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STATEMENT OF ADDITIONAL INFORMATION
SCHWAB ANNUITY PORTFOLIOS
101 Montgomery Street, San Francisco, CA 94104
SCHWAB MONEY MARKET PORTFOLIO
SCHWAB ASSET DIRECTOR(R) - HIGH GROWTH PORTFOLIO
SCHWAB S&P 500 PORTFOLIO
November 8, 1996
This Statement of Additional Information is not a prospectus. It should
be read in conjunction with the Prospectuses dated April 29, 1996 (as amended
from time to time) for the Schwab Money Market Portfolio (the "Money Market
Fund"), and the joint Prospectus dated November 8, 1996 (as amended from time to
time) for the Schwab Asset Director-High Growth Portfolio (the "High Growth
Fund") and the Schwab S&P 500 Portfolio (the "S&P 500 Fund"), three separately
managed investment portfolios (collectively the "Funds") of Schwab Annuity
Portfolios (the "Trust"). The Funds are designed to serve as investment vehicles
for variable annuity contracts ("Contracts") issued through separate accounts
("Separate Accounts") of participating life insurance companies ("Participating
Insurance Companies").
These Funds are intended for retirement savings or other long-term
investment purposes. In the future, shares of the Funds may be offered to other
Participating Insurance Companies and their Separate Accounts as an investment
vehicle for variable life insurance policies and to qualified pension and
retirement plans ("Plans"). To obtain a copy of any of these Prospectuses,
please contact the Schwab Annuity Service Center at Charles Schwab & Co., Inc.
("Schwab") at 800-838-0650 or P.O. Box 7785, San Francisco, CA 94120-9420; in
New York State, call 800-838-0649 or write P.O. Box 7806, San Francisco, CA
94120-9327.
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVES............................. 2
MANAGEMENT OF THE TRUST........................... 27
PORTFOLIO TRANSACTIONS AND TURNOVER............... 38
DISTRIBUTIONS AND TAXES........................... 36
SHARE PRICE CALCULATION........................... 38
HOW THE FUNDS REFLECT PERFORMANCE................. 39
YIELD............................................. 40
THE BENEFITS OF INTERNATIONAL INVESTING........... 41
INDEXING AND ASSET ALLOCATION..................... 41
GENERAL INFORMATION............................... 44
PURCHASE AND REDEMPTION OF SHARES................. 46
OTHER INFORMATION................................. 46
APPENDIX - RATINGS OF INVESTMENT SECURITIES....... 47
FINANCIAL STATEMENTS.............................. F-1
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INVESTMENT OBJECTIVES
SCHWAB MONEY MARKET PORTFOLIO
The Money Market Fund's investment objective is maximum current income
consistent with liquidity and stability of capital.
SCHWAB ASSET DIRECTOR(R)-
HIGH GROWTH PORTFOLIO
The investment objective of the High Growth Fund is to provide high
capital growth with less volatility than an all-stock portfolio. The Fund
provides significant exposure to various stock categories, including domestic
large and small company stocks and international stocks.
SCHWAB S&P 500 PORTFOLIO
The S&P 500 Fund's investment objective is to track the price and
dividend performance (total return) of common stocks of U.S. companies, as
represented by Standard & Poor's 500 Composite Stock Price Index(R) (the "S&P
500").
The investment objectives stated above for each of the Funds, along
with certain investment restrictions adopted by the Funds, are fundamental and
cannot be changed without approval by holders of a majority of the Funds'
outstanding voting shares, as defined in the Investment Company Act of 1940, as
amended (the "1940 Act").
INVESTMENT TECHNIQUES USED BY THE MONEY MARKET FUND
EURODOLLAR CERTIFICATES OF DEPOSIT AND FOREIGN SECURITIES
Before investing in Eurodollar certificates of deposit, the Money
Market Fund will consider their marketability, possible restrictions on
international currency transactions and any regulations imposed by the domicile
country of the foreign issuer. Eurodollar certificates of deposit may not be
subject to the same regulatory requirements as certificates of deposit issued by
U.S. banks, and associated income may be subject to the imposition of foreign
taxes.
Investments in securities of foreign issuers or securities principally
traded overseas may involve certain special risks due to foreign economic,
political and legal developments, including expropriation of assets or
nationalization, imposition of withholding taxes on dividend or interest
payments, and possible difficulty in obtaining and enforcing judgments against
foreign entities.
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SECTION 4(2) PAPER
Commercial paper and other securities are issued in reliance on the
so-called "private placement" exemption from registration afforded by Section
4(2) of the Securities Act of 1933, as amended ("Section 4(2) paper"). Federal
securities laws restrict the disposition of Section 4(2) paper. Section 4(2)
paper generally is sold to institutional investors, such as the Money Market
Fund, who agree that they are purchasing the paper for investment and not for
public distribution. Any resale by the purchaser must be in an exempt
transaction and may be accomplished in accordance with Rule 144A. Section 4(2)
paper is normally resold to other institutional investors such as the Money
Market Fund through or with the assistance of the issuer or investment dealers
who make a market in the Section 4(2) paper, thus providing liquidity. Because
it is not possible to predict with assurance exactly how this market for Section
4(2) paper sold and offered under Rule 144A will continue to develop, Charles
Schwab Investment Management, Inc. (the "Investment Manager"), pursuant to
guidelines approved by the Board of Trustees, will carefully monitor the Money
Market Fund's investments in these securities, focusing on such important
factors, among others, as valuation, liquidity and availability of information.
ASSET-BACKED COMMERCIAL PAPER AND OTHER SECURITIES
The Money Market Fund can invest a portion of its assets in
asset-backed commercial paper and other money market fund Eligible Securities.
(See "Money Market Fund Investment Policies and Restrictions.") The credit
quality of most asset-backed commercial paper depends primarily on the credit
quality of the assets underlying such securities, how well the entity issuing
the security is insulated from the credit risk of the originator (or any other
affiliated entities) and the amount and quality of any credit support provided
to the securities.
Asset-backed commercial paper is often backed by a pool of assets
representing the obligations of a number of different parties. To lessen the
effect of failures by obligors on these underlying assets to make payments, such
securities may contain elements of credit support. This credit support falls
into two classes: liquidity protection and protection against ultimate default
on the underlying assets. Liquidity protection refers to the provision of
advances, generally by the entity administering the pool of assets, to ensure
that scheduled payments on the underlying pool are made in a timely fashion.
Protection against ultimate default ensures payment on at least a portion of the
assets in the pool. This protection may be provided through guarantees,
insurance policies or letters of credit obtained from third parties, through
various means of structuring the transaction or through a combination of such
approaches. The degree of credit support provided on each issue is based
generally on historical information respecting the level of credit risk
associated with such payments. Delinquency or loss in excess of that anticipated
could adversely affect the return on an investment in an asset-backed security.
Bank notes are notes used to represent debt obligations issued by banks
in large denominations.
MONEY MARKET FUND INVESTMENT POLICIES AND RESTRICTIONS
Except as otherwise noted, the restrictions below are fundamental and
cannot be changed without approval of the holders of a majority of the
outstanding voting securities (as defined in the 1940 Act) of the Money Market
Fund.
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THE MONEY MARKET FUND MAY NOT:
(1) Purchase securities or make investments other than in accordance with its
investment objective and policies.
(2) 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 value of its assets would be invested in
securities of that issuer.
(3) Purchase more than 10% of any class of securities of any issuer. All debt
securities and all preferred stocks are each considered as one class.
(4) Concentrate 25% or more of the value of its assets in any one industry;
provided, however, that the Money Market Fund reserves the freedom of
action to invest up to 100% of its assets in certificates of deposit or
bankers' acceptances issued by domestic branches of U.S. banks and U.S.
branches of foreign banks (which the Money Market Fund has determined to
be subject to the same regulation as U.S. banks), or obligations of, or
guaranteed by, the U.S. Government, its agencies or instrumentalities in
accordance with its investment objective and policies.
(5) Invest more than 5% of its total net assets in securities of issuers
(other than obligations of, or guaranteed by, the U.S. Government, its
agencies or instrumentalities) that, with their predecessors, have a
record of less than three years of continuous operation.
(6) Enter into repurchase agreements if, as a result thereof, more than 10% of
its net assets valued at the time of the transaction would be subject to
repurchase agreements maturing in more than seven days and invested in
securities restricted as to disposition under the federal securities laws
(except commercial paper issued under Section 4(2) of the Securities Act
of 1933, as amended, hereinafter the "1933 Act"). The Money Market Fund
will invest no more than 10% of its net assets in illiquid securities.
(7) Invest more than 5% of its total assets in securities restricted as to
disposition under the federal securities laws (except commercial paper
issued under Section 4(2) of the 1933 Act).
(8) Purchase or retain securities of an issuer if any of the officers,
trustees or directors of the Trust or its Investment Manager individually
own beneficially more than 1/2 of 1% of the securities of that issuer and
together beneficially own more than 5% of the securities of such issuer.
(9) Invest in commodities or commodity contracts, including futures contracts,
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.
(10) Invest for the purpose of exercising control or management of another
issuer.
(11) Purchase securities of other investment companies, except in connection
with a merger, consolidation, reorganization or acquisition of assets.(1)
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(1) See the description of the Trustees' deferred compensation plan under
"Management of the Trust" in this Statement of Additional Information for
an exception to this investment restriction.
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(12) Make loans to others, except the Money Market Fund may (i) purchase a
portion of an issue of short-term debt securities or similar obligations
(including repurchase agreements) that are publicly distributed or
customarily purchased by institutional investors, and (ii) lend its
portfolio securities (up to one-third of the Money Market Fund's total
assets) in accordance with its investment objectives and policies.
(13) 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. The Money Market Fund will not borrow
for leverage purposes or purchase securities or make investments while
reverse repurchase agreements or borrowings are outstanding. If, for any
reason, the current value of the Money Market Fund's total net assets
falls below an amount equal to three times the amount of its indebtedness
from money borrowed, the Money Market Fund will, within three business
days, reduce its indebtedness to the extent necessary.
(14) Write, purchase or sell puts, calls or combinations thereof.
(15) 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.
(16) Invest in interests in oil, gas, mineral leases or other mineral
exploration or development programs, although it may invest in the
securities of issuers which invest in or sponsor such programs.
(17) Underwrite securities issued by others except to the extent it may be
deemed to be an underwriter, under the federal securities laws, in
connection with the disposition of securities from its investment
portfolio.
(18) Issue senior securities as defined in the 1940 Act.
Except for restrictions (4) and (13), if a percentage restriction is
adhered to at the time of investment, a later increase in percentage resulting
from a change in values or net assets will not be considered a violation.
The Money Market Fund will purchase only securities that present
minimal credit risks and which are First Tier or Second Tier Securities
(otherwise referred to as "Eligible Securities").(1) An Eligible Security is:
(1) a security with a remaining maturity of 397 days or less: (a) that is
rated by the requisite nationally recognized statistical rating
organizations ("NRSROs") (currently Moody's Investors Service ("Moody's"),
Standard & Poor's Corporation ("S&P"), Duff and Phelps Credit Rating Co.
("Duff"), Fitch
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(1) See the description of the Trustees' deferred compensation plan under
"Management of the Trust" in this Statement of Additional Information for
an exception to this investment restriction.
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Investors Service, Inc. ("Fitch"), Thomson Bankwatch, and, with respect to
debt issued by banks, bank holding companies, United Kingdom building
societies, broker-dealers and broker-dealers' parent companies, and
bank-supported debt, IBCA Limited and its affiliate, IBCA, Inc.)
designated by the Securities and Exchange Commission (the "SEC") in one of
the two highest rating categories for short-term debt obligations (the
requisite NRSROs being any two or, if only rated by one, that one NRSRO),
or (b) that itself was unrated by any NRSRO, but was issued by an issuer
that has outstanding a class of short-term debt obligations (or any
security within that class) meeting the requirements of subparagraph 1(a)
above that is of comparable priority and security;
(2) a security that at the time of issuance was a long-term security but has a
remaining maturity of 397 days or less and: (a) whose issuer received a
rating in one of the two highest rating categories from the requisite
NRSROs for short-term debt obligations with respect to a class of
short-term debt obligations (or any security within that class) that is
now comparable in priority and security with the subject security or (b)
that has long-term ratings from the requisite NRSROs that are in one of
the two highest categories; or
(3) a security not rated by an NRSRO but deemed by the Investment Manager,
pursuant to guidelines adopted by the Board of Trustees, to be of
comparable quality to securities described in (1) and (2) and to represent
minimal credit risks.
A First Tier Security is any Eligible Security that carries (or other
relevant securities issued by its issuer carry) top NRSRO ratings from at least
two NRSROs (a single top rating is sufficient if only one NRSRO rates the
security), or that the Investment Manager has determined, pursuant to guidelines
adopted by the Board of Trustees, to be of comparable quality to such a
security. A Second Tier Security is any other Eligible Security.
The Money Market Fund will limit its investments in the First Tier
Securities of any one issuer to no more than 5% of its assets. (Repurchase
agreements collateralized by non-government securities will be taken into
account when making this calculation.) Moreover, the Money Market Fund's total
holdings of Second Tier Securities will not exceed 5% of its assets, with
investment in the Second Tier Securities of any one issuer being limited to the
greater of 1% of the Money Market Fund's assets or $1 million. In addition, the
underlying securities involved in repurchase agreements collateralized by
non-government securities will be First Tier Securities at the time the
repurchase agreements are executed.
As noted above, the Money Market Fund will not purchase securities of
any issuer (other than obligations of, or guaranteed by, the U.S. Government,
its agencies or instrumentalities) if, as a result thereof, more than 5% of the
value of its assets would be invested in securities of that issuer. However,
pursuant to an exception under the 1940 Act, the Money Market Fund may invest up
to 25% of the value of its total assets in First Tier securities of a single
issuer for a period of up to 3 Business Days after the purchase thereof.
Also as noted above, the Money Market Fund may not borrow money except
as a temporary measure for extraordinary or emergency purposes. Such borrowing
will
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magnify declines as well as increases in the net asset value of the Money Market
Fund's shares and in the net yield on the Money Market Fund's investments.
Borrowing also increases the Money Market Fund's exposure to capital risk.
INVESTMENT TECHNIQUES USED BY THE HIGH GROWTH FUND AND THE S&P 500 FUND
FOREIGN INVESTMENTS
The High Growth Fund expects to invest in stocks of foreign issuers.
Investing in foreign issuers involves certain special considerations, including
those set forth below, which typically are not associated with investing in U.S.
issuers. Since investments in the securities of foreign issuers are usually made
and held in foreign currencies, and since the High Growth Fund may hold cash in
foreign currencies, they may be affected favorably or unfavorably by changes in
currency rates and in exchange control regulations and may incur costs in
connection with conversions between various currencies. The rate of exchange
between the U.S. dollar and other currencies is determined by the forces of
supply and demand in the foreign exchange market as well as by political and
economic factors.
Since foreign companies are not subject to uniform accounting, auditing
and financial reporting standards, practices and requirements comparable to
those applicable to U.S. companies, there may be less publicly available
information about a foreign company than about a U.S. company. Securities of
foreign companies have less volume, are less liquid and are more volatile than
securities of U.S. companies. Fixed commissions on foreign securities exchanges
are generally higher than negotiated commissions on U.S. exchanges, although the
High Growth Fund endeavors to achieve the most favorable net results on its
portfolio transactions. There is generally less government supervision and
regulation of foreign securities exchanges, brokers, dealers and listed
companies than in the United States, which increases the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities.
Foreign markets also have different clearance and settlement
procedures, and 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 delays in settlement could result
in temporary periods when a portion of the assets of the High Growth Fund is
uninvested and no return is earned thereon. The inability to make intended
security purchases due to settlement problems could cause the High Growth Fund
to miss attractive investment opportunities. Losses to the High Growth Fund that
arise out of the inability to fulfill a contract to sell such securities could
result in potential liability to the High Growth Fund.
In addition, with respect to those countries in which the High Growth
Fund may invest or other countries which may have a significant impact on the
companies in which the High Growth Fund may invest, there is the possibility of
expropriation or confiscatory taxation, political or social instability,
diplomatic developments, change of government or war, which could affect the
High Growth Fund's investments. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position.
The High Growth Fund may invest up to 5% of its net assets in companies
located in developing countries. Compared to the United States and other
developed countries, developing
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countries may have relatively unstable governments, economies based on only a
few industries and securities markets that trade a small number of securities.
Prices on these exchanges tend to be volatile, and securities in these countries
have historically offered greater potential for gain (as well as loss) than
securities of companies located in developed countries.
