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[PHOTO OF VINTAGE TIFFANY LAMP APPEARS HERE]
P R O S P E C T U S
V i n t a g e
TRAVELERS SERIES FUND INC.
UNDERLYING FUND PROSPECTUS
September Third
1996
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TRAVELERS SERIES FUND INC.
388 Greenwich Street
New York, New York 10013
1-800-842-8573
The Alliance Growth Portfolio, the Putnam Diversified Income Portfolio and the
MFS Total Return Portfolio are three of twelve portfolios that currently
comprise Travelers Series Fund Inc. (the "Fund"), the investment underlying
certain variable annuity and variable life insurance contracts.
The Alliance Growth Portfolio seeks long-term growth of capital. Current
income is only an incidental consideration.
The Putnam Diversified Income Portfolio seeks high current income consistent
with preservation of capital.
The MFS Total Return Portfolio seeks above-average income (compared to a
portfolio invested entirely in equity securities) consistent with prudent
employment of capital. While current income is the primary objective, the
Portfolio believes that there should be a reasonable opportunity for growth of
capital and income.
Shares of the Fund are offered ONLY to insurance company separate accounts
(the "Separate Accounts"), which fund certain variable annuity and variable life
insurance contracts (the "Contracts"). The Separate Accounts invest in shares of
one or more of the Portfolios in accordance with allocation instructions
received from Contract owners. Such allocation rights are further described in
the accompanying Contract prospectus.
Shares of each Portfolio are offered to Separate Accounts at their net asset
value, without a sales charge, next determined after receipt of an order by an
insurance company. The offering of shares of a Portfolio may be suspended from
time to time and the Fund reserves the right to reject any specific purchase
order.
THIS PROSPECTUS, WHICH SETS FORTH CONCISE INFORMATION ABOUT THE FUND THAT
PROSPECTIVE INVESTORS SHOULD KNOW BEFORE INVESTING, SHOULD BE READ AND RETAINED
FOR FUTURE REFERENCE. A STATEMENT OF ADDITIONAL INFORMATION, ALSO REFERRED TO
AS "PART B", DATED FEBRUARY 28, 1996 AS AMENDED FROM TIME TO TIME IS HEREBY
INCORPORATED BY REFERENCE INTO THIS PROSPECTUS AND IS AVAILABLE FROM THE FUND,
WITHOUT CHARGE, BY WRITING TO THE FUND AT THE ABOVE ADDRESS OR CALLING THE
TELEPHONE NUMBER LISTED ABOVE.
This Prospectus should be read in conjunction with the prospectus for the
Contracts.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS SEPTEMBER 3, 1996.
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TABLE OF CONTENTS
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FINANCIAL HIGHLIGHTS......................................................... 1
THE FUND'S INVESTMENT PROGRAM................................................ 4
Alliance Growth Portfolio................................................. 4
Putnam Diversified Income Portfolio....................................... 5
MFS Total Return Portfolio................................................ 9
SPECIAL INVESTMENT TECHNIQUES AND RISK CONSIDERATIONS........................ 10
DIVIDENDS, DISTRIBUTIONS AND TAXES........................................... 24
REDEMPTION OF SHARES......................................................... 24
PERFORMANCE.................................................................. 24
MANAGEMENT................................................................... 25
SHARES OF THE FUND........................................................... 29
DETERMINATION OF NET ASSET VALUE............................................. 30
APPENDIX A................................................................... 31
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FINANCIAL HIGHLIGHTS
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The following information for the year ended October 31, 1995 and the period
ended October 31, 1994 of each of the portfolios within the Travelers Series
Fund Inc. has been audited in conjunction with the annual audits of the
financial statements of the Fund by KPMG Peat Marwick LLP, independent auditors.
The 1995 financial statements and the independent auditors' report thereon
appear in the October 31, 1995 Annual Report to Shareholders.
For a share of each capital stock outstanding throughout the period:
Alliance Growth
- ------------------------------------------------------------------------
1995 1994(1)
- --------------------------------------------------------------------------------
Net Asset Value, Beginning of Period $10.65 $10.00
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income (2) 0.14 0.06
Net realized and unrealized gain 2.61 0.59
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Total Income from Operations 2.75 0.65
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.02) --
Net realized gains (0.10) --
- --------------------------------------------------------------------------------
Total Distributions (0.12) --
- --------------------------------------------------------------------------------
Net Asset Value, End of Period $13.28 $10.65
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Total Return 26.19% 6.50%++
- --------------------------------------------------------------------------------
Net Assets, End of Period (000's) $111,573 $17,086
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Ratios to Average Net Assets:
Expenses (2) 0.90% 0.88%+
Net investment income 1.24 1.47%+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 77.66% 36.66%
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Average commissions paid
on equity security transactions(3) $0.06 --
================================================================================
(1) For the period from June 16, 1994 (commencement of operations) to
October 31, 1994.
(2) Travelers Group Funds Management Inc. (the "Manager") has waived all or
part of its fees for the year ended October 31, 1995 and the period ended
October 31, 1994. In addition, the Manager has reimbursed the Alliance
Growth Portfolio for $3,500 in expenses for the period ended October 31,
1994. If such fees were not waived and expenses not reimbursed, the per
share decreases in net investment income and the ratios of expenses to
average net assets for the Alliance Growth Portfolio would have been as
follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
------------------------ -------------------
1995 $0.01 0.97%
1994 0.03 1.76+
(3) Due to new Securities and Exchange Commission ("SEC") disclosure
guidelines, average commissions per share are calculated for the current
year and not for the prior period.
(+) Annualized.
(++) Total return is not annualized, as it may not be representative of the
total return for the year.
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For a share of each capital stock outstanding throughout the period:
Putnam Diversified Income
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1995 1994(1)
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Net Asset Value, Beginning of Period $10.18 $10.00
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Income From Operations:
Net investment income (2) 0.79 0.23
Net realized and unrealized gain (loss) 0.58 (0.05)
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Total Income from Operations 1.37 0.18
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Less Distributions From:
Net investment income (0.09) --
- --------------------------------------------------------------------------------
Total Distributions (0.09) --
- --------------------------------------------------------------------------------
Net Asset Value, End of Period $11.46 $10.18
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Total Return 13.55% 1.80%++
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Net Assets, End of Period (000's) $31,514 $6,763
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Ratios to Average Net Assets:
Expenses (2) 0.97% 0.98%+
Net investment income 7.53 6.14 +
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Portfolio Turnover Rate 275.71% 20.02%
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(1) For the period from June 16, 1994 (commencement of operations) to
October 31, 1994.
(2) The Manager has waived all or part of its fees for the year ended
October 31, 1995 and the period ended October 31, 1994. In addition, the
manager has reimbursed the Putnam Diversified Income Portfolio for $19,028
in expenses for the period ended October 31, 1994. If such fees were not
waived and expenses not reimbursed, the per share decreases in net
investment income and the ratios of expenses to average net assets of the
Putnam Diversified Income Portfolio would have been as follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
------------------------ -------------------
1995 $0.04 1.31%
1994 0.07 2.92+
(+) Annualized.
(++) Total return is not annualized, as it may not be representative of the
total return for the year.
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For a share of each capital stock outstanding throughout the period:
MFS Total Return
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1995 1994(1)
- --------------------------------------------------------------------------------
Net Asset Value, Beginning of Period $ 9.98 $10.00
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Income From Operations:
Net investment income (2) 0.45 0.13
Net realized and unrealized gain (loss) 1.15 (0.15)
- --------------------------------------------------------------------------------
Total Income from Operations 1.60 (0.02)
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.05) --
- --------------------------------------------------------------------------------
Total Distributions (0.05) --
- --------------------------------------------------------------------------------
Net Asset Value, End of Period $11.53 $9.98
- --------------------------------------------------------------------------------
Total Return 16.12% (0.20)%++
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Net Assets, End of Period (000's) $49,363 $8,504
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Ratios to Average Net Assets:
Expenses (2) 0.95% 0.93%+
Net investment income 4.40 3.51%+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 103.72% 17.67%
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Average commissions paid
on equity security transactions(3) $0.04 --
================================================================================
(1) For the period from June 16, 1994 (commencement of operations) to
October 31, 1994.
(2) The Manager has waived all or part of its fees for the year ended
October 31, 1995 and the period ended October 31, 1994. In addition, the
Manager has reimbursed the MFS Total Return Portfolio for $13,857 in
expenses for the period ended October 31, 1994. If such fees were not
waived and expenses not reimbursed, the per share decreases in net
investment income and the ratios of expenses to average net assets of the
MFS Total Return Portfolio would have been as follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
------------------------ -------------------
1995 $0.01 1.06%
1994 0.06 2.51+
(3) Due to new SEC disclosure guidelines, average commissions per share are
calculated for the current year and not for the prior period.
(+) Annualized.
(++) Total return is not annualized, as it may not be representative of the
total return for the year.
(+) Annualized.
3
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THE FUND'S INVESTMENT PROGRAM
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The Fund consists of twelve investment portfolios, three of which are offered
herein. Each Portfolio has its own investment objective and policies as
described in more detail below. Of course, no assurance can be given that a
Portfolio's objective will be achieved. Investors should realize that risk of
loss is inherent in the ownership of any securities and that shares of each
Portfolio will fluctuate with the market value of its securities. Additional
information about each Portfolio's investment policies and investment risks can
be found herein under "Special Investment Techniques and Risk Considerations"
and in the Statement of Additional Information.
The investment objectives and certain investment restrictions designated as
such in the Statement of Additional Information are fundamental and may not be
changed by the Directors without shareholder approval. Each Portfolio's
investment policies, however, are not fundamental and may be changed by the
Directors without shareholder approval.
Alliance Growth Portfolio
Investment Objective
The investment objective of the Alliance Growth Portfolio is to provide long-
term growth of capital. Current income is only an incidental consideration. The
Portfolio attempts to achieve its objective by investing primarily in equity
securities of companies with a favorable outlook for earnings and whose rate of
growth is expected to exceed that of the U.S. economy over time. Alliance
Capital Management L.P. serves as the Portfolio's Sub-Adviser and is responsible
for making all investment decisions on behalf of the Portfolio.
Investment Policies
The Alliance Growth Portfolio invests primarily in common stocks and
securities convertible into common stocks such as convertible bonds, convertible
preferred stocks and warrants convertible into common stocks. Because the values
of fixed-income securities are expected to vary inversely with changes in
interest rates generally, when the Sub-Adviser expects a general decline in
interest rates, the Portfolio may also invest for capital growth in fixed-income
securities. The Portfolio may invest up to 25% of its total assets in fixed-
income securities rated at the time of purchase below investment grade, that is,
securities rated Ba or lower by Moody's Investors Service, Inc. ("Moody's") or
BB or lower by Standard & Poor's Ratings Group ("S&P"), or in unrated fixed-
income securities determined by the Sub-Adviser to be of comparable quality. The
Portfolio will generally invest in securities with a minimum rating of Caa- by
Moody's or CCC- by S&P or in unrated securities judged by the Sub-Adviser to be
of comparable quality.
The Portfolio may invest without limit in securities that are not publicly
traded in the U.S., although the Portfolio generally will not invest more than
15% of its total assets in such securities. The Portfolio may also invest a
portion of its assets in developing countries or countries with new or
developing capital markets.
The Portfolio may invest in securities that are not publicly traded,
including securities sold pursuant to Rule 144A under the Securities Act of
1933 ("Rule 144A Securities"). Investment in non-publicly traded securities is
restricted to 5% of the Portfolio's total assets (not including Rule 144A
Securities, to the extent permitted by applicable law) and is also subject to
the Portfolio's restriction against investing more than 15% of net assets in
"illiquid securities". To the extent permitted by applicable law, Rule 144A
Securities will not be
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treated as illiquid for purposes of the foregoing restriction so long as such
securities meet liquidity guidelines established by the Fund's Board of
Directors.
The Portfolio may invest in high-yield, high-risk, fixed-income and
convertible securities rated at the time of purchase Ba or lower by Moody's or
BB or lower by S&P, or, if unrated, judged by the Sub-Adviser to be of
comparable quality. The Portfolio will generally invest in securities with a
minimum rating of Caa- by Moody's or CCC- by S&P or in unrated securities
judged by the Sub-Adviser to be of comparable quality. However, from time to
time, the Portfolio may invest in securities rated in the lowest grades of
Moody's (C) or S&P (D) or in unrated securities judged by the Sub-Adviser to be
of comparable quality, if the Sub-Adviser determines that there are prospects
for an upgrade or a favorable conversion into equity securities (in the case of
convertible securities). Securities rated Ba or lower (and comparable unrated
securities) are commonly referred to as "junk bonds." Securities rated D by S&P
are in default. See "Lower-Quality and Non-Rated Securities." For a description
of the ratings referred to above, See Appendix A.
