<PAGE>
As filed with the Securities and Exchange Commission on June 1, 1995
1940 Act Registration No. 811-8210
=============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
FORM N-1A
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY [ ]
ACT OF 1940
Amendment No. 2 [x]
(Check appropriate box or boxes)
------------------
STERLING FUNDS
(Exact name of Registrant as Specified in Charter)
120 S. LaSalle Street, Chicago, Illinois 60603
(Address of Principal Executive Office) (Zip Code)
Registrant's Telephone Number, including Area Code: (312) 781-1121
Philip J. Collora With a copy to:
Vice President and Secretary Charles F. Custer
Sterling Funds Vedder, Price, Kaufman & Kammholz
120 South LaSalle Street 222 North LaSalle Street
Chicago, Illinois 60603 Chicago, Illinois 60601
(Name and Address of Agent for Service)
It is proposed that this filing will become effective (check appropriate box)
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
<PAGE>
STERLING FUNDS
PART A: INFORMATION REQUIRED IN A PROSPECTUS
Item 1. Cover Page
Inapplicable.
Item 2. Synopsis
Inapplicable.
Item 3. Condensed Financial Information
Inapplicable.
Item 4. General Description of Registrant
Reference is made to the sections entitled "Summary,"
"Investment Objectives and Policies" and "Organization
of the Funds" in the prospectus filed herewith.
Item 5. Management of the Fund
Reference is made to the sections entitled "Summary"
and "How the Fund is Managed" in the prospectus filed
herewith.
Kemper Corporation, the parent of Kemper Financial
Services, Inc. ("KFS," the investment manager for the
Fund), has entered into an agreement with an investor
group led by Zurich Insurance Company ("Zurich")
pursuant to which Kemper Corporation would be acquired
by the investor group in a merger transaction. As part
of the transaction, Zurich or an affiliate would
purchase KFS. Consummation of the transaction is
subject to a number of contingencies, including
approval by the board and stockholders of Kemper
Corporation and the Zurich board and regulatory
approvals. Because the transaction would constitute an
assignment of the Fund's investment management
agreement with KFS and Rule 12b-1 agreement under the
Investment Company Act of 1940, and therefore a
termination of such agreements, it is anticipated that
KFS would seek approval of new agreements from the
Fund's board and shareholder prior to consummation of
the transaction. The transaction is expected to close
early in the fourth quarter of 1995.
<PAGE>
Item 5A. Management's Discussion Of Fund Performance
Inapplicable.
Item 6. Capital Stock and Other Securities
Reference is made to the sections entitled "Summary,"
"Investment Objectives and Policies," "Dividends and
Taxes," "Buying Shares" and "Organization of the Funds"
in the prospectus filed herewith.
Item 7. Purchase of Securities Being Offered
Reference is made to the sections entitled "Summary,"
"Net Asset Value," "Buying Shares," "How the Funds are
Managed" in the prospectus filed herewith.
Item 8. Redemption or Repurchase
Reference is made to the sections entitled "Summary"
and "Selling Shares" in the prospectus filed herewith.
Item 9. Pending Legal Proceedings
Inapplicable.
PART B: INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL
INFORMATION
Item 10. Cover Page
Reference is made to the Cover Page in the Statement of
Additional Information filed herewith.
Item 11. Table of Contents
Reference is made to the section entitled "Table of
Contents" in the Statement of Additional Information
filed herewith.
Item 12. General Information and History
Inapplicable.
Item 13. Investment Objectives and Policies
Reference is made to the sections entitled "Investment
Restrictions," "Investment Policies and Appendix -
Rating of Techniques" in the Statement of Additional
Information filed herewith. In addition, none of the
Series borrowed as permitted by investment restriction
number four during the latest fiscal year.
<PAGE>
Item 14. Management of the Fund
Reference is made to the sections entitled "Investment
Manager and Distributor" and "Officers and Trustees" in
the Statement of Additional Information filed herewith,
except for the following:
Stephen B. Timbers, a Trustee of the Funds, has been
elected President (31) of the Funds replacing Charles
M. Kierscht. Mr. Timbers (120 S. LaSalle St., Chicago,
Illinois) is Chairman, Chief Executive Officer, Chief
Investment Officer and a Director of Kemper Financial
Services, Inc. ("KFS"); President, Chief Operating
Officer and a Director of Kemper Corporation; and a
Director of Kemper Financial Companies, Inc., ("KFC")
and Kemper Securities, Inc. Mr. Timbers also serves as
a Director of Gillett Holdings, Inc. and LTV
Corporation.
David B. Mathis has been elected a Trustee (28) of the
Fund replacing Charles M. Kierscht who resigned. Mr.
Mathis (Kemper Center, Long Grove, Illinois) is
Chairman, Chief Executive Officer and a Director of
Kemper Corporation; and a Director of KFS and KFC. Mr.
Mathis also serves as a Director of IMC Global Inc.
The number following each person's new title is the
number of investment companies managed by KFS for which
he holds similar positions.
Item 15. Control Persons and Principal Holders of Securities
Reference is made to the section entitled "Officers and
Trustees" in the Statement of Additional Information
filed herewith, and in addition, as of May 31, 1995,
the officers and trustees of the Funds, as a group,
owned less than 1% of the outstanding shares of each
Fund and KFS owned of record all of the outstanding
shares of each Fund.
Item 16. Investment Advisory and Other Services
Reference is made to the section entitled "Investment
Manager and Distributor" in the Statement of Additional
Information filed herewith.
Item 17. Brokerage Allocation and Other Practices
Reference is made to the section entitled "Portfolio
Transactions" in the Statement of Additional
Information filed herewith.
<PAGE>
Item 18. Capital Stock and Other Securities
Reference is made to the sections entitled "Dividends
and Taxes" and "Shareholder Rights" in the Statement of
Additional Information filed herewith.
Item 19. Purchase, Redemption and Pricing of Securities Being
Offered
Reference is made to the section entitled "Purchase and
Redemption of Shares" in the Statement of Additional
Information filed herewith, except that shares are not
currently offered.
Item 20. Tax Status
Reference is made to the section entitled "Dividends
and Taxes" in the Statement of Additional Information
filed herewith.
Item 21. Underwriters
Reference is made to the section entitled "Investment
Manager and Distributor" in the Statement of Additional
Information filed herewith, except that Kemper
Distributors, Inc. is the principal underwriter,
distributor and administrator of Registrant.
Item 22. Calculation of Performance Data
Inapplicable.
Item 23. Financial Statements
Attached.
<PAGE>
PROSPECTUS June 1, 1994
- --------------------------------------------------------------------------------
LOGO
Sterling Funds is an open-end
management investment company
that offers a choice of five
investment portfolios to
investors.
.............................................................................
This prospectus contains EQUITY FUND
information about Sterling
Funds that you should know TOTAL RETURN FUND
before investing and should
be retained for future refer- U.S. GOVERNMENT SECURITIES
ence. A Statement of Addi- FUND
tional Information dated June
1, 1994, has been filed with MUNICIPAL BOND FUND
the Securities and Exchange
Commission and is incorpo- GOVERNMENT MONEY MARKET FUND
rated herein by reference. It
is available upon request THESE SECURITIES HAVE NOT
without charge from Sterling BEEN APPROVED OR DISAPPROVED
Funds at the address or tele- BY THE SECURITIES AND
phone number on this cover or EXCHANGE COMMISSION OR ANY
the firm from which this pro- STATE SECURITIES COMMISSION
spectus was obtained. NOR HAS THE SECURITIES AND
EXCHANGE COMMISSION OR ANY
Sterling Funds' shares are STATE SECURITIES COMMISSION
not guaranteed or endorsed by PASSED UPON THE ACCURACY OR
any bank. They are not depos- ADEQUACY OF THIS PROSPECTUS.
its or obligations of a bank, ANY REPRESENTATION TO THE
nor are they federally CONTRARY IS A CRIMINAL
insured by the Federal OFFENSE.
Deposit Insurance Corpora-
tion, the Federal Reserve
Board or any other agency.
Investment in a Fund's shares
involves risk, including the
possible loss of principal.
An investment in the Govern-
ment Money Market Fund is
neither insured nor guaran-
teed by the U.S. Government.
There can be no assurance
that the Fund will be able to
maintain a stable net asset
value of $1.00 per share.
120 South LaSalle Street
Chicago, Illinois 60603
1-800-508-6360
...................................
<PAGE>
TABLE OF CONTENTS
.............................................
<TABLE>
<S> <C>
Summary..................................................................... 3
Summary of Fund Expenses.................................................... 5
Investment Objectives and Policies.......................................... 6
Buying Shares............................................................... 21
Selling Shares.............................................................. 30
Exchanging Shares........................................................... 34
How the Funds are Managed................................................... 36
Dividends and Taxes......................................................... 41
Net Asset Value............................................................. 44
Fund Performance............................................................ 44
Organization of the Funds................................................... 46
Appendix--Ratings of Fixed Income Investments............................... 47
</TABLE>
Prospectus Page 2
<PAGE>
SUMMARY
.............................................
Investment Objectives and Policies
Sterling Funds currently offer shares of five diversified "Funds" with differ-
ent investment objectives, designed to address various investment goals.
Equity Growth of capital by investing primarily in common stocks.
Fund
Total Return Highest total return, a combination of income and capital
Fund appreciation, consistent with reasonable risk by investing
in stocks, bonds and money market instruments.
U.S. Government Current income, liquidity and security of principal by
Securities Fund investing in obligations issued or guaranteed by the U.S.
Government or its agencies and instrumentalities.
Municipal Bond High level of current income exempt from federal income
Fund taxes by investing primarily in investment grade municipal
securities.
Government Maximum current income consistent with stability of capital
Money Market by investing in short-term U.S. Government securities and
Fund related repurchase agreements.
For more details, see "Investment Objectives and Policies." There can be no
assurance that any Fund will achieve its investment objective and investment
in each Fund includes risks, which vary in kind and degree depending upon the
investment policies of the Fund. The Equity, Total Return and Municipal Funds
may engage in futures and options transactions and, except for the Municipal
Fund, in foreign currency transactions (see "Additional Investment Informa-
tion--Options and Financial Futures Transactions"). The Equity and Total
Return Funds may invest in foreign securities (see "Risk Factors--Foreign
Securities"). The Total Return and Municipal Funds may invest in high yield
(high risk) bonds (see "Risk Factors--High Yield (High Risk) Bonds"). Fund
shares are not insured or guaranteed. Fund returns and net asset value will
fluctuate, although the Money Market Fund seeks to maintain a net asset value
of $1.00 per share.
Prospectus Page 3
<PAGE>
Investment Manager
Kemper Financial Services, Inc. ("KFS") is the investment manager for each
Fund. It is one of the largest investment managers in the country and has been
engaged in the management of investment funds for over forty years. KFS and
its affiliates manage approximately $67 billion in assets. KFS also distrib-
utes the Funds' shares. Administrative services are provided to shareholders
under an administrative services agreement with KFS. Each Fund (except the
Money Market Fund) pays an administrative services fee at the annual rate of
up to .25% of average daily net assets of the Fund, which KFS pays to finan-
cial services firms. Also, KFS pays firms a sponsorship fee from its own
assets. See "How the Funds are Managed."
Minimum Investment
The minimum initial investment required is $1,000 and subsequent investments
must be $100 or more. Lower minimums apply for Individual Retirement Accounts
("IRA") and certain automatic investment plans. See "Buying Shares."
Buying Shares
You can buy shares of a Fund from your financial representative at the public
offering price, which is the net asset value of the Fund next determined after
receipt of your buy order plus, for each Fund except the Money Market Fund, a
sales charge. See "Buying Shares." Currently, Sterling Funds offer a single
class of shares of each Fund (Class A Shares). Additional classes may be
available in the future. See "Organization of the Funds."
Selling Shares
You can sell shares at any time at the net asset value next determined after
receipt of your sell order. The redemption within one year of shares purchased
at net asset value under the Large Order Purchase Privilege may be subject to
a 1% contingent deferred sales charge. See "Selling Shares."
If You Have Questions
If you have questions, contact your financial representative or the Share-
holder Service Agent at 1-800-508-6360 or P.O. Box 419077, Kansas City, Mis-
souri 64141-6077.
Prospectus Page 4
<PAGE>
SUMMARY OF FUND EXPENSES
.............................................
Shareholder Transaction Expenses(/1/)
<TABLE>
<CAPTION>
EQUITY AND GOVERNMENT MONEY
TOTAL RETURN AND MUNICIPAL MARKET
A SHARES A SHARES A SHARES
------------ ------------- --------
<S> <C> <C> <C>
Maximum Sales Charge on Purchases (as a
percentage of offering price)............. 5.75% 4.50% None
Maximum Sales Charge on Reinvested
Dividends................................. None None None
Deferred Sales Charge...................... None(/2/) None(/2/) None
Redemption Fees............................ None None None
Exchange Fee............................... None None None
</TABLE>
Annual Fund Operating Expenses
(as a percentage of average net assets)
<TABLE>
<CAPTION>
CLASS A SHARES
--------------------------------------
TOTAL GOVERN- MONEY
EQUITY RETURN MENT MUNICIPAL MARKET
------ ------ ------- --------- ------
<S> <C> <C> <C> <C> <C>
Management Fees......................... .80% .80% .65% .65% .50%
12b-1 Fees.............................. None None None None None
Other Expenses (after expense reimburse-
ment).................................. .70% .70% .35% .35% .30%
----- ----- ----- ----- ----
Total Operating Expenses................ 1.50% 1.50% 1.00% 1.00% .80%
</TABLE>
- ----------
(1) Investment dealers and other firms may independently charge additional
fees for shareholder transactions or for advisory services; please see
their materials for details.
(2) Redemption of shares purchased under the Large Order Purchase Privilege
within one year may be subject to a 1% contingent deferred sales charge.
(See "Buying Shares".)
Example
<TABLE>
<CAPTION>
FUND 1 YEAR 3 YEARS
---- ------ -------
<S> <C> <C> <C>
You would pay the following Equity $72 $102
expenses on a $1,000 investment, Total Return $72 $102
assuming a 5% annual return and Government $55 $ 75
redemption at the end of each Municipal $55 $ 75
time period......................................... Money Market $ 8 $ 26
</TABLE>
The table above is to assist you in understanding the costs and expenses that
an investor in a Fund will bear directly or indirectly.
Prospectus Page 5
<PAGE>
"Other Expenses" includes the effect of the administrative services fee
("ASF") of .25% for the Funds except for the Money Market Fund which currently
does not pay an ASF. As described under "How the Fund is Managed," the Board
of Trustees may implement an ASF of up to .25% of the average daily net assets
of the Money Market Fund and shareholders would be so notified.
Since all the Funds have been operating for less than a year, "Other Expenses"
is an estimate for the current fiscal year. "Other Expenses" for the Govern-
ment, Municipal and Money Market Funds also shows the partial temporary
absorption of operating expenses by KFS. Without this expense absorption,
"Other Expenses" and "Total Operating Expenses" are estimated to be .60% and
1.25% for both the Government and Municipal Funds and .35% and .85% for the
Money Market Fund. In addition, KFS will temporarily absorb additional
expenses for the Government and Municipal Funds.
The 5% rate of return is an illustration that is required by the Securities
and Exchange Commission ("SEC"). The Example should not be considered a repre-
sentation of past or future performance or expenses. Actual expenses may be
greater or lesser than those shown.
INVESTMENT OBJECTIVES & POLICIES
.............................................
We offer five diversified Funds with different objectives. Of course, no
mutual fund offered by us or anyone else can guarantee that its objective will
be met or that you will reach your goals. A Fund's return and net asset value
will fluctuate, although the Money Market Fund seeks to maintain a stable net
asset value.
Equity Fund
The Equity Fund seeks growth of capital. The Fund will invest primarily in
common stocks that the investment manager believes offer the potential for
above-average growth prospects. The Fund will invest at least 65% of its total
assets in equity securities under normal circumstances. Equity securities
include common stocks, preferred stocks, securities convertible into or
exchangeable for common or preferred stock, equity investments in partner-
ships, joint ventures and other forms of non-corporate investment and warrants
and rights exercisable for equity securities. The investment manager will con-
sider several factors when making investments
Prospectus Page 6
<PAGE>
including patterns of increasing growth in sales and earnings, the development
of new or improved products or services, favorable outlooks for industry
growth, the probability of increased operating efficiencies, emphasis on
research and development, cyclical conditions, or other signs that a company
is expected to show greater than average capital appreciation and earnings
growth.
The Fund may also engage in options and financial futures transactions, pur-
chase foreign securities, engage in related foreign currency transactions and
lend its portfolio securities. See "Risk Factors--Foreign Securities" and "Ad-
ditional Investment Information" below. For defensive purposes, the Fund may
temporarily hold a significant portion of its assets in cash or defensive type
securities, such as liquid high grade debt securities, high quality money mar-
ket instruments and repurchase agreements.
Investment for long-term capital growth will be emphasized. The Fund does not
intend to engage actively in trading for short-term profits, although invest-
ments occasionally may be made for short-term capital growth when such action
is believed by the investment manager to be desirable and consistent with
sound investment practice.
Total Return Fund
The Total Return Fund seeks the highest total return, a combination of income
and capital appreciation, consistent with reasonable risk. The Fund will nor-
mally invest in equity and fixed income securities. The percentage of assets
invested in equity and fixed income securities will vary from time to time
depending upon the investment manager's judgment as to general market and eco-
nomic conditions and trends. Fixed income securities include bonds, money mar-
ket instruments and other debt securities. The Fund may also engage in options
and financial futures transactions, purchase foreign securities, engage in
related currency transactions and lend its portfolio securities. See "Risk
Factors--Foreign Securities" and "Additional Investment Information" below.
The Fund may invest in high yield fixed income securities that are in the
lower rating categories and those that are non-rated (sometimes called "junk
bonds"). Investments in lower-rated or non-rated securities are considered
predominantly speculative and entail greater risk of loss of income and prin-
cipal than investments in higher rated securities, although they generally
provide greater income and opportunity for gain.
Prospectus Page 7
<PAGE>
The Fund may invest up to 35% of its net assets in high yield (high risk)
bonds. For a discussion of lower rated and non-rated securities and related
risks, see "Risk Factors--High Yield (High Risk) Bonds" below.
The Fund does not invest for short-term profits, but it is not restricted as
to portfolio turnover and will change its investment portfolio, from time to
time, as business and economic conditions and market prices may dictate and as
its investment policy may require.
U.S. Government Securities Fund
The U.S. Government Securities Fund ("Government Fund") seeks current income,
liquidity and security of principal. As a fundamental investment policy, the
Fund invests exclusively in obligations issued or guaranteed by the U.S. Gov-
ernment or its agencies and instrumentalities, and by engaging in repurchase
agreements and delayed delivery transactions. The Fund intends to invest some
or all of its assets in Government National Mortgage Association ("GNMA") Cer-
tificates of the modified pass-through type. These GNMA Certificates are debt
securities issued by a mortgage banker or other mortgagee and represent an
interest in a pool of mortgages insured by the Federal Housing Administration
or guaranteed by the Veterans Administration. GNMA guarantees the timely pay-
ment of monthly installments of principal and interest on modified pass-
through Certificates at the time such payments are due, whether or not such
amounts are collected by the issuer of the Certificates on the underlying
mortgages. The Fund does not plan on investing in GNMA Certificates of the
straight pass-through type where the payment of principal and interest on a
timely basis is not guaranteed.
The balance of the Fund's assets, other than those invested in GNMA Certifi-
cates, will be invested in obligations issued or guaranteed by the United
States or by its agencies. There are two broad categories of U.S. Government-
related debt instruments:
. direct obligations of the U.S. Treasury; and
. securities issued or guaranteed by U.S. Government agencies and instru-
mentalities.
Examples of direct obligations of the U.S. Treasury are U.S. Treasury bills,
notes, bonds and other debt securities issued by the U.S. Treasury. These
instruments are backed by the "full faith and credit" of the United States.
Some obligations issued or guaranteed by agencies of the
Prospectus Page 8
<PAGE>
U.S. Government are backed by the full faith and credit of the United States
and others are backed only by the rights of the issuer to borrow from the U.S.
Treasury. With respect to securities supported only by the credit of the issu-
ing agency or by an additional line of credit with the U.S. Treasury, there is
no guarantee that the U.S. Government will provide support to such agencies
and such securities may involve risk of loss of principal and interest. U.S.
Government securities may include "zero coupon" securities that have been
stripped by the U.S. Government of their unmatured interest coupons (see "In-
vestment Policies--Zero Coupon Government Securities" in the Statement of
Additional Information for a discussion of their features and risks) and col-
lateralized obligations issued or guaranteed by a U.S. Government agency or
instrumentality (see "Additional Investment Information--Collateralized Obli-
gations").
U.S. Government securities of the type in which the Fund may invest have his-
torically involved little risk of loss of principal if held to maturity. The
government guarantee of the U.S. Government securities in the Fund's portfo-
lio, however, does not guarantee the net asset value of the shares of the
Fund. There are market risks inherent in all investments in securities and the
value of an investment in the Fund will fluctuate over time. Normally, the
value of the Fund's investments varies inversely with changes in interest
rates. In addition, the potential for appreciation in the event of a decline
in interest rates may be limited or negated by increased principal prepayments
in respect to certain mortgage-backed securities, such as GNMA Certificates.
Prepayments of high interest rate mortgage-backed securities during times of
declining interest rates will tend to lower the return of the Fund and may
even result in losses to the Fund if some securities were acquired at a premi-
um. With respect to U.S. Government securities supported only by the credit of
the issuing agency or by an additional line of credit with the U.S. Treasury,
there is no guarantee that the U.S. Government will provide support to such
agencies and such securities may involve risk of loss of principal and inter-
est.
The Fund will not normally engage in the trading of securities for the purpose
of realizing short-term profits, but will adjust its portfolio as considered
advisable in view of prevailing or anticipated market conditions and its
investment objective.
Prospectus Page 9
<PAGE>
Municipal Bond Fund
The objective of the Municipal Bond Fund ("Municipal Fund") is to provide a
high level of current income exempt from federal income taxes. The Fund
invests primarily in debt obligations issued by or on behalf of states, terri-
tories and possessions of the United States and the District of Columbia and
their political subdivisions, agencies and instrumentalities, the income from
which is exempt from federal income taxes ("Municipal Securities").
Under normal conditions, as a fundamental investment policy, the Fund will
maintain at least 80% of its investments in Municipal Securities. As indicated
under "Dividends and Taxes," the Fund may invest in "private activity bonds".
Under normal circumstances, the Fund currently does not consider private
activity bonds to be Municipal Securities for purposes of the 80% limitation.
The Fund's investments will consist of:
. Municipal Securities;
. temporary investments in high grade taxable fixed income instruments,
including repurchase agreements;
. financial futures contracts and options (which may produce taxable gains)
as described under "Additional Investment Information"; and
. cash.
All Municipal Securities will, as a fundamental investment policy, be rated at
the time of purchase within the four highest grades assigned by Moody's
Investors Service, Inc., Standard & Poor's Corporation, Fitch Investors Serv-
ice, Inc. or Duff & Phelps Credit Rating Co. or any other Nationally Recog-
nized Statistical Rating Organization ("NRSRO") as designated by the SEC,
provided that up to 10% of the net assets of the Fund may be invested in
Municipal Securities that are lower-rated or non-rated (sometimes called "junk
bonds").
Municipal Securities rated within the four highest grades by these rating
services are generally considered to be "investment grade." Like higher-rated
securities, securities rated in the fourth category by a rating agency are
considered to have adequate capacity to pay principal and interest, although
they may have fewer protective provisions than higher-rated securities and
thus may be adversely affected by severe economic circumstances and are con-
sidered to have speculative characteristics.
Prospectus Page 10
<PAGE>
The Fund may invest in the entire range of maturities of Municipal Securities
and may adjust the average maturity of its investments from time to time,
depending upon the investment manager's assessment of the relative yields
available on securities of different maturities and its expectations of future
changes in interest rates. However, it is anticipated that, under normal mar-
ket conditions, the Fund will invest primarily in long-term Municipal Securi-
ties (generally, maturities of ten years or more).
The Fund will not normally trade securities to realize short-term profits, but
will adjust its portfolio for prevailing or anticipated market conditions and
the Fund's investment objective.
There are market and investment risks with any security and the value of an
investment in the Fund will fluctuate over time. Normally, the value of the
Fund's investments varies inversely with changes in interest rates. In addi-
tion, the prices of long-term Municipal Securities tend to vary with interest
rate changes more than the prices of shorter-term Municipal Securities.
Government Money Market Fund
The Government Money Market Fund ("Money Market Fund") seeks maximum current
income consistent with stability of capital. As a fundamental investment poli-
cy, the Fund pursues its objective by investing exclusively in U.S. Treasury
bills, notes, bonds and other obligations issued or guaranteed by the U.S.
Government, its agencies and instrumentalities and repurchase agreements of
such obligations. All securities purchased mature in 397 days or less. Please
see "U.S. Government Securities Fund" for a discussion of the types of U.S.
Government securities. Short-term U.S. Government obligations generally are
considered to be the safest short-term investment. The government guarantee of
the securities owned by the Fund does not guarantee the net asset value of its
shares, which the Fund seeks to maintain at $1.00 per share. See "Net Asset
Value."
The Fund may invest in instruments having rates of interest that are adjusted
periodically or that "float" continuously according to formulae intended to
minimize fluctuation in values of the instruments ("Variable Rate Securi-
ties"). Generally, the changes in the interest rate on Variable Rate Securi-
ties reduce the fluctuation in the market value of such securities.
Accordingly, as interest rates decrease or increase, the potential for capital
appreciation or depreciation is less than for fixed rate obligations.
Prospectus Page 11
<PAGE>
Some Variable Rate Securities ("Variable Rate Demand Securities") have a
demand feature entitling the purchaser to resell the securities at an amount
approximately equal to amortized cost or the principal amount thereof plus
accrued interest. As is the case for other Variable Rate Securities, the
interest rate on Variable Rate Demand Securities varies according to some
objective standard intended to minimize fluctuation in the values of the
instruments. The Fund determines the maturity of Variable Rate Securities in
accordance with SEC rules that allow the Fund to consider certain of such
instruments as having maturities shorter than the maturity date on the face of
the instrument.
Risk Factors--Foreign Securities
Although the Equity and Total Return Funds will invest primarily in securities
that are publicly traded in the United States, such Funds can invest some of
their assets in foreign securities that are traded principally in securities
markets outside the United States. These Funds currently limit investment in
these foreign securities to less than 10% of their total assets. These Funds
may also invest in U.S. Dollar-denominated American Depository Receipts
("ADRs"), which are bought and sold in the United States and are not subject
to the 10% limitation. Foreign securities present certain risks in addition to
those presented by domestic securities, such as risks associated with currency
fluctuations, possible foreign governmental regulations or taxes adversely
affecting portfolio securities and generally different degrees of liquidity,
market volatility and availability of information. However, each Fund intends
to invest in foreign securities only when the potential benefits to it are
deemed by the investment manager to outweigh those risks. The Funds may make
investments in developing countries that are in the initial stages of their
industrialization cycle. In the past, markets of developing countries have
been more volatile than the markets of developed countries; however such mar-
kets often have provided higher rates of return to investors. Investments in
foreign securities may include securities issued by enterprises that have
undergone or are currently undergoing privatization. In connection with their
foreign securities investments, the Funds may, to a limited extent, engage in
foreign currency exchange options and futures transactions as a hedge and not
for speculation. See "Additional Investment Information--Options and Financial
Futures Transactions." The Government, Municipal and Money Market Funds do not
invest in foreign securities. Additional information concerning foreign secu-
rities and related techniques is contained under "Investment Policies" in the
Statement of Additional Information.
Prospectus Page 12
<PAGE>
Risk Factors--High Yield (High Risk) Bonds
As stated above, the Total Return and Municipal Funds may invest a portion of
their assets in fixed income securities that are in the lower rating catego-
ries (securities rated below investment grade) of recognized rating agencies
or are non-rated. These investments will be based on the investment manager's
analysis without reliance on published ratings. These Funds will invest in a
particular security if in the view of the investment manager the increased
yield offered, regardless of published ratings, is sufficient to compensate
for a reasonable element of assumed risk. Since investments will be based upon
the manager's analysis rather than upon published ratings, achievement of the
Funds' goals may depend more upon the abilities of the investment manager than
would otherwise be the case.
The investment manager conducts extensive credit research on these securities
before and after purchasing them. However, these lower-rated and non-rated
fixed income securities are considered, on balance, to be predominantly specu-
lative as to the issuer's capacity to pay interest and repay principal and
generally will involve more credit risk than securities in the higher rating
categories. Lower-rated and non-rated securities, which are sometimes referred
to by the popular press as "junk bonds," have widely varying characteristics
and quality. The market values of such securities tend to reflect individual
issuer developments to a greater extent than do those of higher rated securi-
ties, which react primarily to fluctuations in the general level of interest
rates. Lower rated securities are more sensitive to economic conditions than
higher rated securities. Adverse publicity and investor perceptions regarding
lower-rated bonds, whether or not based upon fundamental analysis, may depress
the prices for such securities. These and other factors adversely affecting
the market value of high yield (high risk) securities will adversely affect a
Fund's net asset value. A Fund may have difficulty disposing of certain high
yield (high risk) securities because they may have a thin trading market. The
lack of a liquid secondary market may have an adverse effect on market price
and a Fund's ability to dispose of particular issues and may also make it more
difficult for the Fund to obtain accurate market quotations for purposes of
valuing these assets. Additional information concerning high yield (high risk)
securities appears under "Investment Policies--Other Considerations--High
Yield (High Risk) Bonds" in the Statement of Additional Information and "Ap-
pendix--Ratings of Fixed Income Investments."
Prospectus Page 13
<PAGE>
Additional Investment Information
Portfolio Turnover The Funds' portfolio turnover rates are not expected to
exceed the following amounts: Equity Fund (200%), Total Return Fund (200%),
Government Fund (500%) and Municipal Fund (100%). Since securities with matu-
rities of less than one year are excluded from portfolio turnover calcula-
tions, the portfolio turnover rate for the Money Market Fund will be zero.
Certain Funds may experience relatively high turnover rates (over 100%).
Higher portfolio turnover involves greater brokerage commissions or other
transaction costs and may result in the realization of greater net short-term
capital gains. Frequency of a Fund's portfolio turnover will not be a limiting
factor should the investment manager deem it desirable to purchase or sell
securities. The anticipated level of portfolio turnover for the Government
Fund is due primarily to the Fund's engaging in GNMA roll transactions. GNMA
securities may be purchased on a forward basis and the contracts may be
"rolled" to a new maturity before they settle when this is deemed beneficial
from a yield standpoint. Although this increases portfolio turnover from an
accounting standpoint, the effect upon expenses is insignificant. To qualify
as a regulated investment company for federal income tax purposes, less than
30% of the gross income of a Fund must be derived from the sale or other dis-
position of securities and certain other investments held by a Fund for less
than three months. See "Dividends and Taxes" in the Statement of Additional
Information.