Hong Kong. In addition to the risks discussed above, it is impossible
to currently foresee what risk, if any, may exist to the High Growth Fund's
investments as a result of the planned 1997 incorporation of the British Crown
Colony of Hong Kong into the People's Republic of China. Shareholders should
note that the risks discussed above may increase depending on political and
economic developments as the scheduled time for the change in government in Hong
Kong draws nearer.
DEPOSITARY RECEIPTS
The High Growth Fund may invest up to 5% of its total net assets in
American Depositary Receipts, European Depositary Receipts, Global Depositary
Receipts, Global Depositary Shares ("ADRs," "EDRs," "GDRs" and "GDSs,"
respectively) or other similar global instruments, which are receipts
representing ownership of shares of a foreign-based issuer held in trust by a
bank or similar financial institution. These are designed for U.S. and European
securities markets as alternatives to purchasing underlying securities in their
corresponding national markets and currencies. ADRs, EDRs, GDRs and GDSs can be
sponsored or unsponsored. Sponsored ADRs, EDRs, GDRs and GDSs are certificates
in which a bank or financial institution participates with a custodian. Issuers
of unsponsored ADRs, EDRs, GDRs and GDSs are not contractually obligated to
disclose material information in the United States. Therefore, there may not be
a correlation between such information and the market value of the unsponsored
ADRs, EDRs, GDRs or GDSs.
OPTIONS ON SECURITIES
Writing Covered Options. Both the High Growth Fund and the S&P 500 Fund
may write (sell) covered call and put options on any securities in which they
may invest. The High Growth Fund and S&P 500 Fund may purchase and write such
options on securities that are listed on domestic or foreign securities
exchanges or traded in the over-the-counter market. All call options written by
the High Growth Fund and S&P 500 Fund are covered, which means that the High
Growth Fund and S&P 500 Fund will own the securities subject to the option so
long as the option is outstanding. The purpose of writing covered call options
is to realize greater income than would be realized on portfolio securities
transactions alone. However, in writing covered call options for additional
income, the High Growth Fund and S&P 500 Fund may forego the opportunity to
profit from an increase in the market price of the underlying security.
All put options the High Growth Fund and S&P 500 Fund write will be
covered, which means that each of the High Growth Fund and S&P 500 Fund will
have deposited with its custodian cash, U.S. Government securities or other
high-grade debt securities (i.e., securities rated in one of the top three
categories by Moody's or S&P or, if unrated, determined by the High Growth
Fund's and S&P 500 Fund's Investment Manager to be of comparable credit quality)
with a value at least equal to the exercise price of the put option. The purpose
of writing such options is to generate additional income for the High Growth
Fund and S&P 500 Fund. However, in return for the option premium, the High
Growth Fund and S&P 500 Fund accept the risk that they may be required to
purchase the underlying securities at a price in excess of the securities market
value at the time of purchase.
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The High Growth Fund and S&P 500 Fund may terminate their obligations
under a written call or put option by purchasing an option identical to the one
it has written. These purchases are referred to as "closing purchase
transactions."
Purchasing Options. The High Growth Fund and S&P 500 Fund may purchase
put and call options on any securities in which they may invest or options on
any securities index based on securities in which they may invest. The High
Growth Fund and S&P 500 Fund may also enter into closing sale transactions in
order to realize gains or minimize losses on options they have purchased.
The writer of an option may have no control over when the underlying
securities must be sold, in the case of a call option, or purchased, in the case
of a put option, since, with regard to certain options, the writer may be
assigned an exercise notice at any time prior to the termination of the
obligation. Whether or not an option expires unexercised, the writer retains the
amount of the premium. This amount may, in the case of a covered call option, be
offset by a decline in the market value of the underlying security during the
option period. If a call option is exercised, the writer experiences a profit or
loss from the sale of the underlying security. If a put option is exercised, the
writer must fulfill its obligation to purchase the underlying security at the
exercise price, which will usually exceed the then market value of the
underlying security.
The purchase of a call option would entitle the High Growth Fund and
S&P 500 Fund, in return for the premium paid, to purchase specified securities
at a specified price during the option period. The High Growth Fund and S&P 500
Fund would ordinarily realize a gain if, during the option period, the value of
such securities exceeded the sum of the exercise price, the premium paid and
transaction costs; otherwise the High Growth Fund and S&P 500 Fund would realize
either no gain or a loss on the purchase of the call option.
Risks Associated With Options Transactions. There is no assurance that
a liquid secondary market on a domestic or foreign options exchange will exist
for any particular exchange-traded option or at any particular time. If the High
Growth Fund and S&P 500 Fund are unable to effect a closing purchase transaction
with respect to covered options they have written, the High Growth Fund and S&P
500 Fund will not be able to sell the underlying securities or dispose of assets
held in a segregated account until the options expire or are exercised.
Similarly, if the High Growth Fund and S&P 500 Fund are unable to effect a
closing sale transaction with respect to options they have purchased, they would
have to exercise the options in order to realize any profit and will incur
transaction costs upon the purchase or sale of underlying securities.
Reasons for the absence of a liquid secondary market on an exchange
include the following: (i) there may be insufficient trading interest in certain
options; (ii) an exchange may impose restrictions on opening transactions or
closing transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or the Options
Clearing Corporation (the "OCC") may not at all times be adequate to handle
current trading volume; or (vi) one or more exchanges could, for economic or
other reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), although
outstanding options on that exchange that had been issued by the OCC as a
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result of trades on that exchange would continue to be exercisable in accordance
with their terms.
The High Growth Fund and S&P 500 Fund may purchase and sell both
options that are traded on U.S. and foreign exchanges and options traded
over-the-counter with broker-dealers who make markets in these options. The
ability to terminate over-the-counter options is more limited than with
exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations. Until
such time as the staff of the SEC changes its position, the High Growth Fund and
S&P 500 Fund will treat purchased over-the-counter options and all assets used
to cover written over-the-counter options as illiquid securities, except that
with respect to options written with primary dealers in U.S. Government
securities pursuant to an agreement requiring a closing purchase transaction at
a formula price, the amount of illiquid securities may be calculated with
reference to a formula the staff of the SEC approves. The High Growth Fund and
S&P 500 Fund will write or purchase an option only when the market value of that
option, when aggregated with the market value of all other options transactions
made on behalf of the Funds, does not exceed 5% of each of the High Growth
Fund's and S&P 500 Fund's net assets, respectively.
FOREIGN CURRENCY TRANSACTIONS
Forward Foreign Currency Exchange Contracts. The High Growth Fund may
enter into forward foreign currency exchange contracts in several circumstances.
The High Growth Fund may engage in foreign currency exchange transactions to
protect against uncertainty in the level of future exchange rates. The High
Growth Fund expects to engage in foreign currency exchange transactions in
connection with the purchase and sale of portfolio securities (so-called
"transaction hedging") and to protect the value of specific portfolio positions
("position hedging").
For transaction hedging purposes, the High Growth Fund enters into
foreign currency transactions with respect to specific receivables or payables
of the funds arising in connection with the purchase or sale of portfolio
securities. By transaction hedging, the High Growth Fund will attempt to protect
against a possible loss resulting from an adverse change in the relationship
between (i) the U.S. dollar and the applicable foreign currency during the
period between the date on which the security is purchased or sold and (ii) the
transaction's settlement date. When engaging in position hedging, the High
Growth Fund enters into foreign currency exchange transactions to protect
against a decline in the values of the foreign currencies in which portfolio
securities are denominated (or against an increase in the value of currency for
securities which the High Growth Fund expects to purchase).
When engaging in position and/or transaction hedging, the High Growth
Fund may purchase or sell foreign currencies on a spot (or cash) basis at the
prevailing spot rate and also may enter into contracts to purchase or sell
foreign currencies at a future date ("forward contracts") and purchase and sell
foreign currency futures contracts ("futures contracts"). The High Growth Fund
also may purchase exchange-listed and over-the-counter call and put options on
futures contracts and on foreign currencies. A put option on a futures contract
gives the High Growth Fund the right to assume a short position in the futures
contract until the expiration of the option. A put option on currency gives the
High Growth Fund the right to sell a currency at an exercise price until the
expiration of the option. A call
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option on a futures contract gives the High Growth Fund the right to assume a
long position in the futures contract until the expiration of the option. A call
option on currency gives the High Growth Fund the right to purchase a currency
at the exercise price until the expiration of the option.
Hedging transactions involve costs and may result in losses, and the
ability of the High Growth Fund to engage in hedging transactions may be limited
by tax considerations. Transaction and position hedging do not eliminate
fluctuations in the underlying prices of the securities that the High Growth
Fund owns or expects to purchase or sell. They simply establish a rate of
exchange that may be achieved at some future point in time. Additionally,
although these techniques tend to minimize the risk of loss due to a possible
decline in the value of the hedged currency, they tend to limit any potential
gain that might result from an increase in the value of such currency.
Although the contracts are not presently regulated by the Commodity
Futures Trading Commission (the "CFTC"), the CFTC may in the future assert
authority to regulate these contracts. In such event, the ability of the High
Growth Fund to use forward foreign currency exchange contracts may be
restricted.
The High Growth Fund will enter into a forward foreign currency
exchange contract only when the market value of such contract, when aggregated
with the market value of all other such contracts held by the High Growth Fund,
does not exceed 5% of the High Growth Fund's net assets.
The High Growth Fund generally will not enter into a forward contract
with a term of greater than one year.
While the High Growth Fund will enter into forward contracts to reduce
currency exchange rate risks, transactions in such contracts involve certain
other risks. Thus, while the High Growth Fund may benefit from such
transactions, unanticipated changes in currency prices may result in a poorer
overall performance for the High Growth Fund than if it had not engaged in any
such transactions. Moreover, there may be imperfect correlation between the High
Growth Fund's portfolio holdings of securities denominated in a particular
currency and forward contracts into which the High Growth Fund enters. Such
imperfect correlation may cause the High Growth Fund to sustain losses, which
will prevent the High Growth Fund from achieving a complete hedge or expose the
High Growth Fund to risk of foreign exchange loss.
Writing and Purchasing Currency Call and Put Options. The High Growth
Fund may write covered put and call options and purchase put and call options on
foreign currencies for the purpose of protecting against declines in the dollar
value of portfolio securities and against increases in the dollar cost of
securities to be acquired. A call option written by the High Growth Fund would
obligate the High Growth Fund to sell specified currency to the holder of the
option at a specified price at any time before the expiration date. A put option
written by the High Growth Fund would obligate the High Growth Fund to purchase
specified currency from the option holder at a specified time before the
expiration date. The writing of currency options involves a risk that the High
Growth Fund will, upon exercise of the option, be required to sell currency
subject to a call at a price that is less than the currency's market value or be
required to purchase currency subject to a put at a price that exceeds the
currency's market value.
The High Growth Fund may terminate its obligations under a call or put
option by purchasing an option identical to the one it has written. These
purchases are referred to as "closing purchase transactions." The High Growth
Fund would also be able to enter into
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closing sale transactions in order to realize gains or minimize losses on
options purchased by the High Growth Fund.
The purchase of a call option would entitle the High Growth Fund to
purchase specified currency at a specified price during the option period in
return for the premium paid. The High Growth Fund would ordinarily realize a
gain or a loss on the purchase of the call option.
The purchase of a put option would entitle the High Growth Fund to sell
specific currency at a specified price during the option period in exchange for
the premium paid. The purchase of protective puts is designed merely to offset
or hedge against a decline in the dollar value of the High Growth Fund's
portfolio securities due to currency exchange rate fluctuations. The High Growth
Fund would ordinarily realize a gain, if, during the option period, the value of
the underlying currency were to decrease below the exercise price sufficiently
to more than cover the premium and transaction costs; otherwise the High Growth
Fund would realize either no gain or a loss on the purchase of the put option.
Gains and losses on the purchase of protective put options would tend to be
offset by countervailing changes in the value of the underlying currency.
Special Risks Associated With Options on Foreign Currency. An exchange
traded option position may be closed out only on an options exchange that
provides a secondary market for an option of the same series. Although the High
Growth Fund will generally purchase or write only those options for which there
appears to be an active secondary market, there is no assurance that a liquid
secondary market on an exchange will exist for any particular option or at any
particular time. For some options, no secondary market on an exchange may exist.
In such event, it might not be possible to effect closing transactions in
particular options, with the result that the High Growth Fund would have to
exercise its options in order to realize any profit and would incur transaction
costs upon the sale of underlying securities pursuant to the exercise of put
options. If the High Growth Fund, as a covered call option writer, is unable to
effect a closing purchase transaction in a secondary market, it will not be able
to sell the underlying currency (or security denominated in that currency) until
the option expires or it delivers the underlying currency upon exercise.
There is no assurance that higher than anticipated trading activity or
other unforeseen events might not, at times, render certain of the facilities of
the OCC inadequate. This could result in an exchange instituting special
procedures that may interfere with the timely execution of customers' orders.
The High Growth Fund will purchase and write over-the-counter options
only to the extent consistent with its limitations on investments in illiquid
securities, as described in its Prospectus. Trading in over-the-counter options
is subject to the risk that the other party will be unable or unwilling to
close-out purchasing and writing activities.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The High Growth Fund and S&P 500 Fund may purchase and sell various
kinds of futures contracts and options on futures contracts. The futures
contracts may be based on various securities (such as U.S. Government
securities), securities indices, foreign currencies and other financial
instruments and indices. All futures contracts entered into by the High Growth
Fund and S&P 500 Fund are traded on U.S. exchanges or boards of trade that the
CFTC licenses and regulates or on foreign exchanges. The High Growth Fund and
S&P 500 Fund are
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not permitted to engage in speculative futures trading.
Futures Contracts. A futures contract generally may be described as an
agreement between two parties to buy and sell particular financial instruments
for an agreed upon price during a designated month (or to deliver the final cash
settlement price, in the case of a contract relating to an index or otherwise
not calling for physical delivery at the end of trading in the contract).
When interest rates are rising or securities prices are falling, the
High Growth Fund and S&P 500 Fund can seek, through the sale of futures
contracts, to offset a decline in the value of their current portfolio
securities. When rates are falling or prices are rising, the High Growth Fund
and S&P 500 Fund, through the purchase of futures contracts, may attempt to
secure better rates or prices than might later be available in the market when
they effect anticipated purchases. Similarly, the High Growth Fund can sell
futures contracts on a specified currency to protect against a decline in the
value of that currency and their portfolio securities that are denominated in
that currency. The High Growth Fund can purchase futures contracts on a foreign
currency to fix the price in U.S. dollars of a security denominated in that
currency that the High Growth Fund has acquired or expects to acquire.
Although futures contracts, by their terms, generally call for the
actual delivery or acquisition of underlying securities or the cash value of the
index, in most cases the contractual obligation is fulfilled before the date of
the contract without having to make or take such delivery. The contractual
obligation is offset by buying (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, which is effected through a member of an exchange, cancels
the obligation to make or take delivery of the securities or the cash value of
the index underlying the contractual obligations. The High Growth Fund and S&P
500 Fund may incur brokerage fees when they purchase or sell futures contracts.
Positions taken in the futures markets are not normally held to
maturity but are instead liquidated through offsetting transactions, which may
result in a profit or a loss. While the High Growth Fund's and S&P 500 Fund's
futures contracts on securities or currency will usually be liquidated in this
manner, the High Growth Fund and S&P 500 Fund may instead make or take delivery
of the underlying securities or currency whenever it appears economically
advantageous for them to do so. A clearing corporation associated with the
exchange on which futures on securities or currencies are traded guarantees
that, if still open, the sale or purchase will be performed on the settlement
date.
Options on Futures Contracts. The acquisition of put and call options
on futures contracts will give the High Growth Fund and S&P 500 Fund the right
(but not the obligation), for a specified price, to sell or to purchase,
respectively, the underlying futures contract at any time during the option
period. As the purchaser of an option on a futures contract, the High Growth
Fund and S&P 500 Fund obtain the benefit of the futures position if prices move
in a favorable direction but limit their risk of loss in the event of an
unfavorable price movement to the loss of the premium and transaction costs.
The writing of a call option on a futures contract generates a premium
that may partially offset a decline in the value of the High Growth Fund's and
S&P 500 Fund's assets. By writing a call option, the High Growth Fund and S&P
500 Fund become obligated, in exchange for the premium, to sell a futures
contract that may have a value lower than the exercise price. Thus, the
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loss incurred by the High Growth Fund and S&P 500 Fund in writing options on
futures is potentially unlimited and may exceed the amount of the premium
received. The High Growth Fund and S&P 500 Fund will incur transaction costs in
connection with the writing of options on futures.
