be deemed to control
the Intermediate Term Fund (it beneficially owns 46% of the Fund) and the Short
Term Fund (it beneficially owns 40% of the Fund). Each of these shareholders, as
a result of this ownership, may respectively have the ability to control the
outcome of any proposal submitted for approval to the shareholders of the Fund
the shareholder may be deemed to control, including proposals to change the
Fund's fundamental policies or the terms of the management agreement with the
Fund's investment advisor.
INVESTMENT ADVISORY SERVICES
Pauze, Swanson & Associates Investment Advisors, Inc., dba Pauze Swanson
Capital Management Co., an investment management firm (the "Advisor"), pursuant
to an Advisory Agreement provides investment advisory and management services to
the Trust. It will compensate all personnel, officers and Trustees of the Trust
if such persons are employees of the Advisor or its affiliates.
The Advisory Agreement was approved by the Board of Trustees of the Trust
(including a majority of the "disinterested Trustees") and by vote of a majority
of the outstanding voting securities of the Total Return Fund in May 1996. The
terms of the votes approving the Advisory Agreement provide that it will
continue until October 31, 1997, and from year to year thereafter as long as it
is approved at least annually both (i) by a vote of a majority of the
outstanding voting securities of the Fund (as defined in the Investment Company
Act of 1940 [the "Act"]) or by the Board of Trustees of the Trust, and (ii) by a
vote of a majority of the Trustees who are not parties to the Advisory Agreement
or "interested persons" of any party thereto, cast in person at a meeting called
for the purpose of voting on such approval. The Advisory Agreement may be
terminated on 60 days' written notice by either party and will terminate
automatically if it is assigned. The Advisory Agreement was approved with
respect to the Intermediate Term Fund and the Short Term Fund during March 1996.
13
<PAGE>
The Advisory Agreement with the Trust provides for each Fund to pay the
Advisor an annual management fee equal to a percentage of the Fund's average net
assets (1/12 of the applicable percentage monthly) as follows: Total Return Fund
0.60% on the first $100 million, 0.50% on the next $150 million, 0.45% on the
next $250 million and 0.40% on net assets in excess of $500 million;
Intermediate Term Fund, 0.50%; and Short Term Fund, 0.50%.
For the fiscal years ended April 30, 1998, 1999 and 2000 the Trust, on
behalf of the Total Return Fund, paid the Advisor fees (net of expenses paid by
the Advisor or fee waivers) of $442,281, $414,189 and $356,940, respectively.
For the fiscal years ended April 30, 1998, 1999 and 2000 the Trust, on
behalf of the Intermediate Term Fund, paid the Advisor fees (net of expenses
paid by the Advisor or fee waivers) of $13,686, $38,820 and $33,298,
respectively.
For the fiscal years ended April 30, 1998, 1999 and 2000, the Trust, on
behalf of the Short Term Fund, paid the Advisor fees (net of expenses paid by
the Advisor or fee waivers) of $7,608, $19,205 and $9,169, respectively.
The Trust and the Advisor have each adopted a Code of Ethics under Rule
17j-1 of the Investment Company Act of 1940. The Codes restrict the personal
investing activities of all employees of the Advisor and the Trust. The Code
requires that absent prior approval, no employee shall purchase or sell,
directly or indirectly, any security in which he or she has, or by reason of
such transaction acquires, any direct or indirect beneficial ownership and which
he or she knows or should have known at the time of such purchase or sale that
such security: (a) is being considered for purchase or sale by a Fund; or (b) is
being purchased or sold by a Fund. In addition, employees are prohibited from
buying or selling a security for seven days both before and after he or she
purchases or sells the same security is purchased or sold by a Fund. Employees
are prohibited from acquiring any security in an initial public offering or in a
private placement unless the employee obtains prior approval. The restrictions
and prohibitions apply to most securities transactions by employees of the
Advisor, with limited exceptions for some securities (such as U.S. government
securities and mutual funds).
