LKCM FUNDS
LKCM INTERNATIONAL FUND
301 COMMERCE STREET, SUITE 1600
FORT WORTH, TEXAS 76102
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 30, 1997
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND SHOULD BE READ
IN CONJUNCTION WITH THE PROSPECTUS OF THE LKCM INTERNATIONAL FUND DATED DECEMBER
30, 1997, AS SUCH PROSPECTUS MAY BE SUPPLEMENTED OR REVISED FROM TIME TO TIME. A
COPY OF THE PROSPECTUS MAY BE OBTAINED WITHOUT CHARGE BY CALLING THE LKCM FUNDS
AT (800) 688-LKCM (OPTION 1).
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TABLE OF CONTENTS
PAGE
INVESTMENT OBJECTIVE AND POLICIES.................................4
EQUITY SECURITIES..............................................4
PREFERRED STOCK..............................................4
WARRANTS AND RIGHTS..........................................4
CONVERTIBLE SECURITIES.......................................4
FIXED INCOME SECURITIES........................................4
U.S. GOVERNMENT SECURITIES...................................4
CORPORATE DEBT SECURITIES....................................5
DERIVATIVE INSTRUMENTS.........................................5
OPTIONS......................................................5
OPTIONS ON FOREIGN CURRENCIES................................6
FUTURES CONTRACTS............................................7
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS..................7
RISK FACTORS IN FUTURES TRANSACTIONS.........................8
RISKS OF OPTIONS ON FUTURES, FORWARD CONTRACTS,
AND OPTIONS ON FOREIGN CURRENCIES...........................9
COMBINED TRANSACTIONS........................................9
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS.............9
ILLIQUID INVESTMENTS AND RESTRICTED SECURITIES................10
ILLIQUID INVESTMENTS........................................10
RESTRICTED SECURITIES.......................................10
SECURITIES LENDING............................................10
REPURCHASE AGREEMENTS.........................................11
OTHER INVESTMENT COMPANIES....................................11
INVESTMENT LIMITATIONS...........................................11
MANAGEMENT.......................................................13
INVESTMENT ADVISER............................................13
INVESTMENT SUBADVISER.........................................13
CUSTODIAN.....................................................13
DISTRIBUTOR...................................................13
TRUSTEES AND OFFICERS.........................................14
PRINCIPAL SHAREHOLDERS........................................14
PORTFOLIO TRANSACTIONS AND BROKERAGE.............................14
PURCHASE, REDEMPTION, AND PRICING OF SHARES......................15
PURCHASE OF SHARES............................................15
REDEMPTION OF SHARES..........................................16
PRICING OF SHARES.............................................16
DIVIDENDS, OTHER GAIN DISTRIBUTIONS, AND TAXES...................16
GENERAL.......................................................16
TAXES - INVESTMENTS IN FOREIGN SECURITIES.....................17
PERFORMANCE INFORMATION..........................................18
TOTAL RETURN..................................................18
OTHER INFORMATION.............................................18
COMPARISON OF FUND PERFORMANCE................................19
GENERAL INFORMATION..............................................19
DESCRIPTION OF SHARES AND VOTING RIGHTS.......................19
SHAREHOLDER AND TRUSTEE LIABILITY.............................19
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AUDITORS......................................................20
CODE OF ETHICS................................................20
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THESE CONTAINED IN THIS STATEMENT OF ADDITIONAL
INFORMATION AND THE PROSPECTUS DATED DECEMBER 30, 1997, AND IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MAY NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE FUND.
THIS STATEMENT OF ADDITIONAL INFORMATION DOES NOT CONSTITUTE AN OFFER TO SELL
SECURITIES.
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INVESTMENT OBJECTIVE AND POLICIES
The investment objective and policies of LKCM International Fund (the
"Fund") are described in detail in the Prospectus under the captions "Investment
Objective and Policies" and "Description of Securities and Other Investment
Policies."
EQUITY SECURITIES
The equity securities in which the Fund may invest include common
stocks, preferred stocks, warrants and rights, and debt securities convertible
into or exchangeable for common stock or other equity securities.
PREFERRED STOCK. Preferred stock offers a stated dividend rate payable
from the corporation's earnings. These preferred stock dividends may be
cumulative or non-cumulative, participating, or auction rate. If interest rates
rise, the fixed dividend on preferred stocks may be less attractive, causing the
price of preferred stocks to decline. Preferred stock may have mandatory sinking
fund provisions, as well as call/redemption provisions prior to maturity, a
negative feature when interest rates decline. The rights of preferred stocks are
generally subordinate to rights associated with a corporation's debt securities.
Dividends on some preferred stock may be "cumulative" if stated dividends from
prior periods have not been paid. Preferred stock also generally has a
preference over common stock on the distribution of a corporation's assets in
the event of liquidation of the corporation, and may be "participating," which
means that it may be entitled to a dividend exceeding the stated dividend in
certain cases. The rights of preferred stocks are generally subordinate to
rights associated with a corporation's debt securities.
WARRANTS AND RIGHTS. Warrants are options to purchase equity securities
at specific prices valid for a specific period of time. Their prices do not
necessarily move parallel to the prices of the underlying securities. Rights are
similar to warrants but normally have a short duration and are distributed by
the issuer to its shareholders. Warrants and rights have no voting rights,
receive no dividends and have no rights with respect to the assets of the
issuer.
CONVERTIBLE SECURITIES. A convertible security is a bond, debenture,
note, or other security that entitles the holder to acquire common stock or
other equity securities of the same or a different issuer. A convertible
security generally entitles the holder to receive interest paid or accrued until
the convertible security matures or is redeemed, converted or exchanged. Before
conversion, convertible securities have characteristics similar to
nonconvertible debt securities. Convertible securities rank senior to common
stock in a corporation's capital structure and, therefore, generally entail less
risk that the corporation's common stock, although the extent to which such risk
is reduced depends in large measure upon the degree to which the convertible
security sells above its value as a fixed-income security. A convertible
security may be subject to redemption at the option of the issuer at a
predetermined price. If a convertible security held by a Fund is called for
redemption, the Fund would be required to permit the issuer to redeem the
security and convert it to underlying common stock, or would sell the
convertible security to a third party.
FIXED INCOME SECURITIES
The fixed-income securities in which the Fund may invest include U.S.
Government securities and corporate debt.
U.S. GOVERNMENT SECURITIES. U.S. Government agencies or
instrumentalities that issue or guarantee securities include, but are not
limited to, the Federal National Mortgage Association ("FNMA"), Government
National Mortgage Association ("GNMA"), Federal Home Loan Banks, Federal Home
Loan Mortgage Corporation ("FHLMC"), Federal Intermediate Credit Banks,
Federal Land Banks, Tennessee Valley Authority, Inter-American Development
Bank, Asian Development Bank, Student Loan Marketing Association ("SLMA")
and the International Bank for Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. Government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
Government to purchase the agencies'
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obligations; while still others, such as the SLMA, are supported only by the
credit of the instrumentality. In the case of securities not backed by the
full faith and credit of the United States, the investor must look principally
to the agency or instrumentality issuing or guaranteeing the obligation for
ultimate repayment and may not be able to assert a claim against the United
States itself in the event the agency or instrumentality does not meet its
commitment. Each Fund will invest in securities of such agencies or
instrumentalities only when the Adviser is satisfied that the credit risk
is acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of: (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations ( corpus or
coupons) purchased by a third party (typically an investment banking firm) and
held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATs"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
CORPORATE DEBT SECURITIES. The Fund's investments in U.S. dollar or
foreign currency-denominated corporate debt securities of domestic or foreign
issuers are limited to investment grade corporate debt securities (corporate
bonds, debentures, notes and other similar corporate debt instruments). The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
DERIVATIVE INSTRUMENTS
In pursuing its investment objectives, the Fund may purchase and sell
(write) options on securities, securities indices, and foreign currencies and
enter into interest rate, foreign currency and index futures contracts and
purchase and sell options on such futures contracts and enter into forward
foreign currency exchange contracts for hedging purposes.
OPTIONS. An option is a legal contract that gives the holder the right
to buy or sell a specified amount of the underlying instrument at a fixed or
determinable price upon the exercise of the option. A call option conveys the
right to buy, in return for a premium paid, and a put option conveys the right,
in return for a premium, to sell a specified quantity of the underlying
instrument. Options on indices are settled in cash and gain or loss depends on
changes in the index in question rather than on price movement in individual
securities.
There are certain risks associated with transactions in options on
securities and on indices. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when, and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the life of the option, the opportunity to profit from increases
in the market value of the security covering the call option above the sum of
the premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it has purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index
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purchased by the Fund, movements in the index may result in a loss to the Fund;
however, such losses may be mitigated by changes in the value of the Fund's
securities during the period the option was outstanding.
The Fund is authorized to purchase and sell over-the-counter options
("OTC Options") in addition to exchange listed options. OTC Options are
purchased from or sold to securities dealers, financial institutions or other
parties ("Counterparties") through direct bilateral agreement with the
Counterparty. In contrast to exchange listed options, which generally have
standardized terms and performance mechanics, all the terms of an OTC Option,
including such terms as method of settlement, term, exercise price, premium,
guarantees and security, are set by negotiation between the parties. A Fund will
only sell OTC Options that are subject to a buy-back provision permitting the
Fund to require the Counterparty to sell the option back to the Fund at a
formula price within seven days. The Fund expect generally to enter into OTC
Options that have cash settlement provisions, although they are not required to
do so.
There is no central clearing or guaranty function in an OTC Option. As
a result, if the Counterparty fails to make or take delivery of the security,
currency or other instrument underlying an OTC Option it has entered into with a
Fund or fails to make a cash settlement payment due in accordance with the terms
of the option, the Fund will lose any premium it paid for the option as well as
any anticipated benefit of the transaction. Accordingly, the Adviser must assess
the creditworthiness of each such Counterparty or any guarantor of credit
enhancement of the Counterparty's credit to determine the likelihood that the
terms of the OTC Option will be satisfied. The Fund will engage in OTC Option
transactions only with U.S. government securities dealers recognized by the
Federal Reserve Bank of New York as "primary dealers", or broker dealers,
domestic or foreign banks or other financial institutions which have received
(or the guarantors of the obligation of which have received) a short-term credit
rating of "A-1" from S&P's or "P-1" from Moody's Investors Services, Inc. or an
equivalent rating from any other nationally recognized statistical rating
organization.
OPTIONS ON FOREIGN CURRENCIES. The Fund may purchase and write options
on foreign currencies for hedging purposes. For example, a decline in the dollar
value of a foreign currency in which portfolio securities are denominated will
reduce the dollar value of such securities, even if their value in the foreign
currency remains constant. In order to protect against such diminutions in the
value of portfolio securities, the Fund may purchase put options on the foreign
currency. If the value of the currency does decline, the Fund will have the
right to sell such currency for a fixed amount in dollars and will thereby
offset, in whole or in part, the adverse effect on its portfolio which otherwise
would have resulted.
Conversely, where a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, the Fund may purchase call options on the currency
involved. The purchase of such options could offset, at least partially, the
effects of the adverse movements in exchange rates. As in the case of other
types of options, however, the benefit to the Fund deriving from purchases of
foreign currency options will be reduced by the amount of the premium and
related transaction costs. In addition, where currency exchange rates do not
move in the direction or to the extent anticipated, the Fund could sustain
losses on transaction in foreign currency options which would require it to
forego a portion or all of the benefits of advantageous changes in such rates.
The Fund can write options on foreign currencies for the same types of
hedging purposes. For example, where the Fund anticipates a decline in the
dollar value of foreign currency denominated securities due to adverse
fluctuations in exchange rates it could, instead of purchasing a put option,
write a call option on the relevant currency. If the anticipated decline occurs,
the option will most likely not be exercised, and the diminution in value of
portfolio securities will be offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, the Fund
could write a put option on the relevant currency which, if rates move in the
manner projected, will expire unexercised and allow the Fund to hedge such
increased cost up to the amount of the premium. As in the case of other types of
options, however, the writing of a foreign currency option will constitute only
a partial hedge up to the amount of the premium, and only if exchange rates move
in the expected direction. If this does not occur, the option may be exercised
and the Fund would be required to purchase or sell the underlying currency at a
loss which may not be offset by the amount of the premium. Through the writing
of options on foreign currencies, a Fund also may be required to forego all or a
portion of the benefits which might otherwise have been obtained from favorable
movements in exchange rates.
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The Fund can write covered call options on foreign currencies. A call
option written on a foreign currency by the Fund is "covered" if the Fund owns
the underlying foreign currency covered by the call or has an absolute
and immediate right to acquire that foreign currency without additional cash
consideration (or for additional cash consideration held in a segregated account
by the Fund's custodian) upon conversion or exchange of other foreign currency
held in its portfolio. A call option is also covered if the Fund has a call on
the same foreign currency and in the same principal amount as the call written
where the exercise price of the call held (a) is equal to or less than the
exercise price of the call written or (b) is greater than the exercise price of
the call written if the difference is maintained by the Fund in cash, or liquid
assets in a segregated account with the custodian.
The Fund also can write call options on foreign currencies for
cross-hedging purposes. A call option on a foreign currency is for cross-hedging
purposes if it is designed to provide a hedge against a decline in the U.S.
dollar value of a security which the Fund owns or has the right to acquire and
which is denominated in the currency underlying the option due to an adverse
change in the exchange rate. In such circumstances, the Fund will collateralize
the option by maintaining in a segregated account with the custodian, cash or
liquid assets in an amount not less than the value of the underlying foreign
currency in U.S. dollars marked-to-market daily.
FUTURES CONTRACTS. Futures contracts provide for the future sale by one
party and purchase by another party of a specified amount of a specific security
currency on index at a specified future time and at a specified price. Futures
contracts which are standardized as to maturity date and underlying financial
instrument are traded on national futures exchanges. Futures exchanges and
trading in the United States are regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission ("CFTC").
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities or currency, in most cases the contracts
are closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold" or "selling" a
contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is bought
or sold. Futures contracts on indices are settled in cash.
Futures traders are required to make a good faith margin deposit in
cash or acceptable securities with a broker or custodian to initiate and
maintain open positions in futures contracts. A margin deposit is intended to
assure completion of the contract (delivery or acceptance of the underlying
securities) if it is not terminated prior to the specified delivery date.
Initial margin requirements are established by the futures exchange and may be
changed. Brokers may establish deposit requirements which are higher than the
exchange minimums.
After a futures contract position is opened, the value of the contract
is marked-to-market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, a change in the
contract value may reduce the required variation margin, resulting in a
repayment of excess variation margin to the contract holder. Variation margin
payments are made to and from the futures broker for as long as the contract
remains open.
Regulations of the CFTC applicable to the Fund require that it use
futures contracts and options on futures contracts only for bona fide hedging
purposes, or to the extent that the Fund's futures and options on futures
positions are for other than bona fide hedging purposes, as described by the
CFTC, the aggregate initial margins and premiums required to establish such
non-bona fide hedging positions other than the "in-the-money" amount in the case
of options that are "in-the-money" at the time of purchase, may not exceed 5% of
the Fund's net assets. Adherence to these guidelines does not limit the Fund's
risk to 5% of the Fund's assets. The Fund will only sell futures contracts to
protect securities owned by it against price declines or purchase contracts to
protect against an increase in the price of securities it intends to purchase.
Although techniques other than the sale and purchase of futures contracts could
be used to control the Fund's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
the Fund will incur commission expenses in both opening and closing out futures
positions, these costs may be lower than transaction costs incurred in the
purchase and sale of the underlying securities.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. A forward foreign currency
exchange contract ("Forward Contract") is an obligation to purchase or sell a
specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a price set at the time
of the contract.
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These contracts are traded in the interbank market conducted directly between
currency traders, usually large commercial banks, and their customers. The Fund
can use Forward Contracts to manage currency risks and to facilitate
transactions in foreign securities. The following discussion summarizes the
principal currency management strategies involving Forward Contracts that
the Fund may use.
In connection with purchases and sales of securities denominated in
foreign currencies, the Fund may enter into Forward Contracts to fix a definite
price for the purchase or sale in advance of the trade's settlement date
("transaction hedge" or "settlement hedge").