Investment Restrictions Except as noted below, each Fund has adopted certain
investment restrictions that are described in the Statement of
Additional Information and which, together with the investment objective and
policies of a Fund designated as fundamental, cannot be changed without the
approval of the holders of a majority of its shares. As defined in the Invest-
ment Company Act of 1940 ("1940 Act"), this means the lesser of the vote of
(a) 67% of the shares of a Fund at a meeting where more than 50% of the out-
standing shares are present in person or by proxy; or (b) more than 50% of the
outstanding shares of a Fund. Policies of the Funds that are neither desig-
nated as fundamental nor incorporated into any of the investment restrictions
referred to above are not fundamental and may be changed by the Board of
Trustees without shareholder approval.
Borrowing A Fund may not borrow money except as a temporary measure for
extraordinary or emergency purposes, and then only in an
Prospectus Page 14
<PAGE>
amount up to one-third of the value of its total assets, to meet redemption
requests without immediately selling any portfolio securities. A Fund will not
borrow for leverage purposes and will not purchase securities while borrowings
exceed 5% of total assets. Any such borrowings under this provision will not
be collateralized.
Illiquid Securities A Fund will not buy illiquid securities, including repur-
chase agreements maturing in more than seven days, if more than 15% (10% for
the Government and Money Market Funds) of the Fund's net assets, valued at the
time of the transaction, would be invested in such securities. See "Investment
Policies--Over-the-Counter Options" in the Statement of Additional Information
for a description of the extent to which over-the-counter traded options are
considered illiquid for purposes of the limit on illiquid securities.
Options and Financial Futures Transactions The Equity, Total Return and Munic-
ipal Funds may deal in options on securities, securities indexes and, except
for the Municipal Fund, foreign currencies, which options may be listed for
trading on a national securities exchange or traded over-the-counter. The
Equity, Total Return and Municipal Funds may each write (sell) covered call
and secured put options on up to 25% of net assets and may purchase put and
call options provided that no more than 5% of its net assets may be invested
in premiums (cost of option) on such options. A Fund will not enter into any
futures contracts or options on futures contracts if the aggregate of the con-
tract value of the outstanding futures contracts of the Fund and futures con-
tracts subject to outstanding options written by the Fund would exceed 50% of
the total assets of the Fund. The Government and Money Market Funds may not
engage in options transactions. The ability to engage in options transactions
enables a Fund to pursue its investment objective and also to hedge against
market risks but is not intended for speculation.
A call option gives the purchaser the right to buy, and the writer the obliga-
tion to sell, the underlying security or other asset at the exercise
price during the option period. A put option gives the purchaser the right to
sell, and the writer the obligation to buy, the underlying security or other
asset at the exercise price during the option period. The writer of a covered
call option owns securities that are acceptable for escrow and the writer of a
secured put option invests an amount not less than the exercise price in eli-
gible securities to the extent that it is obligated as
Prospectus Page 15
<PAGE>
a writer. If a call written by a Fund is exercised, the Fund forgoes any possi-
ble profit from an increase in the market price of the underlying security or
other asset over the exercise price plus the premium received. In writing puts,
there is a risk that a Fund may be required to take delivery of the underlying
security or other asset at a disadvantageous price.
Over-the-counter options ("OTC options") differ from exchange traded options in
several respects. They are transacted directly with dealers and not with a
clearing corporation, and there is a risk of non-performance by the dealer, in
which event the Fund may experience material losses. However, in writing
options the premium is paid in advance by the dealer. OTC options are available
for a greater variety of securities, and a wider range of expiration dates and
exercise prices, than for exchange traded options.
A Fund may engage in financial futures transactions. Financial futures con-
tracts are commodity contracts that obligate the long or short holder to take
or make delivery of a specified quantity of a financial instrument, such as a
security, or the cash value of a securities index during a specified future
period at a specified price. A Fund will "cover" futures contracts sold by the
Fund and maintain in a segregated account certain liquid assets in connection
with futures contracts purchased by the Fund as described under "Investment
Policies" in the Statement of Additional Information. In connection with their
foreign securities investments, the Equity and Total Return Funds may also
engage in foreign currency financial futures transactions.
The Funds (other than the Government and Money Market Funds) may engage in
financial futures transactions and may use index options as an attempt to hedge
against market conditions or interest rate changes. Futures contracts entail
risks. If the investment manager's judgment about the general direction of
interest rates, markets or exchange rates is wrong, the overall performance may
be poorer than if no such contracts had been entered into. There may be an
imperfect correlation between movements in prices of futures contracts and
portfolio securities being hedged.
Options on futures contracts and index options involve risks similar to those
risks relating to transactions in financial futures contracts described above.
Also, an option purchased by a Fund may expire worthless, in which case a Fund
would lose the premium it paid.
Prospectus Page 16
<PAGE>
A Fund may engage in futures transactions only on commodities exchanges or
boards of trade. A Fund will not engage in transactions in index options,
financial futures contracts or related options for speculation, but only as an
attempt to hedge against changes in interest rates or market conditions
affecting the values of securities that the Fund owns or intends to purchase.
General The Statement of Additional Information contains more information
about the characteristics, risks and possible benefits of options, futures and
foreign currency transactions. See "Investment Policies" in the Statement of
Additional Information. The principal risks are:
. possible imperfect correlation between movements in the prices of
options, currencies or futures contracts and movements in the prices of
the securities or currencies hedged or used for cover;
. lack of assurance that a liquid secondary market will exist for any par-
ticular option, futures or foreign currency contract at any particular
time;
. the need for skills and techniques beyond those required for normal port-
folio management;
. losses on futures contracts resulting from market movements not antici-
pated by the investment manager; and
. the possible need to defer closing out certain options or futures con-
tracts to qualify for beneficial tax treatment afforded "regulated
investment companies" under the Internal Revenue Code.
Lending of Portfolio Securities Consistent with applicable regulatory require-
ments, the Equity, Total Return and Government Funds may lend securities
(principally to broker-dealers) without limit where such loans are callable at
any time and are continuously secured by segregated collateral (cash or U.S.
Government securities) equal to no less than the market value, determined dai-
ly, of the securities loaned. The Funds will receive amounts equal to divi-
dends or interest on the securities loaned and will earn income for having
made the loan. Any cash collateral pursuant to these loans will be invested in
short-term money market instruments. As with other extensions of credit, there
are risks of delay in recovery or even loss of rights in the collateral if the
borrower fails financially. However, the loans would be made only to firms
deemed by the investment manager to be of good standing, and when the invest-
ment
Prospectus Page 17
<PAGE>
manager believes the potential earnings justify the risk. Management currently
limits such lending to not more than one-third of the value of a Fund's total
assets.
Delayed Delivery Transactions The Government and Municipal Funds may purchase
or sell portfolio securities on a when-issued or delayed delivery basis. When-
issued or delayed delivery transactions involve a commitment by a Fund to pur-
chase or sell securities with payment and delivery to take place in the future
(not to exceed 120 days from trade date for the Government Fund) to secure
what is considered to be an advantageous price or yield to the Fund at the
time of entering into the transaction. The value of fixed yield securities
that will be delivered in the future will fluctuate as interest rates change.
Because a Fund is required to set aside cash or liquid high grade debt securi-
ties to satisfy its commitments to purchase when-issued or delayed delivery
securities, flexibility to manage the Fund's investments may be limited if
commitments to purchase when-issued or delayed delivery securities exceed 25%
of the value of its assets.
To the extent a Fund engages in when-issued or delayed delivery transactions,
it will not do so for investment leverage or speculation on interest rate
changes. A Fund will commit to purchase securities on a when-issued or delayed
delivery basis only with the intention of actually acquiring the securities,
but a Fund reserves the right to sell these securities before the settlement
date.
In some instances, the third-party seller of when-issued or delayed delivery
securities may determine prior to the settlement date that it will be unable
to meet its existing transaction commitments without borrowing securities. If
advantageous from a yield perspective, a Fund may, in that event, agree to
resell its purchase commitment to the third-party seller at the current market
price on the date of sale and concurrently enter into another purchase commit-
ment for such securities at a later date. As an inducement for the Fund to
"roll over" its purchase commitment, the Fund may receive a negotiated fee.
Repurchase Agreements Each Fund may invest in repurchase agreements, under
which it acquires ownership of a security and a broker-dealer or bank agrees
to repurchase the security at a mutually agreed upon time and price, thereby
determining the yield during the Fund's holding period. In the event of a
bankruptcy or other default of a seller of a repur-
Prospectus Page 18
<PAGE>
chase agreement, the Fund might have expenses in enforcing its rights, and
could experience losses, including a decline in the value of the underlying
securities and loss of income. The securities underlying a repurchase agree-
ment are marked-to-market every business day so that the value of such securi-
ties is at least equal to the investment value of the repurchase agreement,
including any accrued interest thereon. In addition, the Fund must take physi-
cal possession of the security or receive written confirmation of the purchase
and a custodial or safekeeping receipt from a third party or be recorded as
the owner of the security through the Federal Reserve Book-Entry System.
Repurchase agreements will be limited to transactions with financial institu-
tions believed by the investment manager to present minimal credit risk. The
investment manager will monitor on an on-going basis the creditworthiness of
the broker-dealers and banks with which the Funds may engage in repurchase
agreements.
Collateralized Obligations Subject to its investment objective and policies, a
Fund may purchase collateralized obligations, including interest only ("IO")
and principal only ("PO") securities. A collateralized obligation is a debt
security issued by a corporation, trust or custodian, or by a U.S. Government
agency or instrumentality, that is collateralized by a portfolio or pool of
mortgages, mortgage-backed securities, U.S. Government securities or other
assets. The issuer's obligation to make interest and principal payments is
secured by the underlying pool or portfolio of securities. Collateralized
obligations issued or guaranteed by a U.S. Government agency or instrumentali-
ty, such as the Federal Home Loan Mortgage Corporation, are considered U.S.
Government securities for purposes of this prospectus. Privately-issued col-
lateralized obligations collateralized by a portfolio of U.S. Government secu-
rities are not direct obligations of the U.S. Government or any of its
agencies or instrumentalities and are not considered U.S. Government securi-
ties for purposes of this prospectus. A Fund will not invest 25% or more of
its total assets in collateralized obligations. A variety of types of collat-
eralized obligations are available currently and others may become available
in the future.
Since the collateralized obligations may be issued in classes with varying
maturities and interest rates, the investor may obtain greater predictability
of maturity than with direct investments in mortgage-backed securities. Clas-
ses with shorter maturities may have lower volatility and lower yield while
those with longer maturities may have higher volatility and higher yield. This
provides the investor with greater control over the
Prospectus Page 19
<PAGE>
characteristics of the investment in a changing interest rate environment.
With respect to interest only and principal only securities, an investor may
select from a pool of underlying collateral the portion of the cash flows that
most closely corresponds to the investor's forecast of interest rate move-
ments. These instruments tend to be highly sensitive to prepayment rates on
the underlying collateral, so it is important to estimate prepayments accu-
rately.
A Fund, other than the Money Market Fund, may invest in collateralized obliga-
tions whose yield floats inversely against a specified index rate. These "in-
verse floaters" are more volatile than conventional fixed or floating rate
collateralized obligations and the yield thereon, as well as the value there-
of, will fluctuate in inverse proportion to changes in the index upon which
interest rate adjustments are based. As a result, the yield on an inverse
floater will generally increase when market yields (as reflected by the index)
decrease and decrease when market yields increase. The extent of the volatil-
ity of inverse floaters depends on the extent of anticipated changes in market
interest rates. Generally, inverse floaters provide for interest rate adjust-
ments based upon a multiple of the specified interest index, which further
increases their volatility. The degree of additional volatility will be
directly proportional to the size of the multiple used in determining interest
rate adjustments.
Additional information concerning collateralized obligations is contained in
the Statement of Additional Information under "Investment Policies--Collater-
alized Obligations."
Certificates of Participation The Municipal Fund may purchase Certificates of
Participation in trusts that hold Municipal Securities. A Certificate of Par-
ticipation gives the Fund an undivided interest in the Municipal Security in
the proportion that the Fund's interest bears to the total principal amount of
the Municipal Security. Certificates of Participation may be variable rate or
fixed rate. Because Certificates of Participation are interests in Municipal
Securities that are generally funded through government appropriations, they
are subject to the risk that sufficient appropriations as to the timely pay-
ment of principal and interest on the underlying Municipal Securities may not
be made. A Certificate of Participation may be backed by a guarantee of a
financial institution that satisfies rating agencies as to the credit quality
of the Municipal Security supporting the payment of principal and interest on
the Certificate of Participation. Payments of principal and interest would be
dependent upon the underlying Municipal Security and may be guaranteed under a
letter of credit to the extent of such credit. The quality rating by
Prospectus Page 20
<PAGE>
a rating service of an issue of Certificates of Participation is based primar-
ily upon the rating of the Municipal Security held by the trust and the credit
rating of the issuer of any letter of credit and of any other guarantor pro-
viding credit support to the issue. The investment manager considers these
factors as well as others, such as any quality ratings issued by the rating
service identified above, in reviewing the credit risk presented by a Certifi-
cate of Participation and in determining whether the Certificate of Participa-
tion is appropriate for investment by the Fund. The investment manager
anticipates that, for most publicly offered Certificates of Participation,
there will be a liquid secondary market or there may be demand features
enabling the Fund to readily sell its Certificates of Participation prior to
maturity to the issuer or a third party.
Advance Refunded Bonds The Municipal Fund may purchase Municipal Securities
that are subsequently refunded by the issuance and delivery of a new issue of
bonds prior to the date on which the outstanding issue of bonds can be
redeemed or paid. The proceeds from the new issue of bonds are typically
placed in an escrow fund consisting of U.S. Government obligations that are
used to pay the interest, principal and call premium on the issue being
refunded. The Municipal Fund may also purchase Municipal Securities that have
been refunded prior to purchase by the Fund.
BUYING SHARES
.............................................
You can buy shares from your financial representative at the public offering
price, which is the next net asset value computed after we have received your
investment, plus, for each Fund other than the Money Market Fund, a sales
charge as described under "Sales Charges." You can buy shares of the Money
Market Fund without a sales charge. Currently, Sterling Funds offer a single
class of shares of each Fund (Class A Shares). Additional classes may be
available in the future.
Investment Minimums
You may make an initial investment in any of the Funds for $1,000 or more.
Subsequent investment must be $100 or more. You can also open an IRA for only
$250 with subsequent investments of $50 or more. The minimum initial and sub-
sequent investment under an automatic investing plan such as Payroll or Gov-
ernment Direct Deposit is $50. These minimums can be changed at any time.
Prospectus Page 21
<PAGE>
Investment Plans
Electronic Transfer
Electronic Transfer permits the transfer of money via the Automated Clearing
House System (minimum $100 and maximum $2,500, except $50,000 maximum for
Money Market Fund) from your bank, savings and loan or credit union account to
purchase shares. By signing up for Electronic Transfer, you authorize the
Shareholder Service Agent to rely upon telephone instructions to transfer the
specified amounts between your Sterling Fund account and the predesignated
financial institution account, subject to the limitations on liability under
"Selling Shares--General." Once enrolled in Electronic Transfer, you can ini-
tiate a transaction by calling Shareholder Services at 1-800-508-6360. Elec-
tronic Transfer cannot be used with passbook savings accounts.
Automatic Investing
You may purchase additional shares through an automatic investment program.
Monthly investments are made automatically from your account at a bank, sav-
ings and loan or credit union into your Fund account. By signing up for this
privilege, you authorize the Fund and its agents to initiate Automated Clear-
ing House debits against the designated account. We may immediately terminate
your privilege if any item is unpaid by your financial institution.
Payroll Direct Deposit and Government Direct Deposit
You may invest in a Fund through Payroll Direct Deposit or Government Direct
Deposit. Under these programs, all or a portion of your net pay or government
check is automatically invested in a Fund account each pay period. You may
stop these programs by written notice to your employer or government agency,
as appropriate. (A reasonable time to act is required.) We are not responsible
for the efficiency of the employer or government agency making the payment or
any financial institution transmitting payment.
IRA's
You can open an Individual Retirement Account in one or more of the Funds.
Accounts with $10,000 balances are not charged the annual trustee fee. Ask
your financial representative for more information or call Shareholder Serv-
ices at 1-800-508-6360.
Prospectus Page 22
<PAGE>
General
Orders for the purchase of shares will be confirmed at a price based on the
net asset value of such Fund next determined after receipt by KFS of the order
accompanied by payment. However, orders received by dealers or other financial
services firms prior to the determination of net asset value (see "Net Asset
Value") and received by KFS prior to the close of its business day will be
confirmed at a price based on the net asset value of such Fund effective on
that day. These procedures for confirmed purchases do not apply to the Money
Market Fund. The Funds reserve the right to determine the net asset value more
frequently than once a day if deemed desirable. Dealers and other financial
services firms are obligated to transmit orders promptly.
The Money Market Fund seeks to be as fully invested as possible to achieve
maximum income. Since the Money Market Fund will be investing in instruments
that normally require immediate payment in federal funds (monies credited to a
bank's account with its regional Federal Reserve Bank), procedures have been
adopted for the convenience of shareholders and to ensure that the Money Mar-
ket Fund receives investable funds. Buy orders for the Money Market Fund
received by wire transfer in the form of federal funds will be effected at the
next determined net asset value after receipt by the Shareholder Service
Agent. Buy orders accompanied by a check or other negotiable bank draft will
be accepted and effected at the net asset value determined on the business day
following receipt and such shares will receive the dividend for the next day.
The Municipal Fund allocates net interest income daily to those shares for
which the Sterling Funds have received payment. To begin accruing interest
income as soon as possible, you should wire payment. Wires should be sent to
Investors Fiduciary Trust Company, ABA Routing No. 101003621, Account No.
7523572, Kansas City, Missouri 64105, the custodian for the Fund. If payment
is to be wired, the firm which services the account should handle the details
of the transaction.
Share certificates will not be issued unless requested in writing. We recom-
mend that you do not request share certificates unless you need them for a
specific purpose. You cannot sell shares by telephone, Electronic Transfer or
wire or use the telephone exchange privilege if share certificates have been
issued. A lost or destroyed certificate is difficult to replace and can be
expensive to the shareholder (a bond worth 2% or more of the certificate value
is normally required.)
Prospectus Page 23
<PAGE>
Because clearance of foreign checks generally takes longer than checks drawn
on domestic banks, shares will not be purchased until the Funds have collected
funds from checks drawn on foreign banks (other than a check drawn on a Cana-
dian bank in U.S. Dollars). The time required for this cannot be determined in
advance.
Investment dealers and other firms provide varying arrangements for their cli-
ents to buy and sell Fund shares. Some may establish higher minimum investment
requirements. Firms may arrange with their clients for other investment or
administrative services. Such firms may independently charge additional
amounts to their clients for services, which
would reduce the clients' return. Firms also may hold Fund shares in nominee
or street name as agent for and on behalf of their customers. In such instanc-
es, the Shareholder Service Agent will have no information with respect to or
control over accounts of specific shareholders. Such shareholders may obtain
access to their accounts and information about their accounts only from their
firm. Certain of these firms may receive compensation from the Shareholder
Service Agent for recordkeeping and other expenses relating to these nominee
accounts. In addition, certain privileges with respect to the purchase and
redemption of shares or the reinvestment of dividends may not be available
through such firms. Some firms may participate in a program allowing them
access to their clients' accounts for servicing including, without limitation,
transfers of registration and dividend payee changes; and may perform func-
tions such as generation of confirmation statements and disbursements of cash
dividends. This prospectus should be read in connection with such firms' mate-
rial regarding their fees and services.
Sterling Funds may terminate or modify these privileges at any time. Sterling
Funds reserves the right to withdraw all or any part of the offering made by
this prospectus and to reject purchase orders. Also, from time to time, Ster-
ling Funds may temporarily suspend the offering of the shares of a Fund to new
investors.
Prospectus Page 24
<PAGE>
Sales Charges
<TABLE>
<CAPTION>
SALES CHARGE
------------------------------------------
AS A AS A ALLOWED TO
PERCENTAGE OF PERCENTAGE OF DEALERS AS A
OFFERING NET ASSET PERCENTAGE OF
PURCHASE AMOUNT PRICE VALUE* OFFERING PRICE
- --------------- ------------- ------------- --------------
<S> <C> <C> <C>
EQUITY AND TOTAL RETURN FUNDS
Less than $50,000.................... 5.75% 6.10% 5.20%
$50,000 but less than $100,000....... 4.50 4.71 4.00
$100,000 but less than $250,000...... 3.50 3.63 3.00
$250,000 but less than $500,000...... 2.60 2.67 2.25
$500,000 but less than $1,000,000.... 2.00 2.04 1.75
$1,000,000 and over.................. 0.00** 0.00** ***
GOVERNMENT AND MUNICIPAL FUNDS
Less than $100,000................... 4.50% 4.71% 4.00%
$100,000 but less than $250,000...... 3.50 3.63 3.00
$250,000 but less than $500,000...... 2.60 2.67 2.25
$500,000 but less than $1,000,000.... 2.00 2.04 1.75
$1,000,000 and over.................. 0.00** 0.00** ***
MONEY MARKET FUND.................... 0.00% 0.00% 0.00%
</TABLE>
- ----------
*Rounded to the nearest one-hundredth percent.
**Redemption of shares may be subject to a contingent deferred sales charge as
discussed below.
***Commissions payable by KFS as discussed below.
The Funds receive the entire net asset value of shares sold. KFS, the princi-
pal underwriter, keeps the sales charge from which it allows discounts from
the applicable public offering price to investment dealers. KFS may reallow up
to the full applicable sales charge upon notice to dealers with whom it has
sales agreements; such reallowances may be based upon reaching minimum sales
levels. During periods when 90% or more of the sales charge is reallowed,
those dealers may be deemed underwriters as that term is defined in the Secu-
rities Act of 1933.
KFS may pay banks and other financial services firms a transaction fee up to
the discount allowable to dealers for administrative services related to order
placement and payment to facilitate transactions. Banks are cur-
Prospectus Page 25
<PAGE>
rently prohibited under the Glass-Steagall Act from providing certain under-
writing or distribution services. Banks or other financial services firms may
be subject to various state laws regarding the services described above and
may be required to register as dealers pursuant to state laws.
KFS will periodically pay or allow special discounts or promotional incen-
tives, in the form of cash or other compensation, to firms that sell shares of
the Funds. Non-cash compensation includes luxury merchandise and trips to lux-
ury resorts. Sometimes those discounts or incentives will only be offered to
certain firms that sell minimum amounts and for only a limited time.
Reductions and Waivers of the Sales Charge
Large Order Purchase Privilege
There is no sales charge on investments of $1 million or more including pur-
chases (other than Money Market Fund investments) pursuant to the "Combined
Purchases," "Letter of Intent" and "Cumulative Discount" features described
below.
A contingent deferred sales charge of 1% may be imposed when you redeem shares
within one year of purchase under the Large Order Purchase Privilege. The
charge is applied to the value of the shares redeemed, excluding reinvested
dividends and share appreciation. The contingent deferred sales charge will be
waived in the event of:
. redemption of shares of a shareholder (including a registered joint own-
er) who has died;
. redemption of shares of a shareholder (including a registered joint own-
er) who after purchase of the shares being redeemed becomes totally disa-
bled (as evidenced by a determination by the federal Social Security
Administration); and
. redemptions under a Fund's Systematic Withdrawal Plan at a maximum of 10%
per year of the net asset value of the account.
Shares purchased under this privilege may be exchanged for shares of another
Fund without paying any contingent deferred sales charge at the time of
exchange. If the shares received on exchange are later redeemed, a contingent
deferred sales charge may be imposed as described above and the shares
redeemed retain their original cost and purchase date for purposes of the con-
tingent deferred sales charge.
Prospectus Page 26
<PAGE>
KFS may in its discretion pay firms for sales under the Large Order Purchase
Privilege as follows: 1.00% of the net asset value of shares sold on amounts
up to $3 million, .50% on the next $2 million and .25% on amounts over $5 mil-
lion for the Equity and Total Return Funds; and .70% of the net asset value of
shares sold on amounts up to $3 million, .50% on the next $2 million and .25%
on amounts over $5 million for the Government and Municipal Funds. For pur-
poses of determining the appropriate commission, KFS will consider the cumula-
tive amount invested by the purchaser in the Funds (other than the Money
Market Fund), including purchases under the "Combined Purchases," "Letter of
Intent" and "Cumulative Discount" privileges. You cannot purchase shares at
net asset value under the Large Order Purchase Privilege if another net asset
value purchase privilege is also applicable.
Combined Purchases
Shares may be purchased at the rate applicable to the discount bracket
attained by combining concurrent investments in shares of the Funds (other
than the Money Market Fund).
Letter of Intent
Reduced sales charges are available for aggregate purchases made by any pur-
chaser within a 24-month period under the Letter of Intent privilege ("Let-
ter") provided by KFS. The privilege, which is non-binding, provides for a
sales charge adjustment depending upon the actual investments made within the
24-month period. Shares will be purchased at the public offering price in
effect at the time of the transaction. Sales charges differ among the Funds
and may change at any time. In determining the total amount of purchases,
shares purchased and then sold during the 24-month period will be deducted
from purchases. Exchanges, except exchanges into the Money Market Fund, will
not be deducted.
The first purchase must be at least $1,000 or 5% of the amount of the total
intended purchase, and that 5% of the amount of the intended purchase normally
will be held in escrow in the form of shares pending completion of the
intended purchase. If escrowed shares are exchanged under the exchange privi-
lege, shares in the new Fund will be substituted in the escrow. If the share-
holder fulfills the Letter, the escrowed shares will be released.
Prospectus Page 27
<PAGE>
If total investments are less than the intended amount and therefore are sub-
ject to a higher sales charge than actually paid, you have the opportunity to
pay the difference in sales charges. If you do not pay the difference in sales
charges, the appropriate number of escrowed shares will be redeemed and the
proceeds used toward satisfaction of the obligation to pay the increased sales
charge.
You may include the value (at the maximum offering price) of all shares of the
Funds (other than the Money Market Fund) held by you of record as of the ini-
tial purchase date under the Letter as an "accumulation credit" toward the
completion of the Letter, but no price adjustment will be made on such shares.
To make sure all your purchases are counted, you or your financial
representative must inform the Shareholder Service Agent of your Letter of
Intent privilege when buying shares. All purchases under this privilege must
be made by the same "purchaser" as described below.
Cumulative Discount
The sales charge for your investment may also be reduced by taking into
account your existing holdings in Sterling Funds (other than the Money Market
Fund) at the maximum offering price.
Availability of Quantity Discounts
You or your financial representative must notify the Shareholder Service Agent
or KFS whenever a quantity discount or reduced sales charge applies. Upon such
notification, you will receive the lowest applicable sales charge. Quantity
discounts described above may be modified or terminated at any time.
Who is a "Purchaser"
. Individual
. Individual, spouse and children under the age of 21
. A pension, profit-sharing or other employee benefit plan whether or not
qualified under Section 401 of the Internal Revenue Code
. Trustee or other fiduciary of a single trust estate or single fiduciary
account
Prospectus Page 28
<PAGE>
. Organized group of persons whether incorporated or not, provided the
organization has been in existence for at least six months and has some
purpose other than the purchase of redeemable securities of a registered
investment company at a discount.
To qualify for a lower sales charge, all orders from an organized group must
be placed through one dealer or firm and identified as a qualifying "purchas-
er."
Other Exceptions
Shares may be sold at net asset value in any amount to:
. Officers, trustees, directors, employees (including retirees) and sales
representatives of each Fund, its investment manager, its principal
underwriter or certain affiliated companies, for themselves or members of
their families, or any trust, pension, profit-sharing or other benefit
plan for only such persons.
. Registered representatives and employees of broker-dealers having selling
group agreements with KFS and officers, directors and
employees of service agents of the Funds for themselves or their spouses
or dependent children, or any trust or pension, profit sharing or other
benefit plan for only such persons.
. Selected employees (including their spouses and dependent children) of
banks and other financial services firms that provide administrative
services related to order placement and payment to facilitate transac-
tions in shares of each Fund for their clients pursuant to an agreement
with KFS or one of its affiliates. Only those employees of such banks and
other firms who as part of their usual duties provide services related to
transactions in Fund shares may purchase Fund shares at net asset value
hereunder.
. Unit investment trusts underwritten by KFS or an affiliate of KFS. In
addition, unitholders of unit investment trusts underwritten by KFS or an
affiliate of KFS may purchase Fund shares at net asset value through
reinvestment programs described in the prospectuses of such trusts which
have such programs.
Shares of a Fund may be sold at net asset value through certain investment
advisers registered under the Investment Advisers Act of 1940 and other finan-
cial services firms that adhere to certain standards established by KFS,
including a requirement that such shares be sold for the benefit
Prospectus Page 29
<PAGE>
of their clients participating in a "wrap account" or similar program under
which such clients pay a fee to the investment adviser or other firm.
Shares that are sold at net asset value through one of these exceptions are
sold for investment purposes and on the condition that they will not be resold
except through redemption or repurchase by the Funds.
The Funds may also issue shares at net asset value in connection with the
acquisition of the net assets of or merger or consolidation with another
investment company, or to shareholders in connection with the investment or
reinvestment of income and capital gains dividends.
SELLING SHARES
.............................................
You can access all or part of your account by selling (redeeming) shares. Call
your financial representative or use one of the methods outlined in this sec-
tion to redeem your shares.
General
The redemption price is the net asset value per share next determined follow-
ing receipt by the Shareholder Service Agent of a properly executed request
with any required documents (see "By Mail" below for what the required docu-
ments are). Shareholders may make redemption requests through their financial
representatives to KFS, which the Funds have authorized to act as their agent.
Financial representatives are obligated to transmit orders to KFS promptly.
Redemption requests received by financial representatives prior to the deter-
mination of net asset value and received by KFS prior to the close of KFS's
business day will be confirmed at the net asset value on that day. These
arrangements for redemption requests through financial representatives may be
terminated at any time. Redemption of shares purchased at net asset value
under the Large Order Purchase Privilege within one year may be subject to a
1% contingent deferred sales charge (see "Buying Shares").
You can request the following telephone privileges: telephone and wire redemp-
tions and Electronic Transfer transactions and telephone exchange transactions
(although you must have owned your shares for 15 days to use these privileges
unless you purchased your shares by wire).
Prospectus Page 30
<PAGE>
You may choose these privileges on the account application or contact the
Shareholder Service Agent for appropriate instructions. Please note that the
telephone exchange privilege is automatic unless you refuse it on the account
application. Neither Sterling Funds nor its agent will be liable for any loss,
expense or cost arising out of any telephone request pursuant to these privi-
leges, including any fraudulent or unauthorized request, and THE SHAREHOLDER
WILL BEAR THE RISK OF LOSS, so long as Sterling Funds or its agent reasonably
believes, based upon reasonable verification procedures, that the telephone
instructions are genuine. The verification procedures include recording
instructions, requiring certain identifying information before acting upon
instructions and sending written confirmations.