The Portfolio may also invest in zero-coupon bonds and payment-in-kind bonds.
It may also buy and sell stock index futures contracts ("index futures") and may
buy options on index futures and on stock indices for hedging purposes. The
Portfolio may buy and sell call and put options on index futures or on stock
indices in addition to, or as an alternative to, purchasing or selling index
futures or, to the extent permitted by applicable law, to earn additional
income. The Portfolio may also, for hedging purposes, purchase and sell futures
contracts, options thereon and options with respect to U.S. Treasury securities,
including U.S. Treasury bills, notes and bonds. The Portfolio may also seek to
increase its current return by writing covered call and put options on
securities it owns or in which it may invest.
The Portfolio may lend portfolio securities amounting to not more than 25% of
its total assets and may enter into repurchase agreements on up to 25% of its
total assets. It may also purchase securities for future delivery, which may
increase its overall investment exposure and involves a risk of loss if the
value of the securities declines prior to the settlement date. For temporary
defensive purposes, the Portfolio may invest all or a major part of its assets
in money market instruments and repurchase agreements. To the extent the
Portfolio's assets are invested for temporary defensive purposes, they will not
be invested in a manner designed to achieve the Portfolio's investment
objective.
Putnam Diversified Income Portfolio
Investment Objective
The Putnam Diversified Income Portfolio seeks high current income consistent
with preservation of capital. Putnam Investment Management, Inc. serves as the
Portfolio's Sub-Adviser and is responsible for making all investment decisions
on behalf of the Portfolio.
Investment Policies
Basic investment strategy. The Putnam Diversified Income Portfolio will
allocate its investments among the following three sectors of the fixed-income
securities markets:
* a U.S. Government Sector, consisting primarily of securities of the U.S.
Government, its agencies and instrumentalities and related options, futures and
repurchase agreements;
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* a High Yield Sector, consisting of high yielding, lower-rated, higher risk
U.S. and foreign fixed-income securities; and
* an International Sector, consisting of obligations of foreign governments,
their agencies and instrumentalities, other fixed-income securities
denominated in foreign currencies, and related options and futures.
The Portfolio may invest significantly in lower rated and unrated U.S. and
foreign bonds whose credit quality is generally considered the equivalent of
U.S. corporate debt securities, commonly known as "junk bonds." Investments of
this type are subject to a greater risk of loss of principal and interest.
Purchasers should carefully assess the risks associated with an investment in
this Portfolio.
The Sub-Adviser believes that diversifying the Portfolio's investments among
these sectors, as opposed to investing in any one sector, will better enable
the Portfolio to preserve capital while pursuing its objective of high current
income. Historically, the markets for U.S. Government securities, lower-rated,
high yielding U.S. corporate fixed-income securities, and debt securities of
foreign issuers have tended to behave independently and have at times moved in
opposite directions. For example, U.S. Government securities have generally
been affected negatively by inflationary concerns resulting from increased
economic activity. High yield U.S. corporate fixed-income securities, on the
other hand, have generally benefitted from increased economic activity due to
improvement in the credit quality of corporate issuers. The reverse has
generally been true during periods of economic decline. Similarly, U.S.
Government securities have often been negatively affected by a decline in the
value of the dollar against foreign currencies, while the bonds of foreign
issuers held by U.S. investors have generally benefitted from such decline. The
Sub-Adviser believes that, when financial markets exhibit such a lack of
correlation, a pooling of investments among these markets may produce greater
preservation of capital and lower volatility over the long term than would be
obtained by investing exclusively in any one of the markets.
The Sub-Adviser will determine the amount of assets to be allocated to each
of the three market sectors in which the Portfolio will invest based on its
assessment of the maximum level of current income that can be achieved from a
portfolio which is invested in all three sectors without incurring undue risks
to principal value. In making this determination, the Sub-Adviser will rely in
part on quantitative analytical techniques that measure relative risks and
opportunities of each market sector based on current and historical market data
for each sector, as well as on its own assessment of economic and market
conditions. The Sub-Adviser will continuously review this allocation of assets
and make such adjustments as it deems appropriate, although there are no fixed
limits on allocations among sectors, including investment in the High Yield
Sector. Because of the importance of sector diversification to the Portfolio's
investment policies, the Sub-Adviser expects that a substantial portion of the
Portfolio's assets will normally be invested in each of the three market
sectors described below. See "Defensive Strategies." The Portfolio's assets
allocated to each of these market sectors will be managed in accordance with
particular investment policies, which are described below. At times, the
Portfolio may hold a portion of its assets in cash and money market instruments.
U.S. Government Sector. The Portfolio will invest assets allocated to the
U.S. Government Sector primarily in U.S. Government securities and engage in
options, futures, and repurchase transactions with respect to such securities.
The Portfolio may also enter into forward commitments for the purchase of U.S.
Government securities and make secured loans of its portfolio securities with
respect to U.S. Government securities. In purchasing securities for the U.S.
Government Sector, the Sub-Adviser may take full advantage of the entire range
of maturities of U.S. Government securities and may adjust the average maturity
of the investments held in the portfolio from time to time, depending on its
assessment of relative yields of securities
6
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of different maturities and its expectations of future changes in interest
rates. Under normal market conditions, the Portfolio will invest at least 20% of
its net assets in U.S. Government securities. The Portfolio may also invest
assets allocated to the U.S. Government Sector in a variety of debt securities,
including asset-backed and mortgage-backed securities, such as CMOs, that are
issued by private U.S. issuers. With respect to the U.S. Government Sector, the
Portfolio will only invest in privately issued debt securities that are rated at
the time of purchase at least A by Moody's or S&P, or in unrated securities that
the Sub-Adviser determines are of comparable quality. The rating services'
descriptions of these rating categories are included in Appendix A. The
Portfolio will not necessarily dispose of a security if its rating is reduced
below these levels, although the Sub-Adviser will monitor the investment to
determine whether continued investment in the security will assist in meeting
the Portfolio's investment objective.
High Yield Sector. The Portfolio will invest assets allocated to the High
Yield Sector primarily in high yielding, lower-rated higher risk U.S. and
foreign corporate fixed-income securities, including debt securities,
convertible securities and preferred stocks. Subject to the foregoing sentence,
the Portfolio may also purchase securities of foreign governmental issuers and
equity securities. As described below, however, the Portfolio may invest all or
any part of the High Yield Sector portfolio in higher-rated and unrated
fixed-income securities. The Portfolio will not necessarily invest in the
highest yielding securities available if in the Sub-Adviser's opinion the
differences in yield are not sufficient to justify the higher risks involved.
In addition, the Portfolio may invest up to 15% of its net assets in securities
that are not publicly traded and for which market quotations are not readily
available. The Portfolio may also invest in "zero-coupon" bonds and
"payment-in-kind" bonds.
At times, a substantial portion of the Portfolio's assets may be invested in
securities as to which the Portfolio, by itself or together with other funds
and accounts managed by the Sub-Adviser and its affiliates, holds a major
portion or all of such securities. Under adverse market or economic conditions
or in the event of adverse changes in the financial condition of the issuer,
the Portfolio could find it more difficult to sell such securities when the
Sub-Adviser believes it advisable to do so or may be able to sell such
securities only at prices lower than if such securities were more widely held.
Under such circumstances, it may also be more difficult to determine the fair
value of such securities for purposes of computing the Portfolio's net asset
value. In order to enforce its rights in the event of a default under such
securities, the Portfolio may be required to take possession of and manage
assets securing the issuer's obligations on such securities, which may increase
the Portfolio's operating expenses and adversely affect the Portfolio's net
asset value.
The High Yield Sector may invest in any security which is rated, at the time
of purchase, at least Caa as determined by Moody's or CCC as determined by
S&P's or in any unrated security which the Sub-Adviser determines is at least
of comparable quality, although up to 5% of the net assets of the Portfolio be
invested in securities rated below such quality, or in unrated securities that
the Sub-Adviser determines are of comparable quality. Securities rated below
Caa by Moody's or CCC by S&P's are of poor standing and may be in default. The
rating services' descriptions of these rating categories, including the
speculative characteristics of the lower categories, are included in Appendix A.
International Sector. The Portfolio will invest the assets allocated to the
International Sector in debt obligations and other fixed-income securities
denominated in non-U.S. currencies. These securities include:
* debt obligations issued or guaranteed by foreign, national, provincial,
state or other governments with taxing authority, or by their agencies or
instrumentalities;
* debt obligations of supranational entities (described below); and
* debt obligations and other fixed-income securities of foreign and U.S.
corporate issuers.
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When investing in the International Sector, the Portfolio will purchase only
debt securities of issuers whose long-term debt obligations are rated A or
better at the time of purchase by Moody's or S&P or in unrated securities that
the Sub-Adviser determines are at least of comparable quality.
In the past, yields available from securities denominated in foreign
currencies have often been higher than those of securities denominated in U.S.
dollars. Although the Portfolio has the flexibility to invest in any country
where the Sub-Adviser sees potential for high income, it presently expects to
invest primarily in securities of issuers in industrialized Western European
countries (including Scandinavian countries) and in Canada, Japan, Australia,
and New Zealand. The Sub-Adviser will consider expected changes in foreign
currency exchange rates in determining the anticipated returns of securities
denominated in foreign currencies. The Sub-Adviser does not believe that the
credit risk inherent in the obligations of stable foreign governments is
significantly greater than in those of U.S. Government securities.
The obligations of foreign governmental entities, including supranational
issuers, have various kinds of government support. Obligations of foreign
governmental entities include obligations issued or guaranteed by national,
provincial, state or other governments with taxing power or by their agencies.
These obligations may or may not be supported by the full faith and credit of a
foreign government.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the World Bank), the European Steel and Coal Community, the Asian
Development Bank, and the Inter-American Development Bank. The governmental
members or "stockholders" usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowing.
Each supranational entity's leading activities are limited to a percentage of
its total capital (including "callable capital" contributed by members at the
entity's call), reserves, and net income.
Defensive Strategies. At times, the Sub-Adviser may judge that conditions
in the securities market make pursuing the Portfolio's basic investment
strategy inconsistent with the best interests of its shareholders. At such
times, the Sub-Adviser may temporarily use alternative strategies, primarily
designed to reduce fluctuations in the value of the Portfolio's assets. In
implementing these "defensive" strategies, depending on the circumstances, the
Portfolio may temporarily reduce or suspend its option writing activities,
shift its portfolio emphasis to higher-rated securities in the High Yield
Sector, hedge currency risks in the International Sector, or generally reduce
the average maturity of its holdings in any or all of the Sectors. Under
unusual market conditions, the Portfolio could invest up to 100% of its assets
in short-term U.S. Government securities when the risks of investing in the
other Sectors are perceived to outweigh the possible benefits of sector
diversification. The Portfolio may also increase the portion of its assets
invested in cash or money market instruments for such defensive purposes or for
liquidity purposes. To the extent the Portfolio's assets are invested for
temporary defensive purposes, they will not be invested in a manner designed to
achieve the Portfolio's investment objective.
The Portfolio may also purchase securities of issuers located in emerging
markets, invest in sovereign debt, Brady Bonds, loan participations and
assignments and enter into dollar roll transactions. It may also engage in the
writing of covered call and put options with respect to foreign fixed-income
securities, foreign currencies, and related futures in order to supplement the
Fund's portfolio income. See "Special Investment Techniques and Risk
Considerations" below and in the Statement of Additional Information.
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MFS Total Return Portfolio
Investment Objectives
The primary investment objective of the MFS Total Return Portfolio is to
obtain above-average income (compared to a portfolio entirely invested in
equity securities) consistent with the prudent employment of capital. While
current income is the primary objective, the Portfolio believes that there
should also be a reasonable opportunity for growth of capital and income, since
many securities offering a better than average yield may also possess growth
potential. Thus, in selecting securities for its portfolio, the Portfolio
considers each of these objectives. Under normal market conditions, at least
25% of the Portfolio's assets will be invested in fixed income securities and
at least 40% and no more than 75% of the Portfolio's assets will be invested in
equity securities. Massachusetts Financial Services Company serves as the
Portfolio's Sub-Adviser and is responsible for making all investment decisions
on behalf of the Portfolio.
Investment Policies
The MFS Total Return Portfolio's policy is to invest in a broad list of
securities, including short-term obligations. The list may be diversified not
only by companies and industries, but also by type of security. Fixed income
securities and equity securities (which include: common and preferred stocks;
securities such as bonds, warrants or rights that are convertible into stock;
and depositary receipts for those securities) may be held by the Portfolio.