The Fund also can use Forward Contracts to hedge against a decline in
the value of existing investments denominated in foreign currency. For example,
if a Fund owned securities denominated in pounds sterling, it could enter into a
forward contract to sell pounds sterling in return for U.S. dollars to hedge
against possible declines in the pound's value ("position hedge"). A position
hedge would tend to offset both positive and negative currency fluctuations, but
would not offset changes in security values caused by other factors. The Fund
could also hedge the position by selling another currency expected to perform
similarly to the pound sterling ("proxy hedge"). A proxy hedge could offer
advantages in terms of cost, yield, or efficiency, but generally would not hedge
currency exposure as effectively as a simple hedge into U. S. dollars. Proxy
hedges may result in losses if the currency used to hedge does not perform
similarly to the currency in which the hedged securities are denominated.
The Fund's custodian will place cash or other liquid assets in a
separate account having a value equal to the aggregate amount of the Fund's
commitments under Forward Contracts entered into with respect to position hedges
and proxy-hedges. If the value of the assets placed in a segregated account
declines, additional cash or liquid assets will be placed in the account on a
daily basis so that the value of the account will equal the amount of the Fund's
commitments with respect to such contracts. Alternatively, the Fund can purchase
a call option permitting the Fund to purchase the amount of foreign currency
being hedged by a forward sale contract at a price no higher than the Forward
Contract price or the Fund can purchase a put option permitting the Fund to sell
the amount of foreign currency subject to a forward purchase contract at a price
as high or higher than the Forward Contract price. Unanticipated changes in
currency prices may result in poorer overall performance for the Fund than if it
had not entered into such contracts.
RISK FACTORS IN FUTURES TRANSACTIONS. Positions in futures contracts
may be closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, the Fund would continue to be required to make daily cash payments to
maintain its required margin. In such situations, if the Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, the Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on the Fund's ability to effectively hedge. The Fund will
minimize the risk that it will be unable to close out a futures contract by only
entering into futures for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures trading. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the Fund. For example, if at the time of
purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract.
Utilization of futures transactions by the Fund involves the risk of
imperfect or no correlation where the securities underlying futures contracts
are different than the portfolio securities being hedged. It is also possible
that the Fund could both lose money on futures contracts and also experience a
decline in value of its portfolio securities. There is also the risk of loss by
the Fund of margin deposits in the event of bankruptcy of a broker with whom the
Fund has an open position in a futures contract or option on a futures contract.
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Most futures exchanges limit the amount of fluctuation permitted in
futures contract and options prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract or option on
a future contract may vary either up or down from the previous day's settlement
price at the end of a trading session. Once the daily limit has been reached in
a particular type of contract, no trades may be made on that day at a price
beyond that limit. The daily limit governs only price movement during a
particular trading day and therefore does not limit potential losses, because
the limit may prevent the liquidation of unfavorable positions. Futures contract
and options prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of futures positions and subjecting some futures traders to
substantial losses.
RISKS OF OPTIONS ON FUTURES, FORWARD CONTRACTS, AND OPTIONS ON FOREIGN
CURRENCIES. Options on currencies may be traded over-the-counter and forward
currency contracts are always traded in the over-the-counter market. In an
over-the-counter trading environment, many of the protections afforded to
exchange participants will not be available. For example, there are no daily
price fluctuation limits, and adverse market movements could therefore continue
to an unlimited extent over a period of time. Although the purchase of an option
cannot lose more than the amount of the premium plus related transaction costs,
this entire amount could be lost. When the Fund enters into a forward currency
contract or purchases an over-the-counter option, it relies on its counterparty
to perform. Failure by the counterparty to do so would result in the loss of any
expected benefit of the transaction.
Futures contracts, options on futures contracts, forward contracts, and
options on foreign currencies may be traded on foreign exchanges. Such
transactions are subject to the risk of governmental actions affecting trading
in or the prices of foreign currencies or securities. The value of such
positions also could be adversely affected by (i) other complex foreign
political and economic factors, (ii) lesser availability than in the United
States of data on which to make trading decisions, (iii) delays in the Fund's
ability to act upon economic events occurring in foreign markets during
non-business hours in the United States, (iv) the imposition of different
exercise and settlement terms and procedures and margin requirements than in the
United States, and (v) lesser trading volume.
Options on foreign currencies traded on national securities exchanges
are within the jurisdiction of the Securities and Exchange Commission ("SEC"),
as are other securities traded on such exchanges. As a result, many of the
protections provided to traders on organized exchanges will be available with
respect to such transactions. In particular, all foreign currency option
positions entered into on a national securities exchange are cleared and
guaranteed by the Options Clearing Corporation ("OCC"), thereby reducing the
risk of counterparty default. The purchase and sale of exchange-traded foreign
currency options, however, is subject to the risks of the availability of a
liquid secondary market described above, as well as the risks regarding adverse
market movements, margining of options written, the nature of the foreign
currency market, possible intervention by governmental authorities and
the effect of other political and economic events. In addition, exchange-traded
options of foreign currencies involve certain risks not presented by the
over-the-counter market. For example, exercise and settlement of such options
must be made exclusively through the OCC, which has established banking
relationships in applicable foreign countries for this purpose. As a result, the
OCC may, if it determines that foreign governmental restrictions or taxes would
prevent the orderly settlement of foreign currency option exercises, or would
result in undue burdens on the OCC or its clearing member, impose special
procedures on exercise and settlement, such as technical changes in the
mechanics of delivery of currency, the fixing of dollar settlement prices or
prohibitions on exercise.
COMBINED TRANSACTIONS. The Fund can enter into multiple transactions,
including multiple options transactions, multiple futures transactions, multiple
foreign currency transactions (including Forward Contracts) and any combination
of futures, options, and foreign currency transactions, instead of a single
transaction, as part of a single hedging strategy when, in the opinion of the
Adviser, it is in the best interest of the Fund to do so. A combined
transaction, while part of a single hedging strategy, may contain elements of
risk that are present in each of its component transactions.
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS. The Fund will comply
with guidelines established by the SEC with respect to coverage of options,
futures and forward contracts strategies by mutual funds, and if the guidelines
so require will set aside appropriate liquid assets in a segregated custodial
account in the amount prescribed. Securities held in a segregated account cannot
be sold while the futures, option or forward contract strategy is outstanding,
unless they are replaced with other suitable assets. Consequently, there is a
possibility that
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segregation of a large percentage of a Fund's assets could impede portfolio
management or the Fund's ability to meet redemption requests or other current
obligations.
ILLIQUID INVESTMENTS AND RESTRICTED SECURITIES
ILLIQUID INVESTMENTS. The Fund may invest up to 15% of their securities
respective net assets in illiquid investments. Illiquid investments are
investments that cannot be sold or disposed of within seven days in the ordinary
course of business at approximately the prices at which they are valued. Under
the supervision of the Board of Trustees, the Subadviser determines the
liquidity of the Fund's investments and, through reports from the Subadviser and
the Fund's administrator, the Board monitors investments in illiquid securities.
In determining the liquidity of the Fund's investments, the Subadviser may
consider various factors, including the frequency of trades and quotations, the
number of dealers and prospective purchasers in the marketplace, dealer
undertakings to make a market, the nature of the security, and the nature of the
marketplace for trades. Investments currently considered by the Fund to be
illiquid include repurchase agreements not entitling the holder to payment of
principal and interest within seven days, certain over-the-counter options, and
restricted securities (other than restricted securities pursuant to Rule 144A
under the Securities Act and commercial paper sold in reliance on Section 4(2)
of the Securities Act). With respect to over-the-counter ("OTC") options that
the Fund writes, all or a portion of the value of the underlying instrument may
be illiquid depending on the assets held to cover the option and the nature and
terms of any agreement the Fund may have to close out the option before
expiration. The Fund will treat as illiquid an amount of assets used to cover
written OTC options, equal to the formula price at which the Fund would have the
absolute right to purchase the option less the amount by which the option is
"in-the-money." The absence of a trading market can make it difficult to
ascertain a market value for illiquid investments. When no market quotations are
available, illiquid investments are priced at fair value as determined in good
faith by the Subadviser under the supervision of the Board of Trustees.
Disposing of these investments may involve time-consuming negotiation and legal
expenses, and it may be difficult or impossible for the Fund to sell them
promptly at an acceptable price. If through a change in values, net assets, or
other circumstances, either Fund was in a position where more than 15% of its
net assets were invested in illiquid securities, it would take appropriate steps
to protect liquidity.
RESTRICTED SECURITIES. Restricted securities can generally be sold in
privately negotiated transactions, pursuant to an exemption from registration
under the Securities Act or in a registered public offering. Where registration
is required, the Fund may be obligated to pay all or part of the registration
expense and a considerable period may elapse between the time it or they decide
to seek registration and the time the Fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the Fund might obtain a less favorable price
than prevailed at the time it decided to seek registration of the security.
SECURITIES LENDING
The Fund may lend securities to qualified brokers, dealers, banks and
other financial institutions. Securities lending allows the Fund to retain
ownership of the securities loaned and, at the same time, to earn additional
income. Since there may be delays in the recovery of loaned securities, or even
a loss of rights in collateral supplied should the borrower fail financially,
loans will be made only to parties deemed by the Subadviser to be of good
standing. In addition, they will only be made if, in the Subadviser's judgment,
the consideration to be earned from such loans would justify the risk. Such
loans will not be made if, as a result, the aggregate of all outstanding loans
of a Fund exceed one-third of the value of its total assets.
It is the Fund's understanding that the current view of the staff of
the SEC is that the Fund can engage in securities loan transactions only under
the following conditions: (1) the Fund must receive 100% collateral in the form
of cash or cash equivalents (i.e., U.S. Treasury bills or notes) from the
borrower; (2) the borrower must increase the collateral whenever the market
value of the securities loaned (determined on a daily basis) rises above the
value of the collateral; (3) after giving notice, the Fund must be able to
terminate the loan at any time; (4) the Fund must receive reasonable interest on
the loan (which may include the Fund investing any cash collateral in interest
bearing short-term investments) or a flat fee from the borrower, as well as
amounts equivalent to any dividends, interest, or other distributions on the
securities loaned and to any increase in market value; (5) the Fund
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may pay only reasonable custodian fees in connection with the loan; and (6) the
Board of Trustees must be able to vote proxies on the securities loaned, either
by terminating the loan or by entering into an alternative arrangement with the
borrower.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with brokers, dealers or
banks that meet the credit guidelines established by the Board of Trustees of
the Fund. In a repurchase agreement, the Fund buys a security from a seller that
has agreed to repurchase it at a mutually agreed upon date and price, reflecting
the interest rate effective for the term of the agreement. The term of these
agreements is usually from overnight to one week and never exceeds one year. A
repurchase agreement may be viewed as a fully collateralized loan of money by a
Fund to the seller. The Fund always receive securities as collateral with a
market value at least equal to the purchase price, including accrued interest,
and this value is maintained during the term of the agreement. If the seller
defaults and the collateral value declines, the Fund might incur a loss. If
bankruptcy proceedings are commenced with respect to the seller, the Fund's
realization upon the collateral may be delayed or limited.
OTHER INVESTMENT COMPANIES
The Fund may invest in other investment companies to the extent
permitted under the 1940 Act, which includes up to 10% of its total assets in
other investment companies. Not more than 5% of the Fund's total assets may be
invested in the securities of any one investment company nor may the Fund
acquire more than 3% of the voting securities of any other investment company.
In addition to the advisory fees and other expenses the Fund bear directly in
connection with their own operations, as shareholders of another investment
company, the Fund would bear their pro rata portion of the other investment
company's advisory fees and other expenses. As such, the Fund's shareholders
would indirectly bear the expenses of the Fund and the other investment company,
some or all of which would be duplicative.
INVESTMENT LIMITATIONS
The Fund is subject to the following restrictions which are fundamental
policies and may not be changed without the approval of the lesser of: (1) at
least 67% of the voting securities of a Fund present at a meeting if the holders
of more than 50% of the outstanding voting securities of the Fund are present or
represented by proxy, or (2) more than 50% of the outstanding voting securities
of a Fund.
As a matter of fundamental policy, the Fund will not:
(1) invest in physical commodities or contracts on physical
commodities;
(2) purchase or sell real estate, although it may purchase and sell
securities of companies which deal in real estate, other than real estate
limited partnerships, and may purchase and sell marketable securities which are
secured by interests in real estate;
(3) make loans except: (i) by purchasing debt securities in accordance
with its investment objective and policies or entering into repurchase
agreements; or (ii) by lending its portfolio securities to banks, brokers,
dealers and other financial institutions, so long as such loans are not
inconsistent with the 1940 Act or the rules and regulations or interpretations
of the SEC thereunder;
(4) with respect to 75% of its assets, purchase more than 10% of any
class of the outstanding voting securities of any issuer;
(5) with respect to 75% of its assets, invest more than 5% of its total
assets in the securities of any single issuer (other than obligations issued or
guaranteed by the U.S. Government or any of its agencies or instrumentalities);
(6) borrow money, except (i) from banks as a temporary measure for
extraordinary or emergency purposes (not for leveraging or investment) or (ii)
in connection with reverse repurchase agreements provided that (i) and (ii)
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in combination do not exceed 331/3% of the Fund's total assets (including the
amount borrowed) less liabilities (exclusive of borrowings);
(7) underwrite the securities of other issuers (except to the extent
that the Fund may be deemed to be an underwriter within the meaning of the
Securities Act in the disposition of restricted securities);
(8) acquire any securities of companies within one industry if, as a
result of such acquisition, more than 25% of the Fund's total assets would be
invested in securities of companies within such industry; provided, however,
that there shall be no limitation on the purchase of obligations issued or
guaranteed by the U.S. Government, its agencies or instrumentalities; and
(9) issue senior securities, except that this limitation shall not
apply to: (i) evidence indebtedness which the Fund is permitted to incur; (ii)
shares of the separate classes or series of the Trust; or (iii) collateral
arrangements with respect to currency-related contracts, futures contracts,
options or other permitted investments, including deposits of initial and
variation margin.
The Fund is also subject to the following restrictions which are
non-fundamental policies and may be changed by the Board of Trustees without
shareholder approval. As a matter of non-fundamental policy, the Fund will not:
(a) purchase securities on margin, except for use of short-term credit
as may be necessary for the clearance of purchases and sales of securities, but
it may make margin deposits in connection with transactions in options, futures,
and options on futures; or sell securities short unless, by virtue of its
ownership of other securities, it has the right to obtain securities equivalent
in kind and amount to the securities sold and, if the right is conditional, the
sale is made upon the same conditions. Transactions in futures contracts,
options and options on futures are not deemed to constitute selling securities
short;
(b) pledge, mortgage, or hypothecate any of its assets to an extent
greater than 331/3% of its total assets at fair market value;
(c) invest more than an aggregate of 15% of its net assets in
securities deemed to be illiquid, including securities which are not readily
marketable, the disposition of which is restricted (excluding securities that
are not registered under the Securities Act but which can be sold to qualified
institutional investors in accordance with Rule 144A under the Securities Act
and commercial paper sold in reliance on Section 4(2) of the Securities Act),
repurchase agreements having maturities of more than seven days and certain OTC
options;
(d) invest its assets in securities of any investment company, except
by purchase in the open market involving only customary brokers' commissions or
in connection with mergers, acquisitions of assets or consolidations and except
as may otherwise be permitted by the 1940 Act; and
(e) write or acquire options or interests in oil, gas or other mineral
exploration or development programs or leases.
With the exception of fundamental investment limitation (6), if a
percentage limitation on the investment or utilization of assets as set forth
above is adhered to at the time an investment is made, a later change in
percentage resulting from changes in the value or total cost of a Fund's assets
will not require the sale of securities.
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<PAGE>
MANAGEMENT
INVESTMENT ADVISER
The investment adviser to the Fund is Luther King Capital Management
Corporation. The Fund and the Adviser have entered into an Investment Advisory
Agreement dated June 21, 1994, as supplemented on December 30, 1997 (the
"Advisory Agreement"). The Advisory Agreement, as it relates to the Fund, was
approved initially by the Board of Trustees on November 13, 1997. By its terms,
the Advisory Agreement continues in effect for a period of two years from the
date of the Agreement, and thereafter for successive one year periods, only if
each renewal is specifically approved by a vote of the Board of Trustees,
including the affirmative votes of a majority of the Trustees who are not
parties to the agreement or "interested persons" (as defined in the 1940 Act) of
any such party in person at a meeting called for the purpose of considering such
approval. In addition, the question of continuance of the Agreement may be
presented to the shareholders of the Fund; in such event, continuance shall be
effective only if approved by the affirmative vote of a majority of the
outstanding voting securities of the Fund. The Agreement can be terminated,
without penalty, with respect to the Fund on 60 days' written notice by the
Board of Trustees or by vote of a majority of the outstanding voting securities.