When it is difficult to contact the Shareholder Service Agent by telephone, it
may be difficult to request a telephone or wire redemption, but you can still
redeem by mail. Also, we reserve the right to change or terminate the special
telephone privileges described in this section.
By Telephone
If you meet the conditions below, you can call 1-800-508-6360 to place a sell
order.
You can only sell shares by telephone or by mail without a signature guarantee
if:
. Your redemption order is $25,000 or less;
. You want the check sent to the shareholder of record at the address of
record and there have been no address changes in the last 60 days; and
. No share certificates have been issued for the shares you want to sell.
If you have an institutional account you can exercise this special privilege
only if:
. You are the trustee, executor or guardian (not including custodial
accounts for gifts and transfers to minors) named in the account regis-
tration and have selected the telephone/wire privilege; or
. You are another kind of institutional account holder and have pre-autho-
rized the telephone redemption by written notice to the Shareholder Serv-
ice Agent with signatures guaranteed.
Prospectus Page 31
<PAGE>
By Mail
You can send your written redemption request to:
Sterling Funds
Attention: Redemption Department
P.O. Box 419077
Kansas City, Missouri 64141-6077
When share certificates have been issued, they must be mailed to the Share-
holder Service Agent, along with a duly endorsed stock power. If you do not
meet the conditions under "By Telephone" above, your redemption request and
stock power must be signed by all account holders with signatures guaranteed.
You must sign the redemption request and stock power exactly as the account is
registered including any titles. Additional documentation may be requested
from institutional and fiduciary account holders, such as corporations, custo-
dians (e.g., under the Uniform Transfers to Minors Act), executors, adminis-
trators, trustees or guardians.
Signature Guarantees are available from a commercial bank, trust company, sav-
ings and loan association, federal savings bank, member firm of a national
securities exchange, credit union or other eligible financial institution.
Electronic Transfer
You can also sell shares by Electronic Transfer (minimum $500 and maximum
$2,500, except $50,000 maximum for the Money Market Fund) and transfer the
proceeds electronically to your bank, savings and loan or credit union
account. Please see "Buying Shares" for details.
By Wire
You can sell shares by wire if you have completed the applicable section of
the Application and named a bank or savings institution with a Federal Reserve
Bank Routing number. There is a $1,000 wire redemption minimum. Requests
received by the Shareholder Service Agent prior to the determination of net
asset value will result in shares being redeemed that day at the net asset
value of the Fund effective on that day, and normally the proceeds will be
sent to the designated account the next business day. We may delay sending
proceeds of a wire redemption
request of $250,000 or more for up to seven days if we deem it appropriate
under then current market conditions. Once authorization
Prospectus Page 32
<PAGE>
is on file, the Shareholder Service Agent will honor requests by telephone at
1-800-508-6360 or in writing, subject to the limitations on liability
described under "General" above. We are not responsible for the efficiency of
the federal wire system or your financial services firm or bank. We currently
do not charge you for wire transfers although your firm or bank may charge you
for wire transfers. To change the designated account to receive wire redemp-
tion proceeds, send a written request to the Shareholder Service Agent with
signatures guaranteed as described above or contact the firm through which
shares of the Fund were purchased. Account holders may not use the wire privi-
lege to redeem shares held in certificated form.
By Systematic Withdrawal Plan
If you own $5,000 or more of a Fund's shares (at the maximum offering price)
you can redeem any requested dollar amount ($100 minimum) to be paid to you or
a designated payee monthly, quarterly, semiannually or annually. The $5,000
minimum is not applicable to Individual Retirement Accounts. Shares are
redeemed so that the payee will receive payment approximately the first of the
month. To participate in the plan, any income and capital gain dividends must
be automatically reinvested at net asset value. Depending upon the size of the
payments requested and fluctuations in the net asset value of the shares
redeemed, these payments may reduce or even exhaust the account.
Buying shares while participating in the systematic withdrawal plan is ordi-
narily disadvantageous to you because you will be paying a sales charge on the
purchase of shares at the same time that you are redeeming shares upon which a
sales charge may have already been paid. Therefore, we will not knowingly per-
mit additional investments of less than $2,000 if you are at the same time
making systematic withdrawals. We reserve the right to amend the plan on 30
days' notice. The plan may be terminated at any time by you or us.
Reinvestment Privilege
If you redeem shares, you may reinvest up to the full amount redeemed within
six months of the redemption, without paying a sales charge. If you paid a
contingent deferred sales charge when you redeemed in connection with the
Large Order Purchase Privilege, you may reinvest up to the full amount
redeemed at net asset value in a Fund. The amount of the contingent deferred
sales charge will also be reinvested. These rein-
Prospectus Page 33
<PAGE>
vested shares will retain their original cost and purchase date for purposes
of tracking the contingent deferred sales charge. Reinvestments are subject to
the minimum investment requirements and may only be made for Funds available
for sale in the shareholder's state of residence. You can only use the rein-
vestment privilege once as to any specific shares. If you realize a loss on
the redemption, the reinvestment may be subject to the "wash sale" rules if
made within 30 days of the redemption, resulting in a postponement of the rec-
ognition of such loss for federal income tax purposes. The reinvestment privi-
lege may be terminated or modified at any time.
Special Considerations
You may not sell shares by wire, Electronic Transfer or by telephone until the
shares have been on the Funds' books for at least 15 days, although there is
no delay for shares purchased by wire. Unless you purchased your shares by
wire we may delay (up to 15 days) sending your redemption proceeds until we
have determined that we have received good funds. You also may not sell shares
with these special privileges if the shares you want to redeem are held in
certificate form.
Because of the high cost of maintaining small accounts, Sterling Funds has the
right to redeem an account that falls below the minimum investment level, cur-
rently $1,000, because of redemptions. Before your account is redeemed, you
will be notified in writing and you will have 60 days to make additional pur-
chases to bring the account value up to the minimum investment level. The
investment required to reach that level may be made without any sales charge.
EXCHANGING SHARES
.............................................
You can exchange shares among the Funds at net asset value with no sales
charge for increased diversification. The only exception is that shares of the
Money Market Fund that you acquire by direct purchase are subject to any
applicable sales charge when you exchange them for shares of another Fund.
This exception does not apply to shares of the Money Market Fund acquired on
exchange or by dividend reinvestment.
An exchange of shares is considered a sale for federal income tax purposes. A
shareholder may realize a gain or loss depending upon whether the value of the
shares being exchanged is more or less than the adjusted cost basis.
Prospectus Page 34
<PAGE>
By Mail
To exchange shares, call your financial representative or send us a written
request that includes:
. Your name
. Your account number
. The name of the Funds you currently own
. The name of the Funds into which you wish to exchange
. The dollar amount or number of shares you wish to exchange
Please remember that you cannot place any conditions on your request. Also,
unless shares were purchased by wire, they cannot be exchanged for at least 15
days from the purchase date. In addition, shares of a Fund (other than the
Money Market Fund) acquired by exchange from another Fund may not be exchanged
again until they have been owned for 15 days.
If you have any share certificates, you must include the certificates with
your request. A signature guarantee is not required to exchange shares, except
in some cases where shares are also redeemed for cash at the same time. For
certificate delivery and signature guarantee instructions, please see "Selling
Shares--By Mail."
By Telephone
You may also exchange shares by calling the Shareholder Service Agent unless
you have previously notified the Funds in writing not to effect telephone
exchanges or your shares are held in certificate form. Exchanges made over the
phone may be made by ANY PERSON, not just the shareholder of record, subject
to the limitations on liability described under "Selling Shares--General."
Please remember that during unusual market conditions, we may have difficulty
in accepting telephone requests. The Funds reserve the right to suspend, ter-
minate or modify the exchange privilege at any time, but we will normally give
you 60 days' advance notice.
By Systematic Exchange Privilege
The owner of $10,000 or more of shares may authorize the automatic exchange of
a specified amount ($100 minimum) of such shares for shares of another Fund.
If selected, exchanges will be made automatically
Prospectus Page 35
<PAGE>
until the privilege is terminated. Exchanges are subject to the terms and con-
ditions described above, except that the $1,000 minimum investment requirement
for the Fund acquired on exchange does not apply to systematic monthly
exchanges. This privilege may not be used for the exchange of shares held in
certificated form.
HOW THE FUNDS ARE MANAGED
.............................................
Investment Manager
Responsibility for overall management of the Funds rests with its Board of
Trustees and officers, with professional investment supervision provided by
KFS. KFS is the manager of each Fund's investment and business operations and
is the distributor of each Fund's shares. KFS is one of the largest investment
managers in the country and has been engaged in the management of investment
funds for more than forty years. KFS and its affiliates provide investment
advice and manage investment portfolios for the Kemper Funds, the Kemper
insurance companies, Kemper Corporation and other corporate, pension, profit-
sharing and individual accounts representing approximately $67 billion under
management. KFS, 120 South LaSalle Street, Chicago, Illinois 60603, is an
indirect subsidiary of Kemper Corporation, a financial services and insurance
firm. KFS may use the services of Kemper Investment Management Company Limit-
ed, River Plate House, 7-11 Finsbury Circus, London EC2M 7EB, a wholly owned
subsidiary of KFS, for a Fund's foreign securities investments, including
analysis, research, execution and trading services.
Each Fund pays an investment management fee monthly based upon such Fund's
average daily net assets at the following annual rates: Equity and Total
Return Funds--.80% on the first $250 million, .79% on the next $750 million,
.77% on the next $1.5 billion and .75% on amounts over $2.5 billion; Govern-
ment and Municipal Funds--.65% on the first $250 million, .64% on the next
$750 million, .62% on the next $1.5 billion and .60% on amounts over $2.5 bil-
lion; and Money Market Fund--.50% on the first $250 million, .49% on the next
$750 million, .47% on the next $1.5 billion and .45% on amounts over $2.5 bil-
lion. To the extent that the management fee is .75% or higher, it is higher
than that charged by most other mutual funds.
KFS has agreed to temporarily absorb operating expenses for each Fund to the
extent that they exceed on an annual basis the following ratios of
Prospectus Page 36
<PAGE>
expenses to average daily net assets: 1.50% for the Equity and Total Return
Funds; 1.00% for the Government and Municipal Funds; and .80% for the Money
Market Fund. "Operating expenses" for this purpose does not include taxes,
interest, extraordinary expenses, brokerage commissions or transaction costs.
KFS places all orders for purchases and sales of the Funds' securities. Sub-
ject to seeking best execution of orders, KFS may consider sales of shares of
the Funds and other funds managed by KFS as a factor in selecting broker-deal-
ers. See "Portfolio Transactions" in the Statement of Additional Information.
Portfolio Managers
C. Beth Cotner is the portfolio manager of the Equity Fund. She has served in
this capacity since it commenced operations. Ms. Cotner joined KFS in January
1985 and is currently an Executive Vice President and Director of Domestic
Equity Portfolio Management of KFS. She received a B.A. from Ohio State Uni-
versity, Columbus, Ohio and an M.B.A. from George Washington University, Wash-
ington, D.C.
Gordon P. Wilson has been the portfolio manager of the Total Return Fund since
it commenced operations. Mr. Wilson joined KFS in January 1971 and is cur-
rently an Executive Vice President of KFS and a Vice President of the Fund. He
received a B.A. in Economics and an M.S. in Finance from the University of
Illinois, Urbana, Illinois. Mr. Wilson is a Chartered Financial Analyst.
KFS' Equity Investment Committee determines overall investment strategy for
equity portfolios managed by KFS. The members of the Equity Investment Commit-
tee are: Daniel J. Bukowski, C. Beth Cotner, James H. Coxon, Bruce A. Ebel,
Richard A. Goers, Frank D. Korth, Gary A. Langbaum, Seamon A. Lincoln, James
R. Neel, Robert S. Takazawa, Jr. and Gordon P. Wilson. The portfolio managers
work together as a team with the Equity Investment Committee and various
equity analysts and equity traders to manage the Equity and Total Return
Funds. Equity analysts, through research, analysis and evaluation, work to
develop investment ideas appropriate for these Funds. These ideas are studied
and debated by the Equity Investment Committee and, if approved, are added to
a list of eligible investments. The portfolio managers use the list of eligi-
ble securities to help them structure the portfolios in a manner consistent
with each Fund's objective. The KFS International Equity
Prospectus Page 37
<PAGE>
Investments area, directed by Mr. Dennis H. Ferro, and the KFS International
Fixed Income Investments area, directed by Mr. Gordon K. Johns, provide
research and analysis regarding foreign investments to the portfolio managers.
After investment decisions are made, equity traders execute the portfolio man-
ager's instructions through various broker-dealer firms.
J. Patrick Beimford, Jr. and Robert H. Schumacher have been the co-portfolio
managers of the Government Fund since it commenced operations. Mr. Beimford
joined KFS in April 1976 and is currently Executive Vice President and Direc-
tor of Fixed Income Investments of KFS and a Vice President of the Fund. He
received a B.S.I.M. in Business from Purdue University, West Lafayette, Indi-
ana, and an M.B.A. in Finance from the University of Chicago, Chicago,
Illinois. Mr. Beimford is a Chartered Financial Analyst. Mr. Schumacher joined
KFS in July 1990 and is currently a Senior Vice President of KFS and a Vice
President of the Fund. Prior to coming to KFS, he was a manager of the fixed-
income division of an international securities firm. He received a B.A. in
Economics from DePauw University, Greencastle, Indiana and an M.M. in Finance
from Northwestern University, Evanston, Illinois. Mr. Schumacher holds a num-
ber of SEC and CFTC licenses.
Mr. Beimford and Christopher J. Mier have been co-portfolio managers of the
Municipal Fund since it commenced operations. Mr. Mier joined KFS in 1986. Mr.
Mier is a First Vice President of KFS and a Vice President of the Fund. He
received a B.A. in Economics from the University of Michigan, Ann Arbor, Mich-
igan and an M.M. in Finance from the Kellogg Graduate School of Management at
Northwestern University, Chicago, Illinois. Mr. Mier is a Chartered Financial
Analyst.
Frank J. Rachwalski, Jr. has been the portfolio manager of the Money Market
Fund since it commenced operations. Mr. Rachwalski joined KFS in January 1973
and is currently a Senior Vice President of KFS and a Vice President of the
Fund. He received a B.B.A. and an M.B.A. from Loyola University, Chicago,
Illinois.
KFS' Fixed Income Investment Committee determines overall investment strategy
for fixed-income portfolios managed by KFS. The members of the Fixed Income
Committee are: J. Patrick Beimford, Jr., Frank E. Collecchia, George Klein,
Seamon A. Lincoln, Michael A. McNamara, Christopher J. Mier, Frank J.
Rachwalski, Jr., Harry E. Resis, Jr., Robert H. Schumacher, John E. Silvia,
Kenneth T.
Prospectus Page 38
<PAGE>
Urbaszewski and Christopher T. Vincent. The portfolio managers work together
as a team with the Fixed Income Committee and various fixed income analysts
and traders to manage the Government, Municipal and Money Market Funds. Ana-
lysts provide market, economic and financial research and analysis that is
used by the Fixed Income Committee to establish broad parameters for the
Funds, including duration and cash levels. In addition, credit research by
analysts is used by portfolio managers in selecting securities appropriate for
the Fund's policies. After investment decisions are made, fixed-income traders
execute the portfolio manager's instructions through various broker-dealer
firms.
Distributor
Shares of Sterling Funds are distributed by KFS. KFS is not compensated by the
Funds as distributor and pays all expenses of distributing shares of the Funds
not otherwise paid by financial services firms ("firms"). As indicated under
"Buying Shares," KFS keeps the sales charge from share purchases and pays or
allows concessions or discounts to firms for selling shares.
Administrative Services
KFS provides information and administrative services for shareholders pursuant
to administrative services agreements ("administrative agreements"). KFS may
enter into related arrangements with various financial services firms, such as
broker-dealer firms or banks ("firms"), that provide services and facilities
for their customers or clients who are Fund shareholders. KFS bears all its
expenses of providing services pursuant to the administrative agreement,
including the payment of any service fees. For services under the administra-
tive agreements, each Fund except the Money Market Fund pays KFS a fee, pay-
able monthly, at an annual rate of .25% of average daily net assets of such
Fund. KFS then pays each firm a service fee at an annual rate of up to .25% of
net assets of those accounts in the Fund that it maintains and services except
for Money Market Fund accounts.
KFS also may provide some of the above services and keep any portion of the
administrative services fee not paid to firms to compensate itself for admin-
istrative functions performed for each Fund. Currently, the administrative
services fee payable to KFS is based only upon Fund assets in accounts for
which there is a firm listed on a Fund's record and it is intended that KFS
will pay all the administrative services fee that it
Prospectus Page 39
<PAGE>
receives from each Fund to firms as service fees. The effective administrative
services fee rate to be charged against all assets of each
Fund while this procedure is in effect will depend upon the proportion of Fund
assets that is in accounts for which there is a firm of record. The Board of
Trustees may implement the administrative agreement for the Money Market Fund
and the Fund would pay KFS an administrative services fee of up to .25% of the
average daily net assets of the Fund. The Board of Trustees, upon the recom-
mendation of KFS, has decided not to implement the agreement at this time for
the Money Market Fund and no administrative services fees are being paid by
that Fund.
From its own assets, KFS may pay firms a sponsorship fee for administrative
services for their customers who are shareholders in the Funds. Such services
include, without limitation, processing orders, assisting with proxy solicita-
tion, changing registration information, changing shareholder options and
advising KFS regarding shareholder requirements. KFS normally pays firms based
upon average net assets in accounts in the Funds that they maintain and serv-
ice at annual rates ranging from .10% to .16% for the Equity and Total Return
Funds, .08% to .11% for the Government and Municipal Funds and .05% for the
Money Market Fund. KFS may pay firms additional sponsorship fees at annual
rates ranging from .01% to .04% of average net assets in accounts in the Funds
that they maintain and service (except for Money Market Fund accounts), which
rates vary based upon the aggregate net assets of each Fund.
Firms to which service and sponsorship fees may be paid include broker-dealers
affiliated with KFS. The fees are calculated and paid quarterly.
Custodian and Shareholder Service Agent
Investors Fiduciary Trust Company ("IFTC"), 127 West 10th Street, Kansas City,
Missouri 64105, as custodian, and the United Missouri Bank, N.A., Tenth and
Grand Streets, Kansas City, Missouri 64106, as sub-custodian, have custody of
all securities and cash of the Funds maintained in the United States. The
Chase Manhattan Bank, N.A., Chase MetroTech Center, Brooklyn, New York 11245,
as custodian, has custody of all securities and cash of the Funds held outside
the United States. They attend to the collection of principal and income, and
payment for and collection of proceeds of securities bought and sold by the
Funds. IFTC is also the Funds' transfer agent and dividend-paying
Prospectus Page 40
<PAGE>
agent. IFTC is owned equally by KFS and DST Systems, Inc., a company that is
not affiliated with KFS. Pursuant to a services agreement with IFTC, Super-
vised Service Company, Inc., an affiliate of KFS, serves as "Shareholder Serv-
ice Agent" of the Funds. For a description of custodian, transfer agent and
shareholder service agent fees payable, see "Investment Manager and Distribu-
tor" in the Statement of Additional Information.
DIVIDENDS AND TAXES
.............................................
Dividends
Each Fund normally distributes dividends of net investment income as follows:
. annually for the Equity Fund
. quarterly for the Total Return Fund
. monthly for the Government, Municipal and Money Market Funds
Each Fund distributes any net realized short-term and long-term capital gains
at least annually. The Municipal and Money Market Funds declare daily divi-
dends of net investment income. The quarterly distributions of the Total
Return Fund may include short-term capital gains. If a shareholder redeems his
or her entire account in a Fund, all dividends declared to the date of redemp-
tion will then be paid.
Dividend Payment Options
. Reinvest Dividends are normally reinvested in shares of the same Fund at
net asset value without a sales charge.
. Cash If you do not want your dividends reinvested, send the Shareholder
Service Agent written notice to pay both your income dividends and capi-
tal gain dividends in cash; or you may have your income and short-term
capital gain dividends paid in cash and your long-term capital gain divi-
dends reinvested at net asset value.
. Dividend Exchange You can send the Shareholder Service Agent a written
request to have your dividends reinvested at net asset value in another
Fund. To use this privilege, you must have $10,000 in the Fund distribut-
ing the dividends or $1,000 in the Fund in which dividends are reinvest-
ed.
Prospectus Page 41
<PAGE>
Taxes
Each Fund intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code (the "Code") and, if so qualified,
will not be liable for federal income taxes to the extent its earnings are
distributed. Dividends representing taxable net investment income and net
short-term capital gains, if any, are taxable to shareholders as ordinary
income and long-term capital gain dividends are taxable to shareholders as
long-term capital gains, regardless of how long the shares have been held and
whether received in cash or shares. Long-term capital gain dividends received
by individual shareholders are taxed at a maximum rate of 28%. Dividends
declared by a Fund in October, November or December to shareholders of record
as of a date in one of those months and paid during the following January are
treated as paid on December 31 of the calendar year declared. A portion of the
dividends paid by the Equity and Total Return Funds may qualify for the divi-
dends received deduction available to corporate shareholders.
A taxable dividend received shortly after the purchase of shares reduces the
net asset value of the shares by the amount of the dividend and, although in
effect a return of capital, will be taxable to the shareholder.
After each transaction, shareholders will receive a confirmation statement
giving complete details of the transaction except that confirmations will be
sent quarterly for dividend reinvestment for Individual Retirement Accounts
("IRAs") and other fiduciary accounts for which Investors Fiduciary Trust Com-
pany serves as trustee and for investments made pursuant to reinvestment pro-
grams for unit investment trusts underwritten by KFS or an affiliate of KFS.
In addition, the statement will show the details of prior transactions in the
account during the calendar year. Information for federal income tax purposes
will be provided after the end of the calendar year. Shareholders are encour-
aged to retain copies of their account confirmation statements or year-end
statements for tax reporting purposes. However, those who have incomplete rec-
ords may obtain historical account transaction information at a reasonable
fee.
Government and Money Market Funds Dividends that are derived from interest on
direct (but not guaranteed) obligations of the U.S. Government and certain of
its agencies and instrumentalities may be exempt from state and local taxes in
certain states. In other states, arguments can be made that such distributions
should be exempt from state and local taxes based on federal law, 31 U.S.C.
Section 3124, and the U.S.
Prospectus Page 42
<PAGE>
Supreme Court's interpretation of that provision in American Bank and
Trust Co. v. Dallas County, 463 U.S. 855 (1983). Shareholders should consult
their tax advisers regarding the possible exclusion of such portion of their
dividends for state and local income tax purposes.
Municipal Fund Shareholders should remember that dividends representing net
realized capital gains on Municipal Securities are not tax-exempt. Gains
attributable to market discount on Municipal Securities acquired after April
30, 1993 are treated as ordinary income. The Municipal Fund intends to meet
the requirements of the Code applicable to regulated investment companies dis-
tributing tax-exempt interest dividends and, therefore, dividends representing
net interest received on Municipal Securities will not be includable by share-
holders in their gross income for federal income tax purposes, except to the
extent such interest is subject to the alternative minimum tax as discussed
below.
The tax exemption of Municipal Fund dividends for federal income tax does not
necessarily result in exemption under the income or other tax laws of any
state or local taxing authority. The laws of the several states and local tax-
ing authorities vary as to the taxation of interest income and investments,
and shareholders are advised to consult their own tax advisers as to the sta-
tus of their accounts under state and local tax laws. The Municipal Fund may
not be an appropriate investment for qualified retirement plans and IRAs.
Net interest on certain "private activity bonds" issued on or after August 8,
1986 is treated as an item of tax preference and may, therefore, be subject to
both the individual and corporate alternative minimum tax. To the extent pro-
vided by regulations to be issued by the Secretary of the Treasury, exempt-
interest dividends from the Municipal Fund are to be treated as interest on
"private activity bonds" in proportion to the interest the Fund receives from
private activity bonds, reduced by allowable deductions.
Individuals whose modified income exceeds a base amount will be subject to
federal income tax on up to 85% of their Social Security benefits. Modified
income includes adjusted gross income, 50% of Social Security benefits, and
tax-exempt interest, including exempt-interest dividends from the Municipal
Fund.
Prospectus Page 43
<PAGE>
NET ASSET VALUE
.............................................
Each Fund's net asset value per share is computed by subtracting its liabili-
ties from the total value of its assets and dividing the remainder by the
total number of its outstanding shares. The net asset value is computed on
each day that the New York Stock Exchange is open at the earlier of 3:00 p.m.
(Central time) or the close of the New York Stock Exchange.
The Funds, other than the Money Market Fund, value their security holdings
using market quotations or, if not readily available, at fair value as deter-
mined in good faith under procedures established by the Board of Trustees.
Securities may also be valued based on values provided by pricing services.
The Money Market Fund normally values its portfolio investments at amortized
cost, which means that they are valued at acquisition cost (and adjusted for
amortization of premium or discount) rather than current market value. This
enables the Money Market Fund to maintain a stable net asset value or share
price of $1.00, although there can be no assurance that a stable price of
$1.00 will always be maintained. In order to value its investments at amor-
tized cost, the Money Market Fund purchases only short-term investments with a
maturity of 397 days or less and maintains a dollar-weighted average portfolio
maturity of 90 days or less. In addition, the Money Market Fund limits its
portfolio investments to instruments that meet the quality requirements of
Rule 2a-7 under the Investment Company Act of 1940.
Please see "Net Asset Value" in the Statement of Additional Information for
details on portfolio security valuation and amortized cost valuation.
FUND PERFORMANCE
.............................................
The Funds may quote information from publications such as The Wall Street
Journal, Money Magazine, Forbes, Barron's, Newsweek, Chicago Tribune, New York
Times, U.S. News and World Report, USA Today, Fortune, Investors Business Dai-
ly, Financial World, Smart Money and The Kiplinger Letter and cite information
from Morningstar, Inc. or the Investment Company Institute. For more informa-
tion on the Funds' performance, see "Performance Data" in the Statement of
Additional
Prospectus Page 44
<PAGE>
Information. Please remember that performance information is based upon his-
torical results and is not necessarily representative of future performance.
We may advertise the performance of the Funds expressed in terms of "total
return" or "average annual total return." Average annual total return is stan-
dardized in accordance with SEC regulations. Total return and average annual
total return measure both the net investment income from and any realized or
unrealized appreciation or depreciation of a Fund's holdings for a stated time
period and assume that all dividends were reinvested. The average annual total
return calculation is annualized and is shown as a percentage change over the
time period while total return represents the aggregate percentage or dollar
value change over the stated period.
The Government, Municipal and Money Market Funds may also advertise "yield"
and the Municipal Fund may advertise "tax-equivalent yield." Yield measures
the net investment income per share earned over a specific one month or 30 day
period (seven day period for the Money Market Fund) expressed as a percentage
of the offering price. Yield is annualized, which assumes that the Fund gener-
ates the same level of net investment income over a one year period. Tax-
equivalent yield is that yield which a taxable investment must generate in
order to equal the yield at a stated tax rate.
A Fund may depict the historical performance of the securities in which the
Fund may invest over periods reflecting a variety of market or economic condi-
tions either alone or in comparison with alternative investments, performance
indexes of those investments or economic indicators. A Fund may also describe
its portfolio holdings and depict its size or relative size compared to other
mutual funds, the number and make-up of its shareholder base and other
descriptive factors concerning the Fund.
A Fund's performance may be compared to that of the Consumer Price Index or
various unmanaged indexes such as the Dow Jones Industrial Average, the Stan-
dard & Poor's 500 Stock Index, the Russell 1000(R) Growth Index, the Lehman
Brothers Government/Corporate Bond Index, the Merrill Lynch Market Weighted
Index, the Lehman Brothers Municipal Bond Index and the Salomon Brothers 30
Year GNMA Index, and it may also be compared to the performance of other
appropriate fixed income or equity mutual funds or mutual fund indexes as
Prospectus Page 45
<PAGE>
reported by independent mutual fund reporting services such as Lipper Analyti-
cal Services, Inc. ("Lipper"). Lipper performance calculations are based upon
changes in net asset value with all dividends reinvested and do not include the
effect of any sales charges.
The Government and Municipal Funds may quote "distribution rate" in sales lit-
erature and shareholder reports. Distribution rate measures the level of divi-
dends distributed for a specified period and is not a complete measure of
performance. It differs from yield, which is a measure of the income actually
earned by the Fund's investments, and from total return, which is a measure of
the income actually earned by, plus the effect of any realized and unrealized
appreciation or depreciation of such investments during the period. Distribu-
tion rate may sometimes be greater than yield since, for instance, it may
include gains from the sale of options or other short-term and possibly long-
term gains (which may be non-recurring) and may not include the effect of amor-
tization of bond premiums. As reflected under "Investment Policies--Additional
Investment Information," option writing can limit the potential for capital
appreciation.
ORGANIZATION OF THE FUNDS
.............................................
Each Fund is a series of Sterling Funds, an open-end management investment com-
pany organized as a business trust under the laws of Massachusetts on March 2,
1990. Each Fund is diversified. Sterling Funds may issue an unlimited number of
shares, no par value, in one or more series or "Funds" and one or more classes.
Shares of five Funds are currently offered, each in a single class (Class A)
and the Board of Trustees can authorize additional Funds and, subject to
receipt of an order from the Securities and Exchange Commission, can offer
shares of each Fund in separate classes. Generally, each class of shares issued
by a particular Fund would differ as to the allocation of certain expenses of
the Fund, such as distribution and administrative expenses, permitting, among
other things, different levels of services or methods of distribution among
various classes. KFS invested the "seed money" as the sole shareholder of each
Fund before the public offering of the Funds' shares and therefore as of the
date of this prospectus, controls each Fund.
Shares of each Fund have equal noncumulative voting rights and equal rights
with respect to dividends, assets and liquidation of that Fund subject to any
preferences, rights or privileges of any classes of shares within
Prospectus Page 46
<PAGE>
the Fund. Shares are fully paid and nonassessable when issued, are freely
transferable and have no preemptive or conversion rights. Sterling Funds is
not required to hold annual shareholder meetings and does not intend to do so.
However, Sterling Funds will hold special meetings as required
or deemed desirable for such purposes as electing trustees, changing fundamen-
tal policies or approving an investment management agreement. Shareholders
will vote separately by Fund except when voting in the aggregate for all Funds
is required under the Investment Company Act of 1940, such as for the election
of trustees.
APPENDIX--RATINGS OF FIXED INCOME INVESTMENTS
.............................................
Corporate Bond Ratings
Moody's Investors Service, Inc. Bonds rated Aaa are highest quality. Aa rated
bonds are high quality. Aaa and Aa rated bonds are generally known as "high
grade bonds." A rated bonds are upper medium grade obligations. Baa bonds are
medium grade. Bonds rated Ba have some speculative elements, while bonds rated
B are considered speculative. Caa rated bonds are of poor standing, Ca bonds
are very speculative and C rated bonds are the lowest class of rated bonds.
