<PAGE>
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 ("SAI"), ALSO
REFERRED TO AS "PART B", DATED FEBRUARY 28, 1997 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 FEBRUARY 28, 1997.
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<TABLE>
<CAPTION>
TABLE OF CONTENTS
=============================================================
<S> <C>
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..................... 25
REDEMPTION OF SHARES................................... 25
PERFORMANCE............................................ 25
MANAGEMENT............................................. 26
SHARES OF THE FUND..................................... 30
DETERMINATION OF NET ASSET VALUE....................... 31
APPENDIX A............................................. 32
</TABLE>
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FINANCIAL HIGHLIGHTS
================================================================================
The following information for the three-year period ended October 31, 1996 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 1996 financial statements and
the independent auditors' report thereon appear in the October 31, 1996 Annual
Report to Shareholders.
For a share of each capital stock outstanding throughout the period:
<TABLE>
<CAPTION>
Alliance Growth
--------------------------------
<S> <C> <C> <C>
1996 1995 1994(1)
- -------------------------------------------------------------------------
Net Asset Value, Beginning of Period $ 13.28 $ 10.65 $ 10.00
- -------------------------------------------------------------------------
Income From Operations:
Net investment income (2) 0.04 0.14 0.06
Net realized and unrealized gain 3.39 2.61 0.59
- -------------------------------------------------------------------------
Total Income from Operations 3.43 2.75 0.65
- -------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.09) (0.02) --
Net realized gains (0.32) (0.10) --
- -------------------------------------------------------------------------
Total Distributions (0.41) (0.12) --
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Net Asset Value, End of Period $ 16.30 $ 13.28 $ 10.65
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Total Return 26.55% 26.19% 6.50%+++
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Net Assets, End of Period (000's) $294,596 $111,573 $ 17,086
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Ratios to Average Net Assets:
Expenses (2) 0.87% 0.90% 0.88%+
Net investment income 0.39 1.24 1.47+
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Portfolio Turnover Rate 88% 78% 37%
=========================================================================
Average commissions paid
on equity security transactions(3) $ 0.05 $ 0.06 --
=========================================================================
</TABLE>
(1) For the period from June 16, 1994 (commencement of operations) to October
31, 1994.
(2) Smith Barney Mutual 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) As of September 1995, the Securities and Exchange Commission ("SEC")
instituted new guidelines requiring the disclosures of average commissions
per share.
(+) Annualized.
(+++) Total return is not annualized, as it may not be representative of the
total return for the year.
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1
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For a share of each capital stock outstanding throughout the period:
<TABLE>
<CAPTION>
Putnam Diversified Income
---------------------------------
1996(3) 1995 1994(1)
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<S> <C> <C> <C>
Net Asset Value, Beginning of Period $ 11.46 $ 10.18 $ 10.00
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Income From Operations:
Net investment income (2) 0.78 0.79 0.23
Net realized and unrealized gain (loss) 0.27 0.58 (0.05)
- --------------------------------------------------------------------------------------------------
Total Income from Operations 1.05 1.37 0.18
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Less Distributions From:
Net investment income (0.39) (0.09) --
Net realized gains (0.13) -- --
- --------------------------------------------------------------------------------------------------
Total Distributions (0.52) (0.09) --
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Net Asset Value, End of Period $ 11.99 $ 11.46 $ 10.18
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Total Return 9.43% 13.55% 1.80%+++
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Net Assets, End of Period (000's) $81,076 $31,514 $ 6,763
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Ratios to Average Net Assets:
Expenses (2) 0.96% 0.97% 0.98%+
Net investment income 7.57 7.53 6.14%+
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Portfolio Turnover Rate 255% 276% 20%
==================================================================================================
</TABLE>
(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+
Per share amounts have been calculated using the monthly average shares method,
which more appropriately presents the per share data for the period since the
use of the undistributed net investment income method does not accord with
results of operations.
(+) Annualized.
(+++) Total return is not annualized, as it may not be representative of the
total return for the year.
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2
<PAGE>
For a share of each capital stock outstanding throughout the period:
<TABLE>
<CAPTION>
MFS Total Return
--------------------------------------
1996 1995 1994(1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period $ 11.53 $ 9.98 $ 10.00
- ----------------------------------------------------------------------------------------
Income From Operations:
Net investment income (2) 0.33 0.45 0.13
Net realized and unrealized gain (loss) 1.62 1.15 (0.15)
- ----------------------------------------------------------------------------------------
Total Income from Operations 1.95 1.60 (0.02)
- ----------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.27) (0.05) --
Net realized gains (0.08) -- --
- ----------------------------------------------------------------------------------------
Total Distributions (0.35) (0.05) --
- ----------------------------------------------------------------------------------------
Net Asset Value, End of Period $ 13.13 $ 11.53 $ 9.98
- ----------------------------------------------------------------------------------------
Total Return 17.16% 16.12% (0.20)%+++
- ----------------------------------------------------------------------------------------
Net Assets, End of Period (000's) $134,529 $49,363 $ 8,504
- ----------