Some fixed income securities may also have a call on common stock by means of a
conversion privilege or attached warrants. The Portfolio may vary the
percentage of assets invested in any one type of security in accordance with
the Sub-Adviser's interpretation of economic and money market conditions,
fiscal and monetary policy and underlying security values. The Portfolio's debt
investments may consist of both "investment grade" securities (rated Baa or
better by Moody's or BBB or better by S&P or Fitch Investors Service, Inc.
("Fitch")) and securities that are unrated or are in the lower rating
categories (rated Ba or lower by Moody's or BB or lower by S&P or Fitch)
(commonly known as "junk bonds") including up to 20% of its net assets in
nonconvertible fixed income securities that are in these lower rating
categories and comparable unrated securities. See "Lower-Quality and Non-Rated
Securities". Generally, most of the Portfolio's long-term debt investments will
consist of "investment grade" securities. See Appendix A to this Prospectus for
a description of these ratings. It is not the Portfolio's policy to rely
exclusively on ratings issued by established credit rating agencies but rather
to supplement such ratings with the Sub-Adviser's own independent and ongoing
review of credit quality.
As noted above, the Portfolio invests in lower-rated and unrated corporate
debt securities, commonly known as "junk bonds." Investments of this type are
subject to a greater risk of loss of principal and interest. Purchasers should
carefully assess the risks associated with an investment in this Portfolio. See
"Lower-Quality and Non-Rated Securities".
The Portfolio may invest up to 20% (and generally expects to invest between
5% and 20%) of its total assets in foreign securities which are not traded on a
U.S. exchange (not including American Depositary Receipts). The Portfolio may
also invest in American Depository Receipts. The Portfolio may also invest in
emerging market securities, Brady Bonds, U.S. Government securities, mortgage
pass-through securities, corporate asset-backed securities, zero-coupon bonds,
deferred interest bonds and payment-in-kind bonds. In addition, the Portfolio
may enter into repurchase agreements and mortgage dollar roll transactions, may
lend its portfolio securities, purchase securities on a when-issued or forward
delivery basis, enter into swap transactions and invest in indexed securities
and loan participations and other direct indebtedness. The Portfolio may invest
up to 15% of its net assets in illiquid securities and may also invest in
restricted securities, including Rule 144A Securities. Finally, the Portfolio
may engage in various options and futures transactions
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including options on securities, options on stock indexes, options on foreign
currencies, stock indices and foreign currency futures contracts, options on
futures contracts, forward foreign currency exchange contracts and yield curve
options. See "Special Investment Techniques and Risk Considerations" for
additional information about these types of securities.
The Portfolio will be managed actively with respect to the Portfolio's fixed
income securities and the asset allocations modified as the Sub-adviser deems
necessary. Although the Portfolio does not intend to seek short-term profits,
fixed income securities will be sold whenever the sub-adviser believes it is
appropriate to do so without regard to the length of time the particular asset
may have been held. With respect to its equity securities the Portfolio does not
intend to trade in securities for short-term profits and anticipates that
portfolio securities ordinarily will be held for one year or longer. However,
the Portfolio will effect trades whenever it believes that changes in its
portfolio securities are appropriate.
In addition, when the Sub-Adviser believes that investing for defensive
purposes is appropriate, such as during periods of unusual or unfavorable market
or economic conditions, or in order to meet anticipated redemption requests, up
to 100% of the Portfolio's assets may be temporarily invested in cash (including
foreign currency) or cash equivalents including, but not limited to, obligations
of banks (including certificates of deposit, bankers' acceptances and repurchase
agreements) with assets of $1 billion or more, commercial paper, short-term
notes, obligations issued or guaranteed by the U.S. or any foreign government or
any of their agencies, authorities or instrumentalities and repurchase
agreements.
SPECIAL INVESTMENT TECHNIQUES AND RISK CONSIDERATIONS
================================================================================
Foreign Securities. Each Portfolio may purchase securities issued by
foreign governments, corporations or banks. Investments in foreign securities
involve risks that are different in some respects from investments in
securities of U.S. issuers, such as the risk of fluctuations in the value of
the currencies in which they are denominated, the risk of adverse political,
social, economic and diplomatic developments, the possible imposition of
exchange controls or other foreign governmental laws or restrictions and, with
respect to certain countries, the possibility of expropriation of assets,
nationalization or confiscatory taxation or limitations on the removal of funds
or other assets of the Portfolios. Securities of some foreign companies and
banks are less liquid and more volatile than securities of comparable domestic
companies and banks. Non-U.S. securities markets, while growing in volume have,
for the most part, substantially less volume than U.S. markets, and there is
generally less government supervision and regulation of exchanges, brokers and
issuers than there is in the U.S. Dividend and interest income from non-U.S.
securities will generally be subject to withholding taxes by the country in
which the issuer is located and may not be recoverable by the Portfolio or the
investors. There also may be less publicly available information about foreign
issuers than domestic issuers, and foreign issuers generally are not subject to
the uniform accounting, auditing and financial reporting standards, practices
and requirements applicable to domestic issuers. Delays may be encountered in
settling securities transactions in certain foreign markets, and the Portfolios
will incur costs in converting foreign currencies into U.S. dollars. Custody
and transaction charges are generally higher for foreign securities. There is
also a risk of the adoption of government regulations that might adversely
affect the payment of principal and interest on securities held by a Portfolio.
In addition, a Portfolio may encounter greater difficulties in invoking legal
processes abroad than would be the case in the U.S. Finally, changes in foreign
currency exchange rates will, to the extent a Portfolio does not adequately
hedge against such fluctuations, affect the value of securities in its
portfolio and the unrealized appreciation or depreciation of investments so far
as U.S. investors are concerned.
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Securities of Emerging Markets. Because of the special risks associated
with investing in emerging markets, an investment in the Putnam Diversified
Income or MFS Total Return Portfolios, should be considered speculative.
Investors are strongly advised to consider carefully the special risks involved
in emerging markets, which are in addition to the usual risks of investing in
developed foreign markets around the world.
Emerging market countries include any country determined by the adviser or
sub-adviser, as the case may be, to have an emerging market economy, taking
into account a number of factors, including the country's foreign currency debt
rating, its political and economic stability and the development of its
financial and capital markets. The adviser (or sub-adviser) determines an
issuer's principal trading market for its securities and the source of its
revenues and assets. The issuer's principal activities generally are deemed to
be located in a particular country if: (a) the security is issued or guaranteed
by the government of that country or any of its agencies, authorities or
instrumentalities; (b) the issuer is organized under the laws of, and maintains
a principle office in, that country; (c) the issuer has its principal
securities trading market in that country; or (d) the issuer has 50% or more of
its assets in that country.
Investing in emerging markets involves risks relating to potential political
and economic instability within such markets and the risks of expropriation,
nationalization, confiscation of assets and property, the imposition of
restrictions on foreign investments and the repatriation of capital invested.
In Eastern Europe, for example, upon the accession to power of Communist
regimes in the past, the governments of a number of Eastern European countries
expropriated a large amount of property. The claims of many property owners
against those governments were never finally settled. There can be no assurance
that any investments that a Portfolio might make in an emerging market would
not be expropriated, nationalized or otherwise confiscated at some time in the
future. In the event of such expropriation, nationalization or other
confiscation in any emerging market, each Portfolio could lose its entire
investment in that market. Many emerging market countries have also experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have negative effects on the economics and securities of certain
emerging market countries.
Economies in emerging markets generally are dependent heavily upon
international trade and, accordingly, have been and may continue to be affected
adversely by trade barriers, exchange controls, managed adjustments in relative
currency values and other protectionist measures imposed or negotiated by the
countries with which they trade. These economies also have been and may
continue to be affected adversely by economic conditions in the countries in
which they trade.
The securities markets of emerging countries are substantially smaller, less
developed, less liquid and more volatile than the securities markets of the
United States and other more developed countries. Disclosure and regulatory
standards in many respects are less stringent than in the United States and
other major markets. There also may be a lower level of monitoring and
regulation of emerging securities markets and the activities of investors in
such markets, and enforcement of existing regulations has been extremely
limited.
In addition, brokerage commissions, custodial services and other costs
relating to investment in foreign markets generally are more expensive than in
the United States, particularly with respect to emerging markets. Such markets
have different settlement and clearance procedures. In certain markets there
have been times when settlements have been unable to keep pace with the volume
of securities transactions, making it difficult to conduct such transactions.
The inability of a Portfolio to make intended securities purchases due to
settlement problems could cause it to miss attractive investment opportunities.
Inability to dispose of a portfolio security caused by settlement problems
could result either in losses to a Portfolio due to subsequent declines in
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value of the portfolio security or, if the Portfolio has entered into a
contract to sell the security, could result in possible liability to the
purchaser.
The risk also exists that an emergency situation may arise in one or more
emerging markets as a result of which trading of securities may cease or may be
substantially curtailed and prices for the portfolio securities in such markets
may not be readily available. Section 22(e) of the Investment Company Act of
1940, as amended (the "1940 Act") permits a registered investment company to
suspend redemption of its shares for any period during which an emergency
exists, as determined by the SEC. Accordingly, if a Portfolio believes that
appropriate circumstances warrant, it will promptly apply to the SEC for a
determination that an emergency exists within the meaning of Section 22(a) of
the 1940 Act. During the period commencing from a Portfolio's identification of
such conditions until the date of SEC action, the portfolio securities in the
affected markets will be valued at fair value as determined in good faith by or
under the direction of the Board of Directors.
Sovereign Debt. The Putnam Diversified Income Portfolio and the MFS Total
Return Portfolio may each invest in sovereign debt securities of emerging
market governments including Brady Bonds. Investments in such securities
involve special risks. The issuer of the debt or the governmental authorities
that control the repayment of the debt may be unable or unwilling to repay
principal or interest when due in accordance with the terms of such debt.
Periods of economic uncertainty may result in the volatility of market prices
of sovereign debt obligations, and in turn a Portfolio's net asset value, to a
greater extent than the volatility inherent in domestic fixed income securities.
A sovereign debtor's willingness or ability to repay principal and pay
interest in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's
policy toward principal international lenders and the political constraints to
which a sovereign debtor may be subject. Emerging market governments could
default on their sovereign debt. Such sovereign debtors also may be dependent
on expected disbursements from foreign governments, multilateral agencies and
other entities abroad to reduce principal and interest arrearages on their
debt. The commitment on the part of these governments, agencies and others to
make such disbursements may be conditioned on a sovereign debtor's
implementation of economic reforms and/or economic performance and the timely
service of such debtor's obligations. Failure to implement such reforms,
achieve such levels of economic performance or repay principal or interest when
due, may result in the cancellation of such third parties' commitments to lend
funds to the sovereign debtor, which may further impair such debtor's ability
or willingness to timely service its debts.
The occurrence of political, social or diplomatic changes in one or more of
the countries issuing sovereign debt could adversely affect a Portfolio's
investments. Emerging markets are faced with social and political issues and
some of them have experienced high rates of inflation in recent years and have
extensive internal debt. Among other effects, high inflation and internal debt
service requirements may adversely affect the cost and availability of future
domestic sovereign borrowing to finance governmental programs, and may have
other adverse social, political and economic consequences. Political changes or
a deterioration of a country's domestic economy or balance of trade may affect
the willingness of countries to service their sovereign debt. Although
management intends to manage each Portfolio in a manner that will minimize the
exposure to such risks, there can be no assurance that adverse political
changes will not cause a Portfolio to suffer a loss of interest or principal on
any of its holdings.
In recent years, some of the emerging market countries in which each Portfolio
expects to invest have encountered difficulties in servicing their sovereign
debt obligations. Some of these countries have withheld
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payments of interest and/or principal of sovereign debt. These difficulties have
also led to agreements to restructure external debt obligations -- in
particular, commercial bank loans, typically by rescheduling principal payments,
reducing interest rates and extending new credits to finance interest payments
on existing debt. In the future, holders of emerging market sovereign debt
securities may be requested to participate in similar rescheduling of such debt.
Certain emerging market countries are among the largest debtors to commercial
banks and foreign governments. Currently, Brazil, Russia and Mexico are among
the largest debtors among developing countries. At times certain emerging market
countries have declared moratoria on the payment of principal and interest on
external debt; such a moratorium is currently in effect in certain emerging
market countries. There is no bankruptcy proceeding by which a creditor may
collect in whole or in part sovereign debt on which an emerging market
government has defaulted.