Standard & Poor's Corporation AAA rated bonds have an extremely strong capaci-
ty, and AA bonds have a very strong capacity to pay interest and repay princi-
pal. Bonds rated A have a strong capacity, and BBB bonds have an adequate
capacity to pay interest and repay principal. Bonds rated BB, B, CCC, CC or C
are regarded, on balance, as predominantly speculative with respect to capac-
ity to pay interest and repay principal in accordance with the terms of the
obligation, with BB indicating the lowest degree of speculation and C the
highest. The rating CI is for bonds on which no interest is being paid. Debt
rated D is in default.
Fitch Investors Service, Inc. Bonds rated AAA are of the highest credit quali-
ty. AA rated bonds are of very high credit quality and A bonds of high credit
quality. BBB rated bonds are of satisfactory credit quality, while BB rated
bonds are considered speculative and B rated bonds highly speculative. CCC
rated bonds may lead to default. Bonds rated CC are minimally protected and
bonds rated C are in imminent default, while bonds rated DDD, DD and D are in
default with a DDD rating representing the highest potential for recovery on
the bonds.
Prospectus Page 47
<PAGE>
Duff & Phelps Rating Co. Bonds rated AAA are of the highest credit quality. AA
rated bonds are of high credit quality with bonds rated A having average pro-
tection factors. Bonds rated BBB have below average protection factors. BB
rated bonds are deemed likely to meet obligations when due with B rated bonds
possessing the risk that obligations will not be met when due. Considerable
uncertainty exists as to timely payment of principal and interest for bonds
rated CCC. Bonds rated D are in default.
After purchase by a Fund, an issue of bonds may cease to be rated or its rating
may be reduced below the minimum required for purchase by the Fund. Neither
event requires the elimination of such obligation from the Fund's portfolio,
but the Fund's investment manager will consider this in its determination of
whether the Fund should continue to hold the obligation. To the extent that the
ratings accorded by the rating agencies change as a result of changes in such
organizations or changes in their rating systems, a Fund will attempt to use
comparable ratings as standards for investments in bonds in accordance with the
Fund's investment policies.
Prospectus Page 48
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
June 1, 1994
STERLING FUNDS
120 South LaSalle Street, Chicago, Illinois 60603
1-800-508-6360
EQUITY FUND
TOTAL RETURN FUND
U.S. GOVERNMENT SECURITIES FUND
MUNICIPAL BOND FUND
GOVERNMENT MONEY MARKET FUND
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the prospectus of Sterling
Funds dated June 1, 1994. The prospectus may be obtained without
charge from the Sterling Funds.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
INVESTMENT RESTRICTIONS. . . . . . . . . . . . . . . . . . B-1
INVESTMENT POLICIES . . . . . . . . . . . . . . . . . . . B-4
PORTFOLIO TRANSACTIONS . . . . . . . . . . . . . . . . . . B-25
BUYING AND SELLING SHARES . . . . . . . . . . . . . . . . B-26
INVESTMENT MANAGER AND DISTRIBUTOR . . . . . . . . . . . . B-27
OFFICERS AND TRUSTEES . . . . . . . . . . . . . . . . . . B-30
DIVIDENDS AND TAXES . . . . . . . . . . . . . . . . . . . B-32
NET ASSET VALUE . . . . . . . . . . . . . . . . . . . . . B-36
PERFORMANCE DATA . . . . . . . . . . . . . . . . . . . . . B-38
SHAREHOLDER RIGHTS . . . . . . . . . . . . . . . . . . . . B-40
REPORT OF INDEPENDENT AUDITORS . . . . . . . . . . . . . . B-43
STATEMENT OF NET ASSETS . . . . . . . . . . . . . . . . . B-44
APPENDIX - RATINGS OF INVESTMENTS . . . . . . . . . . . . B-45
</TABLE>
<PAGE>
INVESTMENT RESTRICTIONS
The Equity Fund, Total Return Fund, U.S. Government Securities
Fund ("Government Fund"), Municipal Bond Fund ("Municipal Fund")
and Government Money Market Fund ("Money Market Fund") have each
adopted certain fundamental investment restrictions which,
together with the investment objective and fundamental investment
policies of such Fund, cannot be changed without approval by a
majority of its outstanding voting shares. As defined in the
Investment Company Act of 1940, this means the lesser of (a) 67%
of Fund shares at a meeting where more than 50% of the
outstanding shares are present or (b) more than 50% of the Funds'
outstanding shares.
A FUND, INDIVIDUALLY, AS A FUNDAMENTAL INVESTMENT RESTRICTION,
MAY NOT:
(1) Purchase securities of any issuer (other than obligations
of, or guaranteed by, the U.S. Government, its agencies or
instrumentalities) if, as a result, more than 5% of the Fund's
total assets would be invested in securities of that issuer.
(2) Purchase more than 10% of any class of voting securities of
any issuer.
(3) Lend money or securities, provided that the making of time
or demand deposits with banks and the purchase of debt securities
such as bonds, debentures, commercial paper, repurchase
agreements and short-term obligations in accordance with its
objective and policies are not prohibited and the Equity, Total
Return and Government Funds may lend their portfolio securities
as described under "Investment Objectives and Policies" in the
prospectus.
(4) Purchase securities (other than securities of the U.S.
Government, its agencies or instrumentalities or in the case of
the Municipal Fund, a state or its political subdivision) if as a
result of such purchase 25% or more of the Fund's total assets
would be invested in any one industry.
(5) Underwrite securities issued by others except to the extent
the Fund may be deemed to be an underwriter, under the federal
securities laws, in connection with the disposition of portfolio
securities.
(6) Issue senior securities except as permitted by the
Investment Company Act of 1940.
(7) Borrow money except as a temporary measure for extraordinary
or emergency purposes and then only in an amount up to one-third
of the value of its total assets, in order to meet redemption
requests without immediately selling any portfolio securities
(any such borrowings under this section will not be
collateralized). If, for any reason, the current value of the
Fund's total assets falls below an amount equal to three times
B-2
<PAGE>
the amount of its indebtedness from money borrowed, the Fund
will, within three days (not including Sundays and holidays),
reduce its indebtedness to the extent necessary. A Fund will not
borrow for leverage purposes.
(8) Make short sales of securities, or purchase any securities
on margin except to obtain such short-term credits as may be
necessary for the clearance of transactions; however, the Equity,
Total Return and Municipal Funds may make margin deposits in
connection with financial futures and options transactions.
THE EQUITY, TOTAL RETURN AND MUNICIPAL FUNDS, INDIVIDUALLY, AS A
FUNDAMENTAL INVESTMENT RESTRICTION, MAY NOT:
(1) Invest in commodities or commodity futures contracts,
although it may buy or sell financial futures contracts and
options on such contracts and engage in foreign currency
transactions; or in real estate (including real estate limited
partnerships), although it may invest in securities which are
secured by real estate and securities of issuers which invest or
deal in real estate including real estate investment trusts.
THE GOVERNMENT AND MONEY MARKET FUNDS, INDIVIDUALLY, AS A
FUNDAMENTAL INVESTMENT RESTRICTION, MAY NOT:
(1) Invest in commodities or commodity futures contracts or in
real estate (or real estate limited partnerships), although it
may invest in securities which are secured by real estate and
securities of issuers which invest or deal in real estate
including real estate investment trusts.
Each Fund has also adopted certain non-fundamental investment
restrictions that may be changed by the Board of Trustees without
shareholder approval.
A FUND, INDIVIDUALLY, AS A NON-FUNDAMENTAL INVESTMENT
RESTRICTION, MAY NOT:
(1) Invest more than 5% of its total assets in securities of
issuers which with their predecessors have a record of less than
three years continuous operation and equity securities of issuers
which are not readily marketable. This policy does not apply to
the Municipal Fund, which may not invest more than 5% of its
total assets in industrial revenue bonds if sponsored by
companies which with their predecessors have less than three
years continuous operation.
(2) Purchase or retain the securities of any issuer if any of
the officers, trustees or directors of the Fund or its investment
adviser owns beneficially more than 1/2 of 1% of the securities
of such issuer and together own more than 5% of the securities of
such issuer.
(3) Invest more than 15% (10% for the Government and Money
Market Funds) of the Fund's net assets in illiquid securities.
B-3
<PAGE>
(4) Invest for the purpose of exercising control or management
of another issuer.
(5) Purchase securities of other investment companies, except in
connection with a merger, consolidation, reorganization or
acquisition of assets.
(6) Invest in interests in oil, gas or other mineral exploration
or development programs or leases, although it may invest in the
securities of issuers which invest in or sponsor such programs.
(7) Invest more than 5% of its total assets in restricted
securities, excluding restricted securities eligible for resale
pursuant to Rule 144A under the Securities Act of 1933 that have
been determined to be liquid pursuant to procedures adopted by
the Board of Trustees, provided that the total amount of Fund
assets invested in restricted securities will not exceed 15% of
total assets.
THE EQUITY, TOTAL RETURN AND MUNICIPAL FUNDS, INDIVIDUALLY, AS A
NON-FUNDAMENTAL INVESTMENT RESTRICTION, MAY NOT:
(1) Write or sell put or call options, combinations thereof or
similar options on more than 25% of the Fund's net assets; nor
may it purchase put or call options if more than 5% of the Fund's
net assets would be invested in premiums on put and call options,
combinations thereof or similar options; however, the Fund may
buy or sell options on financial futures contracts.
(2) Invest in warrants if more than 5% of the Fund's net assets
would be invested in warrants. Included within that amount, but
not to exceed 2% of the Fund's net assets, may be warrants not
listed on the New York or American Stock Exchanges. Warrants
acquired in units or attached to securities may be deemed to be
without value for such purposes.
(3) Invest more than 10% of its total assets in securities of
real estate investment trusts.
THE GOVERNMENT AND MONEY MARKET FUNDS, INDIVIDUALLY, AS A NON-
FUNDAMENTAL INVESTMENT RESTRICTION, MAY NOT:
(1) Write, purchase or sell puts, calls or combinations thereof.
If a percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage beyond the
specified limit resulting from a change in values or net assets
will not be considered a violation. The Funds do not intend to
borrow money as permitted by the investment restrictions during
the current year.
B-4
<PAGE>
INVESTMENT POLICIES
OPTIONS AND FUTURES - GENERAL
The Equity, Total Return and Municipal Funds each may engage in
options transactions and may engage in financial futures
transactions in accordance with its respective investment
objectives and policies. The Equity, Total Return and Municipal
Funds may write (sell) covered call options and secured put
options and may purchase put and call options. These Funds
intend to engage in such transactions if it appears to the
investment manager to be advantageous to do so in order to pursue
its investment objective and also to hedge against the effects of
market risks and/or fluctuating interest rates but not for
speculative purposes. The Government and Money Market Funds do
not engage in options and futures transactions. The use of
futures and options, and possible benefits and attendant risks,
are discussed below along with information concerning other
investment policies and techniques.
OPTIONS ON SECURITIES
A Fund may write (sell) "covered" call options on securities as
long as it owns the underlying securities subject to the option
or an option to purchase the same underlying securities, having
an exercise price equal to or less than the exercise price of the
"covered" option, or will establish and maintain for the term of
the option a segregated account consisting of cash, U.S.
Government securities or other liquid high-grade debt obligations
("eligible securities") having a value at least equal to the
fluctuating market value of the optioned securities. A Fund may
write "covered" put options provided that, as long as the Fund is
obligated as a writer of a put option, the Fund will own an
option to sell the underlying securities subject to the option
having an exercise price equal to or greater than the exercise
price of the "covered" option, or it will deposit and maintain in
a segregated account eligible securities having a value equal to
or greater than the exercise price of the option. A call option
gives the purchaser the right to buy, and the writer the
obligation to sell, the underlying security at the exercise price
during the option period. A put option gives the purchaser the
right to sell, and the writer the obligation to buy, the
underlying security at the exercise price during the option
period. The premium received for writing an option will reflect,
among other things, the current market price of the underlying
security, the relationship of the exercise price to such market
price, the price volatility of the underlying security, the
option period, supply and demand and interest rates. The Funds
may write or purchase spread options, which are options for which
the exercise price may be a fixed dollar spread or yield spread
between the security underlying the option and another security
that is used as a bench mark. The exercise price of an option
may be below, equal to or above the current market value of the
underlying security at the time the option is written. The buyer
of a put who also owns the related security is protected by
ownership of a put option against any decline in that security's
price below the exercise price less the amount paid for the
B-5
<PAGE>
option. The ability to purchase put options allows each of the
Equity, Total Return and Municipal Funds to protect capital gains
in an appreciated security it owns, without being required to
actually sell that security. At times a Fund would like to
establish a position in a security upon which call options are
available. By purchasing a call option, a Fund is able to fix
the cost of acquiring the security, this being the cost of the
call plus the exercise price of the option. This procedure also
provides some protection from an unexpected downturn in the
market, because a Fund is only at risk for the amount of the
premium paid for the call option which it can, if it chooses,
permit to expire.
During the option period the covered call writer gives up the
potential for capital appreciation above the exercise price
should the underlying security rise in value, and the secured put
writer retains the risk of loss should the underlying security
decline in value. For the covered call writer, substantial
appreciation in the value of the underlying security would result
in the security being "called away." For the secured put writer,
substantial depreciation in the value of the underlying security
would result in the security being "put to" the writer. If a
covered call option expires unexercised, the writer realizes a
gain in the amount of the premium received. If the covered call
option writer has to sell the underlying security because of the
exercise of a call option, it realizes a gain or loss from the
sale of the underlying security, with the proceeds being
increased by the amount of the premium.
If a secured put option expires unexercised, the writer realizes
a gain from the amount of the premium plus the interest income on
the money market investment. If the secured put writer has to
buy the underlying security because of the exercise of the put
option, the secured put writer incurs an unrealized loss to the
extent that the current market value of the underlying security
is less than the exercise price of the put option. However, this
would be offset in whole or in part by gain from the premium
received and any interest income earned on the money market
investment.
OPTIONS ON SECURITIES INDICES
The Equity, Total Return and Municipal Funds may each purchase
and write (sell) call and put options on securities indices in an
attempt to hedge against market conditions affecting the value of
securities that the Fund owns or intends to purchase, and not for
speculation. Through the writing or purchase of index options, a
Fund can achieve many of the same objectives as through the use
of options on individual securities. Options on securities
indices are similar to options on a security except that, rather
than the right to take or make delivery of a security at a
specified price, an option on a securities index gives the holder
the right to receive, upon exercise of the option, an amount of
cash if the closing level of the securities index upon which the
option is based is greater than, in the case of a call, or less
than, in the case of a put, the exercise price of the option.
B-6
<PAGE>
This amount of cash is equal to such difference between the
closing price of the index and the exercise price of the option.
The writer of the option is obligated, in return for the premium
received, to make delivery of this amount. Unlike security
options, all settlements are in cash and gain or loss depends
upon price movements in the market generally (or in a particular
industry or segment of the market), rather than upon price
movements in individual securities. Price movements in
securities that the Fund owns or intends to purchase will
probably not correlate perfectly with movements in the level of
an index since the prices of such securities may be affected by
somewhat different factors and, therefore, the Fund bears the
risk that a loss on an index option would not be completely
offset by movements in the price of such securities.
When a Fund writes on option on a securities index, it will
segregate and mark-to-market, eligible securities equal in value
to 100% of the exercise price in the case of a put, or the
contract value in the case of a call. In addition, where the
Fund writes a call option on a securities index at a time when
the contract value exceeds the exercise price, the Fund will
segregate and mark-to-market, until the option expires or is
closed out, cash or cash equivalents equal in value to such
excess.
Options on futures contracts and index options involve risks
similar to those risks relating to transactions in financial
futures contracts described below. Also, an option purchased by
a Fund may expire worthless, in which case the Fund would lose
the premium paid therefor.
OVER-THE-COUNTER OPTIONS
The Equity, Total Return and Municipal Funds may deal in over-
the-counter traded options ("OTC options"). OTC options differ
from exchange traded options in several respects. They are
transacted directly with dealers and not with a clearing
corporation, and there is a risk of nonperformance by the dealer
as a result of the insolvency of such dealer or otherwise, in
which event the Fund may experience material losses. However, in
writing options the premium is paid in advance by the dealer.
OTC options are available for a greater variety of securities,
and a wider range of expiration dates and exercise prices, than
are exchange traded options. Since there is no exchange, pricing
is normally done by reference to information from market makers,
which information is carefully monitored by the Funds investment
manager and verified in appropriate cases.
A writer or purchaser of a put or call option can terminate it
voluntarily only by entering into a closing transaction. In the
case of OTC options, there can be no assurance that a continuous
liquid secondary market will exist for any particular option at
any specific time. Consequently, a Fund may be able to realize
the value of an OTC option it has purchased only by exercising it
or entering into a closing sale transaction with the dealer that
issued it. Similarly, when a Fund writes an OTC option, it
B-7
<PAGE>
generally can close out that option prior to its expiration only
by entering into a closing purchase transaction with the dealer
to which the Fund originally wrote it. If a covered call option
writer cannot effect a closing transaction, it cannot sell the
underlying security until the option expires or the option is
exercised. Therefore, a covered call option writer of an OTC
option may not be able to sell an underlying security even though
it might otherwise be advantageous to do so. Likewise, a secured
put writer of an OTC option may be unable to sell the securities
pledged to secure the put for other investment purposes while it
is obligated as a put writer. Similarly, a purchaser of such put
or call option might also find it difficult to terminate its
position on a timely basis in the absence of a secondary market.
The Funds understand the position of the staff of the Securities
and Exchange Commission ("SEC") to be that purchased OTC options
and the assets used as "cover" for written OTC options are
illiquid securities. The investment manager disagrees with this
position and believes the dealers with which it engages in OTC
options transactions generally agreeable to and capable of
entering into closing transactions. Sterling Funds has adopted
procedures for engaging in OTC options for the purpose of
reducing any potential adverse effect of such transactions upon
the liquidity of each Fund's portfolio. A brief description of
such procedures is set forth below.
A Fund will only engage in OTC options transactions with dealers
that have been specifically approved by the Fund's investment
manager pursuant to procedures adopted by the Funds' Board of
Trustees. The Funds' investment manager believes that the
approved dealers should be able to enter into closing
transactions if necessary and, therefore, present minimal credit
risks to a Fund. The investment manager will monitor the
creditworthiness of the approved dealers on an on-going basis. A
Fund currently will not engage in OTC options transactions if the
amount invested by the Fund in OTC options, plus a "liquidity
charge" related to OTC options written by the Fund, plus the
amount invested by the Fund in illiquid securities, would exceed
15% of the Fund's net assets. The "liquidity charge" referred to
above is computed as described below.
The Equity, Total Return and Municipal Funds anticipate entering
into agreements with dealers to which a Fund sells OTC options.
Under these agreements a Fund would have the absolute right to
repurchase the OTC options from the dealer at any time at a price
no greater than a price established under the agreements (the
"Repurchase Price"). The "liquidity charge" referred to above
for a specific OTC option transaction will be the Repurchase
Price related to the OTC option less the intrinsic value of the
OTC option. The intrinsic value of an OTC call option for such
purposes will be the amount by which the current market value of
the underlying security exceeds the exercise price. In the case
of an OTC put option, intrinsic value will be the amount by which
the exercise price exceeds the current market value of the
underlying security. If there is no such agreement requiring a
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dealer to allow the Fund to repurchase a specific OTC option
written by the Fund, the "liquidity charge" will be the current
market value of the assets serving as "cover" for such OTC
option.
FINANCIAL FUTURES CONTRACTS
The Equity, Total Return and Municipal Funds may each enter into
financial futures contracts for the future delivery of a
financial instrument, such as a security, or the cash value of a
securities index. This investment technique is designed
primarily to hedge (i.e., protect) against anticipated future
changes in interest rates or market conditions which otherwise
might affect adversely the value of securities which the Fund
holds or intends to purchase. A "sale" of a futures contract
means the undertaking of a contractual obligation to deliver the
securities or the cash value of an index called for by the
contract at a specified price during a specified delivery period.
A "purchase" of a futures contract means the undertaking of a
contractual obligation to acquire the securities or cash value of
an index at a specified price during a specified delivery period.
At the time of delivery, in the case of fixed income securities
pursuant to the contract, adjustments are made to recognize
differences in value arising from the delivery of securities with
a different interest rate than that specified in the contract.
In some cases, securities called for by a futures contract may
not have been issued at the time the contract was written. A
Fund will not enter into any futures contracts or options on
futures contracts if the aggregate of the contract value of the
outstanding futures contracts of the Fund and futures contracts
subject to outstanding options written by the Fund would exceed
50% of the total assets of the Fund.
Although some futures contracts by their terms call for the
actual delivery or acquisition of securities, in most cases a
party will close out the contractual commitment before delivery
without having to make or take delivery of the security by
purchasing (or selling, as the case may be) on a commodities
exchange an identical futures contract calling for delivery in
the same month. Such a transaction, if effected through a member
of an exchange, cancels the obligation to make or take delivery
of the securities. All transactions in the futures market are
made, offset or fulfilled through a clearing house associated
with the exchange on which the contracts are traded. A Fund will
incur brokerage fees when it purchases or sells contracts, and
will be required to maintain margin deposits. At the time a Fund
enters into a futures contract, it is required to deposit with
its custodian, on behalf of the broker, a specified amount of
cash or eligible securities, called "initial margin." The
initial margin required for a futures contract is set by the
exchange on which the contract is traded. Subsequent payments,
called "variation margin," to and from the broker are made on a
daily basis as the market price of the futures contract
fluctuates. The costs incurred in connection with futures
transactions could reduce a Fund's return. Futures contracts
entail risks. If the investment manager's judgment about the
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general direction of interest rates or markets is wrong, the
overall performance may be poorer than if no such contracts had
been entered into.
When the near-term market view is bearish but the portfolio
composition is judged satisfactory for the longer term, exposure
to temporary declines in the market may be reduced by entering
into futures contracts to sell securities or the cash value of a
securities index. Conversely, when the near-term view is
bullish, but the Fund is believed to be well positioned for the
longer term with a high cash position, the Fund can hedge against
market increases by entering into futures contracts to buy
securities or the cash value of a securities index. In either
case, the use of futures contracts would tend to reduce portfolio
turnover and facilitate the Fund's pursuit of its investment
objective. Also, if a Fund owned long-term bonds and interest
rates were expected to rise, it could sell financial futures
contracts. If interest rates did increase, the value of the
bonds in the Fund's portfolio would decline, but this decline
would be offset in whole or in part by an increase in the value
of the Fund's futures contracts. If, on the other hand, long-
term interest rates were expected to decline, the Fund could hold
short-term debt securities and benefit from the income earned by
holding such securities, while at the same time the Fund could
purchase futures contracts on long-term bonds or the cash value
of a securities index. Thus, the Fund could take advantage of
the anticipated rise in the value of long-term bonds without
actually buying them. The futures contracts and short-term debt
securities could then be liquidated and the cash proceeds used to
buy long-term bonds.
There may be an imperfect correlation between movements in prices
of futures contracts and portfolio securities being hedged. The
degree of difference in price movements between futures contracts
and the securities being hedged depends upon such things as
variation in speculative market demand for futures contracts and
debt securities and differences between the securities being
hedged and the securities underlying the futures contracts, e.g.,
interest rates, tax status, maturities and credit-worthiness of
issuers. While interest rates on taxable securities generally
move in the same direction as interest rates on Municipal
Securities, there are frequently differences in the rate of such
movements and temporary dislocations. Accordingly, the use of a
financial futures contract by the Municipal Fund on a taxable
security or a taxable securities index may involve a greater risk
of an imperfect correlation between the price movements of the
futures contract and of the Municipal Security being hedged than
when using a financial futures contract on a Municipal Security
or a Municipal Securities index.
In addition, the market prices of futures contracts in general
may be affected by certain factors. If participants in the
futures market elect to close out their contracts through
offsetting transactions rather than meet margin requirements,
distortions in the normal relationship between the securities and
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futures markets could result. Price distortions could also
result if investors in futures contracts decide to make or take
delivery of underlying securities rather than engage in closing
transactions because of the resultant reduction in the liquidity
of the futures market. In addition, because, from the point of
view of speculators, the margin requirements in the futures
markets are less onerous than margin requirements in the cash
market, increased participation by speculators in the futures
market could cause temporary price distortions. Due to the
possibility of price distortions in the futures market and
because of the imperfect correlation between movements in the
prices of securities and movements in the prices of futures
contracts, a correct forecast of market trends by the investment
manager may still not result in a successful hedging transaction.
If any of these event should occur, the Fund could lose money on
the financial futures contracts and also on the value of its
portfolio securities. The costs incurred in connection with
futures transactions could reduce a Fund's return.
OPTIONS ON FINANCIAL FUTURES CONTRACTS
The Equity, Total Return and Municipal Funds may each purchase
and write call and put options on financial futures contracts.
An option on a futures contract gives the purchaser the right, in
return for the premium paid, to assume a position in a futures
contract at a specified exercise price at any time during the
period of the option. Upon exercise, the writer of the option
delivers the futures contract to the holder at the exercise
price. A Fund would be required to deposit with its custodian
initial margin and maintenance margin with respect to put and
call options on futures contracts written by it. A Fund will
establish segregated accounts or will provide cover with respect
to written options on financial futures contracts in a manner
similar to that described under "Options on Securities." Options
on futures contracts involve risks similar to those risks
relating to transactions in financial futures contracts described
above. Also, an option purchased by a Fund may expire worthless,
in which case the Fund would lose the premium paid therefor.
DELAYED DELIVERY TRANSACTIONS
The Government and Municipal Funds may purchase or sell portfolio
securities on a when-issued or delayed delivery basis. When-
issued or delayed delivery transactions involve a commitment by a
Fund to purchase or sell securities with payment and delivery to
take place in the future in order to secure what is considered to
be an advantageous price or yield to the Fund at the time of
entering into the transaction. When the Fund enters into a
delayed delivery transaction, it becomes obligated to purchase
securities and it has all of the rights and risks attendant to
ownership of a security, although delivery and payment occur at a
later date. The value of fixed income securities to be delivered
in the future will fluctuate as interest rates vary. At the time
a Fund makes the commitment to purchase a security on a when-
issued or delayed delivery basis, it will record the transaction
and reflect the liability for the purchase and the value of the
security in determining its net asset value. Likewise, at the
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time a Fund makes the commitment to sell a security on a delayed
delivery basis, it will record the transaction and include the
proceeds to be received in determining its net asset value;
accordingly, any fluctuations in the value of the security sold
pursuant to a delayed delivery commitment are ignored in
calculating net asset value so long as the commitment remains in
effect. The Fund generally has the ability to close out a
purchase obligation on or before the settlement date, rather than
take delivery of the security.
To the extent a Fund engages in when-issued or delayed delivery
purchases, it will do so for the purpose of acquiring portfolio
securities consistent with the Fund's investment objective and
policies and not for the purpose of investment leverage or to
speculate in interest rate changes. A Fund will only make
commitments to purchase securities on a when-issued or delayed
delivery basis with the intention of actually acquiring the
securities, but the Fund reserves the right to sell these
securities before the settlement date if deemed advisable.
REGULATORY RESTRICTIONS
To the extent required to comply with SEC Release No. IC-10666,
when purchasing a futures contract, writing a put option or
entering into a delayed delivery purchase or a forward currency
exchange purchase, a Fund will maintain in a segregated account
cash, U.S. Government securities or liquid high-grade debt
obligations equal to the value of such contracts. A Fund will
use cover in connection with selling a futures contract.
A Fund will not engage in transactions in financial futures
contracts or options thereon for speculation, but only in an
attempt to hedge against changes in interest rates or market
conditions affecting the value of securities which the Fund holds
or intends to purchase.
FOREIGN SECURITIES
As reflected in the prospectus (see "Investment Objective and
Policies"), the Growth Fund and the Total Return Fund may invest
a portion of their assets (less than 10%) in foreign securities.
Foreign securities involve currency risks. The U.S. Dollar value
of a foreign security tends to decrease when the value of the
U.S. Dollar rises against the foreign currency in which the
security is denominated and tends to increase when the value of
the U.S. Dollar falls against such currency. Fluctuations in
exchange rates may also affect the earning power and asset value
of the foreign entity issuing the security. Dividend and
interest payments may be repatriated based on the exchange rate
at the time of payment, and restrictions on capital flows may be
imposed.
Foreign securities may be subject to foreign government taxes
that reduce their attractiveness. Other risks of investing in
such securities include political or economic instability in the
country involved, the difficulty of predicting international
trade patterns and the possible imposition of exchange controls.
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The prices of such securities may be more volatile than those of
domestic securities and the markets for foreign securities may be
less liquid. In addition, there may be less publicly available
information about foreign issuers than about domestic issuers.
Many foreign issuers are not subject to uniform accounting,
auditing and financial reporting standards comparable to those
applicable to domestic issuers. There is generally less
regulation of stock exchanges, brokers, banks and listed
companies abroad than in the United States. Settlement of
foreign securities trades may take longer and present more risk
than domestic securities. With respect to certain foreign
countries, there is a possibility of expropriation or diplomatic
developments that could affect investment in these countries.
Losses and other expenses may be incurred in converting between
various currencies.
Emerging Markets While a Fund's investments in foreign
securities will principally be in developed countries, a Fund may
invest a portion of its assets in developing or "emerging"
markets, which involve exposure to economic structures that are
generally less diverse and mature than in the United States, and
to political systems that may be less stable. A developing or
emerging market country can be considered to be a country that is
in the initial stages of its industrialization cycle. Currently,
emerging markets generally include every country in the world
other than the United States, Canada, Japan, Australia, New
Zealand, Hong Kong, Singapore and most Western European
countries. Currently, investing in many emerging markets may not
be desirable or feasible because of the lack of adequate custody
arrangements for a Fund's assets, overly burdensome repatriation
and similar restrictions, the lack of organized and liquid
securities markets, unacceptable political risks or other
reasons. As opportunities to invest in securities in emerging
markets develop, the Fund may expand and further broaden the
group of emerging markets in which its invests. In the past,
markets of developing countries have been more volatile than the
markets of developed countries; however, such markets often have
provided higher rates of return to investors. The investment
manager believes that these characteristics can be expected to
continue in the future.
Many of the risks described above relating to foreign securities
generally will be greater for emerging markets than for developed
countries. For instance, economies in individual developing
markets may differ favorably or unfavorably from the U.S. economy
in such respects as growth of gross domestic product, rates of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency and balance of payments positions. Many
emerging markets have experienced substantial rates of inflation
for many years. Inflation and rapid fluctuations in inflation
rates have had and may continue to have very negative effects on
the economies and securities markets of certain developing
markets. Economies in emerging markets generally are dependent
heavily upon international trade and, accordingly, have been and
may continue to be affected adversely by trade barriers, exchange
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controls, managed adjustments in relative currency values and
other protectionist measures imposed or negotiated by the
countries with which they trade. These economies also have been
and may continue to be affected adversely by economic conditions
in the countries with which they trade.
Also, the securities markets of developing countries are
substantially smaller, less developed, less liquid and more
volatile than the securities markets of the United States and
other more developed countries. Disclosure, regulatory and
accounting standards in many respects are less stringent than in
the United States and other developed markets. There also may be
a lower level of monitoring and regulation of developing markets
and the activities of investors in such markets, and enforcement
of existing regulations has been extremely limited.