The Adviser can terminate the Advisory Agreement with respect to the Fund,
without penalty, on 90 days' written notice. In addition, the Advisory Agreement
will terminate automatically in the event of its assignment. The Adviser is a
corporation of which J. Luther King, Jr. is a "controlling person" (as that term
is defined in the rules and regulations of the SEC).
INVESTMENT SUBADVISER
The investment subadviser to the Fund is TT International Investment
Management, doing business as TT International. The Adviser and the Subadviser
have entered into an Investment Subadvisory Agreement ("Subadvisory Agreement")
dated December 30, 1997. By its terms, the Subadvisory Agreement continues in
effect for a period of two years from the date of the Subadvisory Agreement, and
thereafter for successive one year periods, only if each renewal is specifically
approved by a vote of the Board of Trustees, including the affirmative votes of
a majority of the Trustees who are not parties to the agreement or "interested
persons" (as defined in the 1940 Act) of any such party in person at a meeting
called for the purpose of considering such approval. In addition, the question
of continuance of the Subadvisory Agreement may be presented to the shareholders
of the Fund; in such event, continuance shall be effective only if approved by
the affirmative vote of a majority of the outstanding voting securities of the
Fund. The Subadvisory Agreement can be terminated, without penalty, on 60 days'
written notice by the Board of Trustees, by the Adviser or by vote of a majority
of the outstanding voting securities of the Fund. The Subadviser can terminate
the Subadvisory Agreement, without penalty, on 90 days' written notice. In
addition, the Subadvisory Agreement will terminate automatically in the event of
its assignment. The Subadviser is a partnership controlled by Timothy A. Tacchi,
who owns 67% of the partnership's participation interests. The Subadviser is
registered as an investment adviser under the Investment Advisers Act of 1940
and is authorized to conduct its investment business in the United Kingdom by
the Investment Management Regulatory Organization Limited (IMRO).
CUSTODIAN
As custodian of the Fund's assets, Firstar Trust Company, 615 East
Michigan Street, Milwaukee, Wisconsin 53202, has custody of all securities and
cash of the Fund, delivers and receives payment for securities sold, receives
and pays for securities purchased, collects income from investments, and
performs other duties, all as directed by the officers of the Trust.
DISTRIBUTOR
Shares of the Fund are distributed through First Data Distributor Inc.
(the "Distributor"), 4400 Computer Drive, Westborough, Massachusetts 01581, a
registered broker-dealer. Jacqui Brownfield, an employee of the Adviser and an
officer of the Trust, is a registered representative of the Distributor.
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TRUSTEES AND OFFICERS
The Trustees and officers of the Trust, their ages, their business
addresses and principal occupations during the past five years are as follows:
J. LUTHER KING, JR.*; 57; 301 Commerce Street, Fort Worth, Texas 76102;
Chairman of the Board of Trustees, President, Chief Executive Officer and
Manager of the Trust; President, Luther King Capital Management Corporation.
H. KIRK DOWNEY; 55; 2900 Lubbock Street, Fort Worth, Texas 76109;
Trustee of the Trust; Dean, M.J. Neeley School of Business, Texas Christian
University Business School.
EARLE A. SHIELDS, JR.; 77; 53 Westover Terrace, Fort Worth, Texas
76107; Trustee of the Trust; Consultant; formerly Consultant for NASDAQ Corp.
and Vice President, Merrill Lynch & Co., Inc.
PAUL W. GREENWELL; 47; 301 Commerce Street, Fort Worth, Texas 76102;
Vice President of the Trust; Vice President, Luther King Capital Management
Corporation.
JACQUI BROWNFIELD; 37; 301 Commerce Street, Fort Worth, Texas 76102;
Secretary and Treasurer of the Trust; Fund Administrator, Luther King Capital
Management Corporation.
* Trustee Mr. King is an "interested person" of the Trust (as defined
in the 1940 Act), because of his affiliation with the Adviser.
Trustees other than those who are officers or affiliated with the
Adviser receive an annual fee of $8,000 plus a meeting fee of $1,000 for each
meeting attended and are reimbursed for expenses incurred in attending Board
meetings. Trustees who are also officers or affiliated persons receive no
remuneration for their services as Trustees. The Trust's officers and employees
are paid by the Adviser or the Administrator.
The following table shows the estimated compensation to be earned by
each Trustee for the fiscal year ending December 31, 1998.
COMPENSATION TABLE
<TABLE>
<CAPTION>
Total Compensation
Aggregate Pension or Retirement Estimated Annual From the Trust and the
Name of Person, Compensation Benefits Accrued as Part Benefits Upon LKCM Family of FUNDS
Position From the Trust of the Trust's Expenses Retirement Paid to Trustees
<S> <C> <C> <C> <C>
H. Kirk Downey, Trustee $12,000 $0 $0 $12,000
J. Luther King, Trustee $0 $0 $0 $0
Earle A. Shields, Jr., Trustee $12,000 $0 $0 $12,000
</TABLE>
PRINCIPAL SHAREHOLDERS
As of the date of this Statement of Additional Information, the Adviser
is the sole shareholder of the Fund.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Subadvisory Agreement authorizes the Subadviser to select the
brokers or dealers that will execute the purchases and sales of investment
securities for the Fund and directs the Subadviser to use its best efforts to
obtain the best execution with respect to all transactions for the Fund. As
permitted by Section 28(e) of the Securities Exchange Act of 1934, as amended,
the Subadviser may cause the Fund to pay higher commission rates than the lowest
available when the Subadviser believes it is reasonable to do so in light of the
value of the research services provided by the broker effecting the transaction.
These services, which in some cases may also be purchased for cash, include such
matters as general economic and security market reviews, industry and company
reviews, evaluations of securities and recommendations as to the purchase and
sale of securities. Some of these services are
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of value to the Subadviser in advising various clients, including the Fund,
although not all of these services are necessarily useful and of value in
managing the Fund.
It is not the Subadviser's practice to allocate brokerage or principal
business on the basis of sales of shares which may be made through intermediary
brokers or dealers. However, the Subadviser may place orders with qualified
broker-dealers who recommend the Fund or who act as agents in the purchase of
shares of the Fund for their clients.
Some securities considered for investment by the Fund may also be
appropriate for other clients served by the Subadviser. If purchases or sales of
securities consistent with the investment policies of the Fund and one or more
of these other clients serviced by the Subadviser is considered at or about the
same time, transactions in such securities will be allocated among the Fund and
clients in a manner deemed fair and reasonable by the Subadviser. Although there
is no specified formula for allocating such transactions, the various allocation
methods used by the Subadviser, and the results of such allocations, are subject
to periodic review by the Board of Trustees.
The Subadviser manages the Fund without regard generally to
restrictions on Fund turnover. The use of futures contracts and other derivative
instruments with relatively short maturities may tend to exaggerate the Fund
turnover rate for the Fund. Trading in fixed-income securities does not
generally involve the payment of brokerage commissions, but does involve
indirect transaction costs. The use of futures contracts may involve the payment
of commissions to futures commission merchants. The higher the rate of Fund
turnover, the higher these transaction costs borne by the Fund generally will
be.
The Fund turnover rate is calculated by dividing (i) the lesser of
purchases or sales of securities for the particular fiscal year by (ii) the
monthly average of the value of the securities owned by the Fund during the
particular fiscal year. In calculating the rate of Fund turnover, there is
excluded from both (i) and (ii) all securities, including options, whose
maturities or expiration dates at the time of acquisition were one year or less.
Proceeds from short sales and assets used to cover short positions undertaken
are included in the amounts of securities sold and purchased, respectively,
during the year.
PURCHASE, REDEMPTION, AND PRICING OF SHARES
PURCHASE OF SHARES
Certain managed account clients of the Adviser may purchase shares of
the Fund. To avoid the imposition of duplicative fees, the Adviser may be
required to make adjustments in the management fees charged separately by the
Adviser to these clients to offset the generally higher level of management fees
and expenses resulting from a client's investment in the Fund.
Certain clients of the Adviser may, subject to the approval of the
Trust, purchase shares of the Fund with liquid securities that are eligible for
purchase by the Fund (consistent with the Fund's investment policies and
restrictions) and that have a value that is readily ascertainable (and not
established only by evaluation procedures) as evidenced by a listing on the
American Stock Exchange, the New York Stock Exchange, or The Nasdaq Stock
Market. These transactions will be effected only if the Adviser intends to
retain the security in the Fund as an investment. Assets so purchased by the
Fund will be valued in generally the same manner as they would be valued for
purposes of pricing the Fund's shares, if such assets were included in the
Fund's assets at the time of purchase.
Shares of the Fund are not qualified or registered for sale in all
states. Shares of the Fund may not be offered or sold in any state unless
registered or qualified in the jurisdiction unless an exemption from
registration or qualification is available.
The Trust reserves the right in its sole discretion (i) to suspend the
offering of Fund shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund, (iii) to reduce
or waive the minimum for initial and subsequent investments for certain
fiduciary accounts such as employee benefit plans or under circumstances where
certain economies can be achieved in sales of the Fund's shares. The officers of
the Trust may from time to time waive the minimum initial and subsequent
investment requirements in connection with investments in the Fund by employees
of the Adviser.
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<PAGE>
REDEMPTION OF SHARES
The Trust may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange (the "Exchange")
is closed, or trading on the Exchange is restricted as determined by the SEC,
(ii) during any period when an emergency exists as defined by the rules of the
SEC as a result of which it is not reasonably practicable for the Fund to
dispose of securities owned by it, or fairly to determine the value of its
assets, and (iii) for such other periods as the SEC may permit.
The Trust has 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 the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the SEC. Redemptions in excess of the above limits may be paid in
whole or in part in investment securities or in cash, as the Trustees may deem
advisable; however, payment will be made wholly in cash unless the Trustees
believe that economic or market conditions exist which would make such a
practice detrimental to the best interests of the Fund. If redemptions are paid
in investment securities the redeeming shareholders might incur brokerage
expenses if they converted these securities to cash. Securities used to make
such "in-kind" redemptions will be readily marketable. The method of valuing
such securities will be the same as the method of valuing Fund securities
described in the Prospectus under "Valuation of Shares," and such valuation will
be made as of the same time the redemption price is determined.
Due to the relatively high cost of maintaining smaller accounts, the
Trust reserves the right to redeem shares in any account for their then-current
value (which will be promptly paid to the investor) if at any time, due to
shareholder redemption, the shares in the account do not have a value of at
least $1,000. Investors will be notified that the value of their account is less
than the minimum and allowed at least 30 days to bring the value of the account
up to at least the minimum before the redemption is processed. The Declaration
of Trust also authorizes the Trust to redeem shares under certain other
circumstances as may be specified by the Board of Trustees.
No fee is charged by the Trust for redemptions. Redemption proceeds may
be more or less than the shareholder's cost depending on the market value of the
securities held by the Fund.
PRICING OF SHARES
The Fund's net asset value per share for the purpose of pricing
purchase and redemption orders is determined as described in the Prospectus. Net
asset value will not be determined on the following holidays: New Year's Day,
Martin Luther King's Birthday, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
DIVIDENDS, OTHER DISTRIBUTIONS, AND TAXES
GENERAL
It is the Fund's policy to distribute all of its net investment income,
if any, together with any net realized capital gains in the amount and at the
times that will avoid federal income tax on it and the imposition of the federal
excise tax on certain undistributed income and capital gain.
To avoid federal income tax on income and gains that are distributed,
the Fund must qualify for the special tax treatment afforded a regulated
investment company ("RIC") under the Internal Revenue Code of 1986, as amended.
To qualify for that treatment, the Fund must distribute to its shareholders for
each taxable year at least 90% of its investment company taxable income
(consisting generally of net investment income, net short-term capital gains,
and net gains from certain foreign currency transactions) and must meet several
additional requirements. These require ments include the following: (1) the Fund
must derive at least 90% of its gross income each taxable year from dividends,
interest, payments with respect to securities loans, and gains from the sale or
other disposition of securities or foreign currencies, or other income
(including gains from options, futures, and Forward Contracts) derived with re
spect to its business of investing in securities or those currencies; and (2) at
the close of each quarter of the Fund's taxable
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year, (i) at least 50% of the value of its total assets must be represented
by cash and cash items, U.S. Government securities, securities of other RICs,
and other securities, with these other securities limited, in respect of any
one issuer, to an amount that does not exceed 5% of the value of the Fund's
total assets and that does not represent more than 10% of the issuer's voting
securities, and (ii) not more than 25% of the value of its total assets may be
invested in securities (other than U.S. Government securities or the securities
of other RICs) of any one issuer.
Any use of hedging strategies, such as writing (selling) and purchasing
options and futures and entering into Forward Contracts, involves complex rules
that will determine for income tax purposes the amount, character, and timing of
recognition of the gains and losses it realizes in connection therewith.
The Fund also intends to declare and pay dividends and capital gain
distributions so as to avoid imposition of federal excise tax.
Undistributed net investment income and net realized gains are included
in the Fund's net assets for the purpose of calculating net asset value per
share. Therefore, on the "ex-distribution" date, the net asset value per share
excludes the distribution (i.e., is reduced by the per share amount of the
distribution). Dividends and other distributions paid shortly after the purchase
of shares by an investor, although in effect a return of capital, are taxable to
the investor.
As stated in the Prospectus, unless the shareholder elects otherwise in
writing, all dividends and other distributions are automatically paid in
additional Fund shares at net asset value (as of the business day following the
record date). This will remain in effect until the Fund is notified by the
shareholder in writing at least three days prior to the record date that either
the Income Option (income dividends in cash and other distributions in
additional shares at net asset value) or the Cash Option (both income dividends
and other distributions in cash) has been elected. An account statement is sent
to shareholders whenever an income dividend or other distribution is paid.
TAXES - INVESTMENTS IN FOREIGN SECURITIES
Dividends and interest received by the Fund, and gains realized
thereby, may be subject to income, withholding, or other taxes imposed by
foreign countries and U.S. possessions ("foreign taxes") that would reduce the
yield and/or total return on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate foreign taxes, however,
and many foreign countries do not impose taxes on capital gains in respect of
investments by foreign investors. If more than 50% of the value of the Fund's
total assets at the close of any taxable year consists of securities of foreign
corporations, it will be eligible to, and may, file an election with the
Internal Revenue Service that will enable its shareholders, in effect, to
receive the benefit of the foreign tax credit with respect to any foreign taxes
paid by it. Pursuant to any such election, the Fund would treat those taxes as
dividends paid to its shareholders and each shareholder would be required to (1)
include in gross income, and treat as paid by the shareholder, the shareholder's
proportionate share of those taxes, (2) treat the shareholder's share of those
taxes and of any dividend paid by the Fund that represents income from foreign
or U.S. possessions sources as the shareholder's own income from those sources,
and (3) either deduct the taxes deemed paid by the shareholder in computing the
shareholder's taxable income or, alternatively, use the foregoing information in
calculating the foreign tax credit against the shareholder's federal income tax.
The Fund will report to its shareholders shortly after each taxable year their
respective shares of its income from sources within, and taxes paid to, foreign
countries and U.S. possessions if it makes this election. Pursuant to the
Taxpayer Relief Act of 1997, individuals who have no more than $300 ($600 for
married persons filing jointly) of creditable foreign taxes included on Forms
1099 and have no foreign sources non-passive income will be able to claim a
foreign tax credit without having to file the detailed Form 1116 that otherwise
is required.