The ability of emerging market governments to make timely payments on their
sovereign debt securities is likely to be influenced strongly by a country's
balance of trade and its access to trade and other international credits. A
country whose exports are concentrated in a few commodities could be vulnerable
to a decline in the international prices of one or more of such commodities.
Increased protectionism on the part of a country's trading partners could also
adversely affect its exports. Such events could diminish a country's trade
account surplus, if any. To the extent that a country receives payments for its
exports in currencies other than hard currencies, its ability to make hard
currency payments could be affected.
Investors should also be aware that certain sovereign debt instruments in
which the Portfolios may invest involve great risk. As noted above, sovereign
debt obligations issued by emerging market governments generally are deemed to
be the equivalent in terms of quality to securities rated below investment
grade by Moody's and S&P. Such securities are regarded as predominantly
speculative with respect to the issuer's capacity to pay interest and repay
principal in accordance with the terms of the obligations and involve major
risk exposure to adverse conditions. Some of such securities, with respect to
which the issuer currently may not be paying interest or may be in payment
default, may be comparable to securities rated D by S&P or C by Moody's. The
Portfolios may have difficulty disposing of and valuing certain sovereign debt
obligations because there may be a limited trading market for such securities.
Because there is no liquid secondary market for many of these securities, each
Portfolio anticipates that such securities could be sold only to a limited
number of dealers or institutional investors.
Brady Bonds. The Putnam Diversified Income Portfolio and the MFS Total Return
Portfolio may each invest in "Brady Bonds," which are debt restructurings that
provide for the exchange of cash and loans for newly issued bonds. Brady Bonds
have been issued by the governments of Argentina, Brazil, Bulgaria, Costa Rica,
Dominican Republic, Ecuador, Jordan, Mexico, Nigeria, Panama, the Philippines,
Poland, Uruguay and Venezuela. In addition, Peru has announced intentions to
issue Brady Bonds. Approximately $139 billion in principal amount of Brady Bonds
has been issued as of the date of this Prospectus, the largest proportion having
been issued by Mexico and Venezuela. Brady Bonds issued by Mexico and Venezuela
currently are rated below investment grade. As of the date of this Prospectus,
the Portfolios are not aware of the occurrence of any payment defaults on Brady
Bonds. Investors should recognize, however, that Brady Bonds have been issued
only recently and, accordingly, do not have a long payment history. Brady Bonds
may be collateralized or uncollateralized, are issued in various currencies
(primarily the U.S. dollar) and are actively traded in the secondary market for
Latin American debt. The Salomon Brothers Brady Bond Index provides a benchmark
that can be used to compare returns of emerging market Brady Bonds with returns
in other bond markets, e.g., the U.S. bond market.
The Portfolios may invest in either collateralized or uncollateralized Brady
Bonds. U.S. dollar-denominated, collateralized Brady Bonds which may be fixed
rate par bonds or floating rate discount bonds, are collateralized in full as
to principal by U.S. Treasury zero coupon bonds having the same maturity as the
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bonds. Interest payments on such bonds generally are collateralized by cash or
securities in an amount that, in the case of fixed rate bonds, is equal to at
least one year of rolling interest payments or, in the case of floating rate
bonds, initially is equal to at least one year's rolling interest payments
based on the applicable interest rate at that time and is adjusted at regular
intervals thereafter.
Loan Participations and Assignments. The Putnam Diversified Income Portfolio
and the MFS Total Return Portfolio may each invest a portion of its assets in
loan participations ("Participations"). By purchasing a Participation, a
Portfolio acquires some or all of the interest of a bank or other lending
institution in a loan to a corporate or government borrower. The Participations
typically will result in the Portfolio having a contractual relationship only
with the lender not the borrower. A Portfolio will have the right to receive
payments of principal, interest and any fees to which it is entitled only from
the lender selling the Participation and only upon receipt by the lender of the
payments from the borrower. In connection with purchasing Participations, a
Portfolio generally will have no right to enforce compliance by the borrower
with the terms of the loan agreement relating to the loan, nor any rights of
set-off against the borrower, and a Portfolio may not directly benefit from any
collateral supporting the loan in which it has purchased the Participation. As a
result, a Portfolio will assume the credit risk of both the borrower and the
lender that is selling the Participation. In the event of the insolvency of the
lender selling a Participation, a Portfolio may be treated as a general creditor
of the lender and may not benefit from any set-off between the lender and the
borrower. Each Portfolio will acquire Participations only if the lender
interpositioned between the Portfolio and the borrower is determined by
management to be creditworthy.
The Putnam Diversified Income Portfolio may also invest in assignments of
portions of loans from third parties ("Assignments"). When it purchases
Assignments from lenders, the Portfolio will acquire direct rights against the
borrower on the loan. However, since Assignments are arranged through private
negotiations between potential assignees and assignors, the rights and
obligations acquired by the Portfolio as the purchaser of an Assignment may
differ from, and be more limited than, those held by the assigning lender.
The Portfolios may have difficulty disposing of Assignments and
Participations. The liquidity of such securities is limited and, each Portfolio
anticipates that such securities could be sold only to a limited number of
institutional investors. The lack of a liquid secondary market could have an
adverse impact on the value of such securities and on each Portfolio's ability
to dispose of particular Assignments or Participations when necessary to meet
the Portfolio's liquidity needs or in response to a specific economic event,
such as a deterioration in the creditworthiness of the borrower. The lack of a
liquid secondary market for Assignments and Participations also may make it
more difficult for the Portfolio to assign a value to those securities for
purposes of valuing the Portfolio's portfolio and calculating its net asset
value.
Lower-Quality and Non-Rated Securities. Each Portfolio may invest in lower-
quality securities. Investments in lower-rated securities are subject to special
risks, including a greater risk of loss of principal and non-payment of
interest. An investor should carefully consider the following factors before
investing in these Portfolios.
Generally, lower-quality securities offer a higher return potential than
higher-rated securities but involve greater volatility of price and greater
risk of loss of income and principal, including the possibility of default or
bankruptcy of the issuers of such securities. Lower-quality securities and
comparable non-rated securities will likely have large uncertainties or major
risk exposure to adverse conditions and are predominantly speculative with
respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligation. The occurrence of adverse
conditions and uncertainties would likely reduce the value of securities held
by a Portfolio, with a commensurate effect on the value of the Portfolio's
shares.
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The markets in which lower-quality securities or comparable non-rated
securities are traded generally are more limited than those in which higher-
quality securities are traded. The existence of limited markets for these
securities may restrict the availability of securities for a Portfolio to
purchase and also may restrict the ability of a Portfolio to obtain accurate
market quotations for purposes of valuing securities and calculating net asset
value or to sell securities at their fair value. The public market for lower-
quality securities and comparable non-rated securities is relatively new and has
not fully weathered a major economic recession. Any such economic downturn could
adversely affect the ability of issuers' lower-quality securities to repay
principal and pay interest thereon.
While the market values of lower-quality securities and comparable non-rated
securities tend to react less to fluctuations in interest rate levels than do
those of higher-quality securities, the market values of certain of these
securities also tend to be more sensitive to individual corporate developments
and changes in economic conditions than higher-quality securities. In addition,
lower-quality securities and comparable non-rated securities generally present
a higher degree of credit risk. Issuers of lower-quality securities and
comparable non-rated securities are often highly leveraged and may not have
more traditional methods of financing available to them so that their ability
to service their debt obligations during an economic downturn or during
sustained periods of rising interest rates may be impaired. The risk of loss
due to default by such issuers is significantly greater because lower-quality
securities and comparable non-rated securities generally are unsecured and
frequently are subordinated to the prior payment of senior indebtedness. A
Portfolio may incur additional expenses to the extent that it is required to
seek recovery upon a default in the payment of principal or interest on its
portfolio holdings.
Fixed-income securities, including lower-quality securities and comparable
non-rated securities, frequently have call and buy-back features that permit
their issuers to call or repurchase the securities from their holders, such as
the Portfolios. If an issuer exercises these rights during periods of declining
interest rates, a Portfolio may have to replace the security with a lower
yielding security, resulting in a decreased return to the Portfolio.
In general, the ratings of nationally recognized statistical rating
organizations represent the opinions of these agencies as to the quality of
securities that they rate. Such ratings, however, are relative and subjective,
and are not absolute standards of quality and do not evaluate the market value
risk of the securities. It is possible that an agency might not change its
rating of a particular issue to reflect subsequent events. These ratings will
be used by each Portfolio as initial criteria for the selection of portfolio
securities, but each Portfolio also will rely upon the independent advice of
the Manager or the Sub-Adviser, as the case may be, to evaluate potential
investments.
In light of these risks, management will take various factors into
consideration in evaluating the creditworthiness of an issue, whether rated or
non-rated. These factors may include, among others, the issuer's financial
resources, its sensitivity to economic conditions and trends, the operating
history of and the community support for the facility financed by the issue,
the ability of the issuer's management and regulatory matters.
Securities Lending. Each Portfolio may seek to increase its net investment
income by lending portfolio securities to unaffiliated brokers, dealers and
other financial institutions, provided such loans are callable at any time and
are continuously secured by cash or U.S. Government securities or other high
grade liquid debt securities equal to no less than the market value, determined
daily, of the securities loaned. The risks in lending portfolio securities
consist of possible delay in receiving additional collateral or in the recovery
of the securities or possible loss of rights in the collateral should the
borrower fail financially.
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Repurchase Agreements. Each Portfolio may on occasion enter into repurchase
agreements, wherein the seller agrees to repurchase a security from the
Portfolio at an agreed-upon future date, normally the next business day. The
resale price is greater than the purchase price, which reflects the agreed-upon
rate of return for the period the Portfolio holds the security and which is not
related to the coupon rate on the purchased security. Each Portfolio requires
continual maintenance of the market value of the collateral in amounts at least
equal to the resale price, thus risk is limited to the ability of the seller to
pay the agreed-upon amount on the delivery date; however, if the seller
defaults, realization upon the collateral by the Portfolio may be delayed or
limited or the Portfolio might incur a loss if the value of the collateral
securing the repurchase agreement declines and might incur disposition costs in
connection with liquidating the collateral. Repurchase agreements are
considered loans by the Portfolios. The Portfolios will only enter into
repurchase agreements with broker/dealers or other financial institutions that
are deemed creditworthy by management, under guidelines approved by the Board
of Directors.
Dollar Roll Transactions. The Putnam Diversified Income Portfolio may enter
into "dollar rolls", in which the Portfolio sells fixed income securities for
delivery in the current month and simultaneously contracts to repurchase
substantially similar (same type, coupon and maturity) securities on a
specified future date. The MFS Total Return Portfolio may enter into similar
transactions pursuant to which the Portfolio sells mortgage-backed securities
for delivery in the future (generally within 30 days). During the roll period,
a Portfolio would forego principal and interest paid on such securities. The
Portfolio would be compensated by the difference between the current sales
price and the forward price for the future purchase, as well as by the interest
earned on the cash proceeds of the initial sale. Since a Portfolio will receive
interest on the securities in which it invests the transaction proceeds, such
transactions may involve leverage. However, since such securities must satisfy
the quality requirements of the Portfolio and will mature on or before the
settlement date on the transaction, management believes that such transactions
do not present the risks to the Portfolios that are associated with other types
of leverage. The MFS Total Return Portfolio will only enter into covered rolls,
where there is an offsetting cash position or a cash equivalent security
position which matures on or before the forward settlement date of the dollar
roll transaction. Dollar roll transactions are considered borrowings by the
Portfolios and will be subject to each Portfolio's overall borrowing
limitation. Dollar roll transactions are considered speculative.
When-Issued, Delayed Delivery and Forward Commitment Securities. Each
Portfolio may purchase or sell securities on a when-issued, delayed delivery or
forward commitment basis. Such transactions arise when securities are purchased
or sold by a Portfolio with payment and delivery taking place in the future in
order to secure what is considered to be an advantageous price and yield to the
Portfolio at the time of entering into the transaction. Purchasing such
securities involves the risk of loss if the value of the securities declines
prior to settlement date. The sale of securities for delayed delivery involves
the risk that the prices available in the market on the delivery date may be
greater than those obtained in the sale transaction. Each Portfolio's custodian
will maintain, in a segregated account on behalf of the Portfolio, cash, U.S.
Government securities or other liquid high-grade debt obligations having a value
equal to or greater than the Portfolio's purchase commitments; the custodian
will likewise segregate securities sold on a delayed basis.
Convertible Securities. Each Portfolio can invest in convertible securities.
Convertible securities are fixed-income securities that may be converted at
either a stated price or stated rate into underlying shares of common stock.