In addition, brokerage commissions, custodial services and other
costs relating to investment in foreign markets generally are
more expensive than in the United States; this is particularly
true with respect to emerging markets. Such markets have
different settlement and clearance procedures. In certain
markets there have been times when settlements have been unable
to keep pace with the volume of securities transactions, making
it difficult to conduct such transactions. Such settlement
problems may cause emerging market securities to be illiquid.
The inability of the Fund to make intended securities purchases
due to settlement problems could cause the Fund to miss
attractive investment opportunities. Inability to dispose of a
portfolio security caused by settlement problems could result
either in losses to the Fund due to subsequent declines in value
of the portfolio security or, if the Fund has entered into a
contract to sell the security, could result in possible liability
to the purchaser. Certain emerging markets may lack clearing
facilities equivalent to those in developed countries.
Accordingly, settlements can pose additional risks in such
markets and ultimately can expose the Fund to the risk of losses
resulting from the Fund's inability to recover from a
counterparty.
The risk also exists that an emergency situation may arise in one
or more emerging markets as a result of which trading securities
may cease or may be substantially curtailed and prices for the
Fund's portfolio securities in such markets may not be readily
available. The Fund's portfolio securities in the affected
markets will be valued at fair value determined in good faith by
or under the direction of the Board of Trustees.
Investment in certain emerging market securities is restricted or
controlled to varying degrees. These restrictions or controls
may at times limit or preclude foreign investment in certain
emerging market securities and increase the cost and expenses of
the Fund. Emerging markets may require governmental approval for
the repatriation of investment income, capital or the proceeds of
sales of securities by foreign investors. In addition, if a
deterioration occurs in an emerging market's balance of payments,
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the market could impose temporary restrictions on foreign capital
remittances.
Fixed Income Since most foreign fixed income securities are not
rated, a Fund (principally the Total Return Fund) will invest in
foreign fixed income securities based on KFS's analysis without
relying on published ratings. Since such investments will be
based upon KFS's analysis rather than upon published ratings,
achievement of a Fund's goals may depend more upon the abilities
of KFS than would otherwise be the case.
The value of the foreign fixed income securities held by a Fund,
and thus the net asset value of the Fund's shares, generally will
fluctuate with (a) changes in the perceived creditworthiness of
the issuers of those securities, (b) movements in interest rates,
and (c) changes in the relative values of the currencies in which
a Fund's investments in fixed income securities are denominated
with respect to the U.S. Dollar. The extent of the fluctuation
will depend on various factors, such as the average maturity of a
Fund's investments in foreign fixed income securities, and the
extent to which a Fund hedges its interest rate, credit and
currency exchange rate risks. Many of the foreign fixed income
obligations in which a Fund will invest will have long
maturities. A longer average maturity generally is associated
with a higher level of volatility in the market value of such
securities in response to changes in market conditions.
Investments in sovereign debt, including Brady Bonds, involve
special risks. Brady Bonds are debt securities issued under a
plan implemented to other debtor nations to restructure their
outstanding commercial bank indebtedness. Foreign governmental
issuers of debt or the governmental authorities that control the
repayment of the debt may be unable or unwilling to repay
principal or pay interest when due. In the event of default,
there may be limited or no legal recourse in that, generally,
remedies for defaults must be pursued in the courts of the
defaulting party. Political conditions, especially a sovereign
entity's willingness to meet the terms of its fixed income
securities, are of considerable significance. Also, there can be
no assurance that the holders of commercial bank loans to the
same sovereign entity may not contest payments to the holders of
sovereign debt in the event of default under commercial bank loan
agreements. In addition, there is no bankruptcy proceeding with
respect to sovereign debt on which a sovereign has defaulted, and
a Fund may be unable to collect all or any part of its investment
in a particular issue.
Foreign investment in certain sovereign debt is restricted or
controlled to varying degrees, including requiring governmental
approval for the repatriation of income, capital or proceed of
sales by foreign investors. These restrictions or controls may
at times limit or preclude foreign investment in certain
sovereign debt or increase the costs and expenses of a Fund. A
significant portion of the sovereign debt in which a Fund may
invest is issued as part of debt restructuring and such debt is
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to be considered speculative. There is a history of defaults
with respect to commercial bank loans by public and private
entities issuing Brady Bonds. All or a portion of the interest
payments and/or principal repayment with respect to Brady Bonds
may be uncollateralized.
Privatized Enterprises The governments of certain foreign
countries have, to varying degrees, embarked on privatization
programs contemplating the sale of all or part of their interests
in state enterprises. The Fund's investments in the securities
of privatized enterprises include privately negotiated
investments in a government- or state-owned or controlled company
or enterprise that has not yet conducted an initial equity
offering, investments in the initial offering of equity
securities of a state enterprise or former state enterprise and
investments in the securities of a state enterprise following its
initial equity offering.
In certain jurisdictions, the ability of foreign entities, such
as the Fund, to participate in privatizations may be limited by
local law, or the price or terms on which the Fund may be able to
participate may be less advantageous than for local investors.
Moreover, there can be no assurance that governments that have
embarked on privatization programs will continue to divest their
ownership of state enterprises, that proposed privatizations will
be successful or that governments will not re-nationalize
enterprises that have been privatized.
In the case of the enterprises in which the Fund may invest,
large blocks of the stock of those enterprises may be held by a
small group of stockholders, even after the initial equity
offerings by those enterprises. The sale of some portion or all
of those blocks could have an adverse effect on the price of the
stock of any such enterprise.
Prior to making an initial equity offering, most state
enterprises or former state enterprises go through an internal
reorganization or management. Such reorganizations are made in
an attempt to better enable these enterprises to compete in the
private sector. However, certain reorganizations could result in
a management team that does not function as well as the
enterprise's prior management and may have a negative effect on
such enterprise. In addition, the privatization of an enterprise
by its government may occur over a number of years, with the
government continuing to hold a controlling position in the
enterprise even after the initial equity offering for the
enterprise.
Prior to privatization, most of the state enterprises in which
the Fund may invest enjoy the protection of and receive
preferential treatment from the respective sovereigns that own or
control them. After making an initial equity offering these
enterprises may no longer have such protection or receive such
preferential treatment and may become subject to market
competition from which they were previously protected. Some of
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these enterprises may not be able to effectively operate in a
competitive market and may suffer losses or experience bankruptcy
due to such competition.
Depository Receipts For many foreign securities, there are U.S.
Dollar-denominated American Depository Receipts ("ADRs"), which
are bought and sold in the United States and are generally issued
by domestic banks. ADRs represent the right to receive
securities of foreign issuers deposited in the domestic bank or a
correspondent bank. ADRs do not eliminate all the risk inherent
in investing in the securities of foreign issuers. However, by
investing in ADRs rather than directly in foreign issuers' stock,
the Fund avoids currency risks during the settlement period. In
general, there is a large, liquid market in the United States for
most ADRs. The Funds may also invest in European Depository
Receipts ("EDRs"), which are receipts evidencing an arrangement
with a European bank similar to that for ADRs and are designed
for use in the European securities markets. EDRs are not
necessarily denominated in the currency of the underlying
security.
Foreign Currency Transactions The Equity and Total Return Funds
may invest a limited portion of their assets in securities
denominated in foreign currencies. The value of a Fund's foreign
securities investments measured in U.S. Dollars may be affected
favorably or unfavorably by changes in foreign currency exchange
rates and exchange control regulations, and the Fund may incur
costs in connection with conversions between various currencies.
A Fund will conduct its foreign currency exchange transactions
either on a spot (i.e., cash) basis at the spot rate prevailing
in the foreign currency exchange market, or through forward
contracts to purchase or sell foreign currencies. A forward
foreign currency exchange contract involves an obligation to
purchase or sell a specific currency at a future date at a price
set at the time of the contract.
By entering into a forward contract in U.S. Dollars for the
purchase or sale of the amount of foreign currency involved in an
underlying security transaction, the Fund is able to protect
itself against a possible loss between trade and settlement dates
resulting from an adverse change in the relationship between the
U.S. Dollar and such foreign currency. However, this tends to
limit potential gains that might result from a positive change in
such currency relationships.
When the Fund's investment manager believes that the currency of
a particular foreign country may suffer a substantial decline
against the U.S. Dollar, it may enter into a forward contract to
sell an amount of foreign currency approximating the value of
some or all of the Fund's securities denominated in such foreign
currency. It is extremely difficult to forecast short-term
currency market movement, and whether such a short-term hedging
strategy would be successful is highly uncertain.
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It is impossible to forecast with absolute precision the market
value of portfolio securities at the expiration of a contract.
Accordingly, it may be necessary for a Fund to purchase
additional currency on the spot market (and bear the expense of
such purchase) if the market value of the security is less than
the amount of foreign currency the Fund is obligated to deliver
when a decision is made to sell the security and make delivery of
the foreign currency in settlement of a forward contract.
Conversely, it may be necessary to sell on the spot market some
of the foreign currency received upon the sale of the portfolio
security if its market value exceeds the amount of foreign
currency the Fund is obligated to deliver.
If a Fund retains the portfolio security and engages in an
offsetting transaction with respect to a forward contract, the
Fund will incur a gain or loss (as described below) to the extent
that there has been movement in forward contract prices. If the
Fund engages in an offsetting transaction, it may subsequently
enter into a new forward contract to sell the foreign currency.
Should forward prices decline during the period between a Fund's
entering into a forward contract for the sale of foreign currency
and the date it enters into an offsetting contract for the
purchase of the foreign currency, the Fund would realize a gain
to the extent the price of the currency it has agreed to sell
exceeds the price of the currency it has agreed to purchase.
Should forward prices increase, the Fund would suffer a loss to
the extent the price of the currency it has agreed to purchase
exceeds the price of the currency it has agreed to sell.
Although such contracts tend to minimize the risk of loss due to
a decline in the value of the hedged currency, they also tend to
limit any gain that might result should the value of such
currency increase. A Fund may have to convert its holdings of
foreign currencies into U.S. Dollars from time to time in order
to meet such needs as Fund expenses and redemption requests.
A Fund does not enter into forward contracts or maintain a net
exposure in such contracts where the Fund would be obligated to
deliver an amount of foreign currency in excess of the value of
the Fund's portfolio securities or other assets denominated in
that currency. A Fund does not intend to enter into forward
contracts for the purchase of a foreign currency if the Fund
would have more than 5% of the value of its total assets
committed to such contracts. The Sterling Funds segregate cash
or liquid high-grade securities in an amount not less than the
value of a Fund's total assets committed to forward foreign
currency exchange contracts entered into for the purchase of a
foreign currency. If the value of the securities segregated
declines, additional cash or securities are added so that the
segregated amount is not less than the amount of the Fund's
commitments with respect to such contracts. The Fund generally
does not enter into a forward contract with a term longer than
one year.
A Fund may also hedge its foreign currency exchange rate risk by
engaging in foreign currency financial futures transactions and
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by purchasing foreign currency options. A foreign currency call
rises in value if the underlying currency appreciates.
Conversely, a put rises in value if the underlying currency
depreciates. Through the purchase or sale of foreign currency
financial futures contracts, the Fund may be able to achieve many
of the same objectives as through forward foreign currency
exchange contracts more effectively and perhaps at a lower cost.
Unlike forward foreign currency exchange contracts, foreign
currency futures contracts and options on foreign currency
futures contracts are standardized as to amount and delivery
period and are traded on boards of trade and commodities
exchanges. Such contracts may provide greater liquidity and
lower cost than forward foreign currency exchange contracts. For
additional information concerning options transactions and
financial futures transactions, please see "Investment Objectives
and Policies - Additional Investment Information" in the
prospectus and related subsections above.
REPURCHASE AGREEMENTS
A Fund may invest in repurchase agreements, which are instruments
under which the Fund acquires ownership of a security from a
broker-dealer or bank that agrees to repurchase the security at a
mutually agreed upon time and price (which price is higher than
the purchase price), thereby determining the yield during the
Fund's holding period. In the event of a bankruptcy or other
default of a seller of a repurchase agreement, the Fund might
incur expenses in enforcing its rights, and could experience
losses, including a decline in the value of the underlying
securities and loss of income. The securities underlying a
repurchase agreement will be marked-to-market every business day
so that the value of such securities is at least equal to the
investment value of the repurchase agreement, including any
accrued interest thereon.
OTHER CONSIDERATIONS
HIGH YIELD (HIGH RISK) BONDS
As reflected in the prospectus, the Total Return and Municipal
Funds may each invest a portion of its assets in fixed income
securities that are in the lower rating categories of recognized
rating agencies or are non-rated. The Equity Fund may invest up
to 5% of its net assets in convertible bonds rated below
investment grade. These lower-rated or non-rated fixed income
securities are considered, on balance, as predominantly
speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation and
generally will involve more credit risk than securities in the
higher rating categories.
The market values of such securities tend to reflect individual
corporate developments to a greater extent than do those of
higher rated securities, which react primarily to fluctuations in
the general level of interest rates. Such lower rated securities
also tend to be more sensitive to economic conditions than are
higher rated securities. Adverse publicity and investor
perceptions, whether or not based on fundamental analysis,
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regarding lower rated bonds may depress the prices for such
securities. These and other factors adversely affecting the
market value of high yield securities will adversely affect the
Fund's net asset value. Although some risk is inherent in all
securities ownership, holders of fixed income securities have a
claim on the assets of the issuer prior to the holders of common
stock. Therefore, an investment in fixed income securities
generally entails less risk than an investment in common stock of
the same issuer.
High yield securities frequently are issued by corporations in
the growth stage of their development. They may also be issued
in connection with a corporate reorganization or a corporate
takeover. Companies that issue such high yielding securities
often are highly leveraged and may not have available to them
more traditional methods of financing. Therefore, the risk
associated with acquiring the securities of such issuers
generally is greater than is the case with higher rated
securities. For example, during an economic downturn or
recession, highly leveraged issuers of high yield securities may
experience financial stress. During such periods, such issuers
may not have sufficient revenues to meet their interest payment
obligations. The issuer's ability to service its debt
obligations may also be adversely affected by specific corporate
developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional
financing. The risk of loss from default by the issuer is
significantly greater for the holders of high yielding securities
because such securities are generally unsecured and are often
subordinated to other creditors of the issuer.
Zero coupon securities and pay-in-kind bonds involve additional
special considerations. Zero coupon securities are debt
obligations that do not entitle the holder to any periodic
payments of interest prior to maturity or a specified cash
payment date when the securities begin payment current interest
(the "cash payment date") and therefore are issued and traded at
a discount from their face amount or par value. The market
prices of zero coupon securities are generally more volatile than
the market prices of securities that pay interest periodically
and are likely to respond to changes in interest rates to a
greater degree than do securities paying interest currently with
similar maturities and credit quality. Zero coupon, pay-in-kind
or deferred interest bonds carry additional risk in that unlike
bonds that pay interest throughout the period to maturity, the
Fund will realize no cash until the cash payment date unless a
portion of such securities is sold and, if the issuer defaults,
the Fund may obtain no return at all on its investment.
COLLATERALIZED OBLIGATIONS
A Fund will currently invest in only those collateralized
obligations that are fully collateralized and that meet the
quality standards otherwise applicable to the Fund's investments.
Fully collateralized means that the collateral will generate cash
flows sufficient to meet obligations to holders of the
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collateralized obligations under even the most conservative
prepayment and interest rate projections. Thus, collateralized
obligations are structured to anticipate a worst case prepayment
condition and to minimize the reinvestment rate risk for cash
flows between coupon dates for the collateralized obligations. A
worst case prepayment condition generally assumes immediate
prepayment of all securities purchased at a premium and zero
prepayment of all securities purchased at a discount.
Reinvestment rate risk may be minimized by assuming very
conservative reinvestment rates and by other means such as by
maintaining the flexibility to increase principal distributions
in a low interest rate environment. The effective credit quality
of the collateralized obligations in such instances is the credit
quality of the issuer of the collateral. The requirements as to
collateralization are determined by the issuer or sponsor of the
collateralized obligation in order to satisfy rating agencies, if
rated. A Fund does not currently intend to invest more than 5%
of its total assets in collateralized obligations that are
collateralized by a pool of credit card or automobile receivables
or other types of assets rather than a pool of mortgages,
mortgage-backed securities or U.S. Government Securities.
Currently, none of the Funds intends to invest more than 5% of
its total assets in inverse floaters. The Money Market Fund does
not invest in inverse floaters.
Payments of principal and interest on the underlying collateral
securities are not passed through directly to the holders of the
collateralized obligations as such. Collateralized obligations
often are issued in two or more classes with varying maturities
and stated rates of interest. Because interest and principal
payments on the underlying securities are not passed through
directly to holders of collateralized obligations, such
obligations of varying maturities may be secured by a single
portfolio or pool of securities, the payments on which are used
to pay interest on each class and to retire successive maturities
in sequence. These relationships may in effect "strip" the
interest payments from principal payments of the underlying
securities and allow for the separate purchase of either the
interest or the principal payments, sometimes called interest
only ("IO") and principal only ("PO") securities. Collateralized
obligations are designed to be retired as the underlying
securities are repaid. In the event of prepayment on or call of
such securities, the class of collateralized obligation first to
mature generally will be paid down first. Therefore, although in
most cases the issuer of collateralized obligations will not
supply additional collateral in the event of such prepayment,
there will be sufficient collateral to secure collateralized
obligations that remain outstanding. It is anticipated that no
more than 5% of a Fund's total assets will be invested in IO and
PO securities. Governmentally-issued and privately-issued IO's
and PO's will be considered illiquid for purposes of a Fund's
limitation on illiquid securities, however, the Board of Trustees
may adopt guidelines under which governmentally-issued IO's and
PO's may be determined to be liquid.
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ZERO COUPON GOVERNMENT SECURITIES
Subject to its investment objective and policies, a Fund may
invest in zero coupon U.S. Government securities. Zero coupon
bonds are purchased at a discount from the face amount. The
buyer receives only the right to receive a fixed payment on a
certain date in the future and does not receive any periodic
interest payments. These securities may include those created
directly by the U.S. Treasury and those created as collateralized
obligations through various proprietary custodial, trust or other
relationships (see "Investment Objectives and Policies -
Collateralized Obligations" in the prospectus). The effect of
owning instruments which do not make current interest payments is
that a fixed yield is earned not only on the original investment
but also, in effect, on all discount accretion during the life of
the obligation. This implicit reinvestment of earnings at the
same rate eliminates the risk of being unable to reinvest
distributions at a rate as high as the implicit yield on the zero
coupon bond, but at the same time eliminates any opportunity to
reinvest earnings at higher rates. For this reason, zero coupon
bonds are subject to substantially greater price fluctuations
during periods of changing market interest rates than those of
comparable securities that pay interest currently, which
fluctuation is greater as the period to maturity is longer. Zero
coupon bonds created as collateralized obligations are similar to
those created through the U.S. Treasury, but the former
investments do not provide absolute certainty of maturity or of
cash flows after prior classes of the collateralized obligations
are retired. No Fund currently intends to invest more than 5% of
its net assets in zero coupon U.S. Government securities during
the coming year.
ILLIQUID AND RESTRICTED SECURITIES
An "illiquid" security is generally considered to be a security
that cannot be disposed of within seven days in the ordinary
course of business at approximately the amount at which it is
valued. This definition would include securities that are "not
readily marketable." "Restricted" securities generally include
securities that are not registered under the Securities Act of
1933 ("1933 Act") and are subject to legal or contractual
restrictions upon resale. Restricted securities are not
necessarily "illiquid" and can often be sold in privately
negotiated transactions or in a registered public offering.
There is an increasing number of securities being issued without
registration under the 1933 Act for which a liquid secondary
market exists among institutional investors such as the Series.
These securities are often called "144A" securities. Rule 144A
establishes a "safe harbor" from the registration requirements of
the 1933 Act for resale of certain securities to qualified
institutional buyers.
ADDITIONAL INFORMATION - GOVERNMENT FUND
Mortgages included in single family residential mortgage pools
backing an issue of GNMA Certificates have a maximum maturity of
30 years. Scheduled payments of principal and interest are made
to the registered holders of GNMA Certificates (such as the Fund)
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each month. Unscheduled prepayments of mortgages included in
these pools occur as a result of the prepayment or refinancing of
such mortgages by homeowners or as a result of the foreclosure of
such mortgages. Such prepayments are passed through to the
registered holders of GNMA Certificates with the regular monthly
payments of principal and interest, which has the effect of
reducing future payments on such Certificates. That portion of
monthly payments received by the Fund which represents interest
and discount will be included in the Fund's net investment
income. See "Dividends and Taxes" in the prospectus. Principal
payments on a GNMA Certificate will be reinvested by the Fund.
The National Housing Act provides that the full faith and credit
of the United States is pledged as to the timely payment of
principal and interest by GNMA of amounts due on these GNMA
Certificates, and an assistant attorney general of the United
States has rendered an opinion that this guarantee by GNMA is a
general obligation of the United Sates backed by its full faith
and credit.
ADDITIONAL INFORMATION - MUNICIPAL FUND
Municipal Securities (as defined in the prospectus) are debt
obligations issued to obtain funds for various public purposes,
including the construction of a wide range of public facilities
such as airports, bridges, highways, housing, hospitals, mass
transportation, schools, streets and water and sewer works.
Other public purposes for which Municipal Securities may be
issued include the refunding of outstanding obligations,
obtaining funds for general operating expenses and the obtaining
of funds to loan to other public institutions and facilities. In
addition, certain types of industrial development bonds are
issued by or on behalf of public authorities to obtain funds to
provide privately-operated housing facilities, sports facilities,
convention or trade show facilities, airport, mass transit, port
or parking facilities, air or water pollution control facilities
and certain local facilities for water supply, gas, electricity
or sewage or sold waste disposal. Such obligations, which may
include lease arrangements, are included within the term
Municipal Securities if the interest paid thereon qualifies as
exempt from federal income tax. Other types of industrial
development bonds, the proceeds of which are used for the
construction, equipment, repair or improvement of privately
operated industrial or commercial facilities, may constitute
Municipal Securities, although the current federal tax laws place
substantial limitations on the size of such issues.
The two principal classifications of Municipal Securities are
"general obligation" and "revenue" bonds. General obligation
bonds are secured by the issuer's pledge of its faith, credit and
taxing power for the payment of principal and interest. Revenue
bonds are payable only from the revenues derived from a
particular facility or class of facilities or, in some cases,
from the proceeds of a special excise or other specific revenue
source. Industrial development bonds that are Municipal
Securities are in most cases revenue bonds and do not generally
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constitute the pledge of the credit of the issuer of such bonds.
There are, of course, variations in the degree of risk of
Municipal Securities, both within a particular classification and
between classifications, depending on numerous factors.
A tax-exempt lease is an obligation, often a lease purchase or
installment contract, pursuant to which a governmental user of a
capital asset, such as an item of equipment, agrees to make
payments of the purchase price plus interest over a period of
years, normally with the right to purchase the asset at the
termination of the lease for a nominal amount. Tax-exempt leases
normally have a term of only two to seven years, a relatively
short period of time, and often have a higher interest rate than
tax-exempt investments of a comparable term. Currently, it is
anticipated that not more than 5% of the net assets of the
Municipal Fund will be invested in tax-exempt leases during the
coming year.
The yields on Municipal Securities are dependent on a variety of
factors, including general money market conditions, general
conditions of the Municipal Securities market, size of a
particular offering, the maturity of the obligation and rating of
the issue. The ratings of Moody's Investors Service, Inc.,
Standard & Poor's Corporation, Fitch Investors Service, Inc. or
Duff & Phelps Credit Rating Co. and any other Nationally
Recognized Statistical Rating Organization ("NRSRO") represent
their opinions as to the quality of the Municipal Securities
which they undertake to rate. It should be emphasized, however,
that ratings are relative and subjective and are not absolute
standards of quality. Consequently, Municipal Securities with
the same maturity, coupon and rating may have different yields
while Municipal Securities of the same maturity and coupon with
different ratings may have the same yield.
Provisions of the federal bankruptcy statutes relating to the
adjustment of debts of political subdivisions and authorities of
states of the United States provide that, in certain
circumstances, such subdivisions or authorities may be authorized
to initiate bankruptcy proceedings without prior notice to or
consent of creditors, which proceedings could result in material
and adverse modification or alteration of the rights of holders
of obligations issued by such subdivisions or authorities.
The Municipal Fund does not intend to invest more than 25% of its
total assets in any one state.
Litigation challenging the validity under state constitutions of
present systems of financing public education has been initiated
or adjudicated in a number of states, and legislation has been
introduced to effect changes in public school finances in some
states. In other instances there has been litigation challenging
the changes in public school finances in some states. In other
instances there has been litigation challenging the issuance of
pollution control revenue bonds or the validity of their issuance
under state or federal law which litigation could ultimately
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affect the validity of those Municipal Securities or the tax-free
nature of the interest thereon.
On a temporary basis because of market conditions, the Municipal
Fund may purchase any of the following fixed income obligations,
the interest on which is subject to federal income taxes:
obligations of the U.S. Government, its agencies or
instrumentalities; debt securities rated within the three highest
grades by an NRSRO; commercial paper rated in the highest two
grades by any of the NRSRO's; certificates of deposit of domestic
banks with assets of $1 billion or more; and Municipal Securities
or any of the foregoing temporary investments subject to short-
term repurchase agreements. Dividends from interest income from
temporary investments may be taxable to shareholders as ordinary
income. See "Dividends and Taxes" in the prospectus. For a
description of the ratings of commercial paper and other debt
securities permitted as temporary investments, see "Appendix -
Ratings of Fixed Income Investments in the prospectus."
PORTFOLIO TRANSACTIONS
Kemper Financial Services, Inc. ("KFS") is the investment manager
or principal underwriter for the Funds and the Kemper Funds and
also furnishes investment management services to other clients
including Kemper Corporation and the Kemper insurance companies.
KFS is the sole shareholder of Kemper Asset Management Company
and Kemper Investment Management Company Limited. These three
entities share some common research and trading facilities. At
times, investment decisions may be made to purchase or sell the
same investment security for a Fund and for one or more of the
other clients managed by KFS. When two or more of such clients
are simultaneously engaged in the purchase or sale of the same
security, the transactions are allocated as to amount and price
in a manner considered equitable to each and so that each
receives, to the extent practicable, the average price of such
transactions, which may or may not be beneficial to a Fund. It
is the opinion of the Board of Trustees that the benefits
available because of the KFS organization outweigh any
limitations that may arise from simultaneous transactions.
KFS, in effecting purchases and sales of portfolio securities for
a Fund, will implement the Funds' policy of seeking best
execution of orders, which includes best net prices, except to
the extent that KFS may be permitted to pay higher brokerage
commissions for research services as described below. Consistent
with this policy, orders for portfolio transactions are placed
with broker-dealer firms giving consideration to the quality,
quantity and nature of each firm's professional services, which
include execution, clearance procedures, wire service quotations
and statistical and other research information provided to the
Funds and KFS. Any research benefits derived are available for
all clients including those of affiliated companies. Since
statistical and other research information is only supplementary
to the research efforts of KFS and still must be analyzed and
reviewed by its staff, the receipt of research information is not
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<PAGE>
expected to materially reduce expenses. In selecting among firms
believed to meet the criteria for handling a particular
transaction, KFS may give consideration to those firms that have
sold or are selling shares of the Funds or receiving service
payments, as well as to those firms that provide market,
statistical and other research information to the Funds and KFS,
although KFS is not authorized to pay higher commissions or, in
the case of principal trades, higher prices to firms that provide
such services except as provided below.
KFS may in certain instances be permitted to pay higher brokerage
commissions solely for receipt of market, statistical and other
research services. Subject to Section 28(e) of the Securities
Exchange Act of 1934 and procedures adopted by the Board of
Trustees, a Fund could pay a firm that provides research services
to KFS a commission for effecting a securities transaction for
the Fund in excess of the amount other firms would have charged
for the transaction if KFS determines in good faith that the
greater commission is reasonable in relation to the value of the
research services provided by the executing firm viewed in terms
either of a particular transaction or KFS's overall
responsibilities to the Fund or other clients. Not all of such
research services may be useful or of value in advising a
particular Fund. Research benefits will be available for all
clients of KFS and its subsidiaries. The investment management
fee paid by a Fund to KFS is not reduced because KFS receives
these research services.
The Funds may purchase instruments issued by banks which are
receiving service payments or commissions; however, no
preferences will be given in making such portfolio purchases.
Money market instruments are normally purchased in principal
transactions directly from the issuer or from an underwriter or
market maker. There are normally no brokerage commissions paid
for such purchases. Purchases from underwriters include a
commission or concession paid by the issuer to the underwriter,
and purchases from dealers serving as market makers include the
spread between the bid and asked prices.
BUYING AND SELLING SHARES
SUSPENSION OF RIGHT OF REDEMPTION
Sterling Funds may suspend the right of redemption or delay
payment more than seven days (a) during any period when the New
York Stock Exchange ("Exchange") is closed other than customary
weekend and holiday closings or during any period on which
trading on the Exchange is restricted, (b) during any period when
an emergency exists as a result of which (i) disposal of the
Fund's investments is not reasonably practicable or (ii) it is
not reasonably practicable for the Fund to determine the value of
its net assets, or (c) for such other periods as the Securities
and Exchange Commission may by order permit for the protection of
Sterling Funds' shareholders.
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<PAGE>
REDEMPTION IN KIND
Although it is Sterling Funds' present policy to redeem in cash,
if the Board of Trustees determines that a material adverse
effect would be experienced by the remaining shareholders if
payment were made wholly in cash, Sterling Funds will pay the
redemption price in whole or in part by a distribution of
portfolio securities in lieu of cash, in conformity with the
applicable rules of the Securities and Exchange Commission,
taking such securities at the same value used to determine net
asset value, and selecting the securities in such manner as the
Board of Trustees may deem fair and equitable. If such a
distribution occurs, shareholders receiving securities and
selling them could receive less than the redemption value of such
securities and in addition would incur certain transaction costs.
Such a redemption would not be as liquid as a redemption made
entirely in cash. Sterling Funds have elected to be governed by
Rule 18f-1 under the Investment Company Act of 1940 pursuant to
which Sterling Funds are obligated to redeem shares solely in
cash up to the lesser of $250,000 or 1 percent of the net asset
value of a Fund during any 90-day period for any one shareholder
of record.
INVESTMENT MANAGER AND DISTRIBUTOR
INVESTMENT MANAGER
Kemper Financial Services, Inc. ("KFS") is the Sterling Funds'
investment manager. Pursuant to an investment management
agreement, KFS acts as each Fund's investment adviser, manages
its investments, administers its business affairs, furnishes
office facilities and equipment, provides clerical, bookkeeping
and administrative services and permits any of its officers or
employees to serve without compensation as trustees or officers
of Sterling Funds if elected to such positions. Sterling Funds
pay the fees and expenses of independent auditors, counsel,
custodian and transfer agent and the cost of share certificates,
reports and notices to shareholders, costs of calculating net
asset value, brokerage commissions or transaction costs, taxes,
registration fees, the fees and expenses of qualifying Sterling
Funds and its shares under federal securities laws and membership
dues in the Investment Company Institute or any similar
organization. Sterling Funds expenses are generally allocated
among each Fund on the basis of relative net assets at the time
of allocation, except that expenses directly attributable to a
particular Fund are charged to that Fund.