The Fund may invest in the stock of "passive foreign investment
companies" ("PFICs"). A PFIC is a foreign corporation -- other than a
"controlled foreign corporation" (i.e., a foreign corporation in which, on any
day during its taxable year, more than 50% of the total voting power of all
voting stock therein or the total value of all stock therein is owned, directly,
indirectly, or constructively, by "U.S. shareholders," defined as U.S. persons
that individually own, directly, indirectly, or constructively, at least 10% of
that voting power) as to which the Fund is a U.S. shareholder -- that, in
general, meets either of the following tests: (1) at least 75% of its gross
income is passive or (2) an average of at least 50% of its assets produce, or
are held for the production of, passive income. Under certain circumstances,
the Fund will be subject to federal income tax on a portion of any "excess
distribution"
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<PAGE>
received on the stock of a PFIC or of any gain on the disposition of the stock
(collectively "PFIC income"), plus interest thereon, even if the Fund
distributes the PFIC income as a taxable dividend to its shareholders. The
balance of the PFIC income will be included in the Fund's investment company
taxable income and, accordingly, will not be taxable to it to the extent that
income is distributed to its shareholders. If the Fund invests in a PFIC and
elects to treat the PFIC as a "qualified electing fund" ("QEF"), then in lieu of
the foregoing tax and interest obligation, the Fund would be required to include
in income each year its pro rata share of the QEF's annual ordinary earnings and
net capital gain (the excess of net long-term capital gain over net short-term
capital loss) -- which probably would have to be distributed by the Fund to its
shareholders -- even if those earnings and gain were not distributed to the Fund
by the QEF. In most instances it will be very difficult, if not impossible, to
make this election because of certain requirements thereof.
The Fund may elect to "mark to market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of the PFIC's stock
over the Fund's adjusted basis therein as of the end of that year. Pursuant to
the election, the Fund also would be allowed to deduct (as an ordinary, not
capital, loss) the excess, if any, of its adjusted basis in PFIC stock over the
fair market value thereof as of the taxable year-end, but only to the extent of
any net mark-to-market gains with respect to that stock included by the Fund for
prior taxable years. The Fund's adjusted basis in each PFIC's stock with respect
to which it makes this election will be adjusted to reflect the amounts of
income included and deductions taken under the election.
Gains or losses (1) from the disposition of foreign currencies, (2) on
the disposition of a debt security denominated in a foreign currency that are
attributable to fluctuations in the value of the foreign currency between the
date of acquisition of the security and the date of disposition, and (3) that
are attributable to fluctuations in exchange rates that occur between the time
the Fund accrues interest, dividends, or other receivables or accrues expenses
or other liabilities denominated in a foreign currency and the time it actually
collects the receivables or pays the liabilities, generally are treated as
ordinary income or loss. These gains or losses may increase or decrease the
amount of investment company taxable income available to the Fund for
distribution to its shareholders.
PERFORMANCE INFORMATION
TOTAL RETURN
Average annual total return quotations used in the Fund's advertising
and promotional materials are calculated according to the following formula:
P(1+T)n = ERV
where P equals a hypothetical initial payment of $1,000; T equals average annual
total return; n equals the number of years; and ERV equals the ending redeemable
value at the end of the period of a hypothetical $1,000 payment made at the
beginning of the period.
Under the foregoing formula, the time periods used in advertising will
be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication. Average
annual total return, or "T" in the above formula, is computed by finding the
average annual compounded rates of return over the period that would equate the
initial amount invested to the ending redeemable value. Average annual total
return assumes the reinvestment of all dividends and distributions.
OTHER INFORMATION
The Fund's performance data quoted in advertising and other promotional
materials represents past performance and is not intended to predict or indicate
future results. The return and principal value of an investment in the Fund will
fluctuate, and an investor's redemption proceeds may be more or less than the
original investment amount.
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COMPARISON OF FUND PERFORMANCE
The performance of the Fund may be compared to data prepared by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc., Morningstar, Inc.,
the Donoghue Organization, Inc. or other independent services which monitor the
performance of investment companies, and may be quoted in advertising in terms
of its ranking in each applicable universe. In addition, the Fund may use
performance data reported in financial and industry publications, including
Barron's, Business Week, Forbes, Fortune, Investor's Daily, IBC/Donoghue's Money
Fund Report, Money Magazine, The Wall Street Journal and USA Today.
The Fund may from time to time use various unmanaged indices for
performance comparison purposes, including the following indices:
S&P 500--The S&P 500 is a Fund of 500 stocks designed to mimic the
overall equity market's industry weightings. Most, but not all, large
capitalization stocks are in the index. There are also some small capitalization
names in the index. The list is maintained by Standard & Poor's Corporation. It
is market capitalization weighted. There are always 500 issuers in the S&P 500.
Changes are made by Standard & Poor's as needed.
EAFE Index--The EAFE Index is an unmanaged index representing the
market value weighted price of stocks of approximately 1100 companies screened
for liquidity, cross-ownership and industry representation and listed on major
stock exchanges in Europe, Australasia and the Far East. The Index is compiled
by Morgan Stanley Capital International.
GENERAL INFORMATION
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund is a series of LKCM Funds, which was established under
Delaware law by a Declaration of Trust dated February 10, 1994. The Trust's
Declaration of Trust permits the Trustees to issue an unlimited number of shares
of beneficial interest, without par value, from an unlimited number of series
("Funds") of shares. Currently, the Trust offers five series. Pursuant to the
Declaration of Trust, the Trustees may also authorize the creation of additional
series of shares (the proceeds of which would be invested in separate,
independently managed Funds with distinct investment objectives and policies and
share purchase, redemption and net asset valuation procedures) with such
preferences, privileges, limitations and voting and dividend rights as the
Trustees may determine. All consideration received by the Trust for shares of
any additional series, and all assets in which such consideration is invested,
would belong to that series and would be subject to the liabilities related
thereto.
The Trustees, in their discretion, may authorize the division of shares
of the Funds into different classes permitting shares of different classes to be
distributed by different methods. Although shareholders of different classes
would have an interest in the same Fund of assets, shareholders of different
classes may bear different expenses in connection with different methods of
distribution. The Trustees have no present intention of taking the action
necessary to effect the division of shares into separate classes nor of changing
the method of distribution of shares of the Funds.
When issued, the shares of the Funds are fully paid and non-assessable,
have no preemptive or subscription rights and are fully transferable. There are
no conversion rights. The shares of the Funds have non-cumulative voting rights,
which means that the holders of more than 50% of the shares voting for the
election of Trustees can elect 100% of the Trustees if they choose to do so. A
shareholder is entitled to one vote for each full share held (and a fractional
vote for each fractional share held), then standing in his name on the books of
a Fund.
SHAREHOLDER AND TRUSTEE LIABILITY
The Declaration of Trust contains an express disclaimer of shareholder
liability for acts or obligations of the Trust and requires that notice of such
disclaimer be given in each agreement, obligation, or instrument entered into or
executed by the Trust or the Trustees, but this disclaimer may not be effective
in some jurisdictions or as to certain types of claims. The Declaration of
Trust further provides for indemnification out of the Trust's property of
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any shareholder held personally liable for the obligations of the Trust. The
Declaration of Trust also provides that the Trust shall, upon request, assume
the defense of any claim made against any shareholder for any act or obligation
of the Trust and satisfy any judgment thereon. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Trust itself would be unable to meet its obligations.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of the
office.
AUDITORS
Deloitte & Touche LLP, 411 East Wisconsin Avenue, Milwaukee, Wisconsin,
serves as the Trust's independent auditors, whose services include examination
of the Trust' financial statements and the performance of other related audit
and tax services.
CODE OF ETHICS
The Trust has adopted a Code of Ethics which restricts to a certain
extent personal transactions by access persons of the Trust and imposes certain
disclosure and reporting obligations.
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LKCM FUNDS
LKCM BALANCED FUND
LKCM FIXED INCOME FUND
301 COMMERCE STREET, SUITE 1600
FORT WORTH, TEXAS 76102
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 30, 1997
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND SHOULD BE READ
IN CONJUNCTION WITH THE PROSPECTUS OF THE LKCM BALANCED AND LKCM FIXED INCOME
FUNDS DATED DECEMBER 30, 1997, AS SUCH PROSPECTUS MAY BE SUPPLEMENTED OR REVISED
FROM TIME TO TIME. A COPY OF THE PROSPECTUS MAY BE OBTAINED WITHOUT CHARGE BY
CALLING THE LKCM FUNDS AT (800) 688-LKCM (OPTION 1).
<PAGE>
TABLE OF CONTENTS
INVESTMENT OBJECTIVES AND POLICIES B- 4
Equity Securities B- 4
Preferred Stock B- 4
Warrants and Rights B- 4
Convertible Securities B- 4
Securities Subject to Reorganization B- 5
Fixed-Income Securities B- 6
U. S. Government Securities B- 6
Corporate Debt Securities B- 6
Mortgage-Related Securities B- 6
Asset-Backed Securities B- 9
Factors Relating to Investing in Mortgage-Related and
Asset-Backed Securities B- 9
Temporary Investments B-10
Derivative Instruments B-11
Options B-11
Options on Foreign Currencies B-12
Futures Contracts B-12
Forward Foreign Currency Exchange Contracts B-13
Risk Factors in Futures Transactions B-14
Risks of Options on Futures, Forward Contracts,
and Options on Foreign Currencies B-14
Combined Transactions B-15
Asset Coverage for Futures and Options Positions B-15
Illiquid Investments, Restricted Securities and Private
Placement Offerings B-15
Illiquid Investments B-15
Restricted Securities B-16
Private Placement Offerings B-16
Securities Lending B-16
INVESTMENT LIMITATIONS B-16
MANAGEMENT B-18
Investment Adviser B-18
Custodian B-18
Distributor B-19
Trustees and Officers B-19
FUND TRANSACTIONS AND BROKERAGE B-20
PURCHASE, REDEMPTION, AND PRICING OF SHARES B-20
Purchase of Shares B-20
Redemption of Shares B-21
Pricing of Shares B-21
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DIVIDENDS, OTHER DISTRIBUTIONS, AND TAXES B-21
General B-21
Taxes - Investments in Foreign Securities B-22
PERFORMANCE INFORMATION B-23
Total Return B-23
Yield B-23
Other Information B-24
Comparison of Portfolio Performance B-24
GENERAL INFORMATION B-24
Description of Shares and Voting Rights B-24
Shareholder and Trustee Liability B-25
Auditors B-25
Code of Ethics B-25
APPENDIX B-26
Description of Bond Ratings B-26
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THESE CONTAINED IN THIS STATEMENT OF ADDITIONAL
INFORMATION AND THE PROSPECTUS DATED DECEMBER 30, 1997, AND IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MAY NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE FUNDS. THIS STATEMENT OF ADDITIONAL INFORMATION DOES NOT
CONSTITUTE AN OFFER TO SELL SECURITIES.
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INVESTMENT OBJECTIVES AND POLICIES
The investment objective of the LKCM Balanced Fund (the "Balanced Fund") is
to seek to provide investors with current income and capital appreciation. The
investment objective of the LKCM Fixed Income Fund (the "Fixed Income Fund") is
to seek to provide investors with current income.
The investment objective and policies of each Fund are described in detail
in the Prospectus under the captions "Investment Objectives and Policies" and
"Description of Securities and Other Investment Policies."
EQUITY SECURITIES
The equity securities in which the Funds may invest include common stocks,
preferred stocks, warrants and rights, and debt securities convertible into or
exchangeable for common stock or other equity securities.
PREFERRED STOCK. Preferred stock offers a stated dividend rate payable from
the corporation's earnings. These preferred stock dividends may be cumulative or
non-cumulative, participating, or auction rate. If interest rates rise, the
fixed dividend on preferred stocks may be less attractive, causing the price of
preferred stocks to decline. Preferred stock may have mandatory sinking fund
provisions, as well as call/redemption provisions prior to maturity, a negative
feature when interest rates decline. The rights of preferred stocks are
generally subordinate to rights associated with a corporation's debt securities.
Dividends on some preferred stock may be "cumulative" if stated dividends
from prior periods have not been paid. Preferred stock also generally has a
preference over common stock on the distribution of a corporation's assets in
the event of liquidation of the corporation, and may be "participating," which
means that it may be entitled to a dividend exceeding the stated dividend in
certain cases. The rights of preferred stocks are generally subordinate to
rights associated with a corporation's debt securities.
WARRANTS AND RIGHTS. Warrants are options to purchase equity securities at
specific prices valid for a specific period of time. Their prices do not
necessarily move parallel to the prices of the underlying securities. Rights are
similar to warrants but normally have a short duration and are distributed by
the issuer to its shareholders. Warrants and rights have no voting rights,
receive no dividends and have no rights with respect to the assets of the
issuer.
CONVERTIBLE SECURITIES. (These are also included in the category of
"Fixed-Income Security" in the Prospectus.) A convertible security is a bond,
debenture, note, or other security that entitles the holder to acquire common
stock or other equity securities of the same or a different issuer. A
convertible security generally entitles the holder to receive interest paid or
accrued until the convertible security matures or is redeemed, converted or
exchanged. Before conversion, convertible securities have characteristics
similar to nonconvertible debt securities. Convertible securities rank senior to
common stock in a corporation's capital structure and, therefore, generally
entail less risk that the corporation's common stock, although the extent to
which such risk is reduced depends in large measure upon the degree to which the
convertible security sells above its value as a fixed-income security.
A convertible security may be subject to redemption at the option of the
issuer at a predetermined price. If a convertible security held by a Fund is
called for redemption, the Fund would be required to permit the issuer to redeem
the security and convert it to underlying common stock, or would sell the
convertible security to a third party.
As disclosed in the Prospectus, up to 5% of the Balanced Fund's assets may
be invested in non-investment grade debt securities. The market values of these
securities tend to be less sensitive to changes in prevailing interest rates
than high-quality securities, but more sensitive to individual corporate
developments than higher-quality securities. Such securities also tend to be
more sensitive to economic conditions than are higher-quality securities.
Accordingly, these securities are
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considered predominantly speculative with respect to the issuer's capacity
to pay interest and repay principal in accordance with the terms of the
obligation and will generally involve more credit risk than securities in the
higher-quality categories.
Even securities rated Baa or BBB by Moody's Investor Services Inc.
("Moody's") and Standard & Poor's ("S&P") respectively, which ratings are
considered investment grade, possess some speculative characteristics. There are
risks involved in applying credit ratings as a method for evaluating high yield
obligations in that credit ratings evaluate the safety of principal and interest
payments, not market value risk. In addition, credit rating agencies may not
change credit ratings on a timely basis to reflect changes in economic or
company conditions that affect a security's market value. Changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
to make principal and interest payments than is the case for higher grade bonds.
The Funds will rely on the judgment, analysis and experience of Luther King
Capital Management Corporation, the investment adviser to the Funds (the
"Adviser"), in evaluating the creditworthiness of an issuer. In this evaluation,
the Adviser will take into consideration, among other things, the issuer's
financial resources and ability to cover its interest and fixed charges, factors
relating to the issuer's industry and its sensitivity to economic conditions and
trends, its operating history, the quality of the issuer's management and
regulatory matters.
The risk of loss due to default by the issuer is significantly greater for
the holders of lower quality securities because such securities are generally
unsecured and are often subordinated to other obligations of the issuer. During
an economic downturn or a sustained period of rising interest rates, highly
leveraged issuers of lower quality securities may experience financial stress
and may not have sufficient revenues to meet their interest payment obligations.
An issuer's ability to service its debt obligations may also be adversely
affected by specific corporate developments, its inability to meet specific
projected business forecasts, or the unavailability of additional financing.
Factors adversely affecting the market value of securities will adversely
affect a Fund's net asset value. In addition, a Fund may incur additional
expenses to the extent it is required to seek recovery upon a default in the
payment of principal of or interest on its portfolio holdings.
The secondary trading market for lower-quality fixed-income securities is
generally not as liquid as the secondary market for higher-quality securities
and is very thin for some securities. The relative lack of an active secondary
market may have an adverse impact on market price and a Fund's ability to
dispose of particular issues when necessary to meet the Fund's liquidity needs
or in response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. The relative lack of an active secondary market
for certain securities may also make it more difficult for the Fund to obtain
accurate market quotations for purposes of valuing the Fund's portfolio. Market
quotations are generally available on many high yield issues only from a limited
number of dealers and may not necessarily represent firm bids of such dealers or
prices for actual sales. During such times, the responsibility of the Trust's
Board of Trustees or its Adviser to value the securities becomes more difficult
and judgment plays a greater role in valuation because there is less reliable,
objective data available.