Convertible securities have general characteristics similar to both fixed-income
and equity securities. Although to a lesser extent than with fixed-income
securities, the market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. In addition, because of the conversion feature, the market value of
convertible securities tends to vary
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with fluctuations in the market value of the underlying common stocks and,
therefore, also will react to variations in the general market for equity
securities.
Convertible securities are investments which provide for a stable stream of
income with generally higher yields than common stocks. There can be no
assurance of current income because the issuers of the convertible securities
may default on their obligations. Synthetic convertible securities differ from
convertible securities in certain respects, including that each component of a
synthetic convertible security has a separate market value and responds
differently to market fluctuations. Investing in synthetic convertible
securities involves the risk normally involved in holding the securities
comprising the synthetic convertible security.
Borrowing. Each Portfolio may borrow from banks, on a secured or unsecured
basis.
Illiquid and Restricted Securities. Each Portfolio may purchase securities
that are not registered ("restricted securities") under the Securities Act of
1933, as amended (the "1933 Act"), but can be offered and sold to "qualified
institutional buyers" under Rule 144A under the 1933 Act ("Rule 144A"). Each
Portfolio may also invest a portion of its assets in illiquid investments,
which include repurchase agreements maturing in more than seven days and
restricted securities. The Board of Directors may determine, based upon a
continuing review of the trading markets for the specific restricted security,
that such restricted securities are liquid. The Board of Directors has adopted
guidelines and delegated to management the daily function of determining and
monitoring liquidity of restricted securities available pursuant to Rule 144A.
The Board, however, retains sufficient oversight and is ultimately responsible
for the determinations. Since it is not possible to predict with assurance
exactly how the market for Rule 144A restricted securities will develop, the
Board will carefully monitor each Portfolio's investments in these securities,
focusing on such important factors, among others, as valuation, liquidity and
availability of information. Investments in restricted securities could have
the effect of increasing the level of illiquidity in a Portfolio to the extent
that qualified institutional buyers become for a time uninterested in
purchasing these restricted securities. The Portfolios may also purchase
restricted securities that are not registered under Rule 144A.
Zero-Coupon Bonds, Deferred Interest Bonds and Payment-in-Kind Bonds. Each
Portfolio may invest in zero-coupon and payment-in-kind bonds. The MFS Total
Return and Putnam Diversified Income Portfolios also may each invest in
deferred interest bonds. Zero-coupon and deferred interest bonds are issued at
a significant discount from their principal amount. While zero-coupon bonds do
not require the periodic payment of interest, deferred interest bonds provide
for a period of delay before the regular payment of interest begins.
Payment-in-kind bonds allow the issuer, at its option, to make current interest
payments on the bonds either in cash or in additional bonds. The value of
zero-coupon bonds is subject to greater fluctuation in market value in response
to changes in market interest rates than bonds of comparable maturity which pay
interest currently. Both zero-coupon and payment-in-kind bonds allow an issuer
to avoid the need to generate cash to meet current interest payments.
Accordingly, such bonds may involve greater credit risks than bonds that pay
interest currently. Even though such bonds do not pay current interest in cash,
the Portfolio is nonetheless required to accrue interest income on such
investments and to distribute such amounts at least annually to shareholders.
Accordingly, for a Portfolio to continue to qualify for tax treatment as a
regulated investment company and to avoid certain excise taxes, the Portfolio
may be required to distribute as a dividend an amount that is greater than the
total amount of cash it actually receives. These distributions must be made
from the Portfolio's cash assets or, if necessary, from the proceeds of sales
of portfolio securities. The Portfolio will not be able to purchase additional
income-producing securities with cash used to make such distributions and its
current income ultimately may be reduced as a result.
Futures, Options and Currency Transactions. Consistent with its investment
objective and policies, each Portfolio may enter into contracts for the
purchase or sale for future delivery of fixed-income securities,
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foreign currencies or contracts based on financial indices including interest
rates or an index of U.S. Government or foreign government securities or equity
or fixed-income securities ("futures contracts"), and may buy and write put and
call options to buy or sell futures contracts ("options on futures contracts").
When a Portfolio buys or sells a futures contract it incurs a contractual
obligation to receive or deliver the underlying instrument (or a cash payment
based on the difference between the underlying instrument's closing price and
the price at which the contract was entered into) at a specified price on a
specified date. An option on a futures contract gives a Portfolio the right (but
not the obligation) to buy or sell a futures contract at a specified price on or
before a specified date.
The Portfolios will not enter into transactions in futures contracts and
options on futures contracts for speculation and will not enter into such
transactions other than to hedge against potential changes in interest or
currency exchange rates or the price of a security or a securities index which
might correlate with or otherwise adversely affect either the value of the
Portfolio's securities or the prices of securities which the Portfolio is
considering buying at a later date. The MFS Total Return Portfolio, however, may
enter into futures contracts and options on futures contracts for non-hedging
purposes, provided that the aggregate initial margin and premiums on such non-
hedging positions does not exceed 5% of the liquidation value of the Portfolio's
assets.
Although futures contracts by their terms call for the delivery or acquisition
of the underlying commodities or a cash payment based on the value of the
underlying commodities, in most cases the contractual obligation is offset
before the delivery date of the contract by buying, in the case of a contractual
obligation to sell, or selling, in the case of a contractual obligation to buy,
an identical futures contract on a commodities exchange. Such a transaction
cancels the obligation to make or take delivery of the commodities. Since all
transactions in the futures market are made through a member of, and are offset
or fulfilled through a clearinghouse associated with, the exchange on which the
contracts are traded, a Portfolio will incur brokerage fees when it buys or
sells futures contracts.
A Portfolio will not (1) enter into any futures contracts or options on
futures contracts if immediately thereafter the aggregate margin deposits on all
outstanding futures contracts positions held by the Portfolio and premiums paid
on outstanding options on futures contracts, after taking into account
unrealized profits and losses, would exceed 5% of the market value of the total
assets of the Portfolio or (2) enter into any futures contracts or options on
futures contracts if the aggregate amount of the Portfolio's commitments under
outstanding futures contracts positions and options on futures contracts written
by the Portfolio would exceed the market value of the total assets of the
Portfolio. See the Statement of Additional Information for further discussion of
the use, risks and costs associated with futures contracts and options on
futures contracts.
Forward Currency Transactions. Each Portfolio may enter into forward
foreign currency exchange contracts ("forward currency contracts") to attempt to
minimize the risk to the Portfolio from adverse changes in the relationship
between the U.S. dollar and other currencies. A forward currency contract is an
obligation to buy or sell an amount of a specified currency for an agreed price
(which may be in U.S. dollars or a foreign currency) at a future date which is
individually negotiated between currency traders and their customers. A
Portfolio may enter into a forward currency contract, for example, when it
enters into a contract to buy or sell a security denominated in a foreign
currency in order to "lock in" the U.S. dollar price of the security
("transaction hedge"). Additionally, when a Portfolio believes that a foreign
currency in which the portfolio securities are denominated may suffer a
substantial decline against the U.S. dollar, the Portfolio may enter into a
forward currency contract to sell an amount of that foreign currency
approximating the value of some or all of the portfolio securities denominated
in that currency, or, when the Portfolio believes that the U.S. dollar may
suffer a substantial decline against a foreign currency, the Portfolio may enter
into a forward
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currency contract to buy that foreign currency for a fixed U.S. dollar amount
("position hedge"). A Portfolio also may enter into a forward currency contract
with respect to a currency where the Portfolio is considering the purchase of
investments denominated in that currency but has not yet done so ("anticipatory
hedge"). In any of these circumstances the Portfolio may, alternatively, enter
into a forward currency contract with respect to a different foreign currency
when the Portfolio believes that the U.S. dollar value of that currency will
correlate with the U.S. dollar value of the currency in which portfolio
securities of, or being considered for purchase by, the Portfolio are
denominated ("cross hedge"). A Portfolio may invest in forward currency
contracts with stated contract values of up to the value of the Portfolio's
assets. The MFS Total Return Portfolio may also enter into forward currency
contracts for non-hedging purposes, subject to applicable law.
A Portfolio also may enter into forward contracts to buy or sell at a later
date instruments in which the Portfolio may invest directly or on financial
indices based on those instruments. The market for those types of forward
contracts is developing and it is not currently possible to identify
instruments on which forward contracts might be created in the future. See the
Statement of Additional Information for further discussion of the use, risks
and costs of forward contracts.
A Portfolio may also enter into currency swaps where each party exchanges
one currency for another on a particular date and agrees to reverse the
exchange on a later date at a specific exchange rate.
Currency Risks. The Portfolios that invest substantially in securities
denominated in currencies other than the U.S. dollar, or that hold foreign
currencies, will be affected favorably or unfavorably by exchange control
regulations or changes in the exchange rates between such currencies and the
U.S. dollar. Changes in currency exchange rates will influence the value of
each Portfolio's shares and also may affect the value of dividends and interest
earned by the Portfolios and gains and losses realized by the Portfolios.
Currencies generally are evaluated on the basis of fundamental economic
criteria (e.g., relative inflation and interest rate levels and trends, growth
rate forecasts, balance of payments status and economic policies) as well as
technical and political data. The exchange rates between the U.S. dollar and
other currencies are determined by supply and demand in the currency exchange
markets, the international balance of payments, governmental intervention,
speculation and other economic and political conditions. If the currency in
which a security is denominated appreciates against the U.S. dollar, the dollar
value of the security will increase. Conversely, a decline in the exchange rate
of the currency would adversely affect the value of the security expressed in
U.S. dollars.
Options on Securities and on Foreign Currencies. In an effort to reduce
fluctuations in net asset value or to increase its portfolio return, the
Portfolios may write covered put and call options and may buy put and call
options and warrants on securities traded on U.S. and foreign securities
exchanges. The purpose of such transactions is to hedge against changes in the
market value of portfolio securities caused by fluctuating interest rates,
fluctuating currency exchange rates and changing market conditions, and to
close out or offset existing positions in such options or futures contracts as
described below. A Portfolio may write and buy options on the same types of
securities that the Portfolio could buy directly and may buy options on
financial indices as described above with respect to futures contracts. There
are no specific limitations on the writing and buying of options on securities.
A put option gives the holder the right, upon payment of a premium, to
deliver a specified amount of a security to the writer of the option on or
before a fixed date at a predetermined price. A call option gives the holder
the right, upon payment of a premium, to call upon the writer to deliver a
specified amount of a security on or before a fixed date at a predetermined
price.
A call option is "covered" if a Portfolio owns the underlying security
covered by the call. If a "covered" call option expires unexercised, the writer
realizes a gain in the amount of the premium received. If the covered
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call option is exercised, the writer realizes either a gain or loss from the
sale or purchase of the underlying security with the proceeds to the writer
being increased by the amount of the premium. Prior to its expiration, a call
option may be closed out by means of a purchase of an identical option. Any gain
or loss from such transaction will depend on whether the amount paid is more or
less than the premium received for the option plus related transaction costs. A
Portfolio also may write a covered call option to cross-hedge if the Portfolio
does not own the underlying security. The option is designed to provide a hedge
against a decline in value in another security which the Portfolio owns or has
the right to acquire.
In purchasing an option, the Portfolio would be in a position to realize a
gain if, during the option period, the price of the underlying security
increased (in the case of a call) or decreased (in the case of a put) by an
amount in excess of the premium paid and would realize a loss if the price of
the underlying security did not increase (in the case of a call) or decrease
(in the case of a put) during the period by more than the amount of the
premium. If a put or call option bought by the Portfolio were permitted to
expire without being sold or exercised, the Portfolio would lose the amount of
the premium.
Although they entitle the holder to buy equity securities, warrants on and
options to purchase equity securities do not entitle the holder to dividends or
voting rights with respect to the underlying securities, nor do they represent
any rights in the assets of the issuer of those securities.
If a put or call option written by a Portfolio were exercised, the Portfolio
would be obligated to buy or sell the underlying security at the exercise
price. Writing a put option involves the risk of a decrease in the market value
of the underlying security, in which case the option could be exercised and the
underlying security would then be sold by the option holder to the Portfolio at
a higher price than its current market value. Writing a call option involves
the risk of an increase in the market value of the underlying security, in
which case the option could be exercised and the underlying security would then
be sold by the Portfolio to the option holder at a lower price than its current
market value. Those risks could be reduced by entering into an offsetting
transaction. The Portfolio retains the premium received from writing a put or
call option whether or not the option is exercised.