THE ADMINISTRATOR
Fund Services Inc., ("FSI") dba Champion Fund Services, 14340 Torrey Chase
Blvd., Suite 170 Houston, Texas 77014, under an Administration Agreement with
the Trust dated July 1, 1999, administers the affairs of the Trust. Philip C.
Pauze, President of FSI has been President and a Trustee of the Trust since its
inception in 1993. Fund Services, Inc. assumed responsibilities as Administrator
effective July 1, 1999.
Under the Administration Agreement, the Administrator, subject to the
overall supervision and review of the Board of Trustees of the Trust, FSI
supervises parties providing services to the Trust, provides the Trust with
office space, facilities and business equipment, and provides the services of
executive and clerical personnel for administering the affairs of the Trust.
The Administration Agreement provides for the Trust to pay the
Administrator an annual fee of $145,000, which is allocated among all of the
funds of the Trust pro rata based on their respective net assets. For the period
July 1, 1999 to April 30, 2000, FSI received $119,640 from the Trust for these
services. FSI also provides transfer agency, dividend disbursing and accounting
services to the Funds for which it receives separate compensation.
14
<PAGE>
TRANSFER AGENT AND OTHER SERVICES
FSI, under a Transfer Agency and Shareholder Services Agreement with the
Trust dated July 1, 1999, provides transfer agency, dividend disbursing, and
shareholder services to the Funds. The Transfer Agency Agreement provides for
the Trust to pay FSI an annual base fee of $90,000, plus $18 per open
shareholder account, plus $1 per shareholder account with 12b-1 fees, plus $1
per shareholder account with front end or back end sales charges, and plus $1
per account in non-annual dividend funds.
FSI, under an Accounting Services Agreement with the Trust dated July 1,
1999, also provides accounting services to the Funds. The Accounting Services
Agreement provides for the Trust to pay FSI an annual fee $125,000, plus an
annual asset based base fee of 0.08% on the second $100 million of assets, 0.06%
on the next $300 million, 0.04% on the next $500 million and 0.02% on assets
over $1 billion. For the period July 1, 1999 to April 30, 2000, FSI received
$103,010 from the Trust for these services.
12B-1 PLAN OF DISTRIBUTION
A separate plan of distribution has been adopted under Rule 12b-1 of the
Investment Company Act of 1940 for each Fund, with separate provisions for each
class of shares. Each plan provides that the applicable Fund may engage in any
activity related to the distribution of its shares. These activities may
include, among others: (a) payments to securities dealers and others that are
engaged in the sale of shares, or that may be advising shareholders regarding
the purchase, sale or retention of shares; (b) payments to securities dealers
and others that hold shares for shareholders in omnibus accounts or as
shareholders of record or provide shareholder support or administrative services
to the Fund and its shareholders; (c) expenses of maintaining personnel who
engage in or support distribution of shares or who render shareholders support
services not otherwise provided by the Trust's transfer agent; (d) costs of
preparing, printing and distributing prospectuses and statements of additional
information and reports of the Fund for recipients other than existing
shareholders; and (e) costs of formulating and implementing marketing and
promotional activities. Payments to a securities dealer or other entity
generally will be based on a percentage of the value of Fund shares held by
clients of the entity.
Expenses which the Fund incurs pursuant to the Distribution Plans are
reviewed quarterly by the Board of Trustees. On an annual basis the Distribution
Plans are reviewed by the Board of Trustees as a whole, and the Trustees who are
not "interested persons" as that term is defined in the 1940 Act, and who have
no direct or indirect financial interest in the operation of the Distribution
Plans ("Qualified Trustees"). Any amendment that materially increases the amount
of expenditures permitted under the Distribution Plan must be approved by a
majority of the outstanding voting securities of the applicable class. A
Distribution Plan may be terminated at any time as to any class by vote of a
majority of the Qualified Trustees, or by vote of a majority of the outstanding
voting securities of the applicable class.