The holder or writer of an option on a futures contract may terminate
its position by selling or purchasing an offsetting option on the same series.
There is no guarantee that these closing transactions can be effected. The High
Growth Fund's and S&P 500 Fund's ability to establish and close out positions on
such options will be subject to the development and maintenance of a liquid
market.
Hedging Strategies With Futures. Hedging by use of futures contracts
seeks to establish more certainty than would otherwise be possible with respect
to the effective price, rate of return or currency exchange rate on portfolio
securities or securities that the High Growth Fund and S&P 500 Fund own or
propose to acquire.
Such futures contracts may include contracts for the future delivery of
securities held by the High Growth Fund and S&P 500 Fund or securities with
characteristics similar to those of the High Growth Fund's and S&P 500 Fund's
portfolio securities. Similarly, the High Growth Fund may sell futures contracts
on currency in which its portfolio securities are denominated or in one currency
to hedge against fluctuations in the value of securities denominated in a
different currency if there is an established historical pattern of correlation
between the two currencies. If, in the opinion of the Investment Manager, there
is a sufficient degree of correlation between price trends for the High Growth
Fund's and S&P 500 Fund's portfolio securities and futures contracts based on
other financial instruments, securities indices or other indices, the High
Growth Fund and S&P 500 Fund may also enter into such futures contracts as part
of their hedging strategy. Although, under some circumstances, prices of
securities in the High Growth Fund's and S&P 500 Fund's portfolio may be more or
less volatile than prices of such futures contracts, the Investment Manager will
attempt to estimate the extent of this difference in volatility based on
historical patterns. The Investment Manager will attempt to compensate for this
volatility by having the High Growth Fund and S&P 500 Fund enter into a greater
or lesser number of futures contracts or by attempting to achieve only a
particular hedge against price changes affecting the High Growth Fund's and S&P
500 Fund's portfolio securities. When hedging of this character is successful,
any depreciation in the value of the portfolio securities will be offset
substantially by appreciation in the value of the futures position. On the other
hand, any unanticipated appreciation in the value of the High Growth Fund's and
S&P 500 Fund's portfolio securities will be offset substantially by a decline in
the value of the futures position.
On other occasions, the High Growth Fund and S&P 500 Fund may take
"long" positions by purchasing such futures contracts. This would be done, for
example, when the High Growth Fund and S&P 500 Fund anticipate the subsequent
purchase of particular securities when they have the necessary cash but expect
the prices or currency exchange rates available on the intended date of purchase
in the applicable market to be less favorable than prices that are currently
available.
When buying or selling futures contracts, a Fund must deposit an amount
of cash, cash equivalents, or liquid, high-quality debt instruments with its
broker equal to a fraction of the contract amount. This amount is known as
"initial margin" and is in the nature of a performance bond or good faith
deposit on the contract, which will be returned to the Fund upon termination of
the futures contract, assuming all
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contractual obligations have been satisfied. Subsequent payments to and from the
broker, known as "variation margin," will be made at least daily as the price of
the futures contract fluctuates and the Fund's position in the contract becomes
more or less valuable. This process is known as "marking-to-market."
Regulations of the CFTC applicable to the High Growth Fund and S&P 500
Fund generally require that all of their futures transactions constitute "bona
fide" hedging transactions. As a result, a Fund will normally sell futures
contracts to protect against a decrease in the price of securities it owns but
intends to sell or purchase futures contracts to protect against an increase in
the price of securities it intends to purchase. In addition, the High Growth
Fund and S&P 500 Fund may purchase and sell futures contracts and options as a
substitute for a comparable market position in the underlying securities.
Futures transactions need not constitute "bona fide" hedging under CFTC
regulations if the aggregate initial margin and premiums required to establish
such positions do not exceed 5% of each Fund's net assets.
Risks Involved in Futures and Options Transactions. Futures and options
transactions involve risks which, in some strategies, can be substantial, due to
the low margin deposits required and the extremely high degree of leverage
involved in futures and options trading. However, to the extent the High Growth
Fund's and S&P 500 Fund's futures and options practices are limited to hedging
purposes, the Investment Manager does not believe that the High Growth Fund and
S&P 500 Fund are subject to the degree of risk frequently associated with
futures and options transactions. To the extent the High Growth Fund and S&P 500
Fund engage in the use of futures and options on futures other than for hedging
purposes, the High Growth Fund and S&P 500 Fund may be subject to additional
risk.
Three principal areas of risk are present when futures and options
contracts are used even in a hedging context. First, there may not always be a
liquid secondary market for a futures or option contract at the time when the
High Growth Fund or S&P 500 Fund seek to "close out" its position. If the High
Growth Fund or S&P 500 Fund is unable to "close out" a futures or option
position and prices move adversely, the Fund will have to continue to make daily
cash payments to maintain its required margin, and if the Fund has insufficient
cash to meet this requirement, it may have to sell portfolio securities at a
disadvantageous time. In addition, the Fund might be required to deliver the
securities underlying futures or options contracts it holds. The High Growth
Fund and S&P 500 Fund will seek to reduce the risk that they will be unable to
"close out" contracts by entering only futures or options contracts that are
traded on national exchanges and for which there appear to be a liquid secondary
market.
It is also possible that changes in the prices of futures or options
contracts might correlate imperfectly, or not at all, with changes in the market
values of the securities being hedged. This situation could result from price
distortions in the futures or options markets due to, among other things, active
trading by speculators and use of offsetting "closing" transactions by other
investors seeking to avoid meeting additional margin deposit requirements. In
the event of significant market distortions, it is possible that the High Growth
Fund and S&P 500 Fund could lose money on futures or options contracts and
experience appreciation in the value of their portfolio securities, or vice
versa.
Finally, adverse market movements could cause the High Growth Fund and
S&P 500 Fund to lose up to their full investment in an options
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contract and/or to experience substantial losses on an investment in a futures
contract. However, barring such significant market distortions, a similar result
could be expected were the High Growth Fund and S&P 500 Fund to invest directly
in the securities being hedged. There is also the risk of loss by either Fund of
margin deposits in the event of bankruptcy of a broker with whom either Fund has
an open position in a futures contract or option.
The extent to which the High Growth Fund and S&P 500 Fund may purchase
and sell futures, options, equity index participations and index participation
contracts may be limited by each Fund's intention to meet Internal Revenue Code
of 1986, as amended (the "Code"), requirements for qualification as a regulated
investment company. See "Distributions and Taxes - Federal Income Tax."
SWAPS
The High Growth Fund may enter into swaps on various securities (such
as U.S. Government securities), securities indices, interest rates, prepayment
rates, foreign currencies or other financial instruments or indices in order to
protect the value of the High Growth Fund from interest rate fluctuations and to
hedge against fluctuations in the floating rate market in which the High Growth
Fund's investments are traded, for both hedging and non-hedging purposes. While
swaps are different from futures contracts (and options on futures contracts) in
that swap contracts are individually negotiated with specific counterparties,
the High Growth Fund will use swap contracts for purposes similar to the
purposes for which they use options, futures and options on futures. Those uses
of swap contracts (i.e., risk management and hedging) present the Fund with
risks and opportunities similar to those associated with options contracts,
futures contracts and options on futures. See "Futures Contracts and Options on
Futures Contracts."
The High Growth Fund may enter into these transactions to manage its
exposure to changing interest rates and other market factors. Some transactions
may reduce the High Growth Fund's exposure to market fluctuations, while others
may tend to increase market exposure.
The use of swaps involves investment techniques and risks different
from and potentially greater than those associated with ordinary fund securities
transactions. If the Investment Manager is incorrect in its expectations of
market values, interest rates or currency exchange rates, the investment
performance of the High Growth Fund would be less favorable than it would have
been if this investment technique were not used. The High Growth Fund will
invest up to 5% of its net assets in swaps.
PREFERRED STOCK
The High Growth Fund may invest in preferred stock. Preferred stock has
priority over common stock as to income and generally as to assets of an issuer;
however, income is usually limited to a definitive percentage regardless of the
issuer's earnings. Preferred stock usually has limited voting rights. The High
Growth Fund will invest up to 5% of its net assets in preferred stock.
CONVERTIBLE SECURITIES
The High Growth Fund may invest up to 5% of its net assets in
securities that are convertible into common stock, including convertible bonds
that are investment grade, convertible preferred stocks and warrants. The S&P
500 Fund will not purchase convertible securities directly. It may, however,
hold convertible securities to the extent that such
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holdings are incident to its ownership of common stocks.
Convertible bonds are issued with lower coupons than nonconvertible
bonds of the same quality and maturity, but they give holders the option to
exchange their bonds for a specific number of shares of the company's common
stock at a predetermined price. This structure allows the convertible bond
holder to participate in share price movements in the company's common stock.
The actual return on a convertible bond may exceed its stated yield if the
company's common stock appreciates in value and the option to convert to common
shares becomes more valuable.
Convertible preferred stocks are nonvoting equity securities that pay a
fixed dividend. These securities have a convertible feature similar to
convertible bonds; however, they do not have a maturity date. Due to their
fixed-income features, convertible issues are typically more sensitive to
interest rate changes than the underlying common stock. In the event of
liquidation, bondholders would have claims on company assets senior to those of
stockholders; preferred stockholders would have claims senior to those of common
stockholders.
Warrants. The High Growth Fund and S&P 500 Fund may invest in warrants,
which are options to purchase equity securities at specific prices for a
specific period of time. The prices do not necessarily move parallel to the
prices of the underlying securities. Warrants have no voting rights, receive no
dividends and have no rights with respect to the assets of the issuer. If a
warrant is not exercised within the specified time period, it will become
worthless and the Fund will lose the purchase price and the right to purchase
the underlying security.
REAL ESTATE-RELATED INVESTMENTS
The High Growth Fund may invest no more than 5% of its net assets in
real estate-related investments. Real estate-related instruments include real
estate investment trusts, commercial and residential mortgage-backed securities
and real estate financings. Real estate-related instruments are sensitive to
factors such as changes in real estate values and property taxes, interest
rates, cash flow of underlying real estate assets, overbuilding, and the
management skill and creditworthiness of the issuer. Real estate-related
instruments may also be affected by tax and regulatory requirements, such as
those relating to the environment.
PRECIOUS METAL-RELATED INVESTMENTS
The High Growth Fund may invest no more than 5% of its net assets in
precious metal-related investments. The High Growth Fund and the S&P 500 Fund
may invest in common stocks of domestic companies principally engaged in
precious metal-related activities which include companies principally engaged in
the extraction, processing, distribution or marketing of precious metals if at
the time of investment the Investment Manager considers that at least 50% of the
company's assets, revenues or profits are derived from the precious metal
industry. The High Growth Fund may also invest in securities of foreign
companies principally engaged in the precious metals industry. For further
disclosure on foreign securities, see "Foreign Investments."
The High Growth Fund and the S&P 500 Fund also may invest in futures on
precious metals, such as gold futures, and options thereon. Such investments are
subject to the investment limitations on investments in futures and options for
the High Growth Fund and the S&P 500 Fund as set forth in "Futures Contracts and
Options on Futures Contracts."
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Prices of precious metals can be expected to respond to changes in
rates of inflation and to perceptions of economic and political instability.
Historically, the prices of precious metals and of securities of companies
engaged in the precious metal-related activities have been subject to extreme
fluctuations, reflecting wider economic or political instability or other
reasons.
U.S. GOVERNMENT SECURITIES
The High Growth Fund and S&P 500 Fund may purchase U.S. Government
securities. Direct obligations of the U.S. Government are supported by the full
faith and credit of the U.S. Treasury. While obligations of certain U.S.
Government agencies and instrumentalities are similarly backed, those of others,
such as the Federal National Mortgage Association and the Student Loan Marketing
Association, are only supported by the right of the issuer to borrow from the
U.S. Treasury, the discretionary authority of the U.S. Government to purchase
the agency's obligations or the credit of the issuing agency or instrumentality.
There can be no assurance that the U.S. Government would provide financial
support to U.S. Government sponsored agencies or instrumentalities if it were
not obligated to do so by law. The High Growth Fund and S&P 500 Fund will invest
in U.S. Government securities not backed by the full faith and credit of the
U.S. Treasury only when the Investment Manager is satisfied that the credit risk
with respect to their issuer is minimal.
GOVERNMENT "MORTGAGE BACKED" SECURITIES
Government "mortgage-backed" (or government guaranteed
mortgage-related) securities are among the U.S. Government securities in which
the High Growth Fund and S&P 500 Fund may invest. Mortgages backing the
securities purchased by the High Growth Fund and S&P 500 Fund include, among
others, conventional 30-year fixed rate mortgages, graduated payment mortgages,
15-year mortgages and adjustable rate mortgages. All of these mortgages can be
used to create pass-through securities. A pass-through security is formed when
mortgages are pooled together and undivided interests in the pool or pools are
sold. The cash flow from the mortgages is passed through to the holders of the
securities in the form of periodic payments of interest, principal and
prepayments (net of a service fee). Prepayments occur when the holder of an
individual mortgage prepays the remaining principal before the mortgage's
scheduled maturity date. As a result of the pass-through of prepayments of
principal on the underlying securities, mortgage-backed securities are often
subject to more rapid prepayment of principal than their stated maturity
indicates. Because the prepayment characteristics of the underlying mortgages
vary, it is not possible to predict accurately the realized yield or average
life of a particular issue of pass-through certificates. Prepayment rates are
important because of their effect on the yield and price of the securities.
Accelerated prepayments adversely impact yields for pass-throughs purchased at a
premium (i.e., a price in excess of principal amount) and may involve additional
risk of loss of principal because the premium may not be fully amortized at the
time the obligation is repaid. The opposite is true for pass-throughs purchased
at a discount. The High Growth Fund and S&P 500 Fund may purchase
mortgage-related securities at a premium or at a discount. Principal and
interest payments on the mortgage-related securities are guaranteed by the
government to the extent described below. Such guarantees do not extend to the
value or yield of the mortgage-related securities themselves or of a Fund's
shares.
GNMA Certificates. Certificates of the Government National Mortgage
Association ("GNMA") are mortgage securities which
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evidence an undivided interest in a pool or pools of mortgages. GNMA
Certificates that the High Growth Fund and S&P 500 Fund may purchase are the
"modified pass-through" type, which entitle the holder to receive timely payment
of all interest and principal payments due on the mortgage pool, net of fees
paid to the "issuer" and GNMA, regardless of whether or not the mortgagor
actually makes the payment.
The National Housing Act authorized GNMA to guarantee the timely
payment of principal and interest on securities backed by a pool of mortgages
insured by the Federal Housing Administration ("FHA") or guaranteed by the
Veterans Administration ("VA"). The GNMA guarantee is backed by the full faith
and credit of the U.S. Government. GNMA is also empowered to borrow without
limitation from the U.S. Treasury if necessary to make any payments required
under its guarantee.
The average life of a GNMA Certificate is likely to be substantially
shorter than the original maturity of the mortgages underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosures will usually
result in the return of the greater part of principal investment long before the
maturity of the mortgages in the pool. Foreclosures impose no risk to principal
investment because of the GNMA guarantee, except to the extent that a Fund has
purchased the certificates above par in the secondary market.
FHLMC Securities. The Federal Home Loan Mortgage Corporation ("FHLMC")
was created in 1970 to promote development of a nationwide secondary market in
conventional residential mortgages. The FHLMC issues two types of mortgage
pass-through securities ("FHLMC Certificates"): mortgage participation
certificates ("PCs") and guaranteed mortgage certificates ("GMCs"). PCs resemble
GNMA Certificates in that each PC represents a pro rata share of all interest
and principal payments made and owed on the underlying pool. The FHLMC
guarantees timely monthly payment of interest on PCs and the ultimate payment of
principal.
GMCs also represent a pro rata interest in a pool of mortgages.
However, these instruments pay interest semi-annually and return principal once
a year in guaranteed minimum payments. The expected average life of these
securities is approximately 10 years. The FHLMC guarantee is not backed by the
full faith and credit of the U.S. Government.
FNMA Securities. The Federal National Mortgage Association ("FNMA") was
established in 1938 to create a secondary market in mortgages the FHA insures.
FNMA issues guaranteed mortgage pass-through certificates ("FNMA Certificates").
FNMA Certificates resemble GNMA Certificates in that each FNMA Certificate
represents a pro rata share of all interest and principal payments made and owed
on the underlying pool. FNMA guarantees timely payment of interest and principal
on FNMA Certificates. The FNMA guarantee is not backed by the full faith and
credit of the U.S. Government.