SECURITIES SUBJECT TO REORGANIZATION. The Funds may invest in equity
securities for which a tender or exchange offer has been made or announced and
in securities of companies for which a merger, consolidation, liquidation or
reorganization proposal has been announced if, in the judgment of the Adviser,
there is a reasonable prospect of capital appreciation significantly greater
than the brokerage and other transaction expenses involved. Generally,
securities which are the subject of such an offer or proposal sell at a premium
to their historic market price immediately prior to the announcement of the
offer or may also discount what the stated or appraised value of the security
would be if the contemplated transaction were approved or consummated. Such
investments may be advantageous when the discount significantly overstates the
risk of the contingencies involved, significantly undervalues the securities,
assets or cash to be received by shareholders of the target company as a result
of the contemplated transaction, or fails adequately to recognize the
possibility that the offer or proposal may be replaced or superseded by an offer
or proposal of greater value. The evaluation of such contingencies requires
broad knowledge and experience on the part of the Adviser which must appraise
not only the value of the issuer and its component businesses as well as the
assets or securities to be received as a result of the contemplated transaction
but also the financial resources and business motivation of the offeror and the
dynamics and business climate when the offer or proposal is in process. Since
such investments are ordinarily short-term in nature, they will tend to increase
the turnover ratio of a Fund thereby increasing its brokerage and other
transaction expenses. The
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Adviser intends to select investments of the type described which, in its view,
have a reasonable prospect of capital appreciation which is significant in
relation to both risk involved and the potential of available alternate
investments.
FIXED-INCOME SECURITIES
The fixed-income securities in which the Funds may invest include U.S.
Government securities, corporate debt, mortgage-backed securities and
asset-backed securities.
US. GOVERNMENT SECURITIES. U.S. Government agencies or instrumentalities
that issue or guarantee securities include, but are not limited to, the Federal
National Mortgage Association ("FNMA"), Government National Mortgage Association
("GNMA"), Federal Home Loan Banks, Federal Home Loan Mortgage Corporation
("FHLMC"), Federal Intermediate Credit Banks, Federal Land Banks, Tennessee
Valley Authority, Inter-American Development Bank, Asian Development Bank,
Student Loan Marketing Association ("SLMA") and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. Government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
Government to purchase the agencies' obligations; while still others, such as
the SLMA, are supported only by the credit of the instrumentality. In the case
of securities not backed by the full faith and credit of the United States, the
investor must look principally to the agency or instrumentality issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the United States itself in the event the agency or
instrumentality does not meet its commitment. Each Fund will invest in
securities of such agencies or instrumentalities only when the Adviser is
satisfied that the credit risk is acceptable.
The Funds may invest in component parts of U.S. Treasury notes or bonds,
namely either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of: (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations ( corpus or
coupons) purchased by a third party (typically an investment banking firm) and
held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATs"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
CORPORATE DEBT SECURITIES. A Fund's investments in U.S. dollar or foreign
currency-denominated corporate debt securities of domestic or foreign issuers
are limited to investment grade corporate debt securities (corporate bonds,
debentures, notes and other similar corporate debt instruments); provided,
however, that the Balanced Fund may invest up to 5% of its total assets in
non-investment grade securities. The rate of return or return of principal on
some debt obligations may be linked or indexed to the level of exchange rates
between the U.S. dollar and a foreign currency or currencies.
MORTGAGE-RELATED SECURITIES. The Funds may invest in residential or
commercial mortgage-related securities, including mortgage pass-through
securities, collateralized mortgage obligations ("CMO"), adjustable rate
mortgage securities, CMO residuals, stripped mortgage-related securities,
floating and inverse floating rate securities and tiered index bonds.
Mortgage Pass-Through Securities. Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers in the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through securities differ form
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at
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maturity or specified call dates. Early repayment of principal on mortgage
pass-through securities (arising form prepayments of principal due to the sale
of underlying property, refinancing, or foreclosure, net of fees and costs which
may be incurred) may expose a Fund to a lower rate of return upon reinvestment
of principal. Also, if a security subject to repayment has been purchased at a
premium, in the event of prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities: (1)
those issued by the U.S. Government or one of its agencies or instrumentalities,
such as the GNMA, the FNMA, and the FHLMC; (2) those issued by private issuers
that represent an interest in or are collateralized by pass-through securities
issued or guaranteed by the U.S. Government or one of its agencies or
instrumentalities; and (3) those issued by private issuers that represent an
interest in or are collateralized by whole mortgage loans or pass-through
securities without a government guarantee but usually having some form of
private credit enhancement.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued
the institutions approved by GNMA (such as savings and loan institutions,
commercial banks and mortgage banks), and backed by pools of FHA-insured or
VA-guaranteed mortgages.
Obligations of FNMA and FHLMC are not backed by the full faith and credit
of the U.S. Government. In the case of obligations not backed by the full faith
and credit of the U.S. Government , the Fund must look principally to the agency
issuing or guaranteeing the obligation for ultimate repayment. FNMA and FHLMC
may borrow form the U.S. Treasury to meet its obligations, but the U.S. Treasury
is under no obligation to lend to FNMA or FHLMC.
Private mortgage pass-through securities are structured similarly to GNMA,
FNMA, and FHLMC mortgage pass-through securities and are issued by originators
of and investors in mortgage loans, including depository institutions, mortgage
banks, investment banks and special purpose subsidiaries of the foregoing.
Pools created by private mortgage pass-through issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments in
the private pools. However, timely payment of interest and principal of these
pools may be supported by various forms of insurance or insured by governmental
entities, private insurers and the mortgage poolers.
Collateralized Mortgage Obligations. CMOs are debt obligations
collateralized by residential or commercial mortgage loans or residential or
commercial mortgage pass-through securities. Interest and prepaid principal are
generally paid monthly. CMOs may be collateralized by portfolios of mortgage
pass-through securities guaranteed by GNMA, FHLMC, or FNMA. The issuer of a
series of CMOs may elect to be treated as a Real Estate Mortgage Investment
Conduit ("REMIC"). All future references to CMOs also include REMICs.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral which is ordinarily unrelated to the stated
maturity date. CMOs often provide for a modified form of call protection through
a de facto breakdown of the underlying pool of mortgages according to how
quickly the loans are repaid. Monthly payment of principal received form the
pool of underlying mortgages, including prepayments, is first returned to
investors holding the shortest maturity class. Investors holding the longer
maturity classes usually receive principal only after the first class has been
retired. An investor may be partially protected against a sooner than desired
return of principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies pursuant to
a rule adopted by the Securities and Exchange Commission ("SEC"), and the Funds
may invest in the securities of such issuers without the limitations imposed by
the Investment Company Act of 1940 ("1940 Act), as investments by the Funds in
other investment companies. In addition, in reliance on earlier SEC
interpretations, the Funds' investments in certain other qualifying CMOs, which
cannot or do not rely on the rule, are also not subject to the limitation of the
1940 Act on acquiring interests in other investment companies. In order to be
able to rely on the SEC's interpretation, these CMOs must be unmanaged, fixed
assets issuers, that: (1) invest primarily in mortgage-backed securities; (2) do
not issue redeemable securities; (3) operate under general exemptive orders
exempting them form all provisions of the 1940 Act; and (4) are not registered
or regulated under the 1940 Act as investment companies. To the extent that the
Funds select CMOs that cannot rely on the rule or do not meet the above
requirements, the Funds may not invest more than 10% of their total assets in
all such
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entities. In addition, not more than 5% of each Fund's total assets may be
invested in the securities of any one investment company nor may either Fund
acquire more than 3% of the voting securities of any single such entity.
The Funds may also invest in, among other things, parallel pay CMOs,
Planned Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, floating
rate CMOs. Parallel pay CMOs are structured to provide payments of principal on
each payment date to more than one class. PAC bonds generally require payments
of a specified amount of principal on each payment date. Sequential pay CMOs
generally pay principal to only one class while paying interest to several
classes. Floating rate CMOs are securities whose coupon rate fluctuates
according to some formula related to an existing marketing index or rate.
Typical indices would include the eleventh district cost-of-funds index
("COFI"), the London Interbank Offered Rate ("LIBOR"), one-year U.S. Treasury
yields, and ten-year U.S. Treasury yields.
Adjustable Rate Mortgage Securities. Adjustable rate mortgage securities
("ARMs") are pass-through securities collateralized by mortgages with adjustable
rather than fixed rates. ARMs eligible for inclusion in a mortgage pool
generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six, or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest rate may adjust for any single adjustment period. In the
event that market rates of interest rise to levels above that of the ARMs
maximum rate, the ARM's coupon may represent a below market rate of interest. In
these circumstances, the market value of the ARM security will likely fall.
Certain ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
If the monthly payment for such an instrument exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment
required at such point to amortize the outstanding principal balance over the
remaining term of the loan, the excess is then utilized to reduce the
outstanding principal balance of the ARM.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayments experience on the mortgage assets.
In part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage-Related Securities" below. In addition, if a series of a CMO
included a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances a Fund may fail to recoup fully its initial investment in a CMO
residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has recently developed and CMO residuals currently may not have
the liquidity of other more established securities trading in other markets.
Transactions in CMO residuals are generally completed only after careful review
of the characteristics of the securities in question. In addition, CMO residuals
may or, pursuant to an exemption therefrom, may not have been registered under
the Securities Act of 1933, as amended (the "Securities Act"). CMO residuals,
whether or not registered under the Securities Act, may be subject to certain
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restrictions on transferability, and may therefore be deemed "illiquid" and
subject to Funds' limitations on investment in illiquid securities as discussed
herein.
Stripped Mortgage-Related Securities. Stripped mortgage-related securities
("SMRS") are derivative multi-class mortgage securities. SMRS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks, and special purpose entities
of the foregoing.
SMRS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMRS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all or the principal (the PO class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on a Fund's yield
to maturity form these securities. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, a Fund may fail to fully
recoup its initial investment in these securities even if the security is in one
of the highest rated categories of investment-grade securities.
Although SMRS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently introduced. As a result, established trading markets have not
yet been fully developed and accordingly, these securities may be deemed
"illiquid" and subject to the Funds' limitations on investment in illiquid
securities as discussed herein.
Inverse Floaters. An inverse floater is a debt instrument with a floating
or variable interest rate that moves in the opposite direction to the interest
rate on another security or index level. Changes in the interest rate on the
other security or index inversely affect the residual interest rate paid on the
inverse floater, with result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
Tiered Index Bonds. Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed-rate bond.
ASSET-BACKED SECURITIES. The Funds may invest in various types of
asset-backed securities. Through the use of trusts and special purpose
corporations, various types of assets, primarily automobile and credit card
receivables and home equity loans, are being securitized in pass-through
structures similar to the mortgage pass-through structure similar to the CMO
structure. Investments in these and other types of asset-backed securities must
be consistent with the investment objectives and policies of the Funds.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES. The yield characteristics of mortgage-related and asset-backed
securities differ from traditional debt securities. Among the major differences
are that interest and principal payments are made more frequently, usually
monthly, and that principal may be prepaid at any time because the underlying
mortgage loans or other assets generally may be prepaid at any time. As a
result, if a Fund purchases such a security at a premium, a prepayment rate that
is faster than expected will reduce yield to maturity, while a prepayment rate
that is slower than expected will have opposite effect of increasing yield to
maturity. Alternatively, if the Fund purchases these securities at a discount,
faster than expected prepayments will increase, while slower than expected
prepayments will reduce, yield to maturity. The Adviser will seek to manage
these risks (and potential benefits) by diversifying its investments in such
securities and through hedging techniques.
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During periods of declining interest rates, prepayment of mortgage-related
securities can be expected to accelerate. Accordingly, a Fund's ability to
maintain positions in higher-yielding mortgage-related securities will be
affected by reductions in the principal amount of such securities resulting form
such prepayments, and its ability to reinvest the returns of principal at
comparable yields is subject to generally prevailing interest rates at that
time. Conversely, slower than expected prepayments may effectively change a
security that was considered short or intermediate-term at the time of purchase
into a long-term security. Long-term securities tend to fluctuate more in
response to interest rate changes, leading to increased net asset value
volatility. Prepayments may also result in the realization of capital losses
with respect to higher yielding securities that had been bought at a premium or
the loss of opportunity to realize capital gains in the future from possible
future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the benefit of a security interest in the
related collateral. For example, credit card receivables generally are unsecured
and the debtors are entitled to the protection of a number of state and federal
consumer credit laws, some of which may reduce the ability to obtain full
payment. In the case of automobile receivables, due to various legal and
economic factors, proceeds form repossessed collateral may not always be
sufficient to support payment on these securities.
TEMPORARY INVESTMENTS
The temporary investments that the Funds may make include:
(1) Time deposits, certificates of deposit (including marketable
variable rate certificates of deposit) and bankers' acceptances issued by a
commercial bank or savings and loan association. Time deposits are
non-negotiable deposits maintained in a banking institution for a specified
period of time at a stated interest rate. Time deposits maturing in more
than seven days will not be purchased by the Funds. Certificates of deposit
are negotiable short-term obligations issued by commercial banks or savings
and loan associations against funds deposited in the issuing institution.
Variable rate certificates of deposit are certificates of deposit on which
the interest rate is periodically adjusted prior to their stated maturity
based upon a specified market rate. A bankers' acceptance is a time draft
drawn on a commercial bank by a borrower usually in connection with an
international commercial transaction (to finance the import, export,
transfer or storage of goods).
The Funds will not invest in any security issued by a commercial bank
unless (i) the bank has total assets of at least $1 billion, or the
equivalent in other currencies, or, in the case of domestic banks which do
not have total assets of at least $1 billion, the aggregate investment made
in any one such bank is limited to $100,000 and the principal amount of
such investment is insured in full by the Federal Deposit Insurance
Corporation and (ii) in the case of U.S.
banks, it is a member of the Federal Deposit Insurance Corporation.
(2) Commercial paper which at the time of purchase is rated in the
highest rating category by a Nationally Recognized Statistical Rating
Organization ("NRSRO") or, if not rated, issued by a corporation having an
outstanding unsecured debt issue that meets such rating requirement at time
of purchase;
(3) Short-term corporate obligations rated in the highest rating
category by a NRSRO, at time of purchase;
(4) U.S. Government obligations including bills, notes, bonds and
other debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in interest rates,
maturities and dates of issue;
(5) U.S. Government agency securities issued or guaranteed by U.S.
Government sponsored instrumentalities and Federal agencies. These include
securities issued by the Federal Home Loan Banks, Federal Land Bank,
Farmers Home Administration, Farm Credit Banks, Federal Intermediate
Credit Bank, FNMA, Federal Financing Bank, the Tennessee Valley Authority,
and others; and
(6) Repurchase agreements collateralized by those securities listed
above.
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DERIVATIVE INSTRUMENTS
In pursuing their respective investment objectives, the Funds may, to a
limited extent, purchase and sell (write) options on securities, securities
indices, and foreign currencies and enter into interest rate, foreign currency
and index futures contracts and purchase and sell options on such futures
contracts and enter into forward foreign currency exchange contracts for hedging
purposes.
OPTIONS. An option is a legal contract that gives the holder the right to
buy or sell a specified amount of the underlying instrument at a fixed or
determinable price upon the exercise of the option. A call option conveys the
right to buy, in return for a premium paid, and a put option conveys the right,
in return for a premium, to sell a specified quantity of the underlying
instrument. Options on indices are settled in cash and gain or loss depends on
changes in the index in question rather than on price movement in individual
securities.
There are certain risks associated with transactions in options on
securities and on indices. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when, and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when a Fund seeks
to close out an option position. If the Fund were unable to close out an option
that it had purchased on a security, it would have to exercise the option in
order to realize any profit or the option may expire worthless. If the Fund were
unable to close out a covered call option that it had written on a security, it
would not be able to sell the underlying security unless the option expired
without exercise. As the writer of a covered call option, the Fund forgoes,
during the life of the option, the opportunity to profit from increases in the
market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by a Fund, the Fund would
not be able to close out the option. If restrictions on exercise were imposed,
the Fund might be unable to exercise an option it has purchased. Except to the
extent that a call option on an index written by the Fund is covered by an
option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
The Fund is authorized to purchase and sell over-the-counter options ("OTC
Options") in addition to exchange listed options. OTC Options are purchased from
or sold to securities dealers, financial institutions or other parties
("Counterparties") through direct bilateral agreement with the Counterparty. In
contrast to exchange listed options, which generally have standardized terms and
performance mechanics, all the terms of an OTC Option, including such terms as
method of settlement, term, exercise price, premium, guarantees and security,
are set by negotiation between the parties. A Fund will only sell OTC Options
that are subject to a buy-back provision permitting the Fund to require the
Counterparty to sell the option back to the Fund at a formula price within seven
days. The Funds expect generally to enter into OTC Options that have cash
settlement provisions, although they are not required to do so.