The following table provides information regarding the amount and manner in
which amounts paid by the Funds under the previous Distribution Plans were spent
during the fiscal year ended April 30, 2000
TOTAL RETURN INT. TERM SHORT TERM
BOND FUND BOND FUND BOND FUND TOTAL
Advertising, Printing Promotion $ 66,488 $ 7,926 $ 2,109 $ 79,523
Administrative Service Fees $129,631 $ 6,564 $ 2,910 $139,105
Class B Shares Financing $ 12,712 $ 10,239 $ 1,054 $ 24,005
Compensation to Dealers $ 2,674 $ -- $ 1,925 $ 4,599
The Trust expects that the Distribution Plans will be used to pay a
"service fee" to persons who provide personal services to prospective and
existing Fund shareholders and to compensate broker-dealers for sales and
promotional services. Shareholders of the Funds will benefit from these services
and the Trust expects to benefit from economies of scale as more shareholders
are attracted to the Fund.
15
<PAGE>
DISTRIBUTOR
On July 1, 1999, pursuant to the Fund's Distribution Plan, the Trust
entered into a Distribution Agreement with B. C. Ziegler and Company
("Ziegler"), pursuant to which Ziegler has agreed to act as the Trust's agent in
connection with the distribution of Fund shares, including acting as agent in
states where designated agents are required, reviewing and filing all
advertising and promotional materials and monitoring and reporting to the Board
of Trustees on Trust distribution plans. For such services, Ziegler will be paid
a fixed annual fee of $30,000 and will be reimbursed for expenses incurred on
behalf of the Trust. The Advisor is committed to pay all sums, if any, that
exceed the amount allowed under the Fund's 12b-1 Plan.
ADDITIONAL INFORMATION ON REDEMPTIONS
Suspension of Redemption Privileges: the Trust may suspend redemption
privileges or postpone the date of payment for up to seven days, but cannot do
so for more than seven days after the redemption order is received except during
any period (1) when the bond markets are closed, other than customary weekend
and holiday closings, or trading on the Exchange is restricted as determined by
the Securities and Exchange Commission ("SEC"), (2) when an emergency exists, as
defined by the SEC, which makes it not reasonably practicable for the Trust to
dispose of securities owned by it or not reasonably practicable to fairly
determine the value of its assets, or (3) as the SEC may otherwise permit.
CALCULATION OF PERFORMANCE DATA
TOTAL RETURN
A Fund may advertise performance in terms of average annual total return
for 1, 5 and 10 year periods, or for such lesser periods as the Fund has been in
existence. Average annual total return is computed by finding the average annual
compounded rates of return over the periods that would equate the initial amount
invested to the ending redeemable value according to the following formula:
n
P(1 + T) = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (exponential number)
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1, 5 or 10 year periods at the
end of the year or period;
The calculation assumes all charges are deducted from the initial $1,000
payment and assumes all dividends and distributions by the Fund are reinvested
at the price stated in the prospectus on the reinvestment dates during the
period, and includes all recurring fees that are charged to all shareholder
accounts. The calculation assumes the deduction of the maximum contingent sales
charge (for Class B shares). The results do not take into account charges for
optional services which involve nominal fees (such as wire redemption fees).
For the period ended April 30, 2000, the average annual total returns were:
<TABLE>
<CAPTION>
Since
1 Year 3 Year 5 Year Inception
------ ------ ------ ---------
Pauze U. S. Government Total Return Bond Fund
<S> <C> <C> <C> <C>
No Load Shares (Inception 1/10/94) (2.63)% 3.30% 3.72% 2.74%
Class B Shares (Inception 9/3/96) (6.72)% 1.60% n/a 1.63%
Class C Shares (Inception 5/13/98) (3.38)% n/a n/a (4.58)%
16
<PAGE>
Since
1 Year 3 Year 5 Year Inception
------ ------ ------ ---------
Pauze U. S. Government Intermediate Term Bond Fund
No Load Shares (Inception 10/10/96) (0.77)% 2.72% n/a 2.26%
Class B Shares (Inception 9/3/96) (5.25)% 0.91% n/a 0.86%
Pauze U. S. Government Short Term Bond Fund
No Load Shares (Inception 9/3/96) (0.52)% 2.66% n/a 2.52%
Class B Shares (Inception 9/3/96) (5.01)% n/a n/a 0.11%
Class C Shares (Inception 11/7/96) (1.14)% 1.91% n/a 1.62%
</TABLE>
The total returns for the Total Return Fund No-load shares, Class B, and
Class C shares for the Fiscal year ended April 30, 2000 were (2.63)%, (3.41)%
and (3.38)%, respectively.