A Portfolio may buy put and call options and may write covered put and call
options on foreign currencies to hedge against declines in the U.S. dollar
value of foreign currency-denominated securities held by the Portfolio and
against increases in the U.S. dollar cost of foreign currency-denominated
securities being considered for purchase by the Portfolio. As in the case of
other options, however, the writing of an option on a foreign currency will
constitute only a partial hedge, up to the amount of the premium received, and
the Portfolio could be required to buy or sell foreign currencies at
disadvantageous exchange rates, thereby incurring losses. The purchase of an
option on a foreign currency may constitute an effective hedge against
fluctuations in exchange rates, although, in the event of rate movements
adverse to the Portfolio's options position, the option may expire worthless
and the Portfolio will lose the amount of the premium. There is no specific
percentage limitation on a Portfolio's investments in options on foreign
currencies.
A Portfolio may buy or write options in privately negotiated transactions on
the types of securities and indices based on the types of securities in which
the Portfolio is permitted to invest directly. The Portfolio will effect such
transactions only with investment dealers and other financial institutions
(such as commercial banks or savings and loan institutions) deemed
creditworthy, and only pursuant to procedures adopted by management for
monitoring the creditworthiness of those entities. To the extent that an option
bought or written by the Portfolio in a negotiated transaction is illiquid, the
value of an option bought or the amount of the Portfolio's obligations under an
option written by the Portfolio, as the case may be, will be subject to the
Portfolio's limitation on illiquid investments. In the case of illiquid
options, it may not be possible for the
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Portfolio to effect an offsetting transaction at a time when management believes
it would be advantageous for the Portfolio to do so. See the Statement of
Additional Information for a further discussion of the use, risks and costs of
option trading.
Swaps and Swap-Related Products. As one way of managing its exposure to
different types of investments, the MFS Total Return Portfolio may enter into
interest rate swaps, currency swaps and other types of available swap
agreements, such as caps, collars and floors. Swaps involve the exchange by the
Portfolio with another party of cash payments based upon different interest
rate indexes, currencies, and other prices or rates, such as the value of
mortgage prepayment rates. For example, in the typical interest rate swap, the
Portfolio might exchange a sequence of cash payments based on a floating rate
index for cash payments based on a fixed rate. Payments made by both parties to
a swap transaction are based on a principal amount determined by the parties.
The MFS Total Return Portfolio may also purchase and sell caps, floors and
collars. In a typical cap or floor agreement, one party agrees to make payments
only under specified circumstances, usually in return for payment of a fee by
the counterparty. For example, the purchase of an interest rate cap entitles
the buyer, to the extent that a specified index exceeds a predetermined
interest rate, to receive payments of interest on a contractually-based
principal amount from the counterparty selling such interest rate cap. The sale
of an interest rate floor obligates the seller to make payments to the extent
that a specified interest rate falls below an agreed-upon level. A collar
arrangement combines elements of buying a cap and selling a floor.
Swap agreements will tend to shift the Portfolio's investment exposure from
one type of investment to another. For example, if the Portfolio agreed to
exchange payments in dollars for payments in foreign currency, in each case
based on a fixed rate, the swap agreement would tend to decrease the
Portfolio's exposure to U.S. interest rates and increase its exposure to
foreign currency and interest rates. Caps and floors have an effect similar to
buying or writing options. Depending on how they are used, swap agreements may
increase or decrease the overall volatility of the Portfolio's investments and
its share price and yield.
Swap agreements are sophisticated hedging instruments that typically involve
a small investment of cash relative to the magnitude of risks assumed. As a
result, swaps can be highly volatile and may have a considerable impact on the
Portfolio's performance. Swap agreements are subject to risks related to the
counterparty's ability to perform, and may decline in value if the
counterparty's creditworthiness deteriorates. The Portfolio may also suffer
losses if it is unable to terminate outstanding swap agreements or reduce its
exposure through offsetting transactions.
Swaps, caps, floors and collars are highly specialized activities which
involve certain risks. See the Statement of Additional Information for a
further discussion on the risks involved in these activities.
Special Investment Considerations and Risks With Respect to Futures, Options
and Currency Transactions and Swaps and Swap-Related Products. The successful
use of the investment practices described above with respect to futures
contracts, options on futures contracts, forward contracts, options on
securities and on foreign currencies, and swaps and swap-related products draws
upon skills and experience which are different from those needed to select the
other instruments in which the Portfolio invests. Should interest or exchange
rates or the prices of securities or financial indices move in an unexpected
manner, a Portfolio may not achieve the desired benefits of futures, options,
swaps and forwards or may realize losses and thus be in a worse position than
if such strategies had not been used. Unlike many exchange-traded futures
contracts and options on futures contracts, there are no daily price
fluctuation limits with respect to options on currencies, forward contracts and
other negotiated or over-the-counter instruments, and adverse market movements
could therefore continue to an unlimited extent over a period of time. In
addition, the
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correlation between movements in the price of the securities and currencies
hedged or used for cover will not be perfect and could produce unanticipated
losses.
With respect to interest rate swaps, each Portfolio recognizes that such
arrangements are relatively illiquid and will include the principal amount of
the obligations owed to it under a swap as an illiquid security for purposes of
the Portfolio's investment restrictions except to the extent a third party
(such as a large commercial bank) has guaranteed the Portfolio's ability to
offset the swap at any time.
A Portfolio's ability to dispose of its positions in the foregoing
instruments will depend on the availability of liquid markets in the
instruments. Markets in a number of the instruments are relatively new and
still developing, and it is impossible to predict the amount of trading
interest that may exist in those instruments in the future. Particular risks
exist with respect to the use of each of the foregoing instruments and could
result in such adverse consequences to the Portfolio as the possible loss of
the entire premium paid for an option bought by the Portfolio, the inability of
the Portfolio, as the writer of a covered call option, to benefit from the
appreciation of the underlying securities above the exercise price of the
option and the possible need to defer closing out positions in certain
instruments to avoid adverse tax consequences. As a result, no assurance can be
given that the Portfolio will be able to use those instruments effectively for
the purposes set forth above. See the Statement of Additional Information for a
further discussion of the use, risks and costs of these instruments.
In connection with its transactions in futures, options, swaps and forwards,
each Portfolio may be required to place assets in a segregated account with the
Portfolio's custodian bank to ensure that the Portfolio will be able to meet
its obligations under these instruments. Assets held in a segregated account
generally may not be disposed of for so long as the Portfolio maintains the
positions giving rise to the segregation requirement. Segregation of a large
percentage of the Portfolio's assets could impede implementation of the
Portfolio's investment policies or the Portfolio's ability to meet redemption
requests or other current obligations.
Mortgage-Backed Securities. The Putnam Diversified Income Portfolio and the
MFS Total Return Portfolio may invest in mortgage-backed securities, which
represent pools of mortgage loans assembled for sale to investors by various
governmental agencies and government-related organizations, such as Government
National Mortgage Association ("GNMA"), Federal National Mortgage Association
("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"), as well as by
private issuers such as commercial banks, savings and loan institutions,
mortgage bankers and private mortgage insurance companies. Mortgage-backed
securities provide a monthly payment consisting of interest and principal
payments. Additional payment may be made out of unscheduled repayments of
principal resulting from the sale of the underlying residential property,
refinancing or foreclosure, net of fees or costs that may be incurred.
Prepayments of principal on mortgage-backed securities may tend to increase due
to refinancing of mortgages as interest rates decline. Prompt payment of
principal and interest on GNMA mortgage pass through certificates is backed by
the full faith and credit of the United States. FNMA guaranteed mortgage
pass-through certificates are solely the obligations of those entities but are
supported by the discretionary authority of the U.S Government to purchase the
agencies' obligations. Mortgage pools created by private organizations
generally offer a higher rate of interest than governmental and
government-related pools because there are no direct or indirect guarantees of
payments in the former pools. Timely payment of interest and principal in these
pools, however, may be supported by various forms of private insurance or
guarantees, including individual loan, title, pool and hazard insurance. There
can be no assurance that the private insurers can meet their obligations under
the policies.
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Collateralized mortgage obligations are a type of bond secured by an
underlying pool of mortgages or mortgage pass-through certificates that are
structured to direct payments on underlying collateral to different series of
classes of the obligations.
To the extent that each Portfolio purchases mortgage-related securities at a
premium, mortgage foreclosures and prepayments of principal (which may be made
at any time without penalty) may result in some loss of the Portfolio's
principal investment to the extent of the premium paid. The yield of a
Portfolio that invests in mortgage-related securities may be affected by
reinvestment of prepayments at higher or lower rates than the original
investment. In addition, like other debt securities, the values of
mortgage-related securities, including government and government related
mortgage pools, generally will fluctuate in response to market interest rates.
Other Asset-Backed Securities. The Putnam Diversified Income Portfolio and
the MFS Total Return Portfolio may invest in asset-backed securities arising
through the grouping by governmental, government-related and private
organizations of loans, receivables and other assets originated by various
lenders. Interests in pools of these assets differ from other forms of debt
securities, which normally provide for periodic payment of interest in fixed
amounts with principal paid at maturity or specified call dates. Instead,
asset-backed securities provide periodic payments which generally consist of
both interest and principal payments.
The estimated life of an asset-backed security varies with the prepayment
experience with respect to the underlying debt instruments. The rate of such
prepayments, and hence the life of an asset-backed security, will be primarily
a function of current market interest rates, although other economic and
demographic factors may be involved. For example, falling interest rates
generally result in an increase in the rate of prepayments of mortgage loans
while rising interest rates generally decrease the rate of prepayments. An
acceleration in prepayments in response to sharply falling interest rates will
shorten the security's average maturity and limit the potential appreciation in
the security's value relative to a conventional debt security. Consequently,
asset-backed securities are not as effective in locking in high long-term
yields. Conversely, in periods of sharply rising rates, prepayments generally
slow, increasing the security's average life and its potential for price
depreciation.
U.S. Government Securities. Each Portfolio may invest in U.S. Government
securities, which are debt obligations issued or guaranteed as to payment of
principal and interest by the U.S. Government (including Treasury bills, notes
and bonds, certain mortgage participation certificates and collateralized
mortgage obligations) or by its agencies and instrumentalities (such as GNMA,
the Student Loan Marketing Association, the Tennessee Valley Authority, the
Bank for Cooperatives, the Farmers Home Administration, Federal Farm Credit
Banks, Federal Home Loan Banks, Federal Intermediate Credit Banks, Federal Land
Banks, the Export-Import Bank of the U.S., the Federal Housing Administration,
FHLMC, the U.S. Postal Service, the Federal Financing Bank and FNMA). Some of
these securities (such as Treasury bills) are supported by the full faith and
credit of the U.S. Treasury; others (such as obligations of the Federal Home
Loan Bank) are supported by the right of the issuer to borrow from the
Treasury; while still others (such as obligations of FNMA and the Student Loan
Marketing Association) are supported only by the credit of the instrumentality.
Portfolio Turnover. Although it is anticipated that most investments of
each Portfolio will be long-term in nature, the rate of portfolio turnover will
depend upon market and other conditions, and it will not be a limiting factor
when management believes that portfolio changes are appropriate. Each
Portfolio's historical portfolio turnover rates are included in the Financial
Highlights tables above. A higher rate of portfolio turnover may result in
higher transaction costs, including brokerage commissions.
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DIVIDENDS, DISTRIBUTIONS AND TAXES
================================================================================
Each Portfolio of the Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Code. To qualify, each Portfolio must meet
certain tests, including distributing at least 90% of its investment company
taxable income, and deriving less than 30% of its gross income from the sale or
other disposition of certain investments held for less than three months. Each
Portfolio intends at least annually to declare and make distributions of
substantially all of its taxable income and net taxable capital gains to its
shareowners (i.e. the Separate Accounts). Such distributions are automatically
reinvested in additional shares of the Portfolio at net asset value and are
includable in gross income of the Separate Accounts holding such shares. See
the accompanying Contract prospectus for information regarding the federal
income tax treatment of distributions to the Separate Accounts and to holders
of the Contracts.
Each Portfolio of the Fund is also subject to asset diversification
regulations promulgated by the U.S. Treasury Department under the Code. The
regulations generally provide that, as of the end of each calendar quarter or
within 30 days thereafter, no more than 55% of the total assets of each
Portfolio may be represented by any one investment, no more than 70% by any two
investments, no more than 80% by any three investments, and no more than 90% by
any four investments. For this purpose all securities of the same issuer are
considered a single investment. If a Portfolio should fail to comply with these
regulations, Contracts invested in that Portfolio would not be treated as
annuity, endowment or life insurance contracts under the Code.
REDEMPTION OF SHARES
================================================================================
The redemption price of the shares of each Portfolio will be the net asset
value next determined after receipt by the Fund of a redemption order from a
Separate Account, which may be more or less than the price paid for the shares.