There is no central clearing or guaranty function in an OTC Option. As a
result, if the Counterparty fails to make or take delivery of the security,
currency or other instrument underlying an OTC Option it has entered into with a
Fund or fails to make a cash settlement payment due in accordance with the terms
of the option, the Fund will lose any premium it paid for the option as well as
any anticipated benefit of the transaction. Accordingly, the Adviser must assess
the creditworthiness of each such Counterparty or any guarantor of credit
enhancement of the Counterparty's credit to determine the likelihood that the
terms of the OTC Option will be satisfied. The Funds will engage in OTC Option
transactions only with U.S. government securities dealers recognized by the
Federal Reserve Bank of New York as "primary dealers", or broker dealers,
domestic or foreign banks or other financial institutions which have received
(or the guarantors of the obligation of which have received) a short-term credit
rating of "A-1" from S&P's or "P-1" from Moody's or an equivalent rating from
any other NRSRO.
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OPTIONS ON FOREIGN CURRENCIES. The Funds may purchase and write options on
foreign currencies for hedging purposes. For example, a decline in the dollar
value of a foreign currency in which portfolio securities are denominated will
reduce the dollar value of such securities, even if their value in the foreign
currency remains constant. In order to protect against such diminutions in the
value of portfolio securities, a Fund may purchase put options on the foreign
currency. If the value of the currency does decline, the Fund will have the
right to sell such currency for a fixed amount in dollars and will thereby
offset, in whole or in part, the adverse effect on its portfolio which otherwise
would have resulted.
Conversely, where a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, a Fund may purchase call options on the currency
involved. The purchase of such options could offset, at least partially, the
effects of the adverse movements in exchange rates. As in the case of other
types of options, however, the benefit to the Fund deriving from purchases of
foreign currency options will be reduced by the amount of the premium and
related transaction costs. In addition, where currency exchange rates do not
move in the direction or to the extent anticipated, the Fund could sustain
losses on transaction in foreign currency options which would require it to
forego a portion or all of the benefits of advantageous changes in such rates.
The Funds may write options on foreign currencies for the same types of
hedging purposes. For example, where a Fund anticipates a decline in the dollar
value of foreign currency denominated securities due to adverse fluctuations in
exchange rates it could, instead of purchasing a put option, write a call option
on the relevant currency. If the anticipated decline occurs, the option will
most likely not be exercised, and the diminution in value of portfolio
securities will be offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a Fund
could write a put option on the relevant currency which, if rates move in the
manner projected, will expire unexercised and allow the Fund to hedge such
increased cost up to the amount of the premium. As in the case of other types of
options, however, the writing of a foreign currency option will constitute only
a partial hedge up to the amount of the premium, and only if exchange rates move
in the expected direction. If this does not occur, the option may be exercised
and the Fund would be required to purchase or sell the underlying currency at a
loss which may not be offset by the amount of the premium. Through the writing
of options on foreign currencies, a Fund also may be required to forego all or a
portion of the benefits which might otherwise have been obtained from favorable
movements in exchange rates.
The Funds may write covered call options on foreign currencies. A call
option written on a foreign currency by a Fund is "covered" if the Fund owns the
underlying foreign currency covered by the call or has an absolute and immediate
right to acquire that foreign currency without additional cash consideration (or
for additional cash consideration held in a segregated account by the Funds'
custodian) upon conversion or exchange of other foreign currency held in its
portfolio. A call option is also covered if the Fund has a call on the same
foreign currency and in the same principal amount as the call written where the
exercise price of the call held (a) is equal to or less than the exercise price
of the call written or (b) is greater than the exercise price of the call
written if the difference is maintained by the Fund in cash, or liquid assets in
a segregated account with the custodian.
The Funds also may write call options on foreign currencies for
cross-hedging purposes. A call option on a foreign currency is for cross-hedging
purposes if it is designed to provide a hedge against a decline in the U.S.
dollar value of a security which the Fund owns or has the right to acquire and
which is denominated in the currency underlying the option due to an adverse
change in the exchange rate. In such circumstances, the Fund will collateralize
the option by maintaining in a segregated account with the custodian, cash or
liquid assets in an amount not less than the value of the underlying foreign
currency in U.S. dollars marked-to-market daily.
FUTURES CONTRACTS. Futures contracts provide for the future sale by one
party and purchase by another party of a specified amount of a specific security
currency on index at a specified future time and at a specified price. Futures
contracts which are standardized as to maturity date and underlying financial
instrument are traded on national futures exchanges. Futures exchanges and
trading are regulated under the Commodity Exchange Act by the Commodity Futures
Trading Commission ("CFTC").
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<PAGE>
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities or currency, in most cases the contracts
are closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold" or "selling" a
contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is bought
or sold. Futures contracts on indices are settled in cash.
Futures traders are required to make a good faith margin deposit in cash or
acceptable securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying securities)
if it is not terminated prior to the specified delivery date. Initial margin
requirements are established by the futures exchange and may be changed. Brokers
may establish deposit requirements which are higher than the exchange minimums.
After a futures contract position is opened, the value of the contract is
marked-to-market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, a change in the
contract value may reduce the required variation margin, resulting in a
repayment of excess variation margin to the contract holder. Variation margin
payments are made to and from the futures broker for as long as the contract
remains open.
Regulations of the CFTC applicable to the Funds require that they use
futures contracts and options on futures contracts only for bona fide hedging
purposes, or to the extent that a Fund's futures and options on futures
positions are for other than bona fide hedging purposes, as described by the
CFTC, the aggregate initial margins and premiums required to establish such
non-bona fide hedging positions other than the "in-the-money" amount in the case
of options that are "in-the-money" at the time of purchase, may not exceed 5% of
the Fund's net assets. Adherence to these guidelines does not limit a Fund's
risk to 5% of the Fund's assets. A Fund will only sell futures contracts to
protect securities owned by it against price declines or purchase contracts to
protect against an increase in the price of securities it intends to purchase.
As evidence of this hedging intent, the Funds expect that approximately 75% of
the futures contracts purchased will be "completed;" that is, equivalent amounts
of related securities will have been purchased or in the process of being
purchased by a Fund upon sale of open futures contracts. Although techniques
other than the sale and purchase of futures contracts could be used to control a
Fund's exposure to market fluctuations, the use of futures contracts may be a
more effective means of hedging this exposure. While the Funds will incur
commission expenses in both opening and closing out futures positions, these
costs may be lower than transaction costs incurred in the purchase and sale of
the underlying securities.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. A forward foreign currency
exchange contract ("Forward Contract") is an obligation to purchase or sell a
specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are traded in the interbank market conducted
directly between currency traders, usually large commercial banks, and their
customers. The Funds may use Forward Contracts to manage currency risks and to
facilitate transactions in foreign securities. The following discussion
summarizes the principal currency management strategies involving Forward
Contracts that the Funds may use.
In connection with purchases and sales of securities denominated in foreign
currencies, the Funds may enter into Forward Contracts to fix a definite price
for the purchase or sale in advance of the trade's settlement date ("transaction
hedge" or "settlement hedge").
The Funds may also use Forward Contracts to hedge against a decline in the
value of existing investments denominated in foreign currency. For example, if a
Fund owned securities denominated in pounds sterling, it could enter into a
forward contract to sell pounds sterling in return for U.S. dollars to hedge
against possible declines in the pound's value ("position hedge"). A position
hedge would tend to offset both positive and negative currency fluctuations, but
would not offset changes in security values caused by other factors. The Fund
could also hedge the position by selling another currency expected to perform
similarly to the pound sterling ("proxy hedge"). A proxy hedge could offer
advantages in terms of cost, yield, or efficiency, but generally would not hedge
currency exposure as effectively as a simple hedge into U. S. dollars. Proxy
hedges may result in losses if the currency used to hedge does not perform
similarly to the currency in which the hedged securities are denominated.
B-13
<PAGE>
The Funds' custodian will place cash or other liquid assets in a separate
account having a value equal to the aggregate amount of the Funds' commitments
under Forward Contracts entered into with respect to position hedges and proxy-
hedges. If the value of the assets placed in a segregated account declines,
additional cash or liquid assets will be placed in the account on a daily basis
so that the value of the account will equal the amount of the Funds' commitments
with respect to such contracts. Alternatively, a Fund may purchase a call option
permitting the Fund to purchase the amount of foreign currency being hedged by a
forward sale contract at a price no higher than the Forward Contract price or a
Fund may purchase a put option permitting the Fund to sell the amount of foreign
currency subject to a forward purchase contract at a price as high or higher
than the Forward Contract price. Unanticipated changes in currency prices may
result in poorer overall performance for the Funds than if they had not entered
into such contracts.
RISK FACTORS IN FUTURES TRANSACTIONS. Positions in futures contracts may be
closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, a Fund would continue to be required to make daily cash payments to
maintain its required margin. In such situations, if the Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, a Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on a Fund's ability to effectively hedge. The Funds will minimize
the risk that they will be unable to close out a futures contract by only
entering into futures which are traded on national futures exchanges and for
which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures trading. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to a Fund. For example, if at the time of
purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract.
Utilization of futures transactions by the Funds involves the risk of
imperfect or no correlation where the securities underlying futures contracts
are different than the portfolio securities being hedged. It is also possible
that a Fund could both lose money on futures contracts and also experience a
decline in value of its portfolio securities. There is also the risk of loss by
a Fund of margin deposits in the event of bankruptcy of a broker with whom the
Fund has an open position in a futures contract or option on a futures contract.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract and options prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract or option on
a future contract may vary either up or down from the previous day's settlement
price at the end of a trading session. Once the daily limit has been reached in
a particular type of contract, no trades may be made on that day at a price
beyond that limit. The daily limit governs only price movement during a
particular trading day and therefore does not limit potential losses, because
the limit may prevent the liquidation of unfavorable positions. Futures contract
and options prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of futures positions and subjecting some futures traders to
substantial losses.
RISKS OF OPTIONS ON FUTURES, FORWARD CONTRACTS, AND OPTIONS ON FOREIGN
CURRENCIES. Options on currencies may be traded over-the-counter and forward
currency contracts are always traded in the over-the-counter market. In an
over-the-counter trading environment, many of the protections afforded to
exchange participants will not be available. For example, there are no daily
price fluctuation limits, and adverse market movements could therefore continue
to an unlimited extent over a period of time. Although the purchase of an option
cannot lose more than the amount of the premium plus related transaction costs,
this entire amount could be lost. When a Fund enters into a forward currency
contract or purchases an over-the-counter option, it relies on its counterparty
to perform. Failure by the counterparty to do so would result in the loss of any
expected benefit of the transaction.
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<PAGE>
Options on foreign currencies traded on national securities exchanges are
within the jurisdiction of the SEC, as are other securities traded on such
exchanges. As a result, many of the protections provided to traders on organized
exchanges will be available with respect to such transactions. In particular,
all foreign currency option positions entered into on a national securities
exchange are cleared and guaranteed by the Options Clearing Corporation ("OCC"),
thereby reducing the risk of counterparty default. The purchase and sale of
exchange-traded foreign currency options, however, is subject to the risks of
the availability of a liquid secondary market described above, as well as the
risks regarding adverse market movements, margining of options written, the
nature of the foreign currency market, possible intervention by governmental
authorities and the effect of other political and economic events. In addition,
exchange-traded options of foreign currencies involve certain risks not
presented by the over-the-counter market. For example, exercise and settlement
of such options must be made exclusively through the OCC, which has established
banking relationships in applicable foreign countries for this purpose. As a
result, the OCC may, if it determines that foreign governmental restrictions or
taxes would prevent the orderly settlement of foreign currency option exercises,
or would result in undue burdens on the OCC or its clearing member, impose
special procedures on exercise and settlement, such as technical changes in the
mechanics of delivery of currency, the fixing of dollar settlement prices or
prohibitions on exercise.
In addition, futures contracts, options on futures contracts, forward
contracts, and options on foreign currencies may be traded on foreign exchanges.
Such transactions are subject to the risk of governmental actions affecting
trading in or the prices of foreign currencies or securities. The value of such
positions also could be adversely affected by (i) other complex foreign
political and economic factors, (ii) lesser availability than in the United
States of data on which to make trading decisions, (iii) delays in a Fund's
ability to act upon economic events occurring in foreign markets during
non-business hours in the United States, (iv) the imposition of different
exercise and settlement terms and procedures and margin requirements than in the
United States, and (v) lesser trading volume.
COMBINED TRANSACTIONS. The Funds may enter into multiple transactions,
including multiple options transactions, multiple futures transactions, multiple
foreign currency transactions (including Forward Contracts) and any combination
of futures, options, and foreign currency transactions, instead of a single
transaction, as part of a single hedging strategy when, in the opinion of the
Adviser, it is in the best interest of the Funds to do so. A combined
transaction, while part of a single hedging strategy, may contain elements of
risk that are present in each of its component transactions.
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS. The Fund will comply with
guidelines established by the SEC with respect to coverage of options, futures
and forward contracts strategies by mutual funds, and if the guidelines so
require will set aside appropriate liquid assets in a segregated custodial
account in the amount prescribed. Securities held in a segregated account cannot
be sold while the futures, option or forward contract strategy is outstanding,
unless they are replaced with other suitable assets. Consequently, there is a
possibility that segregation of a large percentage of a Fund's assets could
impede portfolio management or the Fund's ability to meet redemption requests or
other current obligations.
ILLIQUID INVESTMENTS, RESTRICTED SECURITIES AND PRIVATE PLACEMENT OFFERINGS.
ILLIQUID INVESTMENTS. The Funds may invest up to 15% of their securities
respective net assets in illiquid investments. Illiquid investments are
investments that cannot be sold or disposed of within seven days in the ordinary
course of business at approximately the prices at which they are valued. Under
the supervision of the Board of Trustees, the Adviser determines the liquidity
of a Fund's investments and, through reports from the Adviser and the Funds'
administrator, the Board monitors investments in illiquid securities. In
determining the liquidity of the Funds' investments, the Adviser may consider
various factors, including the frequency of trades and quotations, the number of
dealers and prospective purchasers in the marketplace, dealer undertakings to
make a market, the nature of the security, and the nature of the marketplace for
trades. Investments currently considered by the Funds to be illiquid include
repurchase agreements not entitling the holder to payment of principal and
interest within seven days, certain over-the-counter options, and restricted
securities (other than restricted securities pursuant to Rule 144A under the
Securities Act and commercial paper sold in reliance on Section 4(2) of the
Securities Act). With respect to over-the-counter ("OTC") options that a Fund
writes, all or a portion of the value of the underlying instrument may be
illiquid depending on the assets held to cover the option and the nature and
terms of any agreement the Fund may have to close out the option before
expiration. The Funds will treat as illiquid an amount of assets used to cover
written OTC options, equal to the formula price at which the Funds would have
the absolute right to purchase the option less the amount by which the option is
"in-the-money." The absence
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<PAGE>
of a trading market can make it difficult to ascertain a market value for
illiquid investments. When no market quotations are available, illiquid
investments are priced at fair value as determined in good faith by the Adviser
under the supervision of the Board of Trustees. Disposing of these investments
may involve time-consuming negotiation and legal expenses, and it may be
difficult or impossible for the Funds to sell them promptly at an acceptable
price. If through a change in values, net assets, or other circumstances, either
Fund was in a position where more than 15% of its net assets were invested in
illiquid securities, it would take appropriate steps to protect liquidity.
RESTRICTED SECURITIES. Restricted securities can generally be sold in
privately negotiated transactions, pursuant to an exemption from registration
under the Securities Act or in a registered public offering. Where registration
is required, the Fund(s) may be obligated to pay all or part of the registration
expense and a considerable period may elapse between the time it or they decide
to seek registration and the time the Fund(s) may be permitted to sell a
security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, a Fund might obtain a less favorable
price than prevailed at the time it decided to seek registration of the
security.
PRIVATE PLACEMENT OFFERINGS. Investments in private placement offerings are
made in reliance on the "private placement" exemption from registration afforded
by Section 4(2) of the Securities Act of 1933 (the "1933 Act"), and resold to
qualified institutional buyers under Rule 144A under the 1933 Act ("Section 4(2)
securities"). Section 4 (2) securities are restricted as to disposition under
the federal securities law and generally are sold to institutional investors
such as the Funds that agree they are purchasing the securities for investment
and not with an intention to distribute to the public.