The total returns for the Intermediate Term Fund No-load shares and Class B
shares for the Fiscal year ended April 30, 2000 were (0.77)% and (1.72)%,
respectively.
The total returns for the Short Term Fund No-load shares, Class B shares,
and Class C shares for the Fiscal year ended April 30, 2000 were (0.52)%,
(1.40)%, and (1.14)%, respectively.
YIELD
A Fund may also advertise performance in terms of a 30 day yield quotation.
A Fund's "yield" refers to the income generated by an investment in the Fund
over a 30-day (or one month) period (which period will be stated in the
advertisement). Yield is computed by dividing the net investment income per
share earned during the most recent calendar month by the maximum offering price
per share on the last day of such month. This income is then "annualized." That
is, the amount of income generated by the investment during that 30-day period
is assumed to be generated each month over a 12-month period and is shown as a
percentage of the investment. For purposes of the yield calculation, interest
income is computed based on the yield to maturity of each debt obligation and
dividend income is computed based upon the stated dividend rate of each security
in the Fund's portfolio and all recurring charges are recognized.
The 30 day yield quotation is computed by dividing the net investment income per
share earned during the period by the maximum offering price per share on the
last day of the period according to the following formula:
(6)
YIELD = 2 [ (A - B + 1) - 1]
-----
CD
Where: A = dividends and interest earned during the period
B = expenses accrued for the period (net of reimbursement)
C = the average daily number of shares outstanding during the
period that were entitled to receive dividends
D = the maximum offering price per share on the last day of the
period
The standard total return and yield results for another class may not take into
account the additional Rule 12b-1 fees for Class B and Class C shares. The
performance of Class B and Class C shares will be lower than that of the other
class of shares. Further, the results for other classes may not take into
account the CDSC for the Class B shares. These fees have the effect of reducing
the actual return realized by shareholders.
The Total Return Fund's 30-day yields for No-load shares, Class B, and
Class C shares for the 30 days ending April 30, 2000 were 4.25%, 3.49%, and
3.49%, respectively.
-------------------
17
<PAGE>
The Intermediate Term Fund's 30-day yields for No-load shares and Class B
shares for the 30 days ending April 30, 2000 were 5.63% and 4.86%, respectively.
The Short Term Fund's 30-day yields for No-load shares, Class B, and Class
C shares for the 30 days ending April 30, 2000 were 4.39%, 3.63%, and 3.63%,
respectively.
NONSTANDARDIZED TOTAL RETURN
A Fund may also advertise performance information (a "non-standardized
quotation") which is calculated differently from "average annual total return."
A non-standardized quotation of total return may be a cumulative return which
measures the percentage change in the value of an account between the beginning
and end of a period, assuming no activity in the account other than reinvestment
of dividends and capital gains distributions. A non-standardized quotation may
also be an average annual compounded rate of return over a specified period,
which may be a period different from those specified for "average annual total
return." In addition, a non-standardized quotation may be an indication of the
value of a $10,000 investment (made on the date of the initial public offering
of a Fund's shares) as of the end of a specified period. These non-standardized
quotations do not include the effect of the applicable sales charge, or charges
for optional services which involve nominal fees, which would reduce the quoted
performance if included. A non-standardized quotation will always be accompanied
by the Fund's "average annual total return" as described above.
A Fund may also include in advertisements data comparing performance with
bond or other indices, or with other mutual funds (as reported in non-related
investment media, published editorial comments and performance rankings compiled
by independent organizations and publications that monitor the performance of
mutual funds). For example, a Fund may compare its performance to rankings
prepared by Lipper Analytical Services, Inc. ("Lipper"), a widely recognized
independent service which monitors the performance of mutual funds, to
Morningstar's Mutual Fund Values, to Moody's Bond Survey Bond Index, or to the
Consumer Price Index. Performance information and rankings as reported in
Changing Times, Business Week, Institutional Investor, the Wall Street Journal,
Mutual Fund Forecaster, No-Load Investor, Money Magazine, Forbes, Fortune and
Barrons magazine may also be used in comparing performance of a Fund.