The investment management agreement continues in effect from year
to year for each Fund so long as its continuation is approved at
least annually by a majority of the trustees who are not parties
to such agreement or interested persons of any such party except
in their capacity as trustees and by the shareholders of each
Fund or the Board of Trustees. It may be terminated at any time
upon 60 days' notice by either party, or by a majority vote of
the outstanding shares of a Fund with respect to that Fund, and
will terminate automatically upon assignment. If continuation is
not approved for a Fund, the investment management agreement
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nevertheless may continue in effect for the Funds for which it is
approved and KFS may continue to serve as investment manager for
the Fund for which it is not approved to the extent permitted by
the Investment Company Act of 1940. Additional funds may be
subject to a different agreement. The investment management
agreement provides that KFS shall not be liable for any error of
judgment or of law, or for any loss suffered by the Funds in
connection with the matters to which the agreement relates,
except a loss resulting from willful misfeasance, bad faith or
gross negligence on the part of KFS in the performance of its
obligations and duties, or by reason of its reckless disregard of
its obligations and duties under the agreement.
For the services and facilities furnished, each Fund pays KFS an
annual investment management fee, payable monthly, at the rates
described in the prospectus. Pursuant to the investment
management agreement, KFS has agreed to reimburse each Fund
should the operating expenses of the Fund, including the
investment management fee of KFS, but excluding taxes, interest,
distribution services fee, if any, extraordinary expenses,
brokerage commissions or transaction costs and any other properly
excludable expenses, exceed the applicable state expense
limitations. Sterling Funds believes that the most restrictive
state expense limitation currently in effect would require that
such operating expenses not exceed 2.5% of the first $30 million
of the average daily net assets, 2% of the next $70 million and
1.5% of average daily net assets over $100 million. Under such
state expense limitation, custodian costs attributable to foreign
securities that are in excess of similar domestic custodian costs
are excluded from operating expenses. In addition, KFS has
agreed to temporarily absorb operating expenses as described in
the prospectus.
Certain trustees or officers of Sterling Funds are also directors
or officers of KFS as indicated under "Officers and Trustees."
CUSTODIAN AND SHAREHOLDER SERVICES
Investors Fiduciary Trust Company ("IFTC"), 127 West 10th Street,
Kansas City, Missouri 64105, as custodian, and the United
Missouri Bank of Kansas City, N.A., Tenth and Grand Streets,
Kansas City, Missouri 64105, as sub-custodian, have custody of
all securities and cash of Sterling Funds maintained in the
United States. The Chase Manhattan Bank, N.A., Chase MetroTech
Center, Brooklyn, New York 11245, as custodian, has custody of
all securities and cash held outside the United States. They
attend to the collection of principal and income, and payment for
and collection of proceeds of securities bought and sold by each
Fund. IFTC is also Sterling Funds transfer agent and dividend-
paying agent. IFTC is owned equally by KFS and DST Systems, Inc.
("DST"). DST is not affiliated with KFS. Pursuant to an
agreement with IFTC, Supervised Service Company, Inc. ("SSC"), an
affiliate of KFS, serves as "Shareholder Service Agent." IFTC
receives an annual fee as custodian for the Fund, payable
monthly, at a rate of $.085 per $1,000 of average monthly net
assets (in the case of the Money Market Fund, a rate ranging from
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<PAGE>
$.40 to $.05 per $1,000) plus certain transaction charges and
out-of-pocket expense reimbursement. (The effective custodian
fee rate for the Money Market Fund is based upon the average
daily net assets of all Kemper Funds of the money market type for
which IFTC serves as custodian.) IFTC receives as transfer
agent, and pays to SSC, annual account fees of $6 per account (a
maximum of $8 for Money Market Fund accounts) plus account set
up, transaction, maintenance and disaster recovery charges and
out-of-pocket expense reimbursement. IFTC's fee is reduced by
certain earnings credits in favor of the Fund.
INDEPENDENT AUDITORS AND REPORTS TO SHAREHOLDERS
Sterling Funds' independent auditors, Ernst & Young, 233 South
Wacker Drive, Chicago, Illinois 60606, audit and report on each
Fund's annual financial statements, review certain regulatory
reports and the Funds' federal income tax returns, and perform
other professional accounting, auditing and advisory services
when engaged to do so by Sterling Funds. Shareholders will
receive annual audited financial statements and semi-annual
unaudited financial statements.
DISTRIBUTOR
KFS also serves as distributor and principal underwriter for
Sterling Funds. KFS bears all its expenses of providing services
pursuant to the distribution services agreement between KFS and
Sterling Funds, including the payment of any commissions. KFS
provides for the preparation and distribution of advertising or
sales literature, and bears the cost of printing and mailing
prospectuses to persons other than shareholders. KFS bears the
cost of qualifying and maintaining the qualification of a Fund's
shares for sale under the securities laws of the various states
and Sterling Funds bears the expense of registering shares with
the Securities and Exchange Commission.
The distribution services agreement continues in effect from year
to year so long as such continuance is approved at least annually
by a vote of the Board of Trustees of the Funds, including the
Trustees who are not interested persons of the Funds and who have
no direct or indirect financial interest in the agreement. The
agreement automatically terminates in the event of its assignment
and may be terminated at any time without penalty by Sterling
Funds or by KFS upon six months' notice.
ADMINISTRATIVE SERVICES
Administrative services are provided under an administrative
services agreement ("administrative agreement") with KFS. For
the services under the administrative agreement, each Fund,
except the Money Market Fund, pays KFS an administrative services
fee, payable monthly, at an annual rate of .25 of 1% of average
daily net assets of the Fund. As reflected in the prospectus
(see "How the Funds are Managed"), the Board of Trustees may
implement the administrative agreement for the Money Market Fund.
KFS has entered into related arrangements with various financial
services firms, such as broker-dealers or banks ("firms"), that
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provide services and facilities for their customers or clients
who are shareholders of a Fund. The firms provide such office
space and equipment, telephone facilities and personnel as is
necessary or beneficial for providing information and services to
their clients. Such services and assistance may include, but are
not limited to, answering routine inquiries regarding the Funds
and their special features, and such other services as may be
agreed upon from time to time and permitted by applicable
statute, rule or regulation. KFS pays each firm a service fee,
payable quarterly, at an annual rate of up to .25 of 1% of the
net assets in Fund accounts (except Money Market Fund accounts)
that it maintains and services commencing with the month after
investment. Firms to which service fees may be paid include
broker-dealers affiliated with KFS. KFS also may provide some of
the above services and may retain any portion of the fee under
the administrative agreement not paid to firms to compensate
itself for administrative functions performed for a Fund.
Currently, the administrative service fee payable to KFS for a
Fund is based only upon Fund assets in accounts for which there
is a firm listed on the Fund's records and it is intended that
KFS will pay all the administrative services fee that it receives
from a Fund to firms in the form of service fees. The effective
administrative services fee rate to be charged against all assets
of a Fund while this procedure is in effect will depend upon the
proportion of Fund assets that is in accounts for which there is
a firm of record. The Board of Trustees, in its discretion, may
approve basing the fee to KFS on all Fund assets in the future.
As described in the prospectus (see "How the Funds are Managed"),
KFS may pay firms from its own assets a sponsorship fee.
OFFICERS AND TRUSTEES
The officers and trustees of Sterling Funds, their principal
occupations and their affiliations, if any, with the investment
manager and distributor and principal underwriter, are as
follows:
CHARLES M. KIERSCHT, President and Trustee*, 120 South LaSalle
Street, Chicago, Illinois; Chairman of the Board, Chief Executive
Officer, President and Director, Kemper Financial Services, Inc.
and Kemper Financial Companies, Inc.; Executive Vice President
and Director, Kemper Corporation.
ARTHUR R. GOTTSCHALK, Trustee, 2512 Braeburn Road, Flossmoor,
Illinois; Retired; formerly President, Illinois Manufacturers
Association; Trustee, Illinois Masonic Medical Center; member,
Board of Governors, Heartland Institute/Illinois; formerly,
Illinois State Senator.
FREDERICK T. KELSEY, Trustee, 3133 Laughing Gull Court, John's
Island, South Carolina; Retired; formerly, consultant to Goldman,
Sachs & Co.; formerly, President, Treasurer and Trustee of
Institutional Liquid Assets and its affiliated mutual funds,
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presently comprising the Goldman Sachs Funds Group and currently
Trustee of certain funds in that Group.
STEPHEN B. TIMBERS, Vice President and Trustee*, Kemper Center,
Long Grove, Illinois; President, Chief Operating Officer and
Director, Kemper Corporation; Director, Kemper Financial
Services, Inc.and Kemper Financial Companies, Inc.
JOHN B. TINGLEFF, Trustee, 2015 South Lake Shore Drive, Harbor
Springs, Michigan; President, Tingleff & Associates (management
consulting firm); formerly, Senior Vice President, Continental
Illinois National Bank & Trust Company.
JOHN G. WEITHERS, Trustee, 311 Springlake, Hinsdale, Illinois;
Formerly, Chairman of the Board and Chief Executive Officer,
Chicago Stock Exchange.
SEAMON A. LINCOLN, Vice President*, 120 South LaSalle Street,
Chicago, Illinois; Chief Investment Officer and Director, Kemper
Financial Services, Inc.; Senior Vice President and Chief
Investment Officer, Kemper Corporation.
JOHN E. PETERS, Vice President*, 120 South LaSalle Street,
Chicago, Illinois; Senior Executive Vice President, Kemper
Financial Services, Inc.
J. PATRICK BEIMFORD, JR., Vice President*, 120 South LaSalle
Street, Chicago, Illinois; Senior Vice President/Director of
Fixed Income Investments, Kemper Financial Services, Inc.
JAMES H. COXON, Vice President*, 120 South LaSalle Street,
Chicago, Illinois; Executive Vice President, Kemper Financial
Services, Inc.; formerly, Senior Vice President, Head of
Equities, CIGNA Investments, Inc.
CHRISTOPHER J. MIER, Vice President*, 120 South LaSalle Street,
Chicago, Illinois; First Vice President, Kemper Financial
Services, Inc.
JAMES R. NEEL, Vice President*, 120 South LaSalle Street,
Chicago, Illinois; Senior Vice President, Kemper Financial
Services, Inc.
FRANK J. RACHWALSKI, JR., Vice President*, 120 South LaSalle
Street, Chicago, Illinois; Senior Vice President, Kemper
Financial Services, Inc.
ROBERT H. SCHUMACHER, Vice President*, 120 South LaSalle Street,
Chicago, Illinois; Senior Vice President, Kemper Financial
Services, Inc.; formerly, Manager, Nomura Securities
International.
GORDON P. WILSON, Vice President*, 120 South LaSalle Street,
Chicago, Illinois; Executive Vice President, Kemper Financial
Services, Inc.
B-31
<PAGE>
CHARLES F. CUSTER, Vice President and Assistant Secretary*, 222
North LaSalle Street, Chicago, Illinois; Partner, Vedder, Price,
Kaufman & Kammholz (attorneys), Legal Counsel to the Fund.
JEROME L. DUFFY, Treasurer*, 120 South LaSalle Street, Chicago,
Illinois; Senior Vice President, Kemper Financial Services, Inc.
ROBERT J. ENGLING, Vice President and Secretary*, 120 South
LaSalle Street, Chicago, Illinois; Attorney, Executive Vice
President, Secretary and General Counsel, Kemper Financial
Services, Inc.
PHILIP J. COLLORA, Vice President and Assistant Secretary*, 120
South LaSalle Street, Chicago, Illinois; Attorney, First Vice
President and Assistant Secretary, Kemper Financial Services,
Inc.
ELIZABETH C. WERTH, Assistant Secretary*, 120 South LaSalle
Street, Chicago, Illinois; Vice President and Director of State
Registrations, Kemper Financial Services, Inc.
*Interested persons as defined in the Investment Company Act of
1940.
The officers and trustees of Sterling Funds serve in similar
capacities with some or all of the Kemper Funds. The trustees
and officers who are "interested persons" as designated above
receive no compensation from the Funds. Each Fund pays trustees
who are not designated above as "interested persons" an annual
retainer of $1,500 plus an attendance fee of $200 per Board
meeting and $100 per committee meeting attended. Certain of
these trustees have entered into deferred compensation agreements
with Sterling Funds under which payment of the current fees is
deferred. Deferred amounts accrue interest each month. As of
May 26, 1994, the officers and trustees of the Fund, as a group,
owned less than 1% of the then outstanding shares of each Fund
and KFS owned of record all of the outstanding shares of each
Fund.
DIVIDENDS AND TAXES
DIVIDENDS
The Money Market Fund calculates its dividends based on its daily
net investment income. For this purpose, the net investment
income of the Money Market Fund consists of (1) accrued interest
income plus or minus amortized discount or premium, (2) plus all
net short-term realized gains on investments and (3) minus
accrued expenses allocated to the Fund. Expenses are accrued
each day. While the Money Market Fund's investments are valued
at amortized cost (see "Net Asset Value"), there will be no
unrealized gains or losses on such investments. The dividend
policies of the Funds other than the Money Market Fund are
contained in the prospectus.
B-32
<PAGE>
GENERAL
The Funds may at any time vary their dividend practices and,
therefore, each reserves the right from time to time either to
distribute or retain for reinvestment such of its net investment
income and its net short-term capital gains as the Board of
Trustees determines appropriate under the then current
circumstances. In particular, and without limiting the
foregoing, the Funds may make additional distributions of net
investment income or capital gain net income in order to satisfy
the minimum distribution requirements contained in the Internal
Revenue Code (the "Code"). Under the Code, a 4% excise tax is
imposed on the excess of the required distribution for a calendar
year over the distributed amount for such calendar year. The
distributed amount includes dividends declared in October,
November and December to shareholders of record as of a specified
date in one of those months and paid during the following
January. The required distribution is the sum of 98% of a Fund's
net investment income for the calendar year plus 98% of its
capital gain net income for the one year period ended October 31,
plus any undistributed net investment income from the prior
calendar year, plus any undistributed capital gain net income
from the one year period ended October 31 in the prior calendar
year, minus any overdistribution in the prior calendar year.
Each Fund intends to declare or distribute dividends during the
appropriate periods of an amount sufficient to prevent imposition
of the 4% excise tax.
TAXES
Each Fund intends to qualify as a regulated investment company
under Subchapter M of the Code and, if so qualified, will not be
liable for federal income taxes to the extent its earnings are
distributed. One Subchapter M requirement to be satisfied is
that less than 30% of the Fund's gross income must be derived
from gains (not reduced by losses) from the sale or other
disposition of securities and certain other investments held for
less than three months. A Fund may be limited in its options and
futures and foreign currency transactions (if applicable) in
order to prevent recognition of such gains.
A Fund's options, futures and foreign currency transactions (if
applicable) are subject to special tax provisions that may
accelerate or defer recognition of certain gains or losses,
change the character of certain gains or losses, or alter the
holding periods of certain of the Fund's securities.
The mark-to-market rules of the Code may require a Fund to
recognize unrealized gains and losses on certain options and
futures held by the Fund (if applicable) at the end of the fiscal
year. Under these provisions, 60% of any capital gain or loss
recognized will generally be treated as long-term and 40% as
short-term. However, although certain forward contracts and
futures contracts on foreign currency are marked-to-market, the
gain or loss is generally ordinary under Section 988. In
addition, the straddle rules of the Code would require deferral
of certain losses realized on positions of a straddle to the
B-33
<PAGE>
extent that the Fund had unrealized gains in offsetting positions
at year end.
A shareholder who redeems shares of a Fund will recognize capital
gain or loss for federal income tax purposes measured by the
difference between the value of the shares redeemed and the basis
of the shares. Any loss recognized on the redemption of Fund
shares held six months or less will be treated as long-term
capital loss to the extent that the shareholder has received any
long-term capital gain dividends on such shares. A shareholder
who has redeemed shares of any Fund may reinvest the amount
redeemed at net asset value at the time of the reinvestment in
shares of any Fund within six months of the redemption as
provided in the prospectus. If the redeemed shares were held
less than 91 days, then the lesser of (a) the sales charge waived
on the reinvestment shares, or (b) the sales charge incurred on
the redeemed shares, is included in the basis of the reinvestment
shares and is not included in the basis of the redeemed shares.
If a shareholder realized a loss on the redemption of Fund shares
and reinvests in shares of the same Fund within 30 days before or
after the redemption, the transactions may be subject to the wash
sale rules resulting in a postponement of the recognition of such
loss for federal income tax purposes. An exchange of Fund shares
for shares of another Fund is treated as a redemption and
reinvestment for federal income tax purposes upon which gain or
loss may be recognized.
Gains and losses attributable to fluctuations in the value of
foreign currencies will be characterized generally as ordinary
gain or loss under Section 988 of the Code. For example, if a
Fund sold a foreign bond and part of the gain or loss on the sale
was attributable to an increase or decrease in the value of a
foreign currency, then the currency gain or loss may be treated
as ordinary income or loss. If such transactions result in
greater net ordinary income, the dividends paid by the Fund will
be increased; if the result of such transactions is lower net
ordinary income, a portion of dividends paid could be classified
as a return of capital.
Investment income received by the Equity and Total Return Funds
derived from foreign securities may be subject to foreign income
taxes withheld at the source. Because the amount of a Fund's
investments in various countries will change from time to time,
it is not possible to determine the effective rate of such taxes
in advance.
Each Fund is required by law to withhold 31% of taxable dividends
and redemption proceeds paid to certain shareholders who do not
furnish a correct taxpayer identification number (in the case of
individuals, a social security number) and in certain other
circumstances. Trustees of qualified retirement plans and
403(b)(7) accounts are required by law to withhold 20% of the
taxable portion of any distribution that is eligible to be
"rolled over". The 20% withholding requirement does not apply to
distributions from Individual Retirement Accounts ("IRAs") or any
B-34
<PAGE>
part of a distribution that is transferred directly to another
qualified retirement plan, 403(b)(7) account, or IRA.
Shareholders should consult their tax advisers regarding the 20%
withholding requirement.
Shareholders who are non-resident aliens are subject to U.S.
withholding tax on ordinary income dividends (whether received in
cash or shares) at a rate of 30% or such lower rate as prescribed
by an applicable tax treaty.
MUNICIPAL FUND
Interest on indebtedness which is incurred to purchase or carry
shares of a mutual fund such as the Municipal Fund which
distributes exempt-interest dividends during the year is not
deductible for federal income tax purposes. Further, the
Municipal Fund may not be an appropriate investment for persons
who are "substantial users" of facilities financed by industrial
development bonds held by the Funds or are "related persons" to
such users; such persons should consult their tax advisers before
investing in the Fund.
The "Superfund Act of 1986" (the "Superfund Act"), imposes a
separate tax on corporations at a rate of 0.12 percent of the
excess of such corporation's "modified alternative minimum
taxable income" over $2 million. A portion of tax-exempt
interest, including exempt-interest dividends from the Municipal
Fund, may be includible in modified alternative minimum taxable
income. Corporate shareholders are advised to consult with their
tax advisers with respect to the consequences of the Superfund
Act.
In the case of shareholders holding shares of the Municipal Fund
for six months or less and subsequently selling those shares at a
loss after receiving an exempt-interest dividend, the loss will
be disallowed to the extent of the exempt-interest dividends
received. However, the Secretary of the Treasury may issue
regulations to shorten the required holding period from six
months to 31 days.
Exempt-interest dividends, except to the extent of interest from
"private activity bonds", are not treated as a tax preference
item. For a corporate shareholder, however, such dividends will
be included in determining such corporate shareholder's "adjusted
current earnings." Seventy-five percent of the excess, if any,
of "adjusted current earnings" over the corporate shareholder's
alternative minimum taxable income with certain adjustments will
be a tax preference item. Corporate shareholders are advised to
consult their tax advisers with respect to alternative minimum
tax consequences.
Shareholders will be required to disclose on their federal income
tax returns the amount of tax-exempt interest earned during the
year, including exempt-interest dividends received from the
Municipal Fund.
B-35
<PAGE>
NET ASSET VALUE
For all the Funds except the Money Market Fund, the net asset
value per share is determined by calculating the total value of
the Fund's assets, which normally will be comprised chiefly of
investment securities, deducting total liabilities and dividing
the result by the number of Fund shares outstanding. Fixed
income securities are valued by using market quotations, or
independent pricing services that use prices provided by market
makers or estimates of market values obtained from yield data
relating to instruments or securities with similar
characteristics. Portfolio securities that are primarily traded
on a domestic securities exchange or securities listed on the
NASDAQ National Market are valued at the last sale price on the
exchange or market where primarily traded or listed or, if there
is no recent sale price available, at the last current bid
quotation. Portfolio securities that are primarily traded on
foreign securities exchanges are generally valued at the
preceding closing values of such securities on their respective
exchanges where primarily traded. A security that is listed or
traded on more than one exchange is valued at the quotation on
the exchange determined to be the primary market for such
security by the Board of Trustees or its delegates. Securities
not so traded or listed are valued at the last current bid
quotation if market quotations are available. Equity options are
valued at the last sale price unless the bid price is higher or
the asked price is lower, in which event such bid or asked price
is used. Exchange traded fixed income options are valued at the
last sale price unless there is no sale price, in which event
current prices provided by market makers are used. Over-the-
counter traded options are valued based upon current prices
provided by market makers. Financial futures and options thereon
are valued at the settlement price established each day by the
board of trade or exchange on which they are traded. Other
securities, including restricted securities, and other assets are
valued at fair value as determined in good faith by the Board of
Trustees. Because of the need to obtain prices as of the close
of trading on various exchanges throughout the world, the
calculation of net asset value of a Fund investing in foreign
securities does not necessarily take place contemporaneously with
the determination of the prices of the majority of the portfolio
securities, which may be made prior to the determination of net
asset value. For purposes of determining the net asset value of
a Fund investing in foreign securities, all assets and
liabilities initially expressed in foreign currency values will
be converted into U.S. Dollar values at the mean between the bid
and offered quotations of such currencies against U.S. Dollars as
last quoted by a recognized dealer. If an event were to occur,
after the value of a security was so established but before the
net asset value per share was determined, which was likely to
materially change the net asset value, then that security would
be valued using fair value considerations by the Board of
Trustees or its delegates. On each day the New York Stock
Exchange (the "Exchange") is open for trading, the net asset
B-36
<PAGE>
value is determined as of the earlier of 3:00 p.m. (Central time)
or the close of the Exchange.
For the Money Market Fund, the net asset value per share is
determined as of the earlier of 3:00 p.m. (Central time) or the
close of the Exchange on each day the Exchange is open for
trading. The Fund seeks to maintain a net asset value of $1.00
per share but there is no assurance that it will do so. The net
asset value per share is determined by dividing the total assets
of the Fund less its liabilities by the total number of its
shares outstanding. The Fund values its portfolio instruments at
amortized cost, which means that they are valued at their
acquisition cost (as adjusted for amortization of premium or
discount) rather than at current market value. Calculations are
made to compare the value of its investments valued at amortized
cost with market-based values. Market-based values are obtained
by using actual quotations provided by market makers, estimates
of market value, or values obtained from yield data relating to
classes of money market instruments published by reputable
sources at the mean between the bid and asked prices for the
instruments. If a deviation of 1/2 of 1% or more were to occur
between the Fund's $1.00 per share net asset value, calculated at
amortized cost, and the net asset value per share calculated by
reference to market-based quotations, or if there is any other
deviation which the Board of Trustees believes would result in a
material dilution to shareholders or purchasers, the Board of
Trustees will promptly consider what action, if any, should be
initiated. In order to value its investments at amortized cost,
the Fund purchases only securities with a maturity of one year or
less and maintains a dollar-weighted average portfolio maturity
of 90 days or less. In addition, the Fund limits its portfolio
investments to securities that meet the quality and
diversification requirements of Rule 2a-7. Under the quality
requirements of Rule 2a-7, the Fund may only purchase U.S. Dollar
denominated instruments that are determined to present minimal
credit risks and that are at the time of acquisition "Eligible
Securities" as defined in Rule 2a-7. "Eligible Securities" under
Rule 2a-7 include only securities that are rated in the top two
rating categories by the required number of nationally recognized
statistical rating organizations (at least two or, if only one
such organization has rated the security, that one organization)
or, if unrated, are deemed comparable in quality. Since the
Money Market Fund invests exclusively in U.S. Government
securities and repurchase agreements of such securities, the Fund
is not subject to the diversification requirements of Rule 2a-7.
PERFORMANCE DATA
As described in the prospectus, a Fund's historical performance
or return may be shown in the form of "average annual total
return" and "total return" figures in the case of all Funds;
"yield" in the case of the Government Fund; "yield" and "tax-
equivalent yield" for the Municipal Fund and "yield" and
"effective yield" in the case of the Money Market Fund. These
various measures of performance are described below.
B-37
<PAGE>
Average annual total return and total return measure both the net
investment income generated by, and the effect of any realized
and unrealized appreciation or depreciation of, the underlying
investments of a Fund. Yield is a measure of the net investment
income per share earned over a specific one month or 30-day
period (seven-day period for the Money Market Fund) expressed as
a percentage of the net asset value.
A Fund's average annual total return quotation is computed in
accordance with a standardized method prescribed by rules of the
Securities and Exchange Commission. The average annual total
return for a Fund for a specific period is found by first taking
a hypothetical $1,000 investment in the Fund's shares on the
first day of the period at the maximum offering price, which is
the net asset value per share plus (except in the case of the
Money Market Fund) the maximum sales charge ("initial
investment"), and computing the "redeemable value" of that
investment at the end of the period. The redeemable value is
then divided by the initial investment, and this quotient is
taken to the Nth root (N representing the number of years in the
period) and 1 is subtracted from the result, which is then
expressed as a percentage. The calculation assumes that all
income and capital gains dividends by the Fund have been
reinvested at net asset value on the reinvestment dates during
the period.
Calculation of a Fund's total return is not subject to a
standardized formula, except when calculated for the "Financial
Highlights" table in the financial statements. Total return
performance for a specific period is calculated by first taking
an investment in the Fund's shares on the first day of the period
("initial investment"), either adjusting or not adjusting for the
maximum sales charge, and computing the "ending value" of that
investment at the end of the period. The total return percentage
is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment
and expressing the result as a percentage. The calculation
assumes that all income and capital gains dividends paid by the
Fund have been reinvested at net asset value on the reinvestment
dates during the period. Total return may also be shown as the
increased dollar value of the hypothetical investment over the
period.
The yield for the Government and Municipal Funds is computed in
accordance with a standardized method prescribed by rules of the
Securities and Exchange Commission. Yield is computed by
dividing the net investment income per share earned during the
specified one month or 30-day period by the offering price per
share on the last day of the period, according to the following
formula:
a - b
YIELD = 2[( ------- )(6) -1]
cd
B-38
<PAGE>
Where:
a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of
the period.
In computing the foregoing yield, the Fund follows certain
standardized accounting practices specified by Securities and
Exchange Commission rules. These practices are not necessarily
consistent with those that the Fund uses to prepare its annual
and interim financial statements in accordance with generally
accepted accounting principles.
The Municipal Fund's tax equivalent yield is computed by dividing
that portion of the Fund's yield (computed as described above)
that is tax-exempt by (one minus the stated federal income tax
rate) and adding the result to that portion, if any, of the yield
of the Municipal Fund that is not tax-exempt.
The Money Market Fund's yield is also computed in accordance with
a standardized method prescribed by rules of the Securities and
Exchange Commission. Under that method, the current yield
quotation is based on a seven-day period and is computed as
follows. The first calculation is net investment income per
share, which is accrued interest on portfolio securities, plus or
minus amortized discount or premium, less accrued expenses. This
number is then divided by the price per share (expected to remain
constant at $1.00) at the beginning of the period ("base period
return"). The result is then divided by 7 and multiplied by 365
and the resulting yield figure is carried to the nearest one-
hundredth of one percent. Realized capital gains or losses and
unrealized appreciation or depreciation of investments are not
included in the calculation.
The Money Market Fund's effective yield is determined by taking
the base period return (computed as described above) and
calculating the effect of assumed compounding. The formula for
the effective yield is:
365/7
(base period return + 1) - 1.
Performance quotations are based upon historical results and are
not necessarily representative of future performance. The Funds'
shares are sold at net asset value plus, for each Fund other than
the Money Market Fund, a sales charge. Returns and net asset
value will fluctuate, except that the Money Market Fund seeks to
maintain a $1.00 net asset value per share. Factors affecting a
Fund's performance include general market conditions, operating
expenses and investment management. Any additional fees charged
by a dealer or other financial services firm would reduce the
returns described in this section. Shares of a Fund are
B-39
<PAGE>
redeemable at the then current net asset value, which may be more
or less than original cost.
Investors may want to compare the performance of a Fund to that
of certificates of deposit and money market deposit accounts
offered by banks and other depository institutions and money
market funds. With respect to money market deposit accounts,
account minimums range upward from $2,000 and compounding methods
vary. Generally, the number of checks that may be written is
limited. Bank money market deposit accounts offer variable
rates, guaranteed principal and may be insured. Certificates of
deposit may offer fixed or variable interest rates and principal
is guaranteed and may be insured. Withdrawal of deposits prior
to maturity will normally be subject to a penalty. Rates offered
by banks and other depository institutions are subject to change
at any time specified by the issuing institution. Money market
fund yields will fluctuate and shares are not insured, but share
values usually remain stable. The shares of a Fund are not
insured. The bonds in which the Government and Municipal Funds
invest are generally of longer term than most certificates of
deposit and money market funds and may reflect longer term market
interest rate fluctuations.
Investors also may want to compare the performance of a Fund to
that of U.S. Treasury bills, notes or bonds because such
instruments represent alternative income producing products.
Treasury obligations are issued in selected denominations. Rates
of Treasury obligations are fixed at the time of issuance and
payment of principal and interest is backed by the full faith and
credit of the U.S. Treasury. The market value of such
instruments will generally fluctuate inversely with interest
rates prior to maturity and will equal par value at maturity.
SHAREHOLDER RIGHTS
Sterling Funds generally is not required to hold meetings of its
shareholders. Under its Agreement and Declaration of Trust
("Declaration of Trust"), however, shareholder meetings will be
held in connection with the following matters: (1) the election
or removal of trustees if a meeting is called for such purpose;
(2) the adoption of any contract for which shareholder approval
is required by the Investment Company Act of 1940 ("1940 Act");
(3) any termination of the Funds to the extent and as provided in
the Declaration of Trust; (4) any amendment of the Declaration of
Trust (other than amendments changing the name of Sterling Funds,
supplying any omission, curing any ambiguity or curing,
correcting or supplementing any defective or inconsistent
provision thereof); and (5) such additional matters as may be
required by law, the Declaration of Trust, the By-laws of
Sterling Funds, or any registration of Sterling Funds with the
Securities and Exchange Commission or any state, or as the
trustees may consider necessary or desirable. The shareholders
also would vote upon changes in fundamental investment
objectives, policies or restrictions.