SECURITIES LENDING
Each Fund may lend securities to qualified brokers, dealers, banks and
other financial institutions. Securities lending allows the Fund to retain
ownership of the securities loaned and, at the same time, to earn additional
income. Since there may be delays in the recovery of loaned securities, or even
a loss of rights in collateral supplied should the borrower fail financially,
loans will be made only to parties deemed by the Adviser to be of good standing.
In addition, they will only be made if, in the Adviser's judgment, the
consideration to be earned from such loans would justify the risk. Such loans
will not be made if, as a result, the aggregate of all outstanding loans of a
Fund exceed one-third of the value of its total assets.
It is the Adviser's understanding that the current view of the staff of the
SEC is that a Fund may engage in loan transactions only under the following
conditions: (1) the Funds must receive 100% collateral in the form of cash or
cash equivalents (i.e., U.S. Treasury bills or notes) from the borrower; (2) the
borrower must increase the collateral whenever the market value of the
securities loaned (determined on a daily basis) rises above the value of the
collateral; (3) after giving notice, the Fund must be able to terminate the loan
at any time; (4) the Fund must receive reasonable interest on the loan (which
may include the Fund investing any cash collateral in interest bearing
short-term investments) or a flat fee from the borrower, as well as amounts
equivalent to any dividends, interest, or other distributions on the securities
loaned and to any increase in market value; (5) the Fund may pay only reasonable
custodian fees in connection with the loan; and (6) the Board of Trustees must
be able to vote proxies on the securities loaned, either by terminating the loan
or by entering into an alternative arrangement with the borrower.
INVESTMENT LIMITATIONS
The Funds are subject to the following restrictions which are fundamental
policies and may not be changed without the approval of the lesser of: (1) at
least 67% of the voting securities of a Fund present at a meeting if the holders
of more than 50% of the outstanding voting securities of the Fund are present or
represented by proxy, or (2) more than 50% of the outstanding voting securities
of a Fund.
As a matter of fundamental policy, each Fund will not:
(1) invest in physical commodities or contracts on physical
commodities;
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<PAGE>
(2) purchase or sell real estate, although it may purchase and sell
securities of companies which deal in real estate, other than real estate
limited partnerships, and may purchase and sell marketable securities which
are secured by interests in real estate;
(3) make loans except: (i) by purchasing debt securities in accordance
with its investment objective and policies or entering into repurchase
agreements; or (ii) by lending its portfolio securities to banks, brokers,
dealers and other financial institutions, so long as such loans are not
inconsistent with the 1940 Act or the rules and regulations or
interpretations of the SEC thereunder;
(4) with respect to 75% of its assets, purchase more than 10% of any
class of the outstanding voting securities of any issuer;
(5) with respect to 75% of its assets, invest more than 5% of its
total assets in the securities of any single issuer (other than obligations
issued or guaranteed by the U.S. Government or any of its agencies or
instrumentalities);
(6) borrow money, except (i) from banks and as a temporary measure for
extraordinary or emergency purposes (not for leveraging or investment) or
(ii) in connection with reverse repurchase agreements provided that (i) and
(ii) in combination do not exceed 331/3% of the Fund's total assets
(including the amount borrowed) less liabilities (exclusive of borrowings);
(7) underwrite the securities of other issuers (except to the extent
that the Fund may be deemed to be an underwriter within the meaning of the
Securities Act in the disposition of restricted securities);
(8) acquire any securities of companies within one industry if, as a
result of such acquisition, more than 25% of the Fund's total assets would
be invested in securities of companies within such industry; provided,
however, that there shall be no limitation on the purchase of obligations
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities; and
(9) issue senior securities, except that this limitation shall not
apply to: (i) evidence indebtedness which the Fund is permitted to incur;
(ii) shares of the separate classes or series of the Trust; or (iii)
collateral arrangements with respect to currency-related contracts, futures
contracts, options or other permitted investments, including deposits of
initial and variation margin.
The Funds are also subject to the following restrictions which are
non-fundamental policies and may be changed by the Board of Trustees without
shareholder approval. As a matter of non-fundamental policy, each Fund will not:
(a) purchase securities on margin, except for use of short-term credit
as may be necessary for the clearance of purchases and sales of securities,
but it may make margin deposits in connection with transactions in options,
futures, and options on futures; or sell securities short unless, by virtue
of its ownership of other securities, it has the right to obtain securities
equivalent in kind and amount to the securities sold and, if the right is
conditional, the sale is made upon the same conditions. Transactions in
futures contracts, options and options on futures are not deemed to
constitute selling securities short;
(b) pledge, mortgage, or hypothecate any of its assets to an extent
greater than 33 1/3% of its total assets at fair market value;
(c) invest more than an aggregate of 15% of its net assets in
securities deemed to be illiquid, including securities which are not
readily marketable, the disposition of which is restricted (excluding
securities that are not registered under the Securities Act but which can
be sold to qualified institutional investors in accordance with Rule 144A
under the Securities Act and commercial paper sold in reliance on Section
4(2) of the Securities Act), repurchase agreements having maturities of
more than seven days and certain OTC options;
<PAGE>
(d) invest its assets in securities of any investment company, except
by purchase in the open market involving only customary brokers'
commissions or in connection with mergers, acquisitions of assets or
consolidations and except as may otherwise be permitted by the 1940 Act;
and
(e) write or acquire options or interests in oil, gas or other mineral
exploration or development programs or leases.
With the exception of fundamental investment limitation (6), if a
percentage limitation on the investment or utilization of assets as set forth
above is adhered to at the time an investment is made, a later change in
percentage resulting from changes in the value or total cost of a Fund's assets
will not require the sale of securities.
MANAGEMENT
INVESTMENT ADVISER
The investment adviser to the Funds, Luther King Capital Management
Corporation, was founded in 1979 and is located at 301 Commerce Street, Fort
Worth, Texas 76102. The Adviser provides investment counseling services to
employee benefit plans, endowment funds, foundations and high net-worth
investors.
Under the Investment Advisory Agreement ("Agreement") with the Funds, dated
June 21, 1994, as supplemented on December 30, 1997, the Adviser, subject to the
control and supervision of the Board of Trustees and in conformance with the
stated investment objectives and policies of the Funds, manages the investment
and reinvestment of the assets of the Funds. In this regard, it is the
responsibility of the Adviser to make investment decisions for the Funds and to
place the Funds purchase and sales orders for investment securities. As
compensation for the services rendered by the Adviser under the Agreement and
the assumption by the Adviser of the expenses related thereto (other than the
cost of securities purchased for the Funds and the taxes and brokerage
commissions, if any, payable in connection with the purchase and/or sale of such
securities), the Balanced Fund pays the Adviser an advisory fee calculated by
applying a quarterly rate, equal on an annual basis to .65% of the Fund's
average daily net assets for the quarter and the Fixed Income Fund pays the
Adviser an advisory fee equal on an annual basis to .50% of the Fund's average
daily net assets for the quarter. For the fiscal year ended December 31, 1998,
the Adviser has voluntarily agreed to waive its advisory fees and/or reimburse
expenses to the extent necessary to keep total operating expenses from exceeding
.80% for the Balanced Fund, and .65% for the Fixed Income Fund. Thereafter, the
Adviser may from time to time waive advisory fees and/or reimburse expenses for
a Fund.
The Agreement as it relates to the Balanced and Fixed Income Funds was
approved initially by the Board of Trustees on November 13, 1997. By its terms,
the Agreement continues in effect for a period of two years from the date of the
Agreement, and thereafter for successive one year periods, only if each renewal
is specifically approved by a vote of the Board of Trustees, including the
affirmative votes of a majority of the Trustees who are not parties to the
agreement or "interested persons" (as defined in the 1940 Act) of any such party
in person at a meeting called for the purpose of considering such approval. In
addition, the question of continuance of the Agreement may be presented to the
shareholders of a Fund; in such event, continuance shall be effective only if
approved by the affirmative vote of a majority of the outstanding voting
securities of the Fund. The Agreement is terminated, without penalty, with
respect to a Fund on 60 days' written notice by the Board of Trustees or by vote
of a majority of the outstanding voting securities of such Fund. The Adviser may
terminate the Agreement with respect to a Fund, without penalty, on 90 days'
written notice. In addition, the Agreement will terminate automatically in the
event of its assignment.
The Adviser is a corporation of which J. Luther King, Jr. is a
"controlling person" (as that term is defined in the rules and regulations of
the SEC).
CUSTODIAN
As custodian of each Fund's assets, Firstar Trust Company, 615 East
Michigan Street, Milwaukee, Wisconsin 53202, has custody of all securities and
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<PAGE>
cash of the Funds, delivers and receives payment for securities sold, receives
and pays for securities purchased, collects income from investments, and
performs other duties, all as directed by the officers of the Trust.
DISTRIBUTOR
Shares of the Funds are distributed through First Data Distributor Inc.
(the "Distributor"), 4400 Computer Drive, Westboro, Massachusetts 01581, a
registered broker-dealer. Jacqui Brownfield, an employee of the Adviser and an
officer of the Trust, is a registered representative of the Distributor.
TRUSTEES AND OFFICERS
The Trustees and officers of the Trust, their ages, their business
addresses and principal occupations during the past five years are as follows:
J. LUTHER KING, JR.*; 57; 301 Commerce Street, Fort Worth, Texas 76102;
Chairman of the Board of Trustees, President, Chief Executive Officer and
Manager of the Trust; President, Luther King Capital Management Corporation.
H. KIRK DOWNEY; 55; 2900 Lubbock Street, Fort Worth, Texas 76109; Trustee
of the Trust; Dean, M.J. Neeley School of Business, Texas Christian University
Business School.
EARLE A. SHIELDS, JR.; 77; 53 Westover Terrace, Fort Worth, Texas 76107;
Trustee of the Trust; Consultant; formerly Consultant for NASDAQ Corp. and Vice
President, Merrill Lynch & Co., Inc.
PAUL W. GREENWELL; 47; 301 Commerce Street, Fort Worth, Texas 76102; Vice
President of the Trust; Vice President, Luther King Capital Management.
JACQUI BROWNFIELD; 37; 301 Commerce Street, Fort Worth, Texas 76102;
Secretary and Treasurer of the Trust; Fund Administrator, Luther King Capital
Management.
* Trustee Mr. King is an "interested person" of the Trust (as defined in the
1940 Act), because of his affiliation with the Adviser.
Trustees other than those who are officers or affiliated with the Adviser
receive an annual fee of $8,000 plus a meeting fee of $1,000 for each meeting
attended and are reimbursed for expenses incurred in attending Board meetings.
Trustees who are also officers or affiliated persons receive no remuneration for
their services as Trustees. The Trust's officers and employees are paid by the
Adviser or the Administrator.
The following table shows the estimated compensation to be earned by each
Trustee for the fiscal year ending December 31, 1998.
<TABLE>
<CAPTION>
COMPENSATION TABLE
TOTAL COMPENSATION
AGGREGATE PENSION OR RETIREMENT ESTIMATED FROM THE TRUST AND THE
NAME OF PERSON, COMPENSATION BENEFITS ACCRUED AS PART OF ANNUAL BENEFITS LKCM FAMILY OF
POSITION FROM THE TRUST THE TRUST'S EXPENSES UPON RETIREMENT FUNDS PAID TO TRUSTEES
-------- -------------- -------------------- --------------- ----------------------
<S> <C> <C> <C> <C>
H. Kirk Downey, Trustee $12,000 $0 $0 $12,000
J. Luther King, Trustee $0 $0 $0 $0
Earle A. Sheilds, Jr., Trustee $12,000 $0 $0 $12,000
</TABLE>
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<PAGE>
FUND TRANSACTIONS AND BROKERAGE
The Agreement authorizes the Adviser to select the brokers or dealers that
will execute the purchases and sales of investment securities for the Funds and
directs the Adviser to use its best efforts to obtain the best execution with
respect to all transactions for the Funds. As permitted by Section 28(e) of the
Securities Exchange Act of 1934, as amended, the Adviser may cause the Funds to
pay higher commission rates than the lowest available when the Adviser believes
it is reasonable to do so in light of the value of the research services
provided by the broker effecting the transaction. These services, which in some
cases may also be purchased for cash, include such matters as general economic
and security market reviews, industry and company reviews, evaluations of
securities and recommendations as to the purchase and sale of securities. Some
of these services are of value to the Adviser in advising various clients,
including the Funds, although not all of these services are necessarily useful
and of value in managing the Funds.
It is not the Adviser's practice to allocate brokerage or principal
business on the basis of sales of shares which may be made through intermediary
brokers or dealers. However, the Adviser may place orders with qualified
broker-dealers who recommend the Funds or who act as agents in the purchase of
shares of the Funds for their clients.
Some securities considered for investment by the Funds may also be
appropriate for other clients served by the Adviser. If purchases or sales of
securities consistent with the investment policies of the Funds and one or more
of these other clients serviced by the Adviser is considered at or about the
same time, transactions in such securities will be allocated among the Funds and
clients in a manner deemed fair and reasonable by the Adviser. Although there is
no specified formula for allocating such transactions, the various allocation
methods used by the Adviser, and the results of such allocations, are subject to
periodic review by the Board of Trustees.
The Adviser manages the Funds without regard generally to restrictions on
Fund turnover. The use of futures contracts and other derivative instruments
with relatively short maturities may tend to exaggerate the Fund turnover rate
for a Fund. Trading in fixed-income securities does not generally involve the
payment of brokerage commissions, but does involve indirect transaction costs.
The use of futures contracts may involve the payment of commissions to futures
commission merchants. The higher the rate of Fund turnover of a Fund, the higher
these transaction costs borne by a Fund generally will be.
The Fund turnover rate of a Fund is calculated by dividing (i) the lesser
of purchases or sales of securities for the particular fiscal year by (ii) the
monthly average of the value of the securities owned by the Fund during the
particular fiscal year. In calculating the rate of Fund turnover, there is
excluded from both (i) and (ii) all securities, including options, whose
maturities or expiration dates at the time of acquisition were one year or less.
Proceeds from short sales and assets used to cover short positions undertaken
are included in the amounts of securities sold and purchased, respectively,
during the year.
PURCHASE, REDEMPTION, AND PRICING OF SHARES
PURCHASE OF SHARES
Certain managed account clients of the Adviser may purchase shares of the
Funds. To avoid the imposition of duplicative fees, the Adviser may be required
to make adjustments in the management fees charged separately by the Adviser to
these clients to offset the generally higher level of management fees and
expenses resulting from a client's investment in a Fund.
Certain clients of the Adviser may, subject to the approval of the Trust,
purchase shares of the Funds with liquid securities that are eligible for
purchase by a Fund (consistent with the Fund's investment policies and
restrictions) and that have a value that is readily ascertainable (and not
established only by evaluation procedures) as evidenced by a listing on the
American Stock Exchange, the New York Stock Exchange, or The Nasdaq Stock
Market. These transactions will be effected only if the Adviser intends to
retain the security in the Funds as an investment. Assets so purchased by the
Funds
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<PAGE>
will be valued in generally the same manner as they would be valued for purposes
of pricing a Fund's shares, if such assets were included in the Fund's assets at
the time of purchase.
Shares of the Funds are not qualified or registered for sale in all states.
Shares of the Funds may not be offered or sold in any state unless registered or
qualified in the jurisdiction unless an exemption from registration or
qualification is available.
The Trust reserves the right in its sole discretion (i) to suspend the
offering of Fund shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Funds, (iii) to reduce
or waive the minimum for initial and subsequent investments for certain
fiduciary accounts such as employee benefit plans or under circumstances where
certain economies can be achieved in sales of a Fund's shares. The officers of
the Trust may from time to time waive the minimum initial and subsequent
investment requirements in connection with investments in a Fund by employees of
the Adviser.
REDEMPTION OF SHARES
The Trust may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange (the "Exchange") is
closed, or trading on the Exchange is restricted as determined by the SEC, (ii)
during any period when an emergency exists as defined by the rules of the SEC as
a result of which it is not reasonably practicable for a Fund to dispose of
securities owned by it, or fairly to determine the value of its assets, and
(iii) for such other periods as the SEC may permit.