TAX STATUS
TAXATION OF THE FUNDS -- IN GENERAL
As stated in its prospectus, each Fund intends to qualify as a "regulated
investment company" under Subchapter M of the Internal Revenue Code of 1986, as
amended (the "Code"). Accordingly, each Fund will not be liable for federal
income taxes on its taxable net investment income and capital gain net income
that are distributed to shareholders, provided that the Fund distributes at
least 90% of its net investment income and net short-term capital gain for the
taxable year.
To qualify as a regulated investment company, each Fund must, among other
things, (a) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock, securities or foreign currencies, or other
income derived with respect to its business of investing in such stock,
securities or currencies (the "90% test"); and (b) satisfy certain
diversification requirements at the close of each quarter of the Fund's taxable
year.
The Code imposes a non-deductible 4% excise tax on a regulated investment
company that fails to distribute during each calendar year an amount equal to
the sum of (1) at least 98% of its ordinary income for the calendar year, (2) at
least 98% of its net capital gains for the twelve-month period ending on October
31 of the calendar year and (3) any portion (not taxable to the Fund) of the
respective balance from the preceding calendar year. The Funds intend to make
such distributions as are necessary to avoid imposition of this excise tax.
18
<PAGE>
TAXATION OF THE FUNDS' INVESTMENTS
For federal income tax purposes, debt securities purchased by the Funds may
be treated as having original issue discount. Original issue discount represents
interest for federal income tax purposes and can generally be defined as the
excess of the stated redemption price at maturity of a debt obligation over the
issue price. Original issue discount is treated for federal income tax purposes
as earned by the Fund, whether or not any income is actually received, and
therefore, is subject to the distribution requirements of the Code. Generally,
the amount of original issue discount is determined on the basis of a constant
yield to maturity which takes into account the compounding of accrued interest.
Under Section 1286 of the Code, an investment in a stripped bond or stripped
coupon will result in original issue discount.
Debt securities may be purchased by a Fund at a discount which exceeds the
original issue price plus previously accrued original issue discount remaining
on the securities, if any, at the time the Fund purchases the securities. This
additional discount represents market discount for income tax purposes. In the
case of any debt security issued after July 18, 1984, having a fixed maturity
date of more than one year from the date of issue and having market discount,
the gain realized on disposition will be treated as interest income for purposes
of the 90% test to the extent it does not exceed the accrued market discount on
the security (unless the Fund elects to include such accrued market discount in
income in the tax year to which it is attributable). Generally, market discount
is accrued on a daily basis.
A Fund may be required to capitalize, rather than deduct currently, part or
all of any direct interest expense incurred to purchase or carry any debt
security having market discount unless the Fund makes the election to include
market discount currently. Because a Fund must take into account the original
issue discount for purposes of satisfying various requirements for qualifying as
a regulated investment company under Subchapter M of the Code, it will be more
difficult for the Fund to make the distributions to maintain such status and to
avoid the 4% excise tax described above. To the extent that a Fund holds
zero-coupon or deferred interest bonds in its portfolio or bonds paying interest
in the form of additional debt obligations, the Fund would recognize income
currently even though the Fund received no cash payment of interest, and would
need to raise cash to satisfy the obligations to distribute such income to
shareholders from sales of portfolio securities.
A Fund may purchase debt securities at a premium (i.e., at a purchase price
in excess of face amount). The premium may be amortized if the Fund so elects.
The amortized premium on taxable securities is allowed as a deduction, and, for
securities issued after September 27, 1985, must be amortized under an economic
accrual method.
All Shareholders will be notified annually regarding the tax status of
distributions received from a Fund.