OTHER ASSET-BACKED SECURITIES
The High Growth Fund may invest a portion of its assets in debt
obligations known as "Asset-Backed Securities" that are rated in one of the
three highest rating categories by a nationally recognized statistical rating
organization (e.g., S&P or Moody's) or, if not so rated, deemed to be of
equivalent quality by the Investment Manager pursuant to guidelines adopted by
the Board of Trustees. The credit quality of most Asset-Backed Securities
depends primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated from the
credit risk of the originator (or any other affiliated entities), and the amount
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and quality of any credit support provided to the securities. The rate of
principal payments on Asset-Backed Securities generally depends on the rate of
principal payments received on the underlying assets, which in turn may be
affected by a variety of economic and other factors. As a result, the yield on
any Asset-Backed Security is difficult to predict with precision, and actual
yield to maturity may be more or less than the anticipated yield to maturity.
Asset-Backed Securities may be classified as "Pass-Through Certificates" or
"Collateralized Obligations."
"Pass-Through Certificates" are asset-backed securities that represent
undivided fractional ownership interests in the underlying pool of assets.
Pass-Through Certificates usually provide for payments of principal and interest
received to be passed through to their holders, usually after a deduction for
certain costs and expenses incurred in administering the pool. Because
Pass-Through Certificates represent ownership interests in the underlying
assets, the holders thereof bear directly the risk of any defaults by the
obligors on the underlying assets not covered by any credit support.
Asset-Backed Securities issued in the form of debt instruments, also
known as Collateralized Obligations, are generally issued as the debt of a
special purpose entity organized solely for the purpose of owning such assets
and issuing such debt. The assets collateralizing such Asset-Backed Securities
are pledged to a trustee or custodian for the benefit of the holders thereof.
Such issuers generally hold no assets other than those underlying the
Asset-Backed Securities and any credit support provided. As a result, although
payments on such Asset-Backed Securities are obligations of the issuers, in the
event of default on the underlying assets not covered by any credit support, the
issuing entities are unlikely to have sufficient assets to satisfy their
obligations on the related Asset-Backed Securities.
METHODS OF ALLOCATING CASH FLOWS
While many Asset-Backed Securities are issued with only one class of
security, many others are issued in more than one class, each with different
payment terms. Multiple class Asset-Backed Securities are issued for two main
reasons. First, multiple classes may be used as a method of providing credit
support. This is typically accomplished by creating one or more classes with a
right to payments on the Asset-Backed Security subordinate to that of the
remaining class or classes. Second, multiple classes may permit the issuance of
securities with payment terms, interest rates or other characteristics that
differ both from those of each other and from those of the underlying assets.
Examples include so-called "multi-tranche CMOs" (collateralized mortgage
obligations) with serial maturities such that all principal payments received on
the mortgages underlying the securities are first paid to the class with the
earliest stated maturity, and then sequentially to the class with the next
stated maturity), "Strips" (Asset-Backed Securities that entitle the holder to
disproportionate interests with respect to the allocation of interest and
principal of the assets backing the security) and securities with a class or
classes having characteristics that mimic the characteristics of
non-Asset-Backed Securities, such as floating interest rates (i.e., interest
rates that adjust as a specified benchmark changes) or scheduled amortization of
principal.
TYPES OF CREDIT SUPPORT
Asset-Backed Securities are often backed by a pool of assets
representing the obligations of a number of different parties. To lessen the
effect of failures by obligors on these underlying assets to make payments, such
securities may contain elements of credit support. Such credit support falls
into two classes: liquidity
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protection and protection against ultimate default on the underlying assets.
Liquidity protection refers to the provision of advances, generally by the
entity administering the pool of assets, to ensure that scheduled payments on
the underlying pool are made timely. Protection against ultimate default ensures
payment on at least a portion of the assets in the pool. Such protection may be
provided through guarantees, insurance policies or letters of credit obtained
from third parties, through various means of structuring the transaction, or
through a combination of such approaches. Examples of Asset-Backed Securities
with credit support that arise out of the structure of the transaction include
"senior-subordinated securities" (multiple class Asset-Backed Securities with
certain classes subordinate to other classes as to the payment of principal
thereon, so that defaults on the underlying assets are borne first by the
holders of the subordinated class) and Asset-Backed Securities that have
"reserve funds" (cash or investments, sometimes funded from a portion of the
initial payments on the underlying assets, are held in reserve against future
losses) or that have been "overcollateralized" (the scheduled payments on, or
the principal amount of, the underlying assets substantially exceed that
required to make payment on the Asset-Backed Securities and pay any servicing or
other fees). The degree of credit support provided on each issue is generally
based on historical information respecting the level of credit risk associated
with such payments. Delinquency or loss in excess of that anticipated could
adversely affect the return on an investment in an Asset-Backed Security.
CREDIT CARD RECEIVABLE SECURITIES
The High Growth Fund may invest in Asset-Backed Securities backed by
receivables from revolving credit card agreements ("Credit Card Receivable
Securities"). Most of the Credit Card Receivable Securities issued publicly to
date have been Pass-Through Certificates. In order to lengthen the maturity of
Credit Card Receivable Securities, most of them provide for a fixed period
during which only interest payments on the underlying accounts are passed
through to the security holder and principal payments received on such accounts
are used to fund the transfer of additional credit card charges made on an
account to the pool of assets supporting the related Credit Card Receivable
Securities. The initial fixed period may usually be shortened upon the
occurrence of specified events that signal a potential deterioration in the
quality of the assets backing the security, such as the imposition of a cap on
interest rates. The ability of the issuer to extend the life of an issue of
Credit Card Receivable Securities thus depends upon the continued generation of
additional principal amounts in the underlying accounts during the initial
period and the non-occurrence of specified events. Competitive and general
economic factors could adversely affect the rate at which new receivables are
created in an account and conveyed to an issuer, shortening the expected
weighted average life of the related Credit Card Receivable Security, and
reducing its yield. An acceleration in cardholders' payment rates or any other
event that shortens the period during which additional credit card charges on an
account may be transferred to the pool of assets supporting the related Credit
Card Receivable Security could have a similar effect on the weighted average
life and yield.
Credit card holders are entitled to the protection of certain state
and federal consumer credit laws, many of which give card holders the right to
set off certain amounts against balances owed on the credit card, thereby
reducing amounts paid on accounts. In addition, unlike most other Asset-Backed
Securities, accounts are unsecured obligations of the cardholder.
21
<PAGE> 22
CERTIFICATES OF DEPOSIT AND BANKERS' ACCEPTANCES
The High Growth Fund and S&P 500 Fund may invest in certificates of
deposit, which are certificates issued against funds deposited in a banking
institution for a specified period of time at a specified interest rate.
Bankers' acceptances are credit instruments evidencing a bank's obligation to
pay a draft drawn on it by a customer. These instruments reflect the obligation
both of the bank and the drawer to pay the full amount of the instrument upon
maturity. Each Fund will invest only in certificates of deposit and bankers'
acceptances of banks that have capital, surplus and undivided profits in excess
of $100 million.
COMMERCIAL PAPER
The High Growth Fund and S&P 500 Fund may invest in Commercial Paper,
which consists of short-term, unsecured promissory notes issued to finance
short-term credit needs. The High Growth Fund and S&P 500 Fund will invest only
in commercial paper that at the time of purchase is rated Prime-1 or Prime-2 by
Moody's, A-1 or A-2 by S&P, "Duff 2" or higher by Duff, or "F2" or higher by
Fitch, or if unrated by Moody's, S&P, Duff or Fitch, is determined by the
Investment Manager, using guidelines approved by the Board of Trustees, to be at
least equal in quality to one or more of the above ratings.
OTHER INVESTMENT POLICIES
Securities that are acquired by the High Growth Fund outside the United States
and that are publicly traded in the United States, on a foreign securities
exchange or in a foreign securities market are not considered by the High Growth
Fund to be illiquid assets provided that: (i) the High Growth Fund acquires and
holds the securities with the intention of reselling the securities in the
foreign trading market, (ii) the High Growth Fund reasonably believes it can
dispose of the securities readily in the foreign trading market or for cash in
the United States, or (iii) foreign market and current market quotations are
available readily. Investments may be in securities of foreign issuers, whether
located in developed or undeveloped countries. Investments in foreign securities
where delivery takes place outside the United States will have to be made in
compliance with any applicable U.S. and foreign currency restrictions and tax
laws (including laws imposing withholding taxes on any dividend or interest
income) and laws limiting the amount and types of foreign investments. Changes
of government administrations or of economic or monetary policies in the United
States or abroad, or changed circumstances regarding convertibility or exchange
rates, could result in investment losses for the High Growth Fund. Investments
in foreign securities may also subject the High Growth Fund to losses due to
nationalization, expropriation or foreign accounting practices and treatments
that differ from those in the United States. Moreover, investors should
recognize that foreign securities are often traded with less frequency and
volume, and therefore may have greater price volatility, than many U.S.
securities. Notwithstanding that the High Growth Fund generally intends to
acquire the securities of foreign issuers where there are public trading
markets, the High Growth Fund's investments in the securities of foreign issuers
may tend to increase the risks with respect to the liquidity of the High Growth
Fund's portfolio and its ability to meet a large number of shareholder
redemption requests should there be economic or political turmoil in a country
in which the High Growth Fund has a substantial portion of its assets invested
or should relations between the United States and foreign countries deteriorate
markedly. Furthermore, the reporting and disclosure requirements applicable to
foreign issuers may differ from those applicable to domestic issuers, and there
may be
22
<PAGE> 23
difficulties in obtaining or enforcing judgments against foreign issuers.
Loans of Portfolio Securities. The High Growth Fund and S&P 500 Fund
may loan securities to qualified broker-dealers or other institutional investors
provided that: (i) the loan is secured continuously by collateral consisting of
U.S. Government securities or cash or cash equivalents maintained on a daily
marked-to-market basis in an amount at least equal to the current market value
of the securities loaned; (ii) the High Growth Fund or S&P 500 Fund may at any
time call the loan and obtain the return of the securities loaned; (iii) the
High Growth Fund or S&P 500 Fund will receive any interest or dividends paid on
the loaned securities; and (iv) the aggregate market value of securities loaned
will not at any time exceed one-third of the total assets of the High Growth
Fund or S&P 500 Fund.
The lending of securities is a common practice in the securities
industry. The High Growth Fund and S&P 500 Fund will engage in security lending
arrangements with the primary objective of increasing the High Growth Fund's and
S&P 500 Fund's income by investing the cash collateral in short-term,
interest-bearing obligations, but will do so only to the extent the High Growth
Fund and S&P 500 Fund will not lose the tax treatment available to regulated
investment companies. The High Growth Fund and S&P 500 Fund will be entitled to
all dividends or interest on any loaned securities. Loans of securities involve
a risk that the borrower may fail to return the securities or provide additional
collateral.
Repurchase Transactions. Repurchase agreements are instruments under
which a buyer acquires ownership of a security from a seller 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
buyer's holding period. Under the 1940 Act, a repurchase agreement is deemed to
be the High Growth Fund's and S&P 500 Fund's loan of money to the seller,
collateralized by the underlying security. The interest rate is effective for
the period of time in which the High Growth Fund and S&P 500 Fund are invested
in the agreement and is not related to the coupon rate on the underlying
security. Any repurchase agreements into which either Fund enters will involve
the Fund as the buyer and banks or broker-dealers as the sellers (repurchase
agreements with broker-dealers will be limited to obligations of the U.S.
Government, its agencies or instrumentalities). The period of these repurchase
agreements will usually be short -- from overnight to one week -- and at no time
will the High Growth Fund and S&P 500 Fund invest in repurchase agreements for
more than one year. However, securities subject to repurchase agreements may
have maturity dates in excess of one year from the effective date of the
repurchase agreements. The transaction requires the initial collateralization of
the seller's obligation with securities having a market value, including accrued
interest, equal to at least 102% of the dollar amount invested by the High
Growth Fund and S&P 500 Fund, with the value marked-to-market daily to maintain
100% coverage. A default by the seller might cause the High Growth Fund and S&P
500 Fund to experience a loss or delay in the liquidation of the collateral
securing the repurchase agreement. The High Growth Fund and S&P 500 Fund might
also incur disposition costs in liquidating the collateral. The High Growth Fund
and S&P 500 Fund will make payment for such securities only upon physical
delivery or evidence of book entry transfer to the account of their custodian
bank. The High Growth Fund and S&P 500 Fund may not enter into a repurchase
agreement of more than seven days duration if, as a result, the market value of
the High Growth Fund's and S&P 500 Fund's net assets, together with investments
in other securities deemed to be not
23
<PAGE> 24
readily marketable, would be invested in excess of the High Growth Fund's and
S&P 500 Fund's limits on investments in illiquid securities.
In the event of a bankruptcy or other default of a repurchase
agreement's seller, the High Growth Fund and S&P 500 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. Each Fund will not invest
more than 10% of its net assets at the time of purchase in repurchase agreements
maturing in more than seven days and other illiquid securities.
Illiquid Securities. The High Growth Fund and S&P 500 Fund reserve the
right to invest up to 10% of each of their net assets in illiquid securities.
Generally, an "illiquid security" is any security that cannot be disposed of
promptly and in the ordinary course of business at approximately the amount at
which the High Growth Fund and S&P 500 Fund have valued the instrument. Subject
to this limitation, the High Growth Fund and S&P 500 Fund may invest in
restricted securities when such investment is consistent with the High Growth
Fund's and S&P 500 Fund's investment objectives, and such securities may be
considered to be liquid to the extent the High Growth Fund's and S&P 500 Fund's
Investment Manager determines that there is a liquid institutional or other
market for such securities. In determining whether a restricted security is
properly considered to be a liquid security, the High Growth Fund's and S&P 500
Fund's Investment Manager, under the direction of the Board of Trustees, will
take into account the following factors: (i) the frequency of trades and quotes
for the security; (ii) the number of dealers willing to purchase or sell the
security and the number of potential purchasers; (iii) dealer undertakings to
make a market in the security; and (iv) the nature of the security and
marketplace trades (e.g., the time needed to dispose of the security, the method
of soliciting offers and the mechanics of transfer). To the extent the High
Growth Fund and S&P 500 Fund invest in restricted securities that are deemed
liquid, the general level of illiquidity in the High Growth Fund's and S&P 500
Fund's portfolios may be increased if qualified institutional buyers become
uninterested in purchasing these securities contracts. The High Growth Fund and
S&P 500 Fund will limit their investments in liquid restricted securities to 5%
of their net assets.
When-Issued and Delayed Delivery Securities. The High Growth Fund and
S&P 500 Fund may hold securities on a "when-issued" or "delayed delivery" basis.
When-issued or delayed delivery securities are securities purchased for future
delivery at a stated price an yield. Generally, a Fund will not pay for
securities until the Fund receives them. Securities purchased on a when-issued
or delayed delivery basis are recorded as assets. During the period between the
agreement date and the settlement date, the value of such securities may change
as the prices of securities in the stock market increase or decrease, or as
interest rates change. Default by the other party to the agreement may result in
a loss to a Fund.
INVESTMENT RESTRICTIONS & POLICIES FOR THE HIGH GROWTH FUND AND THE S&P 500 FUND
FUNDAMENTAL INVESTMENT RESTRICTIONS
The restrictions numbered (1), (2) and (3) immediately below are
fundamental and cannot be changed without approval of the holders of a majority
of the outstanding voting securities (as defined in the 1940 Act). For more
detailed information, see "1940 Act Restrictions" and "Other Investment
Policies." The High Growth Fund and S&P 500 Fund:
24
<PAGE> 25
(1) May purchase securities of any issuer only when consistent with the
maintenance of its status as a diversified company under the 1940 Act.
(2) May not concentrate investments in a particular industry or group of
industries as concentration is defined under the 1940 Act, or the rules
or regulations thereunder; except that the S&P 500 Fund may concentrate
investments only to the extent that the S&P 500 Index(R) is also so
concentrated.
(3) May (i) purchase or sell commodities, commodities contracts or real
estate; (ii) lend or borrow money; (iii) issue senior securities; (iv)
underwrite securities; or (v) pledge, mortgage or hypothecate any of
its assets, only if permitted by the 1940 Act or the rules or
regulations thereunder.
The High Growth Fund and S&P 500 Fund have also adopted non-fundamental
investment policies, set forth below, which are generally more restrictive than
the fundamental investment policies of these Funds. The High Growth Fund's or
the S&P 500 Fund's non-fundamental investment policies may be changed by a vote
of the Board of Trustees. Any changes in either the High Growth Fund's or the
S&P 500 Fund's non-fundamental investment policies will be communicated to the
Fund's shareholders prior to the effectiveness of the changes.