The Fund will ordinarily make payment within one business day, though
redemption proceeds must be remitted to a Separate Account on or before the
third day following receipt of proper tender, except on a day on which the New
York Stock Exchange is closed or as permitted by the SEC in extraordinary
circumstances.
PERFORMANCE
================================================================================
From time to time the Fund may include a Portfolio's total return, average
annual total return, yield and current distribution return in advertisements
and/or other types of sales literature. These figures are based on historical
earnings and are not intended to indicate future performance. In addition,
these figures will not reflect the deduction of the charges that are imposed on
the Contracts by the Separate Account (see Contract prospectus) which, if
reflected, would reduce the performance quoted. Total return is computed for a
specified period of time assuming reinvestment of all income dividends and
capital gains distributions at net asset value on the ex-dividend dates at
prices calculated as stated in this Prospectus, then dividing the value of the
investment at the end of the period so calculated by the initial amount
invested and subtracting 100%. The standard average annual total return, as
prescribed by the SEC, is derived from this total return, which provides the
ending redeemable value. Such standard total return information may also be
accompanied with nonstandard total return information over different periods of
time by means of aggregate, average, year-by-year, or other types of total
return figures. The yield of a Portfolio refers to the net investment income
earned by investments in the Portfolio over a thirty-day period. This net
investment income is then annualized, i.e., the amount of income earned by the
investments during that thirty-day period is assumed to be earned each 30-day
period for twelve periods and is expressed as a percentage of the investments.
The yield quotation is calculated according to a formula prescribed by the SEC
to facilitate comparison with yields quoted by other investment companies. The
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Fund calculates current distribution return for each Portfolio by dividing the
distributions from investment income declared during the most recent period by
the net asset value on the last day of the period for which current
distribution return is presented. A Portfolio's current distribution return may
vary from time to time depending on market conditions, the composition of its
investment portfolio and operating expenses. These factors and possible
differences in the methods used in calculating current distribution return, and
the charges that are imposed on the Contracts by the Separate Account, should
be considered when comparing the Portfolio's current distribution return to
yields published for other investment companies and other investment vehicles.
MANAGEMENT
================================================================================
Travelers Investment Adviser, Inc.
Travelers Investment Adviser, Inc. (the "Manager") manages the investment
operations of each Portfolio pursuant to management agreements entered into by
the Fund on behalf of each Portfolio. Under each management agreement the
Manager is responsible for furnishing or causing to be furnished to each
Portfolio advice and assistance with respect to the acquisition, holding or
disposal of investments and recommendations with respect to other aspects and
affairs of each Portfolio, office space and equipment, and the services of the
officers and employees of the Fund. The Manager has entered into a Sub-
Administrative Services Agreement with an affiliate (the "Sub-Administrator")
to: (a) assist the Manager in supervising all aspects of the Portfolios'
operations; (b) supply each Portfolio with office facilities, statistical and
research services, data processing services, clerical, accounting and
bookkeeping services; and (c) prepare reports to each Portfolio's shareholders,
reports to and filings with the SEC and state blue sky authorities, if
applicable. The Manager will pay the Sub-Administrator a fee, from the
management fee, in an amount equal to an annual rate of 0.10% of each
Portfolio's average daily net assets.
The Fund and the Manager have also entered into subadvisory agreements on
behalf of each Portfolio (see "The Sub-Advisers" below). Pursuant to each
subadvisory agreement, each sub-investment adviser ("Sub-Adviser") is
responsible for the day-to-day operations and investment decisions for the
respective Portfolio and is authorized, in its discretion and without prior
consultation with the Manager, to: (a) manage the Portfolio's assets in
accordance with the Portfolio's investment objective(s) and policies as stated
in the Prospectus and the Statement of Additional Information; (b) make
investment decisions for the Portfolio; (c) place purchase and sale orders for
portfolio transactions on behalf of the Portfolio; and (d) employ professional
portfolio managers and securities analysts who provide research services to the
Portfolio.
For the services provided by the Manager, each Portfolio pays the Manager an
annual management fee calculated at a rate equal to the following percentage of
its average daily net assets, paid monthly.
Alliance Growth Portfolio 0.80%
Putnam Diversified Income Portfolio 0.75%
MFS Total Return Portfolio 0.80%
Although the management fee paid by each Portfolio is greater than that paid
by most mutual funds, management has determined that each fee is comparable to
the fee charged by other investment advisers of mutual funds that have similar
investment objectives and policies.
Each management agreement further provides that all other expenses not
specifically assumed by the Manager under the management agreement on behalf of
a Portfolio are borne by the Fund. Expenses payable by the Fund include, but
are not limited to, all charges of custodians and shareholder servicing
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agents, expenses of preparing, printing and distributing all prospectuses, proxy
material, reports and notices to shareholders, all expenses of shareholders' and
directors' meetings, filing fees and expenses relating to the registration and
qualification of the Fund's shares and the Fund under federal and state
securities laws and maintaining such registrations and qualifications (including
the printing of the Fund's registration statements), fees of auditors and legal
counsel, costs of performing portfolio valuations, out-of-pocket expenses of
directors and fees of directors who are not "interested persons" as defined in
the 1940 Act, interest, taxes and governmental fees, fees and commissions of
every kind, expenses of issue, repurchase or redemption of shares, insurance
expense, association membership dues, all other costs incident to the Fund's
existence and extraordinary expenses such as litigation and indemnification
expenses. Direct expenses are charged to each of the Fund's Portfolios; general
corporate expenses are allocated on the basis of relative net assets.
The Manager was incorporated in 1996 under the laws of Delaware. It is an
indirect wholly-owned subsidiary of Travelers Group Inc. ("Travelers"), which
is a financial services holding company engaged, through its subsidiaries,
principally in four business segments: investment services, consumer finance
services, life insurance services and property & casualty insurance services.
The Manager is located at 388 Greenwich Street, New York, New York 10013. The
Manager and its affiliates may in the future act as investment advisers for
other accounts.
The Sub-Advisers
Alliance Capital Management L.P. Alliance Capital Management L.P. ("Alliance
Capital") will serve as Sub-Adviser to the Alliance Growth Portfolio and will
manage the day to day operations of the Portfolio pursuant to a subadvisory
agreement. Pursuant to the subadvisory agreement the Manager pays Alliance
Capital an annual fee calculated at the rate of 0.375% of the Portfolio's
average daily net assets, paid monthly.
Alliance Capital is a Delaware limited partnership with principal offices at
1345 Avenue of the Americas, New York, New York 10105. It is a major
international investment manager, supervising client accounts with assets as of
October 31, 1995 totaling more than $144 billion. Alliance Capital serves its
clients, who primarily are major corporate employee benefit funds, public
employee retirement systems, investment companies, foundations and endowment
funds, with a staff of more than 1,400 employees operating out of five domestic
offices and the overseas offices of five subsidiaries. The 50 registered
investment companies managed by Alliance Capital comprising 100 separate
investment portfolios currently have over one million shareholders.
Alliance Capital Management Corporation ("ACMC") the sole general partner of
Alliance Capital, is an indirect wholly-owned subsidiary of The Equitable Life
Assurance Society of the United States, one of the largest life insurance
companies in the United States, which is itself a wholly-owned subsidiary of
The Equitable Companies Incorporated, a holding company controlled by AXA, a
member of a large French insurance group. AXA is indirectly controlled by a
group of five mutual insurance companies.
Tyler Smith, who is a Senior Vice President of Alliance Capital, is the
portfolio manager of the Alliance Growth Portfolio and is principally
responsible for the Portfolio's investment program. Prior to joining Alliance
Capital in July 1993, Mr. Smith was employed by Equitable Capital Management
Corporation ("Equitable Capital"), or its affiliates for more than 20 years.
Massachusetts Financial Services Company. Massachusetts Financial Services
Company ("MFS") serves as Sub-Adviser to the MFS Total Return Portfolio
pursuant to a subadvisory agreement. Pursuant to
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the subadvisory agreement the Manager pays MFS an annual fee calculated at the
rate of 0.375% of the Portfolio's average daily net assets.
MFS also serves as investment adviser to each of the funds in the MFS Family
of Funds and to MFS/Sun Life Series Trust, MFS Institutional Trust, MFS
Variable Insurance Trust, MFS Union Standard Trust, MFS Municipal Income Trust,
MFS Government Markets Income Trust, MFS Multimarket Income Trust, MFS
Intermediate Income Trust, MFS Charter Income Trust, MFS Special Value Trust,
Sun Growth Variable Annuity Fund, Inc. and seven variable accounts, each of
which is a registered investment company established by Sun Life Assurance
Company of Canada (U.S.)("Sun Life of Canada (U.S.)") in connection with the
sale of various fixed/variable annuity contracts. MFS and its wholly owned
subsidiary, MFS Asset Management, Inc., also provide investment advice to
substantial private clients.
MFS is located at 500 Boylston Street, Boston, Massachusetts 02116. MFS is
America's oldest mutual fund organization. MFS and its predecessor
organizations have a history of money management dating from 1924 and the
founding of the first mutual fund in the United States, Massachusetts Investors
Trust. Net assets under the management of the MFS organization were
approximately $42.2 billion on behalf of approximately 1.8 million investors
accounts as of December 31, 1995. As of such date, the MFS organization managed
approximately $20.6 billion of assets in fixed income securities. MFS is a
wholly owned subsidiary of Sun Life of Canada (U.S.) which in turn is a wholly
owned subsidiary of Sun Life Assurance Company of Canada ("Sun Life"). Sun
Life, a mutual life insurance company, is one of the largest international life
insurance companies and has been operating in the U.S. since 1895, establishing
a headquarters office here in 1973. The executive officers of MFS report to the
Chairman of Sun Life.
David M. Calabro, a Vice President of MFS, Geoffrey L. Kurinsky, a Senior
Vice President of MFS, Judith N. Lamb, a Vice President of MFS, Lisa B. Nurme,
a Vice President of MFS, and Maura A. Shaughnessy, a Vice President of MFS, are
the Fund's portfolio managers. Mr. Calabro is the head of this portfolio
management team and a manager of the common stock portion of the Fund's
portfolio. Mr. Calabro has been employed by MFS since 1992 and served as an
analyst and sector portfolio manager with Fidelity Investments prior to that
time. Mr. Kurinsky, the manager of the Fund's fixed income securities, has been
employed by MFS since 1987. Ms. Lamb, the manager of the Fund's convertible
securities, has been employed by MFS since 1992, and served as an analyst with
Fidelity Investments prior to that time. Ms. Nurme, a manager of the common
stock portion of the Fund's portfolio, has been employed by MFS since 1987. Ms.
Shaughnessy, also a manager of the common stock portion of the Fund's
portfolio, has been employed by MFS since 1991 and served as an analyst with
Harvard Management Company prior to that time.
MFS has established a strategic alliance with Foreign & Colonial Management
Ltd. ("Foreign & Colonial"). Foreign & Colonial is a subsidiary of two of the
world's oldest financial services institutions, the London-based Foreign &
Colonial Investment Trust PLC, which pioneered the idea of investment
management in 1868, and HYPO-BANK (Bayerische Hypotheken-und Weschsel-Bank AG),
the oldest publicly listed bank in Germany, founded in 1835. As part of this
alliance, the portfolio managers and investment analysts of MFS and Foreign &
Colonial will share their views on a variety of investment related issues, such
as the economy, securities markets, portfolio securities and their issuers,
investment recommendations, strategies and techniques, risk analysis, trading
strategies and other portfolio management matters. MFS will have access to the
extensive international equity investment expertise of Foreign & Colonial, and
Foreign & Colonial will have access to the extensive U.S. equity investment
expertise of MFS. One or more MFS investment analysts are expected to work for
an extended period with Foreign & Colonial's portfolio managers and investment
analysts at their offices in London. In return, one or more Foreign & Colonial
employees are expected to work in a similar manner at MFS' Boston offices.
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In certain instances there may be securities which are suitable for the
Fund's portfolio as well as for portfolios of other clients of MFS or clients
of Foreign & Colonial. Some simultaneous transactions are inevitable when
several clients receive investment advice from MFS and Foreign & Colonial,
particularly when the same security is suitable for more than one client. While
in some cases this arrangement could have a detrimental effect on the price or
availability of the security as far as the Fund is concerned, in other cases,
however, it may produce increased investment opportunities for the Fund.
Putnam Investment Management, Inc. Putnam Investment Management, Inc.
("Putnam Management") will serve as Sub-Adviser to the Putnam Diversified
Income Portfolio pursuant to a subadvisory agreement. Pursuant to the
subadvisory agreement the Manager pays Putnam Management an annual fee
calculated at the rate of 0.35% of the Portfolio's average daily net assets,
paid monthly.