The Trust has 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 the net assets of a Fund at the
beginning of such period. Such commitment is irrevocable without the prior
approval of the SEC. Redemptions in excess of the above limits may be paid in
whole or in part in investment securities or in cash, as the Trustees may deem
advisable; however, payment will be made wholly in cash unless the Trustees
believe that economic or market conditions exist which would make such a
practice detrimental to the best interests of the applicable Fund. If
redemptions are paid in investment securities the redeeming shareholders might
incur brokerage expenses if they converted these securities to cash. Securities
used to make such "in-kind" redemptions will be readily marketable. The method
of valuing such securities will be the same as the method of valuing Fund
securities described in the Prospectus under "Valuation of Shares," and such
valuation will be made as of the same time the redemption price is determined.
Due to the relatively high cost of maintaining smaller accounts, the Trust
reserves the right to redeem shares in any account for their then-current value
(which will be promptly paid to the investor) if at any time, due to shareholder
redemption, the shares in the account do not have a value of at least $1,000.
Investors will be notified that the value of their account is less than the
minimum and allowed at least 30 days to bring the value of the account up to at
least the minimum before the redemption is processed. The Declaration of Trust
also authorizes the Trust to redeem shares under certain other circumstances as
may be specified by the Board of Trustees.
No fee is charged by the Trust for redemptions. Redemption proceeds may be
more or less than the shareholder's cost depending on the market value of the
securities held by a Fund.
PRICING OF SHARES
As indicated under "Valuation of Shares" in the Prospectus, a Fund's net
asset value per share for the purpose of pricing purchase and redemption orders
is determined at 4:00 p.m. (Eastern Time) on each day the Exchange is open for
trading. Net asset value will not be determined on the following holidays: New
Year's Day, Martin Luther King's Birthday, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
DIVIDENDS, OTHER DISTRIBUTIONS, AND TAXES
GENERAL
It is the policy of each Fund to distribute all of its net investment
income, if any, together with any net realized capital gains in the amount and
at the times that will avoid both federal income tax on it and the imposition of
the federal excise tax on certain undistributed income and capital gain. To
avoid federal income tax on income and gains that are distributed, a Fund (each
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<PAGE>
of which is treated as a separate corporation for federal income tax purposes)
must qualify for the special tax treatment afforded a regulated investment
company ("RIC") under the Internal Revenue Code of 1986, as amended. To qualify
for that treatment, a Fund must distribute to its shareholders for each taxable
year at least 90% of its investment company taxable income (consisting generally
of net investment income, net short-term capital gains, and net gains from
certain foreign currency transactions) and must meet several additional
requirements. For each Fund, these requirements include the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures, and Forward Contracts) derived
with respect to its business of investing in securities or those currencies; and
(2) at the close of each quarter of the Fund's taxable year, (i) at least 50% of
the value of its total assets must be represented by cash and cash items, U.S.
Government securities, securities of other RICs, and other securi ties, with
these other securities limited, in respect of any one issuer, to an amount that
does not exceed 5% of the value of the Fund's total assets and that does not
represent more than 10% of the issuer's voting securities, and (ii) not more
than 25% of the value of its total assets may be invested in securities (other
than U.S. Government securities or the securities of other RICs) of any one
issuer.
Any use of hedging strategies, such as writing (selling) and purchasing
options and futures and entering into Forward Contracts, involves complex rules
that will determine for income tax purposes the amount, character, and timing of
recognition of the gains and losses it realizes in connection therewith.
The Funds also intend to declare and pay dividends and capital gain
distributions so as to avoid imposition of federal excise tax.
Undistributed net investment income is included in each Fund's net assets
for the purpose of calculating net asset value per share. Therefore, on the
"ex-dividend" date, the net asset value per share excludes the dividend (i.e.,
is reduced by the per share amount of the dividend). Dividends and other
distributions paid shortly after the purchase of shares by an investor, although
in effect a return of capital, are taxable to the investor.
As stated in the Prospectus, unless the shareholder elects otherwise in
writing, all dividends and other distributions are automatically paid in
additional Fund shares at net asset value (as of the business day following the
record date). This will remain in effect until a Fund is notified by the
shareholder in writing at least three days prior to the record date that either
the Income Option (income dividends in cash and other distributions in
additional shares at net asset value) or the Cash Option (both income dividends
and other distributions in cash) has been elected. An account statement is sent
to shareholders whenever an income dividend or other distribution is paid.
TAXES - INVESTMENTS IN FOREIGN SECURITIES
Foreign governments may withhold taxes on dividends and
interest paid with respect to foreign securities. Because the Funds do not
currently anticipate that securities of foreign issuers will constitute more
than 10% of the Balanced Fund's total assets and 10% of the Fixed Income Fund's
total assets at the end of their fiscal year, shareholders should not expect to
claim a foreign tax credit or deduction on their federal income tax returns with
respect to foreign taxes withheld. In addition, special tax consequences apply
to investments in the stock of "passive foreign investment companies" ("PFICs").
A PFIC is a foreign corporation -- other than a "controlled foreign corporation"
(i.e., a foreign corporation in which, on any day during its taxable year, more
than 50% of the total voting power of all voting stock therein or the total
value of all stock therein is owned, directly, indirectly, or constructively, by
"U.S. shareholders," defined as U.S. persons that individually own, directly,
indirectly, or constructively, at least 10% of that voting power) as to which a
Fund is a U.S. shareholder -- that, in general, meets either of the following
tests: (1) at least 75% of its gross income is passive or (2) an average of at
least 50% of its assets produce, or are held for the production of, passive
income. Under certain circumstances, a Fund will be subject to federal income
tax on a portion of any "excess distribution" received on the stock of a PFIC or
of any gain on the disposition of the stock (collectively "PFIC income"), plus
interest thereon, even if the Fund distributes the PFIC income as a taxable
dividend to its shareholders. The balance of the PFIC
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<PAGE>
income will be included in the Fund's investment company taxable income and,
accordingly, will not be taxable to it to the extent that income is distributed
to its shareholders. If a Fund invests in a PFIC and elects to treat the PFIC as
a "qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the Fund would be required to include in income each year
its pro rata share of the QEF's annual ordinary earnings and net capital gain
(the excess of net long-term capital gain over net short-term capital loss) --
which probably would have to be distributed by the Funds to its shareholders --
even if those earnings and gain were not distributed to the Fund by the QEF. In
most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof. Each Fund may elect to "mark
to market" its stock in any PFIC. "Marking-to-market," in this context, means
including in ordinary income each taxable year the excess, if any, of the fair
market value of the PFIC's stock over a Fund's adjusted basis therein as of the
end of that year. Pursuant to the election, a Fund also will be allowed to
deduct (as an ordinary, not capital, loss) the excess, if any, of its adjusted
basis in PFIC stock over the fair market value thereof as of the taxable
year-end, but only to the extent of any net mark-to-market gains with respect to
that stock included by the Fund for prior taxable years. A Fund's adjusted basis
in each PFIC's stock with respect to which it makes this election will be
adjusted to reflect the amounts of income included and deductions taken under
the election.
Gains or losses (1) from the disposition of foreign currencies, (2) on the
disposition of a debt security denominated in a foreign currency that are
attributable to fluctuations in the value of the foreign currency between the
date of acquisition of the security and the date of disposition, and (3) that
are attributable to fluctuations in exchange rates that occur between the time a
Fund accrues interest, dividends, or other receivables or accrues expenses or
other liabilities denominated in a foreign currency and the time it actually
collects the receivables or pays the liabilities, generally are treated as
ordinary income or loss. These gains or losses may increase or decrease the
amount of investment company taxable income available to a Fund for distribution
to its shareholders.
PERFORMANCE INFORMATION
TOTAL RETURN
Average annual total return quotations used in the Funds' advertising and
promotional materials are calculated according to the following formula:
P(1+T)n = ERV
where P equals a hypothetical initial payment of $1,000; T equals average annual
total return; n equals the number of years; and ERV equals the ending redeemable
value at the end of the period of a hypothetical $1,000 payment made at the
beginning of the period.
Under the foregoing formula, the time periods used in advertising will be
based on rolling calendar quarters, updated to the last day of the most recent
quarter prior to submission of the advertising for publication. Average annual
total return, or "T" in the above formula, is computed by finding the average
annual compounded rates of return over the period that would equate the initial
amount invested to the ending redeemable value. Average annual total return
assumes the reinvestment of all dividends and distributions.
YIELD
Annualized yield quotations used in a Fund's advertising and promotional
materials are calculated by dividing the Fund's interest income for a specified
thirty-day period, net of expenses, by the average number of shares outstanding
during the period, and expressing the result as an annualized percentage
(assuming semi-annual compounding) of the net asset value per share at the end
of the period. Yield quotations are calculated according to the following
formula:
YIELD = 2 [ (A-B +1)6 - 1]
-----
cd
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where "a" equals dividends and interest earned during the period; "b" equals
expenses accrued for the period, net of reimbursements; "c" equals the average
daily number of shares outstanding during the period that are entitled to
receive dividends; and "d" equals the maximum offering price per share on the
last day of the period.
For purposes of these calculations, the maturity of an obligation with one
or more call provisions is assumed to be the next date on which the obligation
reasonable can be expected to be called or, if none, the maturity date.
OTHER INFORMATION
Each Fund's performance data quoted in advertising and other promotional
materials represents past performance and is not intended to predict or indicate
future results. The return and principal value of an investment in a Fund will
fluctuate, and an investor's redemption proceeds may be more or less than the
original investment amount.
COMPARISON OF FUND PERFORMANCE
The performance of a Fund may be compared to data prepared by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc., Morningstar, Inc.,
the Donoghue Organization, Inc. or other independent services which monitor the
performance of investment companies, and may be quoted in advertising in terms
of its ranking in each applicable universe. In addition, the Funds may use
performance data reported in financial and industry publications, including
Barron's, Business Week, Forbes, Fortune, Investor's Daily, IBC/Donoghue's Money
Fund Report, Money Magazine, The Wall Street Journal and USA Today.
The Funds may from time to time use the following unmanaged indices for
performance comparison purposes:
S&P 500 - The S&P 500 is a Fund of 500 stocks designed to mimic the
overall equity market's industry weightings. Most, but not all, large
capitalization stocks are in the index. There are also some small
capitalization names in the index. The list is maintained by Standard &
Poor's Corporation. It is market capitalization weighted. There are always
500 issuers in the S&P 500. Changes are made by Standard & Poor's as
needed.
Lehman Brothers Government/Corporate Index ("LB Govt/Corp") - The LB
Govt/Corp is a weighted index comprised of publicly-traded intermediate and
long-term government and corporate debt with an average maturity of 11
years.
GENERAL INFORMATION
DESCRIPTION OF SHARES AND VOTING RIGHTS
Each Fund is a series of the LKCM Funds which was established under
Delaware law by a Declaration of Trust dated February 10, 1994. Prior to
December 30, 1997 the LKCM Funds was known as the LKCM Fund. The Declaration of
Trust permits the Trustees of the Trust to issue an unlimited number of shares
of beneficial interest, without par value, from an unlimited number of series
("Funds") of shares. Currently, the Trust offers four series. Pursuant to the
Declaration of Trust, the Trustees may also authorize the creation of additional
series of shares (the proceeds of which would be invested in separate,
independently managed Funds with distinct investment objectives and policies and
share purchase, redemption and net asset valuation procedures) with such
preferences, privileges, limitations and voting and dividend rights as the
Trustees may determine. All consideration received by the Trust for shares of
any additional series, and all assets in which such consideration is invested,
would belong to that series and would be subject to the liabilities related
thereto.
The Trustees, in their discretion, may authorize the division of shares of
the Funds into different classes permitting shares of different classes to be
distributed by different methods. Although shareholders of different classes
would have an interest in the same Fund of assets, shareholders of different
classes may bear different expenses in connection with methods of distribution.
The Trustees have no present intention of taking the action necessary to effect
the division of shares into separate classes nor of changing the method of
distribution of shares of the Funds.
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different
When issued, the shares of the Funds are fully paid and non-assessable,
have no preemptive or subscription rights and are fully transferable. There are
no conversion rights. The shares of the Funds have non-cumulative voting rights,
which means that the holders of more than 50% of the shares voting for the
election of Trustees can elect 100% of the Trustees if they choose to do so. A
shareholder is entitled to one vote for each full share held (and a fractional
vote for each fractional share held), then standing in his name on the books of
a Fund.
SHAREHOLDER AND TRUSTEE LIABILITY
The Declaration of Trust contains an express disclaimer of shareholder
liability for acts or obligations of the Trust and requires that notice of such
disclaimer be given in each agreement, obligation, or instrument entered into or
executed by the Trust or the Trustees, but this disclaimer may not be effective
in some jurisdictions or as to certain types of claims. The Declaration of Trust
further provides for indemnification out of the Trust's property of any
shareholder held personally liable for the obligations of the Trust. The
Declaration of Trust also provides that the Trust shall, upon request, assume
the defense of any claim made against any shareholder for any act or obligation
of the Trust and satisfy any judgment thereon. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Trust itself would be unable to meet its obligations.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of the
office.
AUDITORS
Deloitte & Touche LLP, 411 East Wisconsin Avenue, Milwaukee, Wisconsin,
serves as the Funds' independent auditors, whose services include examination of
the Funds' financial statements and the performance of other related audit and
tax services.
CODE OF ETHICS
The Trust has adopted a Code of Ethics which restricts to a certain extent
personal transactions by access persons of the Trust and imposes certain
disclosure and reporting obligations.
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<PAGE>
APPENDIX
DESCRIPTION OF BOND RATINGS
Excerpts from Moody's Investors Service, Inc. Corporate Bond Ratings:
AAA: judged to be the best quality; carry the smallest degree of investment
risk; AA: judged to be of high quality by all standards; A: possess many
favorable investment attributes and are to be considered as higher medium grade
obligations; BAA: considered as lower medium grade obligations, i.e., they are
neither highly protected nor poorly secured; BA, B: protection of interest and
principal payments is questionable.
CAA: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest. CA: Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings. C: Bonds which are rated C are lowest rated class of bonds
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's may apply numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Excerpts from Standard & Poor's Corporation Corporate Bond Ratings:
AAA: highest grade obligations; possess the ultimate degree of protection
as to principal and interest; AA: also qualify as high grade obligations, and in
the majority of instances differs from AAA issues only in small degree; A:
regarded as upper medium grade; have considerable investment strength but are
not entirely free from adverse effects of changes in economic and trade
conditions. Interest and principal are regarded as safe; BBB: regarded as
borderline between definitely sound obligations and those where the speculative
element begins to predominate; this group is the lowest which qualifies for
commercial bank investments.
BB, B, CCC, CC, C: Debt rated BB, B, CCC, CC and C is regarded, on balance,
as predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
CI: The rating CI is reserved for income bonds on which no interest is being
paid. D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P's believes that such
payments will be made during such grace period. The D rating also will be used
upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
Plus(+) or Minus(-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Excerpts from Fitch Investors Services, Inc. Corporate Bond Ratings:
AAA: Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA: Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA". Because bonds rated
in the "AAA" and
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"AA" categories are not significantly vulnerable to foreseeable future
developments, short term debt of these issuers is generally rated "-,+".
A: Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds, and therefore
impair timely payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher ratings.
BB: Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B: Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
CCC: Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations requires an
advantageous business and economic environment.
CC: Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C: Bonds are in imminent default in payment of interest or principal.
DDD, DD, AND D: Bonds are in default on interest and/or principal payments.
Such bonds are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor. "DDD"
represents the highest potential for recovery on the these bonds, and "D"
represents the lowest potential for recovery.
PLUS (+) MINUS(-) Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD", "DD", or "D" categories.
Excerpts from Duff & Phelps Corporate Bond Ratings:
AAA: Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA+, AA, AA-: High credit quality. Protection factors are strong. Risk is
modest but may vary slightly from time to time of economic conditions.
A+, A, A-: Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
BBB+, BBB, BBB-: Below average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
BB+, BB, BB-: Below investment grade but deemed likely to meet obligations
when due. Present or prospective financial protection factors fluctuate
according to industry conditions or company fortunes. Overall quality may move
up or down frequently within this category.
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B+, B, B-: Below investment grade and possessing risk that obligations will
not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or company fortunes.
Potential exists for frequent changes in the rating within this category or into
a higher or lower rating grade.
CCC: Well below investment grade securities. Considerable uncertainty
exists as to timely payment of principal, interest or preferred dividends.
Protections factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
DD: Defaulted debt obligations. Issuer failed to meet scheduled principal
and/or interest payments.
DP: Preferred stock with dividend arrearage.
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