1940 ACT RESTRICTIONS
Under the 1940 Act and the rules, regulations and interpretations
thereunder, a "diversified company," as to 75% of its total assets, may not
purchase securities of any issuer (other than obligations of, or guaranteed by,
the U.S. Government, its agencies or its instrumentalities) if, as a result,
more than 5% of the value of its total assets would be invested in the
securities of such issuer or more than 10% of the issuer's voting securities
would be held by the fund. "Concentration" is generally interpreted under the
1940 Act as the investment of more than 25% of net assets in an industry or
group of industries. The 1940 Act limits the ability of investment companies to
borrow and lend money and to underwrite securities. The 1940 Act currently
prohibits an open-end fund from issuing senior securities, as defined in the
1940 Act, except under very limited circumstances.
OTHER INVESTMENT POLICIES
The following investment policies and restrictions are non-fundamental
and may be changed by the Trust's Board of Trustees. The High Growth Fund and
S&P 500 Fund may not:
(1) Purchase or sell commodities, commodities contracts or real estate,
including interests in real estate limited partnerships, provided that
each Fund may (i) purchase securities of companies that deal in real
estate or interests therein, (ii) purchase or sell futures contracts,
options contracts, equity index participations and index participation
contracts, and (iii) purchase securities of companies that deal in
precious metals or interests therein.
(2) Lend money to any person, except that each Fund may (i) purchase a
portion of an issue of short-term debt securities or similar
obligations (including repurchase agreements) that are publicly
distributed or customarily purchased by institutional investors, and
(ii) lend its portfolio securities.
(3) Borrow money or issue senior securities except that each Fund may
borrow from banks as a temporary measure to satisfy
25
<PAGE> 26
redemption requests or for extraordinary or emergency purposes and then
only in an amount not to exceed one-third of the value of its total
assets (including the amount borrowed), provided that each Fund will
not purchase securities while borrowings represent more than 5% of its
total assets.
(4) Pledge, mortgage or hypothecate any of its assets except that, to
secure allowable borrowings, each Fund may do so with respect to no
more than one-third of the value of its total assets.
(5) Underwrite securities issued by others except to the extent it may be
deemed to be an underwriter, under the federal securities laws, in
connection with the disposition of securities from its investment
portfolio.
(6) Invest more than 10% of its net assets in illiquid securities,
including repurchase agreements with maturities in excess of seven
days.
(7) Purchase or retain securities of an issuer if any of the officers,
trustees or directors of the Trust or the Investment Manager
individually own beneficially more than 1/2 of 1% of the securities of
such issuer and together beneficially own more than 5% of the
securities of such issuer.
(8) Invest for the purpose of exercising control or management of another
issuer.
(9) Purchase securities of other investment companies, except as permitted
by the 1940 Act, including any exemptive relief granted by the SEC.
(10) Purchase more than 10% of any class of securities of any issuer if, as
a result of such purchase, it would own more than 10% of such issuer's
outstanding voting securities.
(11) Invest more than 5% of its net assets in warrants, valued at the lower
of cost or market, and no more than 40% of this 5% may be invested in
warrants that are not listed on the New York Stock Exchange or the
American Stock Exchange, provided, however, that for purposes of this
restriction, warrants acquired by a Fund in units or attached to other
securities are deemed to be without value.
(12) Purchase puts, calls, straddles, spreads or any combination thereof if
by reason of such purchase the value of its aggregate investment in
such securities would exceed 5% of the Fund's total assets.
(13) Make short sales, except for short sales against the box.
(14) Purchase or sell interests in oil, gas or other mineral development
programs or leases, although it may invest in companies that own or
invest in such interests or leases.
(15) Purchase securities on margin, except such short-term credits as may be
necessary for the clearance of purchases and sales of securities.
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<PAGE> 27
MANAGEMENT OF THE TRUST
OFFICERS AND TRUSTEES. The officers and Trustees of the Trust, their
principal occupations over the past five years and their affiliations, if any,
with The Charles Schwab Corporation, Schwab and the Investment Manager, are as
follows:
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ ------------- --------------------
<S> <C> <C>
CHARLES R. SCHWAB* Chairman and Trustee Chairman, Chief Executive Officer and
July 29, 1937 Director, The Charles Schwab
Corporation; Chairman and Director,
Charles Schwab & Co., Inc. and Charles
Schwab Investment Management, Inc.;
Chairman and Director, The Charles
Schwab Trust Company; Chairman and
Director (current board positions), and
Chairman (officer position) until
December 1995, Mayer & Schweitzer, Inc.
(a securities brokerage subsidiary of
The Charles Schwab Corporation);
Director, The Gap, Inc. (a clothing
retailer), Transamerica Corporation (a
financial services organization),
AirTouch Communications (a
telecommunications company) and Siebel
Systems (a software company).
TIMOTHY F. McCARTHY** President and Trustee Executive Vice President - Mutual
September 19, 1951 Funds, Charles Schwab & Co., Inc.;
Executive Vice President, President -
Financial Products and International
Group, The Charles Schwab Corporation;
Chief Executive Officer, Charles Schwab
Investment Management, Inc.; President,
Chief Financial Officer and Director,
Charles Schwab Limited; Director, Mayer
& Schweitzer. From 1994 to 1995, Mr.
McCarthy was Chief Executive Officer,
Jardine Fleming Unit Trusts Ltd.;
</TABLE>
- ------------------------
*Mr. Schwab is an "interested person" of the Trust.
**Mr. McCarthy is an "interested person" of the Trust.
27
<PAGE> 28
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ ------------- --------------------
<S> <C> <C>
Executive Director, Jardine Fleming
Holdings Ltd.; Chairman, Jardine
Fleming Taiwan Securities Ltd.; and
Director of JF India and Fleming
Flagship, Europe. Prior to 1994, he was
President of Fidelity Investments
Advisor Group, a division of Fidelity
Investments in Boston.
DONALD F. DORWARD Trustee President and Chief Executive Officer,
September 23, 1931 Dorward & Associates (advertising and
marketing/consulting).
ROBERT G. HOLMES Trustee Chairman, Chief Executive Officer and
May 15, 1931 Director, Semloh Financial, Inc. Semloh
Financial is an international financial
services and investment advisory firm.
DONALD R. STEPHENS Trustee Managing Partner, D.R. Stephens & Co.
June 28, 1938 (investment banking). Since 1985, Mr.
Stephens has been Chairman and Chief
Executive Officer of North American
Trust (a real estate investment trust).
Prior to 1992, Mr. Stephens was
Chairman and Chief Executive Officer of
the Bank of San Francisco.
MICHAEL W. WILSEY Trustee Chairman, Chief Executive Officer and
August 18, 1943 Director, Wilsey Bennett, Inc. (truck
and air transportation, real estate
investment and management, and
investments).
</TABLE>
28
<PAGE> 29
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ ------------- --------------------
<S> <C> <C>
TAI-CHIN TUNG Treasurer and Principal Vice President - Finance, Charles
March 7, 1951 Financial Officer Schwab & Co., Inc.; Controller, Charles
Schwab Investment Management, Inc. From
1994 to 1996, Ms. Tung was Controller
for Robertson Stephens Investment
Management, Inc. From 1993 to 1994, she
was Vice President of Fund Accounting,
Capital Research and Management Co.
Prior to 1993, Ms. Tung was Senior Vice
President of the Sierra Funds and Chief
Operating Officer of Great Western
Financial Securities.
WILLIAM J. KLIPP* Senior Vice President, Executive Vice President-SchwabFunds,
December 9, 1955 Chief Operating Officer Charles Schwab & Co., Inc.; President
and Trustee and Chief Operating Officer, Charles
Schwab Investment Management, Inc.
Prior to 1993, Mr. Klipp was Treasurer
of Charles Schwab & Co., Inc. and Mayer
& Schweitzer, Inc.
STEPHEN B. WARD Senior Vice President and Senior Vice President and Chief
April 5, 1955 Chief Investment Investment Officer, Charles Schwab
Officer Investment Management, Inc.
FRANCES COLE Secretary Vice President, Chief Counsel, Chief
September 9, 1955 Compliance Officer and Assistant
Corporate Secretary, Charles Schwab
Investment Management, Inc.
</TABLE>
- ------------------------
*Mr. Klipp is an "interested person" of the Trust.
29
<PAGE> 30
<TABLE>
<CAPTION>
POSITION WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATION
- ------------------ ------------- --------------------
<S> <C> <C>
DAVID H. LUI Assistant Secretary Vice President and Senior Counsel -
October 14, 1960 Charles Schwab Investment Management,
Inc. From 1991 to 1992, he was
Assistant Secretary and Assistant
Corporate Counsel for the Franklin
Group of Mutual Funds.
CHRISTINA M. PERRINO Assistant Secretary Vice President and Senior Counsel -
June 16, 1961 Charles Schwab Investment Management,
Inc. Prior to 1994, she was Counsel and
Assistant Secretary for North American
Security Life Insurance Company and
Secretary for North American Funds.
</TABLE>
Each of the above-referenced Officers and/or Trustees also serves in
the same capacity as described for the Trust, The Charles Schwab Family of
Funds, Schwab Investments and Schwab Capital Trust. The address of each
individual listed above is 101 Montgomery Street, San Francisco, California
94104.
TRUSTEE DEFERRED COMPENSATION PLAN
Pursuant to exemptive relief received by the Trust from the SEC, the
Trust may enter into deferred fee arrangements (the "Fee Deferral Plan" or the
"Plan") with the Trust's Trustees who are not "interested persons" of any of the
Funds of the Trust (the "Independent Trustees" or the "Trustees").
As of the date of this Statement of Additional Information, none of the
Independent Trustees has elected to participate in the Fee Deferral Plan. In the
event an Independent Trustee does elect to participate in the Plan, the Plan
would operate as described below.
Under the Plan, deferred Trustee's fees will be credited to a book
reserve account established by the Trust (the "Deferred Fee Account"), as of the
date such fees would have been paid to the Trustee. The value of the Deferred
Fee Account as of any date will be equal to the value the Account would have had
as of that date if the amounts credited to the Account had been invested and
reinvested in the securities of the SchwabFund or SchwabFunds(R) selected by the
participating Trustee (the "Selected SchwabFund Securities"). SchwabFunds
include the series or classes of shares of beneficial interest of The Charles
Schwab Family of Funds, Schwab Investments and Schwab Capital Trust.
Pursuant to the exemptive relief granted to the Trust, each Fund will
purchase and maintain the Selected SchwabFund Securities in an amount equal to
the deemed investments in that Fund of the Deferred Fee Accounts of the
Independent Trustees. These transactions would otherwise be limited or
prohibited by the investment policies and/or restrictions of the Funds. (See
"Investment Policies and Restrictions.")
30
<PAGE> 31
COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
Pension or
Retirement Estimated Annua(l)
Benefits Accrued Benefits Upon Total
Aggregate as Part of Fund Retirement from Compensation
Name of Person, Compensation Expenses from the the Fund from the Fund
Position from the Trust Fund Complex(2) Complex(2) Complex(2)
- --------------- -------------- ----------------- ------------------ -------------
<S> <C> <C> <C>
Charles R. Schwab, 0 N/A N/A 0
Chairman and Trustee
Elizabeth G. Sawi(3), 0 N/A N/A 0
President and Trustee
Timothy F. McCarthy(4), 0 N/A N/A 0
President and Trustee
William J. Klipp, 0 N/A N/A 0
Sr. Vice President,
Chief Operating
Officer and Trustee
Donald F. Dorward, $1,300 N/A N/A $73,000
Trustee
Robert G. Holmes, $1,300 N/A N/A $73,000
Trustee
Donald R. Stephens, $1,300 N/A N/A $73,000
Trustee
Michael W. Wilsey, $1,300 N/A N/A $73,000
Trustee
</TABLE>
(1) Figures are for the Trust's fiscal year ended December 31, 1995.
(2) "Fund Complex" comprises all 26 funds of the Trust, The Charles Schwab
Family of Funds, Schwab Investments and Schwab Capital Trust.
(3) Ms. Sawi served as President and Trustee until October 1995.
(4) Mr. McCarthy became President and Trustee in October 1995.
----------------------------------------
31
<PAGE> 32
INVESTMENT MANAGER
The Investment Manager, a wholly-owned subsidiary of The Charles Schwab
Corporation, serves as the investment adviser for all the Funds and
administrator pursuant to an Investment Advisory and Administration Agreement
dated March 28, 1994 (the "Advisory Agreement") between it and the Trust. The
Investment Manager is registered as an investment adviser under the Investment
Advisers Act of 1940, as amended, and currently provides investment management
services to the Schwab mutual fund complex, a family of 29 mutual funds with
over $40 billion in assets as of October 25, 1996. The Investment Manager is an
affiliate of Schwab and is the Trust's distributor and shareholder services and
transfer agent.
The Advisory Agreement will be in effect for an initial two year term
and thereafter will continue in effect for one year terms, subject to annual
approval by: (1) the Trust's Board of Trustees or (2) a vote of a majority (as
defined in the 1940 Act) of the outstanding voting securities of a Fund. In
either event, the continuance must also be approved by a majority of the Trust's
Board of Trustees who are not parties to the Agreement or interested persons (as
defined in the 1940 Act) of any such party by vote cast in person at a meeting
called for the purpose of voting on such approval. The Advisory Agreement 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, and will terminate automatically upon
assignment.
Money Market Fund. For its advisory and administrative services to the
Money Market Fund, the Investment Manager is entitled to receive a graduated
annual fee, payable monthly, of 0.46% of the Fund's average daily net assets not
in excess of $2 billion; 0.45% of such net assets over $2 billion but not in
excess of $3 billion; and 0.40% of such net assets over $3 billion. For the
fiscal period ended December 31, 1995 and for the fiscal period from May 3, 1994
(commencement of operations) to December 31, 1994, the Fund paid investment
advisory and administration fees of $53,557 and $608, respectively (fees were
reduced by $60,678 and $52,949, respectively).
High Growth Fund. For its advisory and administrative services to the
High Growth Fund, the Investment Manager is entitled to receive a graduated
annual fee, payable monthly, of 0.74% of the Fund's average daily net assets not
in excess of $1 billion; 0.69% of the next $1 billion; and 0.64% of such net
assets over $2 billion.
The Investment Manager and Schwab have guaranteed that, through at
least July 1, 1997, the total fund operating expenses for the High Growth Fund
will not exceed 0.75% of the Fund's average daily net assets.
S&P 500 Fund. For its advisory and administrative services to the S&P
500 Fund, the Investment Manager is entitled to receive a graduated annual fee,
payable monthly, of 0.36% of the Fund's average daily net assets not in excess
of $1 billion; 0.33% of the next $1 billion; and 0.31% of such net assets over
$2 billion.
The Investment Manager and Schwab have guaranteed that, through at
least July 1, 1997, the total Fund operating expenses will not exceed 0.35% of
the average daily net assets of the Fund.
Additional Information. The Advisory Agreement provides that the fees
to be paid to the Investment Manager will be less than the amount that would
cause the aggregate operating expenses of a Fund (excluding interest, taxes, net
brokerage commissions and extraordinary expenses) in any year to exceed the most
stringent limits prescribed by any state in which
32
<PAGE> 33
shares of a Fund are offered for sale. The most stringent current limit for such
expenses is 2.5% of a fund's first $30 million of average net assets, 2.0% of a
fund's next $70 million of average net assets and 1.5% of a fund's average net
assets in excess of $100 million.
From time to time, each Fund may compare its total operating expense
ratio to the total operating expense ratio of other mutual funds or mutual fund
averages with similar investment objectives as reported by Lipper Analytical
Service, Inc., Morningstar, Inc. or other independent sources of such
information ("independent sources").
SUB-ADVISER
The Investment Manager has entered into an investment sub-advisory
agreement (the "Sub-Advisory Agreement") with respect to the High Growth Fund
with Symphony Asset Management, Inc. (the "Sub-Adviser") pursuant to which
Symphony Asset Management, Inc. will act as the High Growth Fund's sub-adviser.
The Sub-Adviser is registered as an investment adviser under the Investment
Advisers Act of 1940 and currently manages directly and indirectly approximately
$700 million in institutional and private account assets.
The Sub-Adviser furnishes investment advice through direct assistance
to the Investment Manager in the development and execution of quantitatively
based investment strategies. The Sub-Adviser uses a sophisticated optimization
technique known as "Tactical Asset Allocation" in evaluating the optimal
allocation of the High Growth Fund's assets among asset categories (stocks,
bonds and cash).