Putnam Management principal offices are located at One Post Office Square,
Boston, Massachusetts 02109. Putnam is wholly-owned subsidiary of Putnam
Investments, Inc., a holding company which is in turn wholly owned by Marsh &
McLennan Companies, Inc., a publicly owned holding company whose principal
businesses are international insurance and reinsurance brokerage, employee
benefit consulting and investment management.
Putnam has been managing mutual funds since 1937. The firm serves as the
investment manager for the funds in the Putnam family, with approximately $93
billion in assets in over three million shareholder accounts as of December 31,
1995. The Putnam Advisory Company, Inc., an affiliate, manages domestic and
foreign institutional accounts and foreign mutual funds. Another affiliate,
Putnam Fiduciary Trust Company, provides investment advice to institutional
clients under its banking and fiduciary powers. Putnam and its affiliates
managed over $125 billion in assets as of December 31, 1995.
Rosemary H. Thomsen, Senior Vice President of Putnam Management, D. William
Kohli, Senior Vice President of Putnam Management and Neil J. Powers, Vice
President of Putnam Management are primarily responsible for the day-to-day
management of the Portfolio. Mr. Thomsen and Mr. Powers have been employed by
Putnam Management since 1986. Mr. Kohli has been employed by Putnam Management
since September, 1994. Prior to September, 1994, Mr. Kohli was Executive Vice
President and Co-Director of Global Bond Management and Senior Portfolio
Manager from 1988 to 1993 at Franklin Advisors/Templeton Investment Counsel.
Portfolio Transactions and Distribution
The Manager and each Sub-Adviser are subject to the supervision and
direction of the Fund's Board of Directors and manage the applicable Portfolio
in accordance with its investment objective and policies, make investment
decisions for the Portfolio, place orders to purchase and sell securities and
employ professionals who provide research services. All orders for transactions
in securities on behalf of a Portfolio are made by management, with
broker-dealers selected by management, including affiliated brokers. In placing
orders management will seek to obtain the most favorable price and execution
available. In selecting broker-dealers, management may consider research and
brokerage services furnished to it and its affiliates.
The Fund's Board of Directors has determined that transactions for the Fund
may be executed through any broker-dealer affiliate of the Fund ("Affiliated
Broker") if, in the judgement of management, the use of an Affiliated Broker is
likely to result in price and execution at least as favorable to the Fund as
those obtainable through other qualified broker-dealers, and if, in the
transaction, the Affiliated Broker charges the Fund a fair and
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reasonable rate consistent with that charged to comparable unaffiliated
customers in similar transactions. The Fund will not deal with an Affiliated
Broker in any transaction in which such Affiliated Broker acts as principal. In
addition, the Alliance Growth Portfolio may not deal with Donaldson, Lufkin &
Jenrette ("DLJ") (an affiliate of Alliance Capital) in any transaction in which
DLJ acts as principal.
SHARES OF THE FUND
================================================================================
General
The Fund, an open-end managed investment company, was incorporated in Maryland
on February 22, 1994. The Fund has an authorized capital of 6,000,000,000 shares
with a par value of $.00001 per share. The Board of Directors has authorized the
issuance of twelve series of shares, each representing shares in one of twelve
separate Portfolios. The Directors also have the power to create additional
series of shares. The assets of each Portfolio will be segregated and separately
managed and a shareowner's interest is in the assets of the Portfolio in which
he or she holds shares.
Voting Rights
The Fund offers its shares only for purchase by insurance company separate
accounts. Thus, the insurance company is technically the shareholder of the
Fund and, under the 1940 Act, is deemed to be in control of the Fund.
Nevertheless, with respect to any Fund shareholder meeting, an insurance
company will solicit and accept timely voting instructions from its
contractowners who own units in a separate account investment division which
corresponds to shares in the Fund in accordance with the procedures set forth
in the accompanying prospectus for the applicable contract issued by the
insurance company and to the extent required by law. Shares of the Fund
attributable to contractowner interests for which no voting instructions are
received will be voted by an insurance company in proportion to the shares for
which voting instructions are received.
Each share of a Portfolio represents an equal proportionate interest in that
Portfolio with each other share of the same Portfolio and is entitled to such
dividends and distributions out of the net income of that Portfolio as are
declared in the discretion of the Directors. Shareowners are entitled to one
vote for each share held and will vote by individual Portfolio except to the
extent required by the 1940 Act. The Fund is not required to hold annual
shareowner meetings, although special meetings may be called for the Fund as a
whole, or a specific Portfolio, for purposes such as electing or removing
Directors, changing fundamental policies or approving a management contract.
Shareowners may cause a meeting of shareowners to be held upon a vote of 10% of
the Fund's outstanding shares for the purpose of voting on the removal of
Directors.
Availability of the Fund
Investment in the Fund is only available to owners of either variable
annuity or variable life insurance contracts issued by insurance companies
through their separate accounts. It is possible that in the future it may
become disadvantageous for both variable annuity and variable life insurance
separate accounts to be invested simultaneously in the Fund. However, the Fund
does not currently foresee any disadvantages to the contractowners of the
different contracts which are funded by such separate accounts. The Board
monitors events for the existence of any material irreconcilable conflict
between or among such owners, and each insurance company will take whatever
remedial action may be necessary to resolve any such conflict. Such action
could include the sale of Fund shares by one or more of the insurance company
separate accounts which fund these contracts, which could have adverse
consequences to the Fund. Material irreconcilable
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conflicts could result from, for example: (a) changes in state insurance laws;
(b) changes in U.S. federal income tax laws; or (c) differences in voting
instructions between those given by variable annuity contractowners and those
given by variable life insurance contractowners. If the Board were to conclude
that separate series of the Fund should be established for variable annuity and
variable life separate accounts, each insurance company would bear the attendant
expenses. Should this become necessary, contractowners would presumably no
longer have the economies of scale resulting from a larger combined mutual fund.
DETERMINATION OF NET ASSET VALUE
================================================================================
The net asset value of each Portfolio's shares is determined as of the close
of regular trading on the New York Stock Exchange ("NYSE"), which is currently
4:00 P.M. New York City time on each day that the NYSE is open, by dividing the
Portfolio's net assets by the number of its shares outstanding. Securities
owned by a Portfolio for which market quotations are readily available are
valued at current market value or, in their absence, at fair value. Securities
traded on an exchange are valued at last sales price on the principal exchange
on which each such security is traded, or if there were no sales on that
exchange on the valuation date, the last quoted sale, up to the time of
valuation, on the other exchanges. If instead there were no sales on the
valuation date with respect to these securities, such securities are valued at
the mean of the latest published closing bid and asked prices. Over-the-counter
securities are valued at last sales price or, if there were no sales that day,
at the mean between the bid and asked prices. Options, futures contracts and
options thereon that are traded on exchanges are also valued at last sales
prices as of the close of the principal exchange on which each is listed or if
there were no such sales on the valuation date, the last quoted sale, up to the
time of valuation, on other exchanges. In the absence of any sales on the
valuation date, valuation shall be the mean of the latest closing bid and asked
prices. Fixed income obligations are valued at the mean of bid and asked prices
based on market quotations for those securities or if no quotations are
available, then for securities of similar type, yield and maturity. Securities
with a remaining maturity of 60 days or less are valued at amortized cost where
the Board of Directors has determined that amortized cost is fair value.
Premiums received on the sale of call options will be included in the
Portfolio's net assets, and current market value of such options sold by a
Portfolio will be subtracted from that Portfolio's net assets. Any other
investments of a Portfolio, including restricted securities and listed
securities for which there is a thin market or that trade infrequently (i.e.,
securities for which prices are not readily available), are valued at a fair
value determined by the Board of Directors in good faith. This value generally
is determined as the amount that a Portfolio could reasonably expect to receive
from an orderly disposition of these assets over a reasonable period of time
but in no event more than seven days. The value of any security or commodity
denominated in a currency other than U.S. dollars will be converted into U.S.
dollars at the prevailing market rate as determined by management.
Foreign securities trading may not take place on all days on which the NYSE
is open. Further, trading takes place in various foreign markets on days on
which the NYSE is not open. Accordingly, the determination of the net asset
value of a Portfolio may not take place contemporaneously with the
determination of the prices of investments held by such Portfolio. Events
affecting the values of investments that occur between the time their prices
are determined and 4:00 P.M. on each day that the NYSE is open will not be
reflected in a Portfolio's net asset value unless management under the
supervision of the Fund's Board of Directors, determines that the particular
event would materially affect the net asset value. As a result, a Portfolio's
net asset value may be significantly affected by such trading on days when a
shareholder has no access to such Portfolio.
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APPENDIX A
================================================================================
RATINGS ON DEBT OBLIGATIONS
BOND (AND NOTES) RATINGS
Moody's Investors Service, Inc.
Aaa - Bonds that are rated "Aaa" are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa - Bonds that are rated "Aa" are judged to be of high quality by all
standards. Together with the "Aaa" group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present that make the long term risks appear somewhat larger than in "Aaa"
securities.
A - Bonds that are rated "A" possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present that suggest a susceptibility to impairment sometime in the future.
Baa - Bonds that are rated "Baa" are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca - Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Note: 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.
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Standard & Poor's
AAA - Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA - Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A - Debt rated "A" has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB - Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB, B, CCC, CC, C - Debt rated "BB", "B", "CCC", "CC" or "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.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Provisional Ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion. The
investor should exercise judgment with respect to such likelihood and risk.
L - The letter "L" indicates that the rating pertains to the principal
amount of those bonds where the underlying deposit collateral is fully insured
by the Federal Savings & Loan Insurance Corp. or the Federal Deposit Insurance
Corp.
+ - Continuance of the rating is contingent upon S&P's receipt of closing
documentation confirming investments and cash flow.
* - Continuance of the rating is contingent upon S&P's receipt of an
executed copy of the escrow agreement.
NR - Indicates no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of obligation as a matter of policy.
Fitch Investors Service, Inc.
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.
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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 "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is generally
rated "F-1+".
A - Bonds considered to be investment grade and of very 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
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.
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 "AAA" category.
NR - Indicates that Fitch does not rate the specific issue.
Conditional - A conditional rating is premised on the successful completion
of a project or the occurrence of a specific event.
Suspended - A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn - A rating will be withdrawn when an issue matures or is called or
refinanced and at Fitch's discretion when an issuer fails to furnish proper and
timely information.
FitchAlert - Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the likely direction
of such change. These are designated as "Positive", indicating a potential
upgrade, "Negative", for potential downgrade, or "Evolving", where ratings may
be lowered. FitchAlert is relatively short-term, and should be resolved within
12 months.
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COMMERCIAL PAPER RATINGS
Moody's Investors Service, Inc.
Issuers rated "Prime-1" (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
will normally be evidenced by the following characteristics: leading market
positions in well-established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earnings coverage of fixed
financial changes and high internal cash generation; well-established access to
a range of financial markets and assured sources of alternate liquidity.
Issuers rated "Prime-2" (or related supporting institutions) have strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Standard & Poor's
A-1 - This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issuers determined to
possess overwhelming safety characteristics will be denoted with a plus (+)
sign designation.
A-2 - Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues designated
A-1.
IBCA Limited or its affiliate, IBCA Inc.
A-1+ - This designation indicates the highest capacity for timely repayment.
A-1 - Capacity for timely repayment on issues with this designation is very
strong.
A-2 - This designation indicates a strong capacity for timely repayment,
although such capacity may be susceptible to adverse changes in business,
economic or financial conditions.
Fitch Investors Service, Inc.
F-1+ - Indicates the strongest degree of assurance for timely payment.
F-1 - This designation reflects an assurance of timely payment only slightly
less in degree than issues rated F-1+.
F-2 - This indicates a satisfactory degree of assurance for timely payment,
although the margin of safety is not as great as indicated by the F-1+ and F-1
categories.
Duff & Phelps Inc.
Duff 1+ - Indicates the highest certainty of timely payment: short-term
liquidity is clearly outstanding, and safety is just below risk-free United
States Treasury short-term obligations.
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Duff 1 - Indicates a high certainty of timely payment.
Duff 2 - Indicates a good certainty of timely payment: liquidity factors and
company fundamentals are sound.
The Thomson BankWatch ("TBW")
TBW-1 - Indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
TBW-2 - While the degree of safety regarding timely repayment of principal
and interest is strong, the relative degree of safety is not as high as for
issues rated TBW-1.
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VINTAGE TIFFANY LAMP
[PHOTO OF VINTAGE TIFFANY LAMP]
P R O S P E C T U S
L12410 Travelers Series Fund Inc. SB Ed. -96