TAXATION OF THE SHAREHOLDER
Taxable distributions generally are included in a shareholder's gross
income for the taxable year in which they are received. However, dividends
declared in October, November or December and made payable to shareholders of
record in such a month will be deemed to have been received on December 31, if a
Fund pays the dividends during the following January. Since none of the net
investment income of the Fund is expected to arise from dividends on domestic
common or preferred stock, none of the Funds' distributions will qualify for the
70% corporate dividends-received deduction.
Distributions by a Fund will result in a reduction in the fair market value
of the Fund's shares. Should a distribution reduce the fair market value below a
shareholder's cost basis, such distribution nevertheless would be taxable to the
shareholder as ordinary income or long-term capital gain, even though, from an
investment standpoint, it may constitute a partial return of capital. In
particular, investors should be careful to consider the tax implications of
buying shares of a Fund just prior to a distribution. The price of such shares
purchased at that time includes the amount of any forthcoming distribution.
Those investors purchasing the Fund's shares just prior to a distribution may
receive a return of investment upon distribution which will nevertheless be
taxable to them.
19
<PAGE>
A shareholder of a Fund should be aware that a redemption of shares
(including any exchange into another Portfolio) is a taxable event and,
accordingly, a capital gain or loss may be recognized. If a shareholder of a
Fund receives a distribution taxable as long-term capital gain with respect to
shares of the Fund and redeems or exchanges shares before he has held them for
more than six months, any loss on the redemption or exchange (not otherwise
disallowed as attributable to an exempt-interest dividend) will be treated as
long-term capital loss to the extent of the long term capital gain recognized.
TAX IDENTIFICATION NUMBER
The Trust is required by Federal law to withhold and remit to the United
States Treasury a portion of the dividends, capital gains distributions and
proceeds of redemptions paid to any shareholder who fails to furnish the Trust
with a correct taxpayer identification number, who underreports dividend or
interest income or who fails to provide certification of tax identification
number. In order to avoid this withholding requirement, you must certify on your
application, or on a separate W-9 Form supplied by the Transfer Agent, that your
taxpayer identification number is correct and that you are not currently subject
to backup withholding or you are exempt from backup withholding. For
individuals, your taxpayer identification number is your social security number.
Instructions to exchange or transfer shares held in established accounts
will be refused until the certification has been provided. In addition, the Fund
assesses a $50 administrative fee if the taxpayer identification number is not
provided by year end.
OTHER TAX CONSIDERATIONS
Distributions to shareholders may be subject to additional state, local and
non-U.S. taxes, depending on each shareholder's particular tax situation.
Shareholders subject to tax in certain states may be exempt from state income
tax on distributions made by the Fund to the extent such distributions are
derived from interest on direct obligations of the United States Government.
Shareholders are advised to consult their own tax advisers with respect to the
particular tax consequences to them of an investment in shares of a Fund.
CUSTODIAN
Firstar Bank, N.A., 425 Walnut Street, Cincinnati, Ohio 45202, is Custodian
of the Funds' investments. The Custodian acts as the Funds' depository, safe
keeps their portfolio securities, collects all income and other payments with
respect thereto, disburse funds at the Funds' request and maintains records in
connection with its duties.
INDEPENDENT ACCOUNTANTS
Tait, Weller & Baker, 8 Penn Center Plaza, Suite 800, Philadelphia, PA
19103, has been selected as independent accountants for the Trust for the fiscal
year ending April 30, 2000. Tait, Weller & Baker performs an annual audit of
each Fund's financial statements and provides financial, tax and accounting
consulting services as requested.
FINANCIAL STATEMENTS
The Trust was established on October 15, 1993 and commenced offering shares
of the Total Return Fund in January 1994. In addition, the Trust commenced
offering Class B and C shares of the Total Return Fund and No-load, Class B and
Class C shares of the Intermediate Term Fund and Short Term Fund in August 1996.
The audited financial statements and auditor's report required to be included in
the Statement of Additional Information are hereby incorporated by reference to
the Funds' Annual Report to Shareholders for the period ended April 30, 2000.
The Funds will provide the Annual Report without charge at written request or
request by telephone.
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