Tactical Asset Allocation is a value-oriented strategy which seeks the
highest reward for a given level of risk. Expected returns are measured for each
asset category; for stocks, the internal rate of return is measured on
forecasted dividend stream; for bonds, the yield to maturity is evaluated on
representative long corporate bonds; and for cash-equivalents, yield to maturity
is evaluated on representative money market instruments. Risks and correlations
of the asset categories are measured from long-term return histories.
The Investment Manager pays the Sub-Adviser an annual investment
sub-advisory fee, payable monthly, of 0.08% of the first $100 million of the
aggregate average daily net assets of the High Growth Fund; 0.06% of the next
$150 million; 0.04% of the next $600 million; and 0.02% of the Fund's aggregate
average daily net assets over $850 million.
DISTRIBUTOR
Pursuant to a Distribution Agreement, Schwab is the principal
underwriter for shares of the Trust and the Trust's agent for the purpose of the
continuous offering of the Funds' shares. Currently, the Funds are designed as
an investment vehicle for Separate Accounts of Participating Insurance Companies
and are intended for retirement savings or other long-term investment purposes.
The Funds pay the cost for the prospectuses and shareholder reports to be
prepared and delivered to existing Participating Insurance Company Contract
owners with investment allocations in either of the three sub-accounts. Schwab
pays such costs when the described materials are used in connection with the
offering of shares to prospective investors and for supplementary sales
literature and advertising. Schwab receives no fee under the Distribution
Agreement. Terms of continuation, termination and assignment under the
Distribution Agreement are identical to those described above with respect to
the Advisory Agreement.
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CUSTODIAN AND FUND ACCOUNTANT
PNC Bank, National Association, at the Airport Business Center, 200
Stevens Drive, Suite 440, Lester, Pennsylvania 19113, serves as Custodian for
the Money Market Fund and S&P 500 Fund.
PFPC, Inc., at 400 Bellevue Parkway Wilmington, Delaware 19809, serves
as Fund Accountant for the Money Market Fund and S&P 500 Fund.
State Street Bank and Trust Company, at 1 Heritage Drive, North Quincy,
Massachusetts 02171-2197, serves as Custodian and as Fund Accountant for the
High Growth Fund.
ACCOUNTANTS AND REPORTS TO SHAREHOLDERS
The Trust's independent accountants, Price Waterhouse LLP, audit and
report on the annual financial statements of each series of the Trust and review
certain regulatory reports and each Fund's federal income tax return. Price
Waterhouse LLP also performs other professional accounting, auditing, tax and
advisory services when the Trust engages it to do so. Shareholders will be sent
audited annual and unaudited semi-annual financial statements. The address of
Price Waterhouse LLP is 555 California Street, San Francisco, California 94104.
LEGAL COUNSEL
Ropes & Gray, One Franklin Square, 1301 K Street, N.W., Suite 800 East,
Washington, D.C. 20005, is counsel to the Trust.
PORTFOLIO TRANSACTIONS AND TURNOVER
PORTFOLIO TRANSACTIONS
Portfolio transactions are undertaken principally to: pursue the Funds'
objective in relation to movements in the general level of interest rates;
invest money obtained from the sale of the Funds' shares; reinvest proceeds from
maturing portfolio securities; and meet redemptions of Fund shares. Portfolio
transactions may increase or decrease the yield of the Funds depending upon
management's ability to correctly time and execute them.
In effecting securities transactions for the Funds, the Investment
Manager seeks to obtain best price and execution. Subject to the supervision of
the Board of Trustees, the Investment Manager generally selects broker-dealers
for the Funds primarily on the basis of the quality and reliability of brokerage
services, including execution capability and financial responsibility. In
assessing these criteria, the Investment Manager will, among other things,
monitor the performance of brokers effecting transactions for the Funds to
determine the effect, if any, the Funds' transactions through those brokers have
on the market prices of the stocks involved. This may be of particular
importance for the Funds' investments in relatively smaller companies the stocks
of which are not as actively traded as those of their larger counterparts. The
Funds will seek to buy and sell securities in a manner that causes the least
possible fluctuation in the prices of those stocks in view of the size of the
transactions.
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In an attempt to obtain best execution for the Funds, the Investment
Manager may also place orders directly with market makers or with third market
brokers, Instinet or brokers on an agency basis. Placing orders with third
market brokers or through Instinet may enable the Funds to trade directly with
other institutional holders on a net basis. At times, this may allow the Funds
to trade larger blocks than would be possible if they were to trade through a
single market maker.
When the execution and price offered by two or more broker-dealers are
comparable, the Investment Manager may, in its discretion, utilize the services
of broker-dealers that provide it with investment information and other research
resources. The Investment Manager may also use such resources when it provides
advisory services to other investment advisory clients, including mutual funds.
The Trust expects that purchases and sales of portfolio securities
usually will be principal transactions. Securities normally will be purchased
directly from the issuer or from an underwriter or market maker for the
securities.
In determining when and to what extent to use Schwab or any other
affiliated broker-dealer as its broker for executing orders for the Funds on
securities exchanges, the Investment Manager will consider (if relevant) whether
the compensation to be paid Schwab or any other affiliated broker-dealer will be
(i) fair and reasonable, (ii) at least as favorable to the Funds as commissions
that would be charged by other qualified brokers having comparable execution
capabilities and (iii) at least as favorable as commissions contemporaneously
charged by Schwab or any other affiliated broker-dealer on comparable
transactions for its most favored unaffiliated customers. The Funds do not
consider it practicable or in the best interests of their shareholders to
solicit competitive bids for commission rates on each transaction. However, the
Board of Trustees, including a majority of the Trustees who are not "interested
persons" of Schwab or any other affiliated broker-dealer within the meaning of
the 1940 Act, (i) has prescribed procedures designed to provide that the Funds
do not pay commissions that do not meet the standards described above, (ii)
reviews those procedures annually to determine whether they remain adequate and
(iii) considers quarterly whether or not the commissions charged by Schwab or
any other affiliated broker-dealer have met the standards.
Brokerage services Schwab provides to the Funds are also subject to
Rule 11a2-2(T) under the Securities Exchange Act of 1934, as amended. Rule
11a2-2(T) permits the Funds to use Schwab as a broker provided certain
conditions are met. Among these requirements are that members of the exchange
not associated with Schwab perform the floor brokerage element of portfolio
transactions (that is, execution on the exchange floor or through use of
exchange facilities) that the orders to such members be transmitted from off the
exchange floor and that neither Schwab nor an associated person of Schwab
participates in the execution of the transaction after the order has been so
transmitted. In connection with transactions in which Schwab acts as broker for
the Funds, Schwab, while not permitted to perform floor brokerage (which is
undertaken by members Schwab selects who are not associated with that firm),
still continues to bear principal responsibility for determining important
elements of overall execution such as timing and order size, and also clears and
settles such transactions. Schwab pays the fees charged by those persons
performing the described floor brokerage elements. Schwab will not trade
directly with the Funds in any transactions in which Schwab or an affiliate acts
as principal.
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PORTFOLIO TURNOVER
For reporting purposes, each Fund's turnover rate is calculated by
dividing the value of purchases or sales of portfolio securities for the fiscal
year, whichever is less, by the monthly average value of portfolio securities
each Fund owned during the fiscal year. When making the calculation, all
securities whose maturities at the time of acquisition were one year or less
("short-term securities") are excluded.
Because securities with maturities of less than one year are excluded
from required portfolio turnover rate calculations, the Money Market Fund's
portfolio turnover rate for reporting purposes is expected to be zero.
A 100% portfolio turnover rate would occur, for example, if all
portfolio securities (aside from short-term securities) were sold and either
repurchased or replaced once during the fiscal year. The High Growth Fund and
S&P 500 Fund expect that their portfolio turnover rate will not exceed 100% in
any given year. This 100% portfolio turnover rate applies to the High Growth
Fund's stock and bond categories separately. A high portfolio turnover rate may
increase a Fund's transaction costs.
From time to time, each Fund may compare its portfolio turnover rate
with that of other mutual funds as reported by independent sources.
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The Money Market Fund calculates its dividends based on its daily net
investment income. For this purpose, the net investment income of the Fund
consists of: (1) accrued interest income plus or minus amortized discount or
premium, minus (2) accrued expenses allocated to the Fund. If the Money Market
Fund realizes any capital gains, they will be distributed at least once during
the year as determined by the Board of Trustees. Any realized capital losses to
the extent not offset by realized capital gains will be carried forward. It is
not anticipated that the Fund will realize any long-term capital gains, but if
it does so, these gains will be distributed annually. Trust expenses are accrued
each day. Should the net asset value of the Money Market Fund deviate
significantly from market value, the Board of Trustees could decide to value the
investments at market value and any unrealized gains and losses could affect the
amount of the Fund's distributions.
Since the Funds are intended as an investment vehicle for Plans and
Participating Insurance Companies' Separate Accounts, it is anticipated these
Plans and Separate Accounts will be the Funds' only shareholders. On each day
that the net asset value per share of the Money Market Fund is determined
("Business Day"), the Money Market Fund's net investment income will be declared
as of the close of trading on the New York Stock Exchange (normally 4:00 p.m.
(Eastern time)) as a daily dividend to shareholders of record as of the last
calculation of net asset value prior to the declaration. Shareholders will
receive dividends in additional shares unless they elect to receive cash.
Dividends will normally be reinvested monthly in full shares of the Money Market
Fund at the net asset value on the 25th day of each month if a Business Day,
otherwise on the next Business Day, with the exception of dividends reinvested
in December, which are scheduled on the last Business Day in December.
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The High Growth Fund and S&P 500 Fund will distribute substantially all
of their net investment income each year, as determined by the Board of
Trustees. The High Growth Fund and S&P 500 Fund will distribute net investment
income and capital gains, if any, to the Plans and Participating Insurance
Company Separate Accounts annually in December. The Participating Insurance
Company Separate Accounts will automatically reinvest all distributions in
additional shares at the net asset value next determined after their record
date.
FEDERAL INCOME TAXES
For a discussion of the tax status of a particular Contract and the tax
consequences of ownership of such a Contract, refer to the appropriate Separate
Account Prospectus. Shares of the Funds are available only through Separate
Accounts of Participating Insurance Companies and Plans.
It is each Fund's policy to qualify for taxation as a "regulated
investment company" by meeting the requirements of Subchapter M of the Code. By
following this policy, each Fund expects to eliminate or reduce to a nominal
amount the federal income tax to which it is subject.
In order to qualify as a regulated investment company, each Fund must,
among other things, (1) derive at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stocks, securities, foreign currencies or other income
(including gains from options, futures or forward contracts) derived with
respect to its business of investing in stocks, securities or currencies; (2)
derive less than 30% of its gross income from gains from the sale or other
disposition of certain assets (including stocks and securities) held for less
than three months; and (3) diversify its holdings so that at the end of each
quarter of its taxable year, (i) at least 50% of the market value of the Fund's
total assets is represented by cash or cash items, U.S. Government securities,
securities of other regulated investment companies and other securities limited,
in respect of any one issuer, to a value not greater than 5% of the value of the
Fund's total assets and 10% of the outstanding voting securities of such issuer,
and (ii) not more than 25% of the value of its assets is invested in the
securities of any one issuer (other than U.S. Government securities or
securities of any other regulated investment company) or of two or more issuers
that the Fund controls, within the meaning of the Code, and that are engaged in
the same, similar or related trades or businesses. These requirements may
restrict the degree to which a Fund may engage in short-term trading and certain
hedging transactions and may limit the range of a Fund's investments. If a Fund
qualifies as a regulated investment company, it will not be subject to federal
income tax on the part of its net investment income and net realized capital
gains, if any, which it distributes to shareholders, provided that the Fund
meets certain minimum distribution requirements. To comply with these
requirements, a Fund must distribute at least (a) 90% of its "investment company
taxable income" (as that term is defined in the Code) and (b) 90% of the excess
of its (i) tax-exempt interest income over (ii) certain deductions attributable
to that income (with certain exceptions), for its taxable year. Each Fund
intends to make sufficient distributions to shareholders to meet these
requirements.
The Funds may engage in investment techniques that may alter the timing
and character of the Funds' income. Each Fund may be restricted in its use of
these techniques by rules relating to its qualification as a regulated
investment company.
Although the High Growth Fund will attempt not to invest in any
non-U.S. corporation which could be treated as a passive foreign
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investment company ("PFIC"), or become a PFIC, under the Code, it might
inadvertently do so. This could result in adverse tax consequences upon the
disposition of, or the receipt of "excess distributions" with respect to, such
equity investments. To the extent the High Growth Fund does invest in PFICs, it
may adopt certain tax strategies to reduce or eliminate the adverse effects of
certain federal tax provisions governing PFIC investments. Many non-U.S. banks
and insurance companies may not be treated as PFICs if they satisfy certain
technical requirements under the Code. To the extent the High Growth Fund does
invest in foreign securities that are determined to be PFIC securities and is
required to pay a tax on these investments, a credit for this tax would not be
allowed to be passed through to the High Growth Fund's shareholders. Therefore,
the payment of this tax would reduce the High Growth Fund's economic return from
its PFIC shares.
The foregoing discussion relates only to U.S. federal income tax law.
SHARE PRICE CALCULATION
The Money Market Fund values its portfolio instruments at amortized
cost, which means 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 the Money Market Fund's
investments valued at amortized cost with market values. Market valuations 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. The amortized cost method of valuation
seeks to maintain a stable $1.00 per share net asset value even when there are
fluctuations in interest rates that affect the value of portfolio instruments.
Accordingly, this method of valuation can, in certain circumstances, lead to a
dilution of a shareholder's interest. If a deviation of 1/2 of 1% or more were
to occur between the net asset value per share calculated by reference to market
values and the Money Market Fund's $1.00 per share net asset value, or if there
were any other deviation that the Board of Trustees of the Trust believed would
result in a material dilution to shareholders or purchasers, the Board of
Trustees would promptly consider what action, if any, should be initiated. If
the Money Market Fund's net asset value per share (computed using market values)
declined, or were expected to decline, below $1.00 (computed using amortized
cost), the Board of Trustees might temporarily reduce or suspend dividend
payments in an effort to maintain the net asset value at $1.00 per share. As a
result of this reduction or suspension of dividends or other action by the Board
of Trustees, an investor would receive less income during a given period than if
the reduction or suspension had not taken place. Such action could result in
investors not receiving a dividend for the period during which they hold their
shares and receiving, upon redemption, a price per share lower than that which
they paid. On the other hand, if the Money Market Fund's net asset value per
share (computed using market values) were to increase, or were anticipated to
increase above $1.00 (computed using amortized cost), the Board of Trustees
might supplement dividends in an effort to maintain the net asset value at $1.00
per share.
The High Growth Fund's and S&P 500 Fund's net asset value per share is
determined each Business Day at the close of trading on the New York Stock
Exchange, generally as of 4:00 p.m. (Eastern time). Currently, the New York
Stock Exchange is closed on the following
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holidays: New Year's Day (observed), Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day. The High Growth
Fund and S&P 500 Fund value their portfolio securities daily based on their fair
value. Each security the High Growth Fund and S&P 500 Fund hold that is listed
on a securities exchange and for which market quotations are available is valued
at the last quoted sale price for a given day, or if a sale is not reported for
that day, at the mean between the most recent quoted bid and asked prices. Price
information on each listed security is taken from the exchange where the
security is primarily traded. Unlisted securities for which market quotations
are readily available are valued at the mean between the most recent bid and
asked prices. The value of other assets for which no quotations are readily
available (including any restricted securities) are valued at fair value as
determined in good faith by the Investment Manager pursuant to Board of Trustees
guidelines. Securities may be valued on the basis of prices provided by pricing
services when such prices are believed to reflect fair market value.
HOW THE FUNDS REFLECT PERFORMANCE
STANDARDIZED TOTAL RETURN
Each Fund may advertise its average annual return. Average annual
total return for a period is determined by calculating the actual dollar amount
of investment return on a $1,000 investment in a Fund made at the beginning of
the period, then calculating the average annual compounded rate of return that
would produce the same investment return on the $1,000 over the same period. In
computing average annual total return, a Fund assumes the reinvestment of all
distributions at net asset value on applicable reinvestment dates.
NONSTANDARDIZED TOTAL RETURN
Nonstandardized total return for a Fund differs from standardized total
return in that it relates to periods other than the period for standardized
total return, and/or that it represents aggregate (rather than average) total
return.
In addition, an after-tax total return for each Fund may be calculated
by taking that Fund's standardized or non-standardized total return and
subtracting applicable federal taxes from the portions of each Fund's total
return attributable to capital gains distributions and ordinary income. This
after-tax total return may be compared to that of other mutual funds with
similar investment objectives as reported by independent sources.