B-40
<PAGE>
Each trustee serves until the next meeting of shareholders, if
any, called for the purpose of electing trustees and until the
election and qualification of a successor or until such trustee
sooner dies, resigns, retires or is removed by a majority vote of
the shares entitled to vote (as described below) or a majority of
the trustees. In accordance with the 1940 Act (i) Sterling Funds
will hold a shareholder meeting for the election of trustees at
such time as less than a majority of the trustees have been
elected by shareholders, and (ii) if, as a result of a vacancy in
the Board of Trustees, less than two-thirds of the trustees have
been elected by the shareholders, that vacancy will be filled
only by a vote of the shareholders.
Trustees may be removed from office by a vote of the holders of a
majority of the outstanding shares at a meeting called for that
purpose, which meeting shall be held upon the written request of
the holders of not less than 10% of the outstanding shares. Upon
the written request of ten or more shareholders who have been
such for at least six months and who hold shares constituting at
least 1% of the outstanding shares of Sterling Funds stating that
such shareholders wish to communicate with the other shareholders
for the purpose of obtaining the signatures necessary to demand a
meeting to consider removal of a trustee, Sterling Funds have
undertaken to disseminate appropriate materials at the expense of
the requesting shareholders.
The Declaration of Trust provides that the presence at a
shareholder meeting in person or by proxy of at least 30% of the
shares entitled to vote on a matter shall constitute a quorum.
Thus, a meeting of shareholders of Sterling Funds could take
place even if less than a majority of the shareholders were
represented on its scheduled date. Shareholders would in such a
case be permitted to take action which does not require a larger
vote than a majority of a quorum, such as the election of
trustees and ratification of the selection of independent
auditors. Some matters requiring a larger vote under the
Declaration of Trust, such as termination or reorganization of
Sterling Funds and certain amendments of the Declaration of
Trust, would not be affected by this provision; nor would matters
which under the 1940 Act require the vote of a "majority of the
outstanding voting securities" as defined in the 1940 Act.
The Declaration of Trust specifically authorizes the Board of
Trustees to terminate Sterling Funds (or any Fund or class) by
notice to the shareholders without shareholder approval.
Under Massachusetts law, shareholders of a Massachusetts business
trust could, under certain circumstances, be held personally
liable for obligations of Sterling Funds. The Declaration of
Trust, however, disclaims shareholder liability for acts or
obligations of Sterling Funds and requires that notice of such
disclaimer be given in each agreement, obligation, or instrument
entered into or executed by Sterling Funds or the trustees.
Moreover, the Declaration of Trust provides for indemnification
out of Sterling Funds property for all losses and expenses of any
B-41
<PAGE>
shareholder held personally liable for the obligations of
Sterling Funds and Sterling Funds will be covered by insurance
which the trustees consider adequate to cover foreseeable tort
claims. Thus, the risk of a shareholder incurring financial loss
on account of shareholder liability is considered by KFS remote
and not material, since it is limited to circumstances in which a
disclaimer is inoperative and Sterling Funds itself are unable to
meet their obligations.
B-42
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Trustees and Shareholder
Sterling Funds
We have audited the accompanying statement of net assets of
Equity Fund, Total Return Fund, U.S. Government Securities Fund,
Municipal Bond Fund and Government Money Market Fund, comprising
Sterling Funds, as of March 23, 1994. This statement of net
assets is the responsibility of Sterling Funds' management. Our
responsibility is to express an opinion on this statement of net
assets based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the statement of net assets is free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the statement of net assets. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall statement of net assets presentation. We believe
that our audit provides a reasonable basis for our opinion.
In our opinion, the statement of net assets referred to above
presents fairly, in all material respects, the financial position
of each of the Funds comprising Sterling Funds at March 23, 1994,
in conformity with generally accepted accounting principles.
ERNST & YOUNG
Chicago, Illinois
March 23, 1994
B-43
<PAGE>
STATEMENT OF NET ASSETS
STERLING FUNDS
MARCH 23, 1994
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Gov't
Total U.S. Gov't Money
Equity Return Securities Municipal Market
Fund Fund Fund Bond Fund Fund
------ ------ ---------- --------- ------
ASSETS
Cash $20,000 $20,000 $20,000 $20,000 $20,000
Net Assets
Net Assets(1) $20,000 $20,000 $20,000 $20,000 $20,000
Pricing of Shares
Net Asset Value $9.00 $9.00 $9.00 $9.00 $1.00
and redemption
price per
share(2)
Maximum Offering $9.55 $9.55 $9.42 $9.42 $1.00
price per
share(3)
</TABLE>
NOTES:
(1) Net assets applicable to 2,222.222 shares of beneficial
interest outstanding for each of the Equity Fund, the Total
Return Fund, the U.S. Government Securities Fund, and the
Municipal Bond Fund, equivalent to $9.00 per share of each such
Fund, and 20,000 shares for the Government Money Market Fund,
equivalent to $1.00 per share (unlimited number of shares
authorized, no par value).
(2) Net assets divided by the number of shares of beneficial
interest outstanding.
(3) Net asset value, plus 6.10% of net asset value or 5.75% of
offering price for Equity Fund and Total Return Fund and net
asset value, plus 4.71% of net asset value or 4.50% of offering
price for the U.S. Government Securities Fund and the Municipal
Bond Fund. Net asset value for the Government Money Market Fund.
NOTES:
Sterling Funds was organized as a business trust under the laws
of the Commonwealth of Massachusetts on March 2, 1990. Currently
five series of shares of Sterling Funds have been established,
each with one class of shares, Class A Shares. Sterling Funds
B-44
<PAGE>
may establish additional series and classes. Shares of
beneficial interest of each of the five authorized series were
issued to Kemper Financial Services, Inc. ("KFS"), the investment
manager for each series, on March 23, 1994 for $20,000 cash; a
total of $100,000 for the Funds.
The cost of organization of Sterling Funds will be paid by KFS.
APPENDIX - RATINGS OF INVESTMENTS
COMMERCIAL PAPER RATINGS
Commercial paper rated by Standard & Poor's Corporation has the
following characteristics: Liquidity ratios are adequate to meet
cash requirements. Long-term senior debt is rated "A" or better.
The issuer has access to at least two additional channels of
borrowing. Basic earnings and cash flow have an upward trend
with allowance made for unusual circumstances. Typically, the
issuer's industry is well established and the issuer has a strong
position within the industry. The reliability and quality of
management are unquestioned. Relative strength or weakness of
the above factors determine whether the issuer's commercial paper
is rated A-1 or A-2.
The ratings Prime-1 and Prime-2 are the two highest commercial
paper ratings assigned by Moody's Investors Service, Inc. Among
the factors considered by them in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2)
economic evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in
certain areas; (3) evaluation of the issuer's products in
relation to competition and customer acceptance; (4) liquidity;
(5) amount and quality of long-term debt; (6) trend of earnings
over a period of ten years; (7) financial strength of a parent
company and the relationships which exist with the issuer; and
(8) recognition by the management of obligations which may be
present or may arise as a result of public interest questions and
preparations to meet such obligations. Relative strength or
weakness of the above factors determines whether the issuer's
commercial paper is rated Prime-1 or 2.
CORPORATE BONDS
STANDARD & POOR'S CORPORATION BOND RATINGS
AAA. Debt rated AAA has the highest rating assigned by Standard
& Poor's. Capacity to pay interest and repay principal is
extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest
and repay principal and differs from the higher rated issues only
in small degree.
B-45
<PAGE>
A. Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
debt in higher rated categories.
BBB. Debt rated BBB is regarded as having an adequate capacity
to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay interest and repay principal for debt in
this category than in higher rated categories.
BB, B, CCC, CC, C. Debt rated BB, B, CCC, CC and C is regarded,
on balance, as predominantly speculative with respect to capacity
to pay interest and repay principal in accordance with the terms
of the obligation. BB indicates the lowest degree of speculation
and C the highest degree of speculation. While such debt will
likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to
adverse conditions.
CI. The rating CI is reserved for income bonds on which no
interest is being paid.
D. Debt rated D is in default, and payment of interest and/or
repayment of principal is in arrears.
MOODY'S INVESTORS SERVICE, INC. BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and
are generally referred to as "gilt-edge." 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 sometime in the future.
Baa. Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly
B-46
<PAGE>
secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as
well.
Ba. Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured.
Often the protection of interest and principal payments may be
very moderate and thereby not well safeguarded during both good
and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B. Bonds which are rated B generally lack characteristics of
the desirable investment. Assurance of interest and principal
payments or of maintenance of other terms of the contract over
any long period of time may be small.
Caa. Bonds which are rated Caa are of poor standing. Such
issues may be in default or there may be present elements of
danger with respect to principal or interest.
Ca. Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default
or have other marked shortcomings.
C. Bonds which are rated C are the lowest rated class of bonds
and issues so rated can be regarded as having extremely poor
prospects of ever attaining any real investment standing.
FITCH INVESTORS SERVICE, INC. BOND RATINGS
AAA. Bonds rated AAA are considered to be investment grade and
of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and repay principal, which is
unlikely to be affected by reasonably foreseeable events.
AA. Bonds rated AA are considered to be investment grade and of
very high credit quality. The obligor's ability to pay interest
and repay principal is very strong, although not quite as strong
as bonds rated AAA.
A. Bonds rated A are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest and
repay principal is considered to be strong, but may be more
vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB. Bonds rated BBB are considered to be investment grade and
of satisfactory credit quality. The obligor's ability to pay
interest and repay principal is considered to be adequate.
Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds,
and therefore impair timely payment.
B-47
<PAGE>
BB. Bonds rated BB are considered speculative. The obligor's
ability to pay interest and repay principal may be affected over
time by adverse economic changes. However, business and
financial alternatives can be identified which could assist the
obligor in satisfying its debt service requirements.
B. Bonds rated B are considered highly speculative. While
bonds in this class are currently meeting debt service
requirements, the probability of continued timely payment of
principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity
throughout the life of the issue.
CCC. Bonds rated CCC have certain identifiable characteristics
which, if not remedied, may lead to default. The ability to meet
obligations requires an advantageous business and economic
environment.
CC. Bonds rated CC are minimally protected. Default in payment
of interest and/or principal seems probable over time.
C. Bonds rated C are in imminent default in payment of interest
or principal.
DDD, DD and D. Bonds rated DDD, DD and D are in default on
interest and/or principal payments. Such bonds are extremely
speculative and should be valued on the basis of their ultimate
recovery value in liquidation or reorganization of the obligor.
DDD represents the highest potential for recovery on these bonds,
and D represents the lowest potential for recovery.
DUFF & PHELPS RATING CO. BOND RATINGS
AAA. Bonds rated AAA have the highest rating assigned to a debt
obligation. They are of the highest credit quality. The risk
factors are negligible, being only slightly more than for risk-
free U.S. Treasury debt.
AA. Bonds rated AA are of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from
time to time because of economic conditions.
A. Bonds rated A have protection factors that are average but
adequate. However, risk factors are more variable and greater in
periods of economic stress.
BBB. Bonds rated BBB have below average protection factors but
are still considered sufficient for prudent investment. They
have considerable volatility in risk during economic cycles.
BB. Bonds rated BB are below investment grade but deemed likely
to meet obligations when due. Present or prospective financial
protection factors fluctuate according to industry conditions or
company fortunes. Overall quality may move up or down frequently
within this category.
B-48
<PAGE>
B. Bonds rated B are below investment grade and possessing risk
that obligations will not be met when due. Financial protection
factors will fluctuate widely according to economic cycles,
industry conditions and/or company fortunes. Potential exists
for frequent changes in the rating within this category or into a
higher or lower rating grade.
CCC. Bonds rated CCC are well below investment grade
securities. Considerable uncertainty exists as to timely payment
of principal or interest. Protection factors are narrow and risk
can be substantial with unfavorable economic/industry conditions,
and or with unfavorable company developments.
D. Bonds rated D are in default. The issuer failed to meet
scheduled principal and/or interest payments.
B-49
<PAGE>
STERLING FUNDS
ANNUAL REPORT
For the Period Ended January 31, 1995
<PAGE>
STERLING FUNDS
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
================================================================================
THE BOARD OF TRUSTEES AND SHAREHOLDER
STERLING FUNDS
We have audited the accompanying statement of net assets of the Equity Fund,
Total Return Fund, U.S. Government Securities Fund, Municipal Bond Fund and
Government Money Market Fund, comprising the Sterling Funds, as of January 31,
1995, and the related statements of operations and changes in net assets and the
financial highlights for the period from March 23, 1994 (date of inception) to
January 31, 1995. These financial statements and financial highlights are the
responsibility of the Sterling Funds' management. Our responsibility is to
express an opinion on these financial statements and financial highlights based
on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and financial highlights are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of investments owned as of January 31, 1995, by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of each
of the Funds of the Sterling Funds at January 31, 1995, and the results of their
operations, the changes in their net assets and financial highlights for the
period ended January 31, 1995, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Chicago, Illinois
May 22, 1995
(1)
<PAGE>
STERLING FUNDS
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
January 31, 1995
<TABLE>
<CAPTION>
=========================================================================================================
U.S. GOVERNMENT MUNICIPAL GOVERNMENT
EQUITY TOTAL RETURN SECURITIES BOND MONEY MARKET
ASSETS FUND FUND FUND FUND FUND
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Federal Farm Credit Banks $19,795 19,795 19,795 - 19,790
6.313%, due 4/3/95, $20,000 par
(Cost for each Fund is $19,790)
- ---------------------------------------------------------------------------------------------------------
Cash 295 240 295 20,000 273
- ---------------------------------------------------------------------------------------------------------
Total assets $20,090 20,035 20,090 20,000 20,063
- ---------------------------------------------------------------------------------------------------------
NET ASSETS $20,090 20,035 20,090 20,000 20,063
=========================================================================================================
ANALYSIS OF NET ASSETS
- ---------------------------------------------------------------------------------------------------------
Amounts received from issuance
of shares $20,000 20,000 20,000 20,000 20,000
- ---------------------------------------------------------------------------------------------------------
Accumulated net realized loss
on investments - (59) - - -
- ---------------------------------------------------------------------------------------------------------
Unrealized appreciation 5 5 5 - -
- ---------------------------------------------------------------------------------------------------------
Undistributed net investment income 85 89 85 - 63
- ---------------------------------------------------------------------------------------------------------
Net assets applicable to shares
outstanding $20,090 20,035 20,090 20,000 20,063
=========================================================================================================
THE PRICING OF SHARES
- ---------------------------------------------------------------------------------------------------------
Shares outstanding, no par value
(unlimited shares authorized) 2,222 2,222 2,222 2,222 20,000
- ---------------------------------------------------------------------------------------------------------
Net asset value and redemption
price per share $9.04 9.02 9.04 9.00 1.00
=========================================================================================================
</TABLE>
See accompanying Note to Financial Statements.
(2)
<PAGE>
<TABLE>
<CAPTION>
STERLING FUNDS
- -----------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
For the period from March 23, 1994 (date of inception)
to January 31, 1995
=====================================================================================================
U.S. GOVERNMENT MUNICIPAL GOVERNMENT
EQUITY TOTAL RETURN SECURITIES BOND MONEY MARKET
FUND FUND FUND FUND FUND
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income $801 805 801 - 801
- -----------------------------------------------------------------------------------------------------
Net investment income 801 805 801 - 801
- -----------------------------------------------------------------------------------------------------
Net realized loss on investments - (59) - - -
- -----------------------------------------------------------------------------------------------------
Net change in unrealized
appreciation 5 5 5 - -
- -----------------------------------------------------------------------------------------------------
Net gain (loss) on investments 5 (54) 5 - -
- -----------------------------------------------------------------------------------------------------
Net increase in net assets
resulting from operations $806 751 806 - 801
=====================================================================================================
</TABLE>
See accompanying Note to Financial Statements.
(3)
<PAGE>
<TABLE>
<CAPTION>
STERLING FUNDS
- ---------------------------------------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
For the period from March 23, 1994 (date of inception)
to January 31, 1995
===============================================================================================================
U.S. GOVERNMENT MUNICIPAL GOVERNMENT
EQUITY TOTAL RETURN SECURITIES BOND MONEY MARKET
FUND FUND FUND FUND FUND
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operations:
Net investment income $801 805 801 - 801
- ---------------------------------------------------------------------------------------------------------------
Net realized loss on investments - (59) - - -
- ---------------------------------------------------------------------------------------------------------------
Net change in unrealized appreciation 5 5 5 - -
- ---------------------------------------------------------------------------------------------------------------
Net increase from operations 806 751 806 - 801
- ---------------------------------------------------------------------------------------------------------------
Dividends to shareholders from net
investment income (716) (716) (716) - (738)
- ---------------------------------------------------------------------------------------------------------------
Total increase in net assets 90 35 90 - 63
- ---------------------------------------------------------------------------------------------------------------
Net assets:
Beginning of period 20,000 20,000 20,000 20,000 20,000
- ---------------------------------------------------------------------------------------------------------------
End of period $20,090 20,035 20,090 20,000 20,063
===============================================================================================================
</TABLE>
See accompanying Notes to Financial Statements.
(4)
<PAGE>
STERLING FUNDS
- --------------------------------------------------------------------------------
NOTE TO FINANCIAL STATEMENTS
================================================================================
1. Description of the Funds and general accounting policies.
Sterling Funds, organized as a Massachusetts business trust, consists of five
series: Equity Fund, Total Return Fund, U.S. Government Securities Fund,
Municipal Bond Fund and Government Money Market Fund. Shares of beneficial
interest of each of the series were issued to Kemper Financial Services, Inc.
("KFS"), the Funds' investment manager, for $20,000, totaling $100,000. As of
January 31, 1995, shares of the Funds have not been offered to the public and
KFS remains the only shareholder. During the period ended January 31, 1995, the
activity of the Funds was limited to holding short-term securities or cash. With
the exception of the Government Money Market Fund, the investments of the Funds
are stated at value based on market quotations. The securities in the Government
Money Market Fund are stated at amortized cost, which approximates market value.
The net asset value of each series is determined by dividing the net assets
applicable to a series by the respective number of shares outstanding.
(5)
<PAGE>
<TABLE>
<CAPTION>
STERLING FUNDS
- ----------------------------------------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
For the period from March 23, 1994 (date of inception) to January 31, 1995
================================================================================================================
U.S. GOVERNMENT MUNICIPAL GOVERNMENT
EQUITY TOTAL RETURN SECURITIES BOND MONEY MARKET
FUND FUND FUND FUND FUND
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $9.00 9.00 9.00 9.00 1.00
- ---------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .36 .36 .36 - .04
- ---------------------------------------------------------------------------------------------------------------
Net loss on investments - (.02) - - -
- ---------------------------------------------------------------------------------------------------------------
Total from investment operations .36 .34 .36 - .04
- ---------------------------------------------------------------------------------------------------------------
Less dividends from net investment income .32 .32 .32 - .04
- ---------------------------------------------------------------------------------------------------------------
Net asset value, end of period $9.04 9.02 9.04 9.00 1.00
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 4.06 3.84 4.06 - 3.71
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME TO AVERAGE
NET ASSETS (ANNUALIZED)(%): 4.67 4.70 4.67 - 4.67
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
NET ASSETS AT END OF PERIOD: $20,090 20,035 20,090 20,000 20,063
===============================================================================================================
</TABLE>
(6)
<PAGE>
STERLING FUNDS
PART C
OTHER INFORMATION
Item 24. Financial Statements and Exhibits
(a) Financial Statements
(i) Financial Statements included in Part A of the
Registration Statement:
None
(ii) Financial Statements included in Part B of the
Registration Statement:
Statement of net assets - January 31, 1995
Statement of operations for the year ended January
31, 1995
Statement of changes in net assets for the period
ended January 31, 1995
Financial highlights
Note to financial statements
Schedules I, II, III, IV, V, VI and VII have been
omitted as the required information is not
present.
(b) Exhibits
EX-99.B
1. (a) Amended and Restated Agreement and Declaration of
Trust.(1)
(b) Written Instrument Amending the Agreement and
Declaration of Trust.(1)
2. By-Laws.(1)
3. Inapplicable.
4. (a) Specimen of Share Certificates(2).
(i) Equity Fund.
(ii) Total Return Fund.
(iii) U.S. Government Securities Fund.
(iv) Municipal Bond Fund.
(v) Government Money Market Fund.
C-1
<PAGE>
(b) Constituent Instruments
(i) Written Instrument Establishing and
Designating Government Money Market
Fund.(2)
(ii) Written Instrument Changing the Designation
of Growth Fund.(2)
5. Investment Management Agreement(2).
6. Inapplicable.
7. Inapplicable.
8. (a) Custody Agreement (Form 1).(1)
(b) Custody Agreement (Form 2).(2)
9. (a) Agency Agreement.(1)
(b) Administrative Services Agreement.(1)
(c) Assignment of Administrative Services Agreement
10. Inapplicable.
11. Inapplicable.
12. Inapplicable.
13. Inapplicable.
14. Model Individual Retirement Account.(2)
15. Inapplicable.
16. Inapplicable.
24. Powers of Attorney.
----------------------
(1) Incorporated herein by reference to Registrant's Registration
Statement on Form N-1A filed on or about December 10, 1993.
(2) Incorporated herein by reference to Pre-Effective Amendment No. 1
to Registrant's Registration Statement on Form N-1A filed on or about
March 29, 1994.
C-2
<PAGE>
Items 25. Persons Controlled by or Under Common Control with
Registrant
Inapplicable.
Item 26. Number of Holders of Securities
As of April 14, 1995, there was one recordholder of each series
of "Registrant."
Item 27. Indemnification
Article VIII of the Registrant's Amended and Restated Agreement
and Declaration of Trust (Exhibit 1 hereto, which is incorporated
herein by reference) provides in effect that the Registrant will
indemnify its officers and trustees under certain circumstances.
However, in accordance with Section 17(h) and 17(i) of the Investment
Company Act of 1940 and its own terms, said Article of the Amended and
Restated Agreement and Declaration of Trust does not protect any
person against any liability to the Registrant or its shareholders to
which such person would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence, or reckless disregard of the
duties involved in the conduct of such person's office.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to trustees, officers, and
controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that, in the
opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Act and
is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a trustee, officer, or
controlling person of the Registrant in the successful defense of any
action, suit, or proceeding) is asserted by such trustee, officer, or
controlling person in connection with the securities being registered,
the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question as to whether such
indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
Item 28.(a) Business and Other Connections of Investment Adviser
Information pertaining to business and other connections of the
Registrant's investment adviser is hereby incorporated by reference to
the section of the Prospectus captioned "How the Fund is Managed," and
to the section of the Statement of Additional Information captioned
"Investment Manager and Distributor."
C-3
<PAGE>
Kemper Financial Services, Inc., investment adviser of the
Registrant, is investment adviser of:
Kemper Mutual Funds: Kemper Closed-End Funds:
------------------- -----------------------
Kemper Technology Fund Kemper High Income Trust
Kemper Total Return Fund Kemper Intermediate Government Trust
Kemper Growth Fund Kemper Municipal Income Trust
Kemper Small Capitalization Kemper Multi-Market Income Trust
Equity Fund Kemper Strategic Municipal Income Trust
Kemper Income and Capital The Growth Fund of Spain, Inc.
Preservation Fund Kemper Strategic Income Fund
Kemper Money Market Fund
Kemper National Tax-Free
Income Series
Kemper Diversified Income Fund
Kemper High Yield Fund
Cash Equivalent Fund
Kemper U.S. Government
Securities Fund
Kemper International Fund
Kemper Portfolios
Kemper State Tax-Free
Income Series
Tax-Exempt California Money
Market Fund
Kemper Adjustable Rate
U.S. Government Fund
Kemper Blue Chip Fund
Kemper Global Income Fund
Kemper Target Equity Fund
Cash Account Trust
Investors Cash Trust
Tax-Exempt New York Money
Market Fund
Kemper Financial Services, Inc. also furnishes investment
advice to and manages investment portfolios for other clients
including Kemper Investors Fund, Kemper International Bond Fund
and Sterling Funds.
Item 28(b) Business and Other Connections of Officers
and Directors of Kemper Financial Services Inc.,
the Investment Advisor:
C-4
<PAGE>
BORIS, JAMES R.
Director, Kemper Financial Services, Inc.
Director, INVEST Financial Corporation
Director, INVEST Financial Corporation Holding Company
Executive Vice President, Kemper Corporation
Director, Executive Vice President, Kemper Financial Companies,
Inc.
Director, Kemper Investors Life Insurance Company
Director, Kemper Sales Company
Director, Chairman and CEO, Kemper Securities, Inc.
MATHIS, DAVID B.
Director, Kemper Financial Services, Inc.
Director, Federal Kemper Life Assurance Company
Director, Fidelity Life Association
Director, Chairman and Chief Executive Officer, Kemper
Corporation
Director, Kemper Financial Companies, Inc.
Director, Kemper Investors Life Insurance Company
Director, Kemper Securities Holdings, Inc.
Director, Kemper Securities, Inc.
Director, IMC Global, Inc.
Trustee, Kemper Mutual Funds
Trustee, Kemper Closed-End Funds
Trustee, Kemper International Bond Fund
TIMBERS, STEPHEN B.
Director, Chairman, Chief Executive Officer and Chief
Investment Officer, Kemper Financial Services, Inc.
Director, Vice President, Kemper Asset Holdings, Inc.
Director, Kemper Distributors, Inc.
Director, Chairman, Kemper Asset Management Company
Director, Chairman, Kemper Service Company
Director, Federal Kemper Life Assurance Company
Director, Vice President, FKLA Loire Court, Inc.
Director, Vice President, FKLA Realty Corporation
Director, President, Galaxy Offshore, Inc.
Director, Vice President, FLA First Nationwide, Inc.
Director, Vice President, FLA Plate Building, Inc.
Director, Vice President, FLA Realty Corp.
Trustee and President, Kemper Closed-End Funds
Director, President and Chief Operating Officer, Kemper
Corporation
Director, Chairman, President and Chief Executive Officer,
Kemper Financial Companies, Inc.
Director, President, Kemper International Management, Inc.
Trustee and Vice President, Kemper Investors Fund
Director, Kemper Investors Life Insurance Company
Trustee and President, Kemper Mutual Funds
Director, Vice President, Kemper Portfolio Corp.
C-5
<PAGE>
Director, Vice President, Kemper Real Estate, Inc.
Director, Kemper Securities, Inc.
Director, Kemper Securities Holdings, Inc.
Director, Vice President, Kemper/Cymrot Management, Inc.
Director, Vice President, Kemper/Cymrot, Inc.
Director, Vice President, KFC Portfolio Corp.
Director, Vice President, KI Aaron Rents, Inc.
Director, Vice President, KI Arnold Industrial, Inc.
Director, Vice President, KI Canyon Park, Inc.
Director, Vice President, KI Dublin Boulevard, Inc.
Director, Vice President, KI LaFiesta Square, Inc.
Director, Vice President, KI Monterey Research, Inc.
Director, Vice President, KI Olive Street, Inc.
Director, Vice President, KI Sutter Street, Inc.
Director, Vice President, KI Thornton Boulevard, Inc.
Director, Vice President, KILICO Realty Corporation
Director, Vice President, KR 77 Fitness Center, Inc.
Director, Vice President, KR Avondale Redmond, Inc.
Director, Vice President, KR Black Mountain, Inc.
Director, Vice President, KR Brannan Resources, Inc.
Director, Vice President, KR Clay Capital, Inc.
Director, Vice President, KR Cranbury, Inc.
Director, Vice President, KR Delta Wetlands, Inc.
Director, Vice President, KR Gainesville, Inc.
Director, Vice President, KR Hotels, Inc.
Director, Vice President, KR Lafayette Apartments, Inc.
Director, Vice President, KR Lafayette BART, Inc.
Director, Vice President, KR Palm Plaza, Inc.
Director, Vice President, KR Red Hill Associates, Inc.
Director, Vice President, KR Seagate/Gateway North, Inc.
Director, Vice President, KR Venture Way, Inc.
Director, Vice President, KR Walnut Creek, Inc.
Trustee, Vice President, Sterling Funds
Director, The LTV Corporation
Director, Gillett Holdings, Inc.
Director, Investment Analysts Society of Chicago
NEAL, JOHN E.
President and Chief Operating Officer, Kemper Financial
Services, Inc.
Director, Kemper Distributors, Inc.
Director, Kemper Asset Management Company
Director, President, Kemper Service Company
Director, Supervised Service Company
Director, Ardenwood Financial Corporation
Director, Avondale Redmond, Inc.
Director, Bedford Holding Company
Director, Black Mountain, Inc.
Director, Brannan Resources, Inc.
Director, Butterfield Financial Corporation
Director, Camelot Financial Corporation
Director, Clay Capital, Inc.
Director, Concord Aviation, Inc.
C-6
<PAGE>
Director, Coast Broadcasting Company
Director, Crow Canyon, Inc.
Director, Hawaii Kai Development Company
Director, Kacor Gateway, Inc.
Director, Kailua Associates, Inc.
Director, Kacor Trust Deed Company
Director, Community Investment Corporation
Director, Continental Community Development Corporation
Director, President, FKLA Loire Court, Inc.
Director, President, FKLA Realty Corporation
Director, President, FLA First Nationwide, Inc.
Director, President, FLA Plate Building, Inc.
Director, President, FLA Realty Corporation
Director, Kemper/Lumbermens Properties, Inc.
Director, Senior Vice President, Kemper Real Estate Management
Company
Director, KRDC, Inc.
Director, Lafayette Apartments
Director, Lafayette Hills, Inc.
Director, Margarita Village Retirement Community
Director, Mesa Homes
Director, Mesa Homes Brokerage Company
Director, Mount Doloroes Corporation
Director, Montgomery Gallery, Inc.
Director, Monterey Research Park, Inc.
Director, One Business Centre
Director, Pacific Homes, Inc.
Director, Palomar Triad, Inc.
Director, Pine/Battery Properties, Inc.
Director, Rancho and Industrial Property Brokerage, Inc.
Director, Rancho California, Inc.
Director, Rancho Regional Shopping Center, Inc.
Director, Red Hill Associates, Inc.
Director, Seagate Associates, Inc.
Director, Seattle Gateway, Inc.
Director, Sutter Street, Inc.
Director, Technology Way, Inc.
Director, Time DC, Inc.
Director, Tourelle, Inc.
Director, Two Corporate Center
Director, Venture Way, Inc.
Director, President, Kemper Portfolio Corporation
Director, President, KFC Portfolio Corporation
Director, President, KILICO Realty Corporation
Director, President, KI Arnold Industrial, Inc.
Director, President, KI Canyon Park, Inc.
Director, President, KI Dublin Boulevard, Inc.
Director, President, KI LaFiesta Square, Inc.
Director, President, KI Lafayette BART, Inc.