Each Fund also may report the percentage of that Fund's standardized or
non-standardized total return which would be paid to taxes annually (at the
applicable federal personal income and capital gains tax rates) before
redemption of Fund shares. This proportion may be compared to that of other
mutual funds with similar investment objectives as reported by independent
sources.
A Fund may also advertise its cumulative total return since inception.
This number is calculated using the same formula that is used for average annual
total return except that, rather than calculating the total return based on a
one-year period, cumulative total return is calculated from inception to the
date specified.
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YIELD
The historical performance of the Funds may be shown in the form of
yield or effective yield. These measures of performance are described below.
YIELD
Yield refers to the net investment income generated by a hypothetical
investment in the Money Market Fund over a specific 7-day period and the High
Growth Fund and S&P 500 Fund over a specific 30-day period. This net investment
income is then annualized, which means that the net investment income generated
during the 7-day period and 30-day period is assumed to be generated in each
7-day period and 30-day period, respectively, over an annual period, and is
shown as a percentage of the investment. For the 7-day period ended December 31,
1995, the Money Market Fund's yield was 5.14%.
EFFECTIVE YIELD
A Funds' effective yield is calculated similarly, but the net
investment income earned by the investment is assumed to be compounded weekly
when annualized for the Money Market Fund and monthly when annualized for the
High Growth Fund and S&P 500 Fund. The effective yield will be slightly higher
than the yield due to this compounding effect. For the 7-day period ended
December 31, 1995, the Money Market Fund's effective yield was 5.27%.
Yields quoted for the Money Market Fund include the effect of deducting
the Money Market Fund's expenses, but may not include charges and expenses
attributable to a Separate Account or a Contract. Since you can only purchase
shares of the Money Market Fund through Participating Insurance Companies'
Separate Accounts, you should carefully review the appropriate Separate Account
Prospectus for information on relevant charges and expenses. Excluding these
charges from quotations of the Money Market Fund's performance has the effect of
increasing the performance quoted. You should bear in mind the effect of these
charges when comparing the Money Market Fund's performance to those of other
mutual funds.
COMPARING THE PERFORMANCE OF THE FUNDS WITH OTHER FUNDS AND INDICES
The performance of the Funds may be compared with the performance of
other mutual funds by comparing the ratings and rankings of mutual fund rating
services, various indices of investment performance, U.S. Government
obligations, bank certificates of deposit, the consumer price index and other
investments for which reliable data is available.
The High Growth Fund also may compare its historical performance
figures to the performance of indices similar to its asset categories and
sub-categories, and to the performance of "blended indices" similar to the High
Growth Fund's portfolio strategies, such as those indices named in the High
Growth Fund's Prospectus under "Market Performance."
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THE BENEFITS OF INTERNATIONAL INVESTING
INCREASED DIVERSIFICATION CAN LOWER RISK
To some extent, all U.S.-based investments -- stocks, bonds, mutual
funds and certificates of deposit -- are affected by the same economic forces.
Tax cuts, interest rate changes and the performance of the U.S. stock market can
all influence U.S. investments. Adding international (or overseas) investments
to a U.S.-based portfolio has historically reduced the portfolio's overall
volatility. Although U.S. and international markets may be interrelated, they do
not move in tandem -- so losses in one market can be offset by gains in another.
POTENTIALLY HIGHER OVERALL PERFORMANCE
During the past 10 years ending December 31, 1994, international equity
markets outperformed the U.S. equity market and most other U.S. securities
investments -- corporate bonds, certificates of deposit and U.S. Treasuries. The
returns the international markets produced have also kept investors well ahead
of inflation. This historical performance means that investors diversified
overseas earned a higher level of return.
BROADER GROWTH OPPORTUNITIES
Investors who limit their portfolios to U.S. securities will not
participate in certain investment opportunities. Ten years ago, the United
States made up more than half of the world's equity investments. As of December
31, 1993, it represented just over one-third.
INDEXING AND ASSET ALLOCATION
Because the unmanaged performance of a broad-based equity index has
often proven superior to that of many individually selected stock portfolios, a
growing percentage of assets invested in the equity markets are being placed in
"index" portfolios. Institutional investors often devote a substantial
percentage of their assets to indexed strategies.
An index typically tracks the performance of a group of securities
selected to represent a particular market, and is most often used to gauge that
market's performance. The Dow Jones Industrial Average and S&P 500 are two
indices designed to measure the performance of U.S. stocks. When investment
managers invest indexed separate accounts or index fund assets, they attempt to
replicate the performance of the applicable target index by holding all or a
representative sample of the securities included in the index.
An index's performance data assumes the reinvestment of dividends but
does not reflect deductions for administrative and management expenses. The S&P
500 Fund will be subject to these costs and expenses, while an index does not
have these expenses. In addition, various factors, such as holding a cash
balance, may cause the S&P 500 Fund's performance to be higher or lower than
that of an index.
The S&P 500 Fund is intended to make indexed investing easily available
to Schwab customers with the highest level of convenience and economy, thereby
facilitating their ability to
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participate in the long-term performance of the U.S. stock market.
THE S&P 500 INDEX
The S&P 500 is representative of the performance of the U.S. stock
market. The S&P 500 consists of 500 stocks chosen for market size, liquidity and
industry group representation. It is a market-value weighted index (stock price
times number of shares outstanding), with each stock's weight in the S&P 500
proportionate to its market value. The S&P 500 does not contain the 500 largest
stocks, as measured by market capitalization. Although many of the stocks in the
S&P 500 are among the largest, there are also some relatively small companies in
the S&P 500. Those companies, however, are generally established companies
within their industry group. The S&P 500 identifies important industry groups
within the U.S. economy and then allocates a representative sample of stocks
with each group to the S&P 500. There are four major industry sectors within the
S&P 500: Industrials, Utilities, Financial and Transportation.
ASSET ALLOCATION STRATEGIES USING THE HIGH GROWTH FUND
Shareholders may choose to invest in the High Growth Fund, which offers
the benefits of asset allocation in a single fund. The High Growth Fund invests
a portion of its assets in all or a representative sample of the common stocks
in the following stock sub-categories: large company; small company and
international. Under normal market conditions, the Investment Manager currently
intends to utilize an indexing approach to investing within each stock
sub-category. The Investment Manager generally intends to track the performance
of the S&P 500 for the large company stock sub-category, the Schwab Small-Cap
Index(R) for the small company stock sub-category and the Schwab International
Index(R) for the international stock sub-category, by investing in all or a
representative sample of the common stocks comprising the relevant index. The
stock sub-categories of the High Growth Fund will not track the relevant stock
indices perfectly because of factors such as Fund expenses. Over the long term,
the performance of the Fund's stock sub-categories is expected to correlate
generally with that of the relevant stock index. The Investment Manager retains
the right to adopt a different portfolio management style without prior notice
to shareholders. The Fund's indexing approach for each stock sub-category
provides shareholders with the potential benefits to be realized from both an
asset allocation strategy and an indexing approach with one investment.
THE SCHWAB INTERNATIONAL INDEX(R)
The Schwab International Index is a broad-based stock market index
which contains the common stocks of the 350 largest operating companies (i.e.,
non-investment companies) incorporated outside the United States. To reduce
undue risk, the Index represents equities only from countries that are
considered to have developed markets and economies. By tracking the largest
companies in developed markets, the Index represents the performance of the
"blue chips" of international markets. The Index is also designed to provide a
broad representation of the international market, by limiting each country to no
more than 35% of the total market capitalization of the Index. As such, the
Index provides a reliable measure of market performance. The Index was first
made available to the public on July 29, 1993.
THE SCHWAB SMALL-CAP INDEX(R)
To be included in the Schwab Small-Cap Index, a company must satisfy
all of the following criteria: (1) it must be an "operating company" (i.e., not
an investment company)
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incorporated in the United States or its territories or possessions; (2) a
liquid market for its common shares must exist on the New York Stock Exchange,
American Stock Exchange or the NASDAQ/NMS; and (3) its market value must place
it among the second 1,000 such companies as measured by market capitalization
(i.e., from the company with a rank of 1,001 through the company with a rank of
2,000). Shareholders generally avoid exposure to the smallest companies, the
shares of which are often thinly traded and very volatile, because these stocks
are not included in the Index.
A particular stock's weighting in the Schwab Small-Cap Index is based
on its relative total market value (i.e., its market price per share multiplied
by the number of shares outstanding), divided by the total market capitalization
of the Schwab Small-Cap Index. The returns produced by the U. S. stock market
during the 25 years ending December 31, 1995 have been exceeded by very few
types of securities investments. Because the unmanaged performance of the U.S.
stock market has often proven superior to that of many individually selected
stock portfolios, a growing percentage of assets invested in the equity markets
are being placed in "index" portfolios. Indexed institutional holdings have
grown from less than $9 billion in 1980 to over $280 billion, a figure equal to
approximately one-quarter of all institutional assets. (Source: Callan
Associates Survey, reported in Fall 1990 edition of The Journal of Portfolio
Management.)
Historically, returns in a long-term investment in a group of common
stocks representative of the stock market as a whole, as well as a group of
common stocks representative of small-cap stocks, have significantly exceeded
the returns of U.S. Treasury Bills, certificates of deposit, corporate bonds and
inflation.
OTHER INFORMATION
Each Fund has adopted a number of policies that should cause its
portfolio turnover rate to be below the portfolio turnover rate of many other
mutual funds. A lower portfolio turnover rate acts to minimize associated
transaction costs.
Each Fund may, from time to time, refer to recent studies that analyze
certain techniques and strategies which the Funds may use. In addition, each
Fund may, from time to time, promote the advantages of investing in a series
that is part of a large, diverse mutual fund complex.
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GENERAL INFORMATION
The Trust is generally not required to hold shareholder meetings.
However, as provided in its Agreement and Declaration of Trust and Bylaws,
shareholder meetings will be held in connection with the following matters: (1)
election or removal of Trustees if a meeting is requested in writing by a
shareholder or shareholders who beneficially own(s) 10% or more of the Trust's
shares; (2) adoption of any contract for which shareholder approval is required
by the 1940 Act; (3) any termination of the Trust 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 the Trust or any of its investment
portfolios, supplying any omission, curing any ambiguity or curing, correcting
or supplementing any defective or inconsistent provision thereof); (5)
determining whether a court action, proceeding or claim should or should not be
brought or maintained derivatively or as a class action on behalf of the Trust
or the shareholders, to the same extent as the stockholders of a Massachusetts
business corporation; and (6) such additional matters as may be required by law,
the Declaration of Trust, the Bylaws or any registration of the Trust with the
SEC or any state or as the Board of Trustees may consider desirable. The
shareholders also would vote upon changes to a Fund's fundamental investment
objective, policies or restrictions.
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 his or her successor or until death, resignation, retirement or
removal by a majority vote of the shares entitled to vote (as described below)
or of a majority of the Trustees. In accordance with the 1940 Act, (i) the Trust
will hold a shareholder meeting for the election of Trustees when 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 by a
vote of the shareholders.
Upon the written request of 10 or more shareholders who have been such
for at least 6 months and who hold shares constituting at least 1% of the
Trust's outstanding shares stating that they wish to communicate with the other
shareholders for the purpose of obtaining signatures necessary to demand a
meeting to consider removal of one or more Trustees, the Trust has undertaken to
disseminate appropriate materials at the expense of the requesting shareholders.
The Bylaws provide that a majority of shares entitled to vote shall be
a quorum for the transaction of business at a shareholders' meeting, except that
where any provision of law, of the Declaration of Trust or of these Bylaws
permits or requires that (i) holders of any series shall vote as a series, then
a majority of the aggregate number of shares of that series entitled to vote
shall be necessary to constitute a quorum for the transaction of business by
that series, or (ii) holders of any class shall vote as a class, then a majority
of the aggregate number of shares of that class entitled to vote shall be
necessary to constitute a quorum for the transaction of business by that class.
Any lesser number shall be sufficient for adjournments. Any adjourned session or
sessions may be held, within a reasonable time after the date set for the
original meeting, without the necessity of further notice. The Declaration of
Trust specifically authorizes the Board of Trustees to terminate the Trust (or
any of its investment portfolios) by notice to the shareholders without
shareholder approval.
44
<PAGE> 45
Under Massachusetts law, shareholders of a Massachusetts business trust
could, under certain circumstances, be held personally liable for the Trust's
obligations. The Declaration of Trust, however, disclaims shareholder liability
for the Trust's acts or obligations and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the Trust or the Trustees. In addition, the Declaration of Trust provides for
indemnification out of the property of an investment portfolio in which a
shareholder owns or owned shares for all losses and expenses of such shareholder
or former shareholder if he or she is held personally liable for the obligations
of the Trust solely by reason of being or having been a shareholder. Moreover,
the Trust will be covered by insurance that 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 remote, because
it is limited to circumstances in which a disclaimer is inoperative and the
Trust itself is unable to meet its obligations.
For further information, please refer to the registration statement and
exhibits for the Trust on file with the SEC in Washington, D.C. and available
upon payment of a copying fee. The statements in the Prospectuses and this
Statement of Additional Information concerning the contents of contracts or
other documents, copies of which are filed as exhibits to the registration
statement, are qualified by reference to such contracts or documents.
PRINCIPAL HOLDERS OF SECURITIES
As of October 25, 1996, Transamerica Occidental, Separate Account VA-5,
Variable Annuity Dept. B-100, 1150 South Olive, Los Angeles, California 90015
and First Transamerica Life Insurance Co., Separate Account, VA-5NLNY Variable
Annuity Dept. 3-150, 1150 South Olive, Los Angeles, California 95015 legally or
beneficially owned 92.4% and 5.3%, respectively, of the Money Market Fund's
shares of beneficial interest. In addition, as of October 31, 1996, the officers
and Trustees of the Trust, as a group, owned less than 1% of the Trust's
outstanding voting securities.
45
<PAGE> 46
PURCHASE AND REDEMPTION OF SHARES
You cannot purchase shares of the Funds directly, but you may allocate
account value under your Contract to and from the Funds in accordance with the
terms of your Contract. Please refer to the appropriate Separate Account
Prospectus for information on how to purchase units of a Contract and how to
select specific portfolios as investment options.
The Funds have made an election with the SEC to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of its net assets at the beginning
of such period. This election is irrevocable without the SEC's prior approval.
Redemption requests in excess of the stated limits may be paid, in whole or in
part, in investment securities or in cash, as the Trust's Board of Trustees may
deem advisable; however, payment will be made wholly in cash unless the Board of
Trustees believes that economic or market conditions exist that would make such
a practice detrimental to the best interests of the Funds. If redemption
proceeds are paid in investment securities, such securities will be valued as
set forth in the Prospectus of the Fund affected under "Share Price Calculation"
and a redeeming shareholder would normally incur brokerage expenses if he or she
were to convert the securities to cash.
OTHER INFORMATION
The Funds' Prospectuses and this Statement of Additional Information do
not contain all the information included in the Registration Statement filed
with the SEC under the 1933 Act with respect to the securities offered by the
Prospectuses. Certain portions of the Registration Statement have been omitted
from the Prospectuses and this Statement of Additional Information pursuant to
the rules and regulations of the SEC. The Registration Statement, including the
exhibits filed therewith, may be examined at the SEC's office in Washington,
D.C.
Statements contained in the Prospectuses or in this Statement of
Additional Information as to the contents of any contract or other document
referred to are not necessarily complete, and, in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement of which the Prospectuses and this Statement of
Additional Information form a part, each such statement being qualified in all
respects by such reference.
46
<PAGE> 47
APPENDIX - RATINGS OF INVESTMENT SECURITIES
COMMERCIAL PAPER
MOODY'S INVESTORS SERVICE
Prime-1 is the highest commercial paper rating assigned by Moody's
Investors Service ("Moody's"). Issuers (or related supporting institutions) of
commercial paper with this rating are considered to have a superior ability to
repay short-term promissory obligations. Issuers (or related supporting
institutions) of securities rated Prime-2 are viewed as having a strong capacity
to repay short-term promissory obligations. This capacity will normally be
evidenced by many of the characteristics of issuers whose commercial paper is
rated Prime-1 but to a lesser degree.
STANDARD & POOR'S CORPORATION
A Standard & Poor's Corporation ("S&P") A-1 commercial paper rating
indicates either an overwhelming or very strong degree of safety regarding
timely payment of principal and interest. Issues determined to possess
overwhelming safety characteristics are denoted A-1+. Capacity for timely
payment on commercial paper rated A-2 is strong, but the relative degree of
safety is not as high as for issues designated A-1.