Director, President, KI Monterey Research, Inc.
Director, President, KI Olive Street, Inc.
Director, President, KI Thornton Boulevard, Inc.
Director, President, KI Sutter Street, Inc.
C-7
<PAGE>
Director, President, KR 77 Fitness Center, Inc.
Director, President, KR Avondale Redmond, Inc.
Director, President, KR Black Mountain, Inc.
Director, President, KR Brannan Resources, Inc.
Director, President, KR Clay Capital, Inc.
Director, President, KR Cranbury, Inc.
Director, President, KR Delta Wetlands, Inc.
Director, President, KR Gainesville, Inc.
Director, President, KR Hotels, Inc.
Director, President, KR Lafayette Apartments, Inc.
Director, President, KR Palm Plaza, Inc.
Director, President, KR Red Hill Associates, Inc.
Director, President, KR Seagate/Gateway North, Inc.
Director, President, KR Venture Way, Inc.
Director, President, KR Walnut Creek, Inc.
Director, K-P Greenway, Inc.
Director, K-P Enterprise Centers, Inc.
Director, K-P Plaza Dallas, Inc.
Director, Kemper/Prime Acquisition Fund, Inc.
Director, KRDC, Inc.
Director, RespiteCare
Director, President, SMS Realty Corp.
Director, Urban Shopping Centers, Inc.
PETERS, JOHN E.
Director, Senior Executive Vice President, Kemper Financial
Services, Inc.
Director, President, Kemper Distributors, Inc.
Director, President, Kemper Sales Company
Vice President, Kemper Asset Management Company
Vice President, Kemper Closed-End Funds
Vice President, Kemper International Bond Fund
Vice President, Kemper Investors Fund
Vice President, Kemper Mutual Funds
Vice President, Kemper Target Equity Fund
Director, Kemper Service Company
Vice President, Sterling Funds
FITZPATRICK, JOHN H.
Chief Financial Officer, Kemper Financial Services, Inc.
Director, Ardenwood Financial Corporation
Director, Camelot Financial Corporation
Director, Crow Canyon, Inc.
Director, Hawaii Kai Development Company
Director, Kacor Gateway, Inc.
Director, Kacor Trust Deed Company
Director, Senior Vice President and Chief Financial Officer,
Federal Kemper Life Assurance Company
Senior Vice President, Chief Financial Officer, Fidelity Life
Association
Director, Vice President, FKLA Loire Court, Inc.
Director, Vice President, FLA First Nationwide, Inc.
Director, Vice President, FLA Plate Building, Inc.
C-8
<PAGE>
Director, Executive Vice President and Chief Financial Officer,
Kemper Corporation
Director, Executive Vice President and Chief Financial
Officer,Kemper Financial Companies, Inc.
Senior Vice President, Kemper Investors Life Insurance Company
Director, Senior Vice President, Kemper Real Estate Management
Company
Director, Vice President, Kemper/Cymrot Management, Inc.
Director, Vice President, Kemper/Cymrot, Inc.
Director, Vice President, Kemper/Lumbermens Properties, Inc.
Director, Senior Vice President, Kemper Real Estate Management
Company
Director, KRDC, Inc.
Director, Margarita Retirement Community, Inc.
Director, Mesa Homes
Director, Mesa Homes Brokerage Company
Director, Montgomery Gallery, Inc.
Director, One Corporate Centre, Inc.
Director, Pacific Homes, Inc.
Director, Palomar Triad, Inc.
Director, Pine/Battery Property, Inc.
Director, Rancho and Industrial Property Brokerage, Inc.
Director, Rancho California, Inc.
Director, Rancho Regional Shopping Center, Inc.
Director, Seattle Gateway, Inc.
Director, SMS Realty Corporation
Director, Sutter Street, Inc.
Director, Time DC, Inc.
Director, Two Corporate Center
Director, Vice President, KFC Portfolio Corp.
Director, Vice President, KI Aaron Rents, Inc.
Director, Vice President, KI Arnold Industrial, Inc.
Director, Vice President, KI Canyon Park, Inc.
Director, Vice President, KI Dublin Boulevard, Inc.
Director, Vice President, KI Lafayette BART, Inc.
Director, Vice President, KI LaFiesta Square, Inc.
Director, Vice President, KI Monterey Research, Inc.
Director, Vice President, KI Olive Street, Inc.
Director, Vice President, KI Thornton Boulevard, Inc.
Director, Vice President, KILICO Realty Corporation
Director, Vice President, KR 77 Fitness Center, Inc.
Director, Vice President, KR Avondale Redmond, Inc.
Director, Vice President, KR Black Mountain, Inc.
Director, Vice President, KR Brannan Resources, Inc.
Director, Vice President, KR Clay Capital, Inc.
Director, Vice President, KR Cranbury, Inc.
Director, Vice President, KR Delta Wetlands, Inc.
Director, Vice President, KR Gainesville, Inc.
Director, Vice President, KR Hotels, Inc.
Director, Vice President, KR Lafayette Apartments, Inc.
Director, Vice President, KR Palm Plaza, Inc.
Director, Vice President, KR Red Hill Associates, Inc.
Director, Vice President, KR Seagate/Gateway North, Inc.
C-9
<PAGE>
Director, Vice President, KR Venture Way, Inc.
Director, Vice President, KR Walnut Creek, Inc.
BEIMFORD, JR., JOSEPH P.
Executive Vice President, Kemper Financial Services, Inc.
Vice President, Cash Account Trust
Vice President, Cash Equivalent Fund
Vice President, Galaxy Offshore, Inc.
Vice President, Investors Cash Trust
Vice President, Kemper Adjustable Rate U.S. Government Fund
Vice President, Kemper Diversified Income Fund
Vice President, Kemper Global Income Fund
Vice President, Kemper High Income Trust
Vice President, Kemper High Yield Fund
Vice President, Kemper Income and Capital Preservation Fund
Vice President, Kemper Intermediate Government Trust
Vice President, Kemper International Bond Fund
Vice President, Kemper Investors Fund
Vice President, Kemper Money Market Fund
Vice President, Kemper Multi-Market Income Trust
Vice President, Kemper Municipal Income Trust
Vice President, Kemper National Tax-Free Income Series
Vice President, Kemper Portfolios
Vice President, Kemper State Tax-Free Income Series
Vice President, Kemper Strategic Income Fund
Vice President, Kemper Strategic Municipal Income Trust
Vice President, Kemper U.S. Government Securities Fund
Vice President, Sterling Funds
Vice President, Tax-Exempt California Money Market Fund
Vice President, Tax-Exempt New York Money Market Fund
CHAPMAN II, WILLIAM E.
Executive Vice President, Kemper Financial Services, Inc.
Director, Executive Vice President, Kemper Distributors, Inc.
COTNER, C. BETH
Executive Vice President, Kemper Financial Services, Inc.
Trustee, Kemper Financial Services, Inc., Profit Sharing Plan
Vice President, Kemper Blue Chip Fund
Vice President, Kemper Growth Fund
Vice President, Kemper Investors Fund
Vice President, Kemper Small Capitalization Equity Fund
Vice President, Kemper Target Equity Fund
Vice President, Kemper Technology Fund
Vice President, Kemper Total Return Fund
Vice President, Sterling Funds
COXON, JAMES H.
Executive Vice President, Kemper Financial Services, Inc.
Director, Vice President, Galaxy Offshore, Inc.
Executive Vice President, Kemper Asset Management Company
C-10
<PAGE>
FERRO, DENNIS H.
Executive Vice President, Kemper Financial Services, Inc.
Vice President, Kemper International Fund
Director, Managing Director-Equities, Kemper Investment
Management Company Limited
Vice President, Kemper Investors Fund
Vice President, Kemper Target Equity Fund
Vice President, The Growth Fund of Spain, Inc.
GREENAWALT, JAMES L.
Executive Vice President, Kemper Financial Services, Inc.
Director, Executive Vice President, Kemper Distributors, Inc.
Director, Kemper Sales Company
JOHNS, GORDON K.
Executive Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Global Income Fund
Vice President, Kemper Diversified Income Fund
Vice President, Kemper International Bond Fund
Vice President, Kemper International Management, Inc.
Managing Director and Joint Secretary, Kemper Investment
Management Company Limited
Vice President, Kemper Portfolios
Director, Thames Heritage Parade Limited
LANGBAUM, GARY A.
Executive Vice President, Kemper Financial Services, Inc.
SILIGMUELLER, DALE S.
Executive Vice President, Kemper Financial Services, Inc.
Director, Executive Vice President, Kemper Service Company
Director, Executive Vice President, Supervised Service Company,
Inc.
BUKOWSKI, DANIEL J.
Senior Vice President, Kemper Financial Services, Inc.
BUTLER, DAVID H.
Senior Vice President, Kemper Financial Services, Inc.
CERVONE, DAVID M.
Senior Vice President, Kemper Financial Services, Inc.
CESSINE, ROBERT S.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Income and Capital Preservation Fund
Vice President, Kemper Diversified Income Fund
CHESTER, TRACY McCORMICK
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Blue Chip Fund
Vice President, Kemper Target Equity Fund
C-11
<PAGE>
COLLECCHIA, FRANK E.
Senior Vice President, Kemper Financial Services, Inc.
Senior Investment Officer, Federal Kemper Life Assurance
Company
Senior Investment Officer, Fidelity Life Association
Vice President, FKLA Loire Court, Inc.
Vice President, FLA First Nationwide, Inc.
Vice President, FLA Plate Building, Inc.
Vice President, Galaxy Offshore, Inc.
Senior Investment Officer, Kemper Investors Life Insurance
Company
Vice President, KI Aaron Rents, Inc.
Vice President, KI Arnold Industrial, Inc.
Vice President, KI Canyon Park, Inc.
Vice President, KI Dublin Boulevard, Inc.
Vice President, KI Lafayette BART, Inc.
Vice President, KI LaFiesta Square, Inc.
Vice President, KI Monterey Research, Inc.
Vice President, KI Olive Street, Inc.
Vice President, KI Thornton Boulevard, Inc.
Vice President, KR 77 Fitness Center, Inc.
Vice President, KR Avondale Redmond, Inc.
Vice President, KR Black Mountain, Inc.
Vice President, KR Brannan Resources, Inc.
Vice President, KR Clay Capital, Inc.
Vice President, KR Cranbury, Inc.
Vice President, KR Delta Wetlands, Inc.
Vice President, KR Gainesville, Inc.
Vice President, KR Gulf Coast Factory Shops, Inc.
Vice President, KR Halawa Associates, Inc.
Vice President, KR Hotels, Inc.
Vice President, KR Lafayette Apartments, Inc.
Vice President, KR Palm Plaza, Inc.
Vice President, KR Red Hill Associates, Inc.
Vice President, KR Seagate/Gateway North, Inc.
Vice President, KR Venture Way, Inc.
Vice President, KR Walnut Creek, Inc.
COLLORA, PHILIP J.
Senior Vice President and Assistant Secretary, Kemper Financial
Services, Inc.
Vice President and Secretary, Kemper Closed-End Funds
Assistant Secretary, Kemper International Management, Inc.
Vice President and Secretary, Kemper Investors Fund
Vice President and Secretary, Kemper Mutual Funds
Vice President and Secretary, Kemper Target Equity Fund
Vice President and Secretary, Sterling Funds
DIERENFELDT, DAVID F.
Senior Vice President, Associate General Counsel,
Assistant Secretary and Compliance Officer, Kemper Financial
Services, Inc.
Director, Secretary, Kemper Advisors, Inc.
C-12
<PAGE>
Vice President and Secretary, Kemper Distributors, Inc.
Assistant Secretary, Galaxy Offshore, Inc.
Director, Secretary, INVEST Financial Corporation
Secretary, INVEST Financial Corporation Holding Company
Assistant Secretary, Investors Brokerage Services
Insurance Agency, Inc.
Assistant Secretary, Investors Brokerage Services, Inc.
Secretary, Kemper Asset Management Company
Assistant Secretary, Kemper International Management, Inc.
Assistant Secretary, Kemper Investment Management Company
Limited
Vice President and Assistant Secretary, Kemper Investors Fund
Secretary, Kemper Sales Company
Secretary, Kemper Service Company
Secretary, Supervised Service Company, Inc.
DUDASIK, PATRICK H.
Senior Vice President, Kemper Financial Services, Inc.
Director, Treasurer and Chief Financial Officer, Kemper
Advisors, Inc.
Vice President and Treasurer, Kemper Asset Management Company
Treasurer and Chief Financial Officer, Kemper Distributors,
Inc.
Director, Treasurer and Chief Financial Officer, Kemper Sales
Company
Treasurer and Chief Financial Officer, Kemper Service Company
Treasurer and Chief Financial Officer, Supervised Service
Company, Inc.
Director and Treasurer, Kemper Investment Management Company
Limited
DUFFY, JEROME L.
Senior Vice President, Kemper Financial Services, Inc.
Treasurer, Kemper Closed-End Funds
Treasurer, Kemper International Bond Fund
Treasurer, Kemper Investors Fund
Treasurer, Kemper Mutual Funds
Treasurer, Kemper Target Equity Fund
Treasurer, Sterling Funds
GLASSMAN, HARVEY
Senior Vice President, Kemper Financial Services, Inc.
GOERS, RICHARD A.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Technology Fund
GUENTHER, HAROLD E.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Galaxy Offshore, Inc.
HUSSEY, KAREN A.
Senior Vice President, Kemper Financial Services, Inc.
C-13
<PAGE>
Vice President, Kemper Investors Fund
Vice President, Kemper Small Capitalization Equity Fund
INNES, BRUCE D.
Vice President, Kemper Financial Services, Inc.
Co-President, International Association of Corporate and
Professional Recruiters
KLEIN, GEORGE
Senior Vice President, Kemper Financial Services, Inc.
Director, Executive Vice President, Kemper Asset Management
Company
KORTH, FRANK D.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Technology Fund
McNAMARA, MICHAEL A.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Diversified Income Fund
Vice President, Kemper High Income Trust
Vice President, Kemper High Yield Fund
Vice President, Kemper Investors Fund
MIER, CHRISTOPHER J.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper National Tax-Free Income Series
Vice President, Kemper Municipal Income Trust
Vice President, Kemper State Tax-Free Income Series
Vice President, Kemper Strategic Municipal Income Trust
Vice President, Sterling Funds
MURRIHY, MAURA J.
Senior Vice President, Kemper Financial Services, Inc.
NATHANSON, IRA
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Corporation
NEEL, JAMES R.
Senior Vice President, Kemper Financial Services, Inc.
Executive Vice President, Kemper Asset Management Company
RACHWALSKI, JR. FRANK J.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Cash Account Trust
Vice President, Cash Equivalent Fund
Vice President, Investors Cash Trust
Vice President, Kemper Investors Fund
Vice President, Kemper Money Market Fund
Vice President, Kemper Portfolios
Vice President, Sterling Funds
Vice President, Tax-Exempt California Money Market Fund
C-14
<PAGE>
Vice President, Tax-Exempt New York Money Market Fund
REGNER, THOMAS M.
Senior Vice President, Kemper Financial Services, Inc.
RESIS, JR., HARRY E.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Diversified Income Fund
Vice President, Kemper High Income Trust
Vice President, Kemper High Yield Fund
Vice President, Kemper Investors Fund
SCHUMACHER, ROBERT T.
Senior Vice President, Kemper Financial Services, Inc.
SLOAN, PAUL F.
Senior Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Investors Fund
Vice President, Kemper Intermediate Government Trust
Vice President, Kemper Multi-Market Income Trust
Vice President, Kemper Strategic Income Fund
Vice President, Kemper Diversified Income Fund
Vice President, Kemper Portfolios
Vice President, Kemper U.S. Government Securities Fund
Vice President, Kemper Adjustable Rate U.S. Government Fund
URBASZEWSKI, KENNETH T.
Senior Vice President, Kemper Financial Services, Inc.
BURROW, DALE R.
First Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Strategic Municipal Income Trust
BYRNES, ELIZABETH A.
First Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Adjustable Rate U.S. Government Fund
Vice President, Kemper Intermediate Government Trust
CHIEN, CHRISTINE
First Vice President, Kemper Financial Services, Inc.
DeMAIO, CHRIS C.
First Vice President, Kemper Financial Services, Inc.
Vice President and Chief Accounting Officer, Kemper Service
Company
Vice President and Chief Accounting Officer, Supervised Service
Company, Inc.
DEXTER, STEPHEN P.
First Vice President, Kemper Financial Services, Inc.
DOYLE, DANIEL J.
First Vice President, Kemper Financial Services, Inc.
C-15
<PAGE>
FENGER, JAMES E.
First Vice President, Kemper Financial Services, Inc.
FISHER, REMY M.
First Vice President, Kemper Financial Services, Inc.
HALE, DAVID D.
First Vice President, Kemper Financial Services, Inc.
HARRINGTON, MICHAEL E.
First Vice President, Kemper Financial Services, Inc.
HORTON, ROBERT J.
First Vice President, Kemper Financial Services, Inc.
JACOBS, PETER M.
First Vice President, Kemper Financial Services, Inc.
KEELEY, MICHELLE M.
First Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Intermediate Government Trust
Vice President, Kemper Portfolios
KIEL, CAROL L.
First Vice President, Kemper Financial Services, Inc.
LAUGHLIN, ANN M.
First Vice President, Kemper Financial Services, Inc.
LENTZ, MAUREEN P.
First Vice President, Kemper Financial Services, Inc.
McCRINDLE-PETRARCA, SUSAN
First Vice President, Kemper Financial Services, Inc.
PAYNE, III, ROBERT D.
First Vice President, Kemper Financial Services, Inc.
PANOZZO, ROBERTA L.
First Vice President, Kemper Financial Services, Inc.
RATEKIN, DIANE E.
First Vice President, Assistant General Counsel and Assistant
Secretary, Kemper Financial Services, Inc.
Assistant Secretary, Kemper Distributors, Inc.
SILVIA, JOHN E.
First Vice President, Kemper Financial Services, Inc.
STUEBE, JOHN W.
First Vice President, Kemper Financial Services, Inc.
Vice President, Cash Account Trust
Vice President, Cash Equivalent Fund
C-16
<PAGE>
THOUIN-LEERKAMP, EDITH A.
First Vice President, Kemper Financial Services, Inc.
Director-European Equities, Kemper Investment Management
Company Limited
TRUTTER, JONATHAN W.
First Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Diversified Income Fund
VINCENT, CHRISTOPHER T.
First Vice President, Kemper Financial Services, Inc.
First Vice President, Kemper Asset Management Company
WILLSON, STEPHEN R.
First Vice President, Kemper Financial Services, Inc.
Vice President, Kemper Strategic Municipal Income Trust
WITTNEBEL, MARK E.
First Vice President, Kemper Financial Services, Inc.
CARNEY, ANNE T.
Vice President, Kemper Financial Services, Inc.
COHEN, JERRI I.
Vice President, Kemper Financial Services, Inc.
GERACI, AUGUST L.
Vice President, Kemper Financial Services, Inc.
GERICKE, KATHLEEN E.
Vice President, Kemper Financial Services, Inc.
GOLAN, JAMES S.
Vice President, Kemper Financial Services, Inc.
HESS, THOMAS L.
Vice President, Kemper Financial Services, Inc.
HUOT, LISA L.
Vice President, Kemper Financial Services, Inc.
KARWOWSKI, KENNETH F.
Vice President, Kemper Financial Services, Inc.
KNAPP, WILLIAM M.
Vice President, Kemper Financial Services, Inc.
KOCH, DEBORAH L.
Vice President, Kemper Financial Services, Inc.
C-17
<PAGE>
KOVACS, WILLIAM P.
Vice President and Assistant Secretary, Kemper Financial
Services, Inc.
Director, Kemper Advisors, Inc.
KRANZ, KATHY J.
Vice President, Kemper Financial Services, Inc.
KRUEGER, PAMELA D.
Vice President, Kemper Financial Services, Inc.
LeFEBVRE, THOMAS J.
Vice President, Kemper Financial Services, Inc.
MANGIPUDI, V. RAO
Vice President, Kemper Financial Services, Inc.
McGOVERN, KAREN B.
Vice President, Kemper Financial Services, Inc.
MILLER, MAUREEN A.
Vice President, Kemper Financial Services, Inc.
MINER, EDWARD
Vice President, Kemper Financial Services, Inc.
MITCHELL, KATHERINE H.
Vice President, Kemper Financial Services, Inc.
PANOZZO, ALBERT R.
Vice President, Kemper Financial Services, Inc.
PONTECORE, SUSAN E.
Vice President, Kemper Financial Services, Inc.
QUADRINI, LISA L.
Vice President, Kemper Financial Services, Inc.
RADIS, STEVE A.
Vice President, Kemper Financial Services, Inc.
ROKOSZ, PAUL A.
Vice President, Kemper Financial Services, Inc.
SMITH, ROBERT G.
Vice President, Kemper Financial Services, Inc.
TEPPER, SHARYN A.
Vice President, Kemper Financial Services, Inc.
WERTH, ELIZABETH C.
Vice President, Kemper Financial Services, Inc.
Assistant Secretary, Kemper Mutual Funds
C-18
<PAGE>
Assistant Secretary, Kemper International Bond Fund
Assistant Secretary, Kemper Target Equity Fund
Assistant Secretary, Sterling Funds
WIZER, BARBARA K.
Vice President, Kemper Financial Services, Inc.
ZURAWSKI, CATHERINE N.
Vice President, Kemper Financial Services, Inc.
Item 29. Principal Underwriters
(a) Kemper Distributors, Inc. is principal underwriter and
distributor of the Registrant's shares, the Kemper Mutual Funds,
Kemper Investors Fund, Sterling Funds and Kemper International
Bond Fund.
(b) Information on the officers and directors of Kemper
Distributors, Inc. is set forth below. The principal business
address is 120 South LaSalle Street, Chicago, Illinois 60603.
<TABLE>
<CAPTION>
<S> <C> <C>
Positions and
Offices with
Name Positions and Offices with Underwriter Registrant
---- -------------------------------------- -------------
John E. Peters Principal, Director and President Vice President
James L. Greenawalt Director, Executive Vice President None
Patrick H. Dudasik Financial Principal, Treasurer and None
Chief Financial Officer
Linda A. Bercher Senior Vice President None
Daniel T. O'Lear Senior Vice President None
David F. Dierenfeldt Vice President, Secretary None
Thomas V. Bruns Vice President None
Carlene D. Merold Vice President None
Diane E. Ratekin Assistant Secretary None
</TABLE>
(c) Not applicable.
Item 30. Location of Accounts and Records
Accounts, books and other documents are maintained at the
offices of the Registrant, the offices of Registrant's investment
adviser, Kemper Financial Services, Inc. and the principal
C-19
<PAGE>
underwriter, Kemper Distributors, Inc., 120 South LaSalle Street,
Chicago, Illinois 60603, the offices of the custodian and
transfer agent, Investors Fiduciary Trust Company, 127 West 10th
Street, Kansas City, Missouri 64105 or, at the offices of the
shareholder service agent, Supervised Service Company, 811 Main
Street, Kansas City, Missouri 64105.
Item 31. Management Services
Not applicable.
Item 32. Undertakings
(a) Not applicable.
(b) Registrant undertakes to file a post-effective
amendment containing financial statements, which need not be
certified, within four to six months from the commencement of
sales.
(c) Not applicable.
C-20
<PAGE>
S I G N A T U R E S
-------------------
Pursuant to the requirements of the Investment Company Act
of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Chicago and State of
Illinois, on the 31st day of May, 1995.
STERLING FUNDS
By /s/ Stephen B. Timbers
------------------------------
Stephen B. Timbers, President
<PAGE>
INDEX TO EXHIBITS
EX-99.B
1. (a) Amended and Restated Agreement and
Declaration of Trust.(1)
(b) Written Instrument Amending the Agreement
and Declaration of Trust.(1)
2. By-Laws.(1)
3. Inapplicable.
4. (a) Specimen of Share Certificates(2).
(i) Equity Fund.
(ii) Total Return Fund.
(iii) U.S. Government Securities Fund.
(iv) Municipal Bond Fund.
(v) Government Money Market Fund.
(b) Constituent Instruments.
(i) Written Instrument Establishing and
Designating Government Money Market
Fund.(2)
(ii) Written Instrument Changing the
Designation of Growth Fund.(2)
5. Investment Management Agreement(2).
6. Inapplicable.
7. Inapplicable.
8. (a) Custody Agreement (Form 1).(1)
(b) Custody Agreement (Form 2).(2)
9. (a) Agency Agreement.(1)
(b) Administrative Services Agreement.(1)
(c) Assignment of Administrative Services Agreement
10. Inapplicable.
11. Inapplicable.
12. Inapplicable.
13. Inapplicable.
14. Model Individual Retirement Account.(2)
15. Inapplicable.
16. Inapplicable.
<PAGE>
24. Powers of Attorney.
(1) Incorporated herein by reference to Registrant's Registration
Statement on Form N-1A filed on or about December 10, 1993.
(2) Incorporated herein by reference to Pre-Effective Amendment
No. 1 to Registrant's Registration Statement on Form N-1A filed
on or about March 29, 1994.
<PAGE>
EXHIBIT 99.B9(c)
ASSIGNMENT AND ASSUMPTION
ASSIGNMENT AND ASSUMPTION ("Assignment and Assumption") made
and entered into as of February 1, 1995 by and between Kemper
Financial Services, Inc., a Delaware corporation ("Assignor"),
and Kemper Distributors, Inc., a Delaware corporation
("Assignee").
WHEREAS, Assignor serves as administrator for Sterling
Funds, a Massachusetts business trust (the "Fund"), pursuant to
that certain Administrative Services Agreement dated June 1, 1994
by and between Assignor and the Fund, as may have been amended,
(the "Agreement");
WHEREAS, Assignee is a wholly-owned subsidiary of Assignor;
WHEREAS, It has been proposed that the rights, duties and
responsibilities of Assignor under the Agreement be transferred
to and assumed by Assignee;
WHEREAS, The Fund has determined that such transfer of
rights, duties and responsibilities is reasonable and in the best
interests of the Fund and the Fund's shareholders; and
NOW, THEREFORE, in consideration of the covenants
hereinafter contained, it is hereby agreed by and between the
parties hereto as follows:
1. Assignment and Assumption. Assignor assigns and
transfers to Assignee all of Assignor's rights, interests,
liabilities, duties and obligations under the Agreement
("Assigned Rights and Obligations"). Assignee accepts the
foregoing assignment and transfer of the Assigned Rights and
Obligations and agrees to assume, pay, perform and otherwise be
fully responsible for the same.
2. Further Assurances. From time to time, at the request
of either party, the other party will execute and deliver such
further instruments of assignment, transfer and assumption and
take such further action as may be required to assign, transfer
and assume the Assigned Rights and Obligations.
3. Applicable Law. This Assignment and Assumption shall
be governed by the laws of the State of Illinois.
4. Amendments. This Assignment and Assumption may only be
amended by the written agreement of the parties.
<PAGE>
IN WITNESS WHEREOF, the parties have each caused this
Assignment and Assumption to be executed on its behalf by a duly
authorized officer as of the date first written above.
KEMPER FINANCIAL SERVICES, INC.
By:
----------------------------
Its:
KEMPER DISTRIBUTORS, INC.
By:
----------------------------
Its:
The undersigned hereby acknowledges and consents to the foregoing
Assignment and Assumption as of February 1, 1995.
STERLING FUNDS
By:
------------------------------
Its:
2
<PAGE>
EXHIBIT 99.B24
POWER OF ATTORNEY
-----------------
The person whose signature appears below hereby appoints
Charles F. Custer, Stephen B. Timbers and Philip J. Collora and
each of them, any of whom may act without the joinder of the
others, as his attorney-in-fact to sign and file on his behalf
individually and in the capacity stated below such registration
statements, amendments, post-effective amendments, exhibits,
applications and other documents with the Securities and
Exchange Commission or any other regulatory authority as may be
desirable or necessary in connection with the public offering of
shares of Sterling Funds.
Signature Title Date
/s/ Arthur R. Gottschalk Trustee May 4, 1995
-------------------------
<PAGE>
POWER OF ATTORNEY
-----------------
The person whose signature appears below hereby appoints
Charles F. Custer, Stephen B. Timbers and Philip J. Collora and
each of them, any of whom may act without the joinder of the
others, as his attorney-in-fact to sign and file on his behalf
individually and in the capacity stated below such registration
statements, amendments, post-effective amendments, exhibits,
applications and other documents with the Securities and
Exchange Commission or any other regulatory authority as may be
desirable or necessary in connection with the public offering of
shares of Sterling Funds.
Signature Title Date
/s/ Frederick T. Kelsey Trustee 3/2/95
-------------------------
<PAGE>
POWER OF ATTORNEY
-----------------
The person whose signature appears below hereby appoints
Charles F. Custer, Stephen B. Timbers and Philip J. Collora and
each of them, any of whom may act without the joinder of the
others, as his attorney-in-fact to sign and file on his behalf
individually and in the capacity stated below such registration
statements, amendments, post-effective amendments, exhibits,
applications and other documents with the Securities and
Exchange Commission or any other regulatory authority as may be
desirable or necessary in connection with the public offering of
shares of Sterling Funds.
Signature Title Date
/s/ David B. Mathis Trustee May 4, 1995
-------------------------
<PAGE>
POWER OF ATTORNEY
-----------------
The person whose signature appears below hereby appoints
Charles F. Custer, Stephen B. Timbers and Philip J. Collora and
each of them, any of whom may act without the joinder of the
others, as his attorney-in-fact to sign and file on his behalf
individually and in the capacity stated below such registration
statements, amendments, post-effective amendments, exhibits,
applications and other documents with the Securities and
Exchange Commission or any other regulatory authority as may be
desirable or necessary in connection with the public offering of
shares of Sterling Funds.
Signature Title Date
/s/ Stephen B. Timbers Trustee May 4, 1995
-------------------------
<PAGE>
POWER OF ATTORNEY
-----------------
The person whose signature appears below hereby appoints
Charles F. Custer, Stephen B. Timbers and Philip J. Collora and
each of them, any of whom may act without the joinder of the
others, as his attorney-in-fact to sign and file on his behalf
individually and in the capacity stated below such registration
statements, amendments, post-effective amendments, exhibits,
applications and other documents with the Securities and
Exchange Commission or any other regulatory authority as may be
desirable or necessary in connection with the public offering of
shares of Sterling Funds.
Signature Title Date
/s/ John B. Tingleff Trustee May 4, 1995
-------------------------
<PAGE>
POWER OF ATTORNEY
-----------------
The person whose signature appears below hereby appoints
Charles F. Custer, Stephen B. Timbers and Philip J. Collora and
each of them, any of whom may act without the joinder of the
others, as his attorney-in-fact to sign and file on his behalf
individually and in the capacity stated below such registration
statements, amendments, post-effective amendments, exhibits,
applications and other documents with the Securities and
Exchange Commission or any other regulatory authority as may be
desirable or necessary in connection with the public offering of
shares of Sterling Funds.
Signature Title Date
/s/ John G. Weithers Trustee May 4, 1995
-------------------------