DUFF & PHELPS CREDIT RATING CO.
Duff-1 is the highest commercial paper rating assigned by Duff &
Phelps Credit Rating Co. ("Duff"). Three gradations exist within this rating
category: a Duff-1+ rating indicates the highest certainty of timely payment
(issuer short-term liquidity is found to be outstanding and safety is deemed to
be just below that of risk-free short-term U.S. Treasury obligations); a Duff-1
rating signifies a very high certainty of timely payment (issuer liquidity is
determined to be excellent and risk factors are considered minor); and a Duff-1-
rating denotes high certainty of timely payment (issuer liquidity factors are
strong and risk is very small). A Duff-2 rating indicates a good certainty of
timely payment. Liquidity factors and company fundamentals are sound and risk
factors are small.
FITCH INVESTORS SERVICE, INC.
A Fitch Investors Service, Inc.'s ("Fitch") F-1+ is the highest
commercial paper rating, and indicates the strongest degree of assurance for
timely payment. Issues rated F-1 reflect an assurance of timely payment only
slightly less than issues rated F-1+. Issues assigned an F-2 rating have a
satisfactory degree of assurance for timely payment, but the margin of safety is
not as great as for issues in the first two rating categories.
47
<PAGE> 48
SHORT-TERM NOTES AND VARIABLE RATE DEMAND OBLIGATIONS
MOODY'S
Short-term notes/variable rate demand obligations bearing the
designations MIG-1/VMIG-1 are considered to be of the best quality. They have
strong protection from established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing. Obligations rated
MIG-2/VMIG-2 are of high quality and have ample margins of protection, although
not as large as those of the top rated securities.
S&P
An S&P SP-1 rating indicates that the subject securities' issuer has a
very strong capacity to pay principal and interest. Issues determined to possess
overwhelming safety characteristics are given a plus (+) designation. S&P's
determination that an issuer has a satisfactory capacity to pay principal and
interest is denoted by an SP-2 rating.
IBCA
Obligations supported by the highest capacity for timely repayment are
rated A1+. An A1 rating indicates that the obligation is supported by a very
strong capacity for timely repayment. Obligations rated A2 are supported by a
strong capacity for timely repayment, although adverse changes in business,
economic or financial conditions may affect this capacity.
BONDS
MOODY'S
Moody's rates the bonds it judges to be of the best quality Aaa. These
bonds carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or extraordinarily
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 these issues. Bonds carrying an Aa
designation are deemed to be of high quality by all standards. Together with Aaa
rated bonds, they comprise what generally are known as "high grade bonds." Aa
bonds are rated lower than the best bonds because they may enjoy relatively
lower margins of protections, fluctuations of protective elements may be of
greater amplitude or there may be other factors present which make them appear
to be subject to somewhat greater long-term risks.
S&P
AAA is the highest rating assigned by S&P to a bond and indicates the
issuer's extremely strong capacity to pay interest and repay principal. An AA
rating denotes a bond whose issuer has a very strong capacity to pay interest
and repay principal and differs from an AAA rating only in small degree.
48
<PAGE> 49
DUFF
Duff confers an AAA designation to bonds of issuers with the highest
credit quality. The risk factors associated with these bonds are negligible --
only slightly more than for risk-free U.S. Treasury debt. AA rated bonds are of
high credit quality and have strong protection factors. The risks associated
with them are modest but may vary slightly from time to time because of economic
conditions.
COMMERCIAL PAPER, SHORT-TERM OBLIGATIONS AND DEPOSIT OBLIGATIONS ISSUED BY BANKS
THOMSON BANKWATCH (TBW)
TBW-1 is the highest category and indicates that the degree of safety
regarding timely repayment of principal and interest is very strong. TBW-2 is
the second highest category, and while the degree of safety regarding timely
repayment of principal and interest is strong, the relative degree of safety is
not as high as for issues rated TBW-1.
49
<PAGE> 50
SCHWABFUNDS(R)
SCHWAB MONEY MARKET PORTFOLIO
SCHEDULE OF INVESTMENTS
December 31, 1995
<TABLE>
<CAPTION>
AGENCY OBLIGATIONS - 78.8% PAR VALUE
- --------------------------------------------------------------------
<S> <C> <C>
DISCOUNT NOTES
Federal Farm Credit Bank
5.67%, 01/08/96 .......................... $ 600,000 $ 599,342
5.66%, 01/12/96 .......................... 1,450,000 1,447,506
5.68%, 01/31/96 .......................... 400,000 398,127
Federal Home Loan Bank
5.68%, 01/25/96 .......................... 1,325,000 1,320,027
5.65%, 01/25/96 .......................... 445,000 443,345
5.62%, 02/02/96 .......................... 565,000 562,223
Federal Home Loan Mortgage Corp.
5.52%, 01/10/96 .......................... 1,270,000 1,268,254
5.68%, 01/16/96 .......................... 1,520,000 1,516,428
5.67%, 01/22/96 .......................... 170,000 169,442
Federal National Mortgage Assoc.
5.68%, 01/18/96 .......................... 245,000 244,346
5.52%, 01/18/96 .......................... 1,625,000 1,620,780
5.60%, 02/12/96 .......................... 810,000 804,765
5.60%, 02/22/96 .......................... 1,350,000 1,339,197
Tennessee Valley Authority
5.65%, 01/12/96 .......................... 1,020,000 1,018,258
5.59%, 02/13/96 .......................... 1,220,000 1,211,927
----------
TOTAL AGENCY OBLIGATIONS (Cost $13,963,967). 13,963,967
----------
U.S. TREASURY OBLIGATIONS - 21.2%
- --------------------------------------------------------------------------
U.S. TREASURY BILLS
5.37%, 01/11/96 .......................... 95,000 94,860
5.50%, 02/08/96 .......................... 230,000 228,683
5.40%, 02/08/96 .......................... 385,000 382,830
5.39%, 02/08/96 .......................... 525,000 522,055
5.43%, 02/15/96 .......................... 1,635,000 1,624,035
5.29%, 02/15/96 .......................... 95,000 94,377
5.39%, 02/22/96 .......................... 105,000 104,193
5.45%, 03/07/96 .......................... 75,000 74,267
5.02%, 03/07/96 .......................... 265,000 262,585
4.88%, 03/14/96 .......................... 160,000 158,435
5.02%, 03/28/96 .......................... 220,000 217,360
-----------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost $3,763,680) ..................... 3,763,680
-----------
TOTAL INVESTMENTS - 100% (Cost $17,727,647). $17,727,647
===========
</TABLE>
- -----------
Notes to Schedule of Investments.
Yields shown are effective yields at the time of purchase and are stated
according to the market convention for the security type. For each security,
cost (for financial reporting and federal income tax purposes) and carrying
value are the same.
See accompanying Notes to Financial Statements.
F-1
<PAGE> 51
SCHWABFUNDS(R)
SCHWAB MONEY MARKET PORTFOLIO
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- ---------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS
Investments, at value (Cost: $17,727,647) .................... $17,727,647
Cash ....................................................... 3,850
Receivable for fund shares sold ............................ 223,817
Deferred organization costs ................................ 25,732
Prepaid expenses ........................................... 98
----------
Total assets ............................................. 17,981,144
----------
LIABILITIES
Payable for:
Dividends .................................................. 80,464
Fund shares redeemed ....................................... 970,101
Investment advisory fee .................................... 105
Other ...................................................... 18,042
----------
Total liabilities ........................................ 1,068,712
----------
NET ASSETS applicable to outstanding shares .................... $16,912,432
----------
NET ASSETS CONSIST OF:
Capital paid in .............................................. $16,912,496
Accumulated net realized loss on investments sold ............ (64)
-----------
$16,912,432
===========
THE PRICING OF SHARES
Outstanding shares, $0.00001 par value (unlimited shares
authorized) ............................................... 16,912,496
NET ASSET VALUE, offering and redemption price per share .... $1.00
</TABLE>
- -----------
See accompanying Notes to Financial Statements.
F-2
<PAGE> 52
SCHWABFUNDS(R)
SCHWAB MONEY MARKET PORTFOLIO
STATEMENT OF OPERATIONS
For the year ended December 31, 1995
- ---------------------------------------------------------------------------
<TABLE>
<S> <C>
Interest income ............................................... $660,502
--------
EXPENSES
Investment advisory and administration fee ................. 53,557
Custodian fees ............................................. 12,415
Registration fees .......................................... 92
Professional fees .......................................... 26,643
Shareholder reports ........................................ 11,735
Trustees' fees ............................................. 5,214
Amortization of deferred organization costs ................ 7,665
Insurance and other expenses ............................... 3,572
-------
118,893
Less expenses reduced and absorbed ............................ (60,678)
-------
Total expenses incurred by Fund ............................ 58,215
-------
Net investment income ......................................... 602,287
Net realized gain on investments sold ......................... 33
-------
Net increase in net assets resulting from operations .......... $602,320
</TABLE>
- -----------------
See accompanying Notes to Financial Statements.
F-3
<PAGE> 53
SCHWABFUNDS(R)
SCHWAB MONEY MARKET PORTFOLIO
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE PERIOD
MAY 3, 1994
FOR THE (COMMENCEMENT
YEAR ENDED OF OPERATIONS) TO
DECEMBER 31, DECEMBER 31,
1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS
Net investment income ..................... $ 602,287 $ 81,012
Net realized gain (loss) on
investments sold ........................ 33 (97)
----------- -----------
Increase in net assets resulting from
operations ............................ 602,320 80,915
----------- -----------
Dividends to shareholders from net
investment income ....................... (602,287) (81,012)
----------- -----------
CAPITAL SHARE TRANSACTIONS (dollar amounts
and number of shares are the same)
Proceeds from shares sold ................ 68,313,915 16,565,781
Net asset value of shares issued in
reinvestment of dividends .............. 552,602 50,171
Less payments for shares redeemed ........ (59,363,572) (9,206,401)
----------- -----------
Increase in net assets from
capital share transactions .......... 9,502,945 7,409,551
----------- -----------
Total increase in net assets ............... 9,502,978 7,409,454
NET ASSETS
Beginning of period ...................... 7,409,454 --
----------- -----------
End of period ........................... $16,912,432 $ 7,409,454
----------- -----------
</TABLE>
- -----------
See accompanying Notes to Financial Statements.
F-4
<PAGE> 54
SCHWABFUNDS(R)
SCHWAB MONEY MARKET PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
For the year ended December 31, 1995
1. DESCRIPTION OF THE FUND
The Schwab Money Market Portfolio (the "Fund") is a series of Schwab
Annuity Portfolios (the "Trust"), a diversified, no-load, open-end, management
investment company organized as a Massachusetts business trust on January 21,
1994 and registered under the Investment Company Act of 1940, as amended. The
Fund commenced operations on May 3, 1994.
The Fund invests primarily in a portfolio of high quality, debt
securities which mature within 397 days. The Fund is intended exclusively as an
investment vehicle for Schwab Investment Advantage(TM), a variable annuity
program.
2. SIGNIFICANT ACCOUNTING POLICIES
The following significant accounting policies are in conformity with
generally accepted accounting principles for investment companies. The
preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts and disclosures in the financial statements.
Actual results could differ from those estimates.
SECURITY VALUATION: Investments are stated at amortized cost which
approximates market value.
SECURITY TRANSACTIONS AND INTEREST INCOME: Security transactions are
accounted for on a trade date basis (date the order to buy or sell is
executed). Interest income is recorded on the accrual basis and includes
amortization of premium and accretion of discount on investments. Realized
gains and losses from security transactions are determined or an identified
cost basis.
REPURCHASE AGREEMENTS: Repurchase agreements are fully collateralized
by U.S. Treasury or government agency securities. All collateral is held by the
Fund's custodian and is monitored daily to ensure that its market value at
least equals the repurchase price under the agreement.
DIVIDENDS TO SHAREHOLDERS: The Fund declares a daily dividend, equal to
its net investment income for that day, payable monthly.
DEFERRED ORGANIZATION COSTS: Costs incurred in connection with the
organization of the Fund and its initial registration with the Securities and
Exchange Commission and with various states are amortized on a straight-line
basis over a five-year period from the Fund's commencement of operations.
EXPENSES: Expenses arising in connection with the Fund are charged
directly to the Fund. As the Trust offers additional funds, expenses common to
all series of the Trust will be allocated to each series in proportion to their
relative net assets.
FEDERAL INCOME TAXES: It is the Fund's policy to meet the requirements
of the Internal Revenue Code applicable to regulated investment companies and
to distribute all net investment income and realized net capital gains, if any,
to shareholders. Therefore, no federal income tax provision is required. The
Fund intends to qualify under the Code with respect to the diversification
requirements related to the tax-deferred status of insurance company separate
accounts. The Fund is considered a separate entity for tax purposes.
3. TRANSACTIONS WITH AFFILIATES
INVESTMENT ADVISORY AND ADMINISTRATION AGREEMENTS: The Trust has an
investment advisory and administration agreement with Charles Schwab Investment
Management, Inc. (the "Investment Manager"). For advisory services and
facilities furnished, the Fund pays an annual fee, payable monthly, of .46% of
the first $2 billion of average daily net assets, .45% of such assets over $2
billion and .40% of such assets in excess of $3 billion. Under this agreement,
the Fund incurred investment advisory and administration fees of $53,557 for
the year ended December 31, 1995, before the Investment Manager reduced its
fee (see Note 4).
OFFICERS AND TRUSTEES: Certain officers and trustees of the Trust are
also officers or directors of the Investment Manager. During the year ended
December 31, 1995, the Trust made no direct payments to its officers or
trustees who are "interested persons" within the meaning of the Investment
Company Act of 1940, as amended. The Fund incurred fees of $5,214 related to
the Trust's unaffiliated trustees.
4. EXPENSES REDUCED AND ABSORBED BY THE INVESTMENT MANAGER
The Investment Manager reduced a portion of its fee and absorbed
certain expenses in order to limit the Fund's ratio of operating expenses to
average net assets. For the year ended December 31, 1995, the total of such
fees and expenses reduced and absorbed by the Investment Manager was $60,678.
F-5
<PAGE> 55
SCHWABFUNDS(R)
SCHWAB MONEY MARKET PORTFOLIO
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the year ended December 31, 1995
5. INVESTMENT TRANSACTIONS
Purchases, sales and maturities of investment securities for the year
ended December 31, 1995, aggregated $117,667,482 and $107,376,242, respectively.
6. FINANCIAL HIGHLIGHTS
Per share income and capital changes for a share outstanding throughout
the period:
<TABLE>
<CAPTION>
FOR THE PERIOD
MAY 3, 1994
FOR THE (COMMENCEMENT
YEAR ENDED OF OPERATIONS) TO
DECEMBER 31, DECEMBER 31,
1995 1994
-------------- ----------------
<S> <C> <C>
Net asset value at beginning of period.... $1.00 $1.00
Income from investment operations
Net investment income................... .05 .03
Net realized and unrealized gain (loss)
on investments........................ -- --
--------- ----------
Total from investment operations..... .05 .03
Less distributions
Dividends from net investment income.... (.05) (.03)
Distributions from realized gain
on investments........................ -- --
--------- ----------
Total distributions.................. (.05) (.03)
--------- ----------
Net asset value at end of period.......... $1.00 $1.00
========= =========
Total return.............................. 5.26% 2.55%
Ratios/Supplemental data
Net assets, end of period............... $16,912,432 $7,409,454
Ratio of expenses to average net assets. .50% .50%*
Ratio of net investment income to
average net assets.................... 5.17% 4.16%*
</TABLE>
The Investment Manager has reduced a portion of its fees and
absorbed certain expenses in order to limit the Fund's ratio of operating
expenses to average net assets. Had these fees and expenses not been reduced
and absorbed, the ratio of expenses to average net assets for the periods ended
December 31, 1995 and 1994, would have been 1.02% and 2.10%*, respectively, and
the ratio of net investment income to average net assets would have been 4.65%
and 2.56%*, respectively.
- ---------------------
* Annualized
F-6
<PAGE> 56
SCHWABFUNDS(R)
SCHWAB MONEY MARKET PORTFOLIO
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees and Shareholders of the Schwab Money Market Portfolio
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of the Schwab Money Market Portfolio
(one of the series constituting Schwab Annuity Portfolios, hereafter referred
to as the "Trust") at December 31, 1995, the results of its operations for the
year then ended, the changes in its net assets and the financial highlights for
the periods presented, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the Trust's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audits to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at December 31, 1995 by correspondence with the
custodian, provide a reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
PRICE WATERHOUSE LLP
San Francisco, California
January 31, 1996
F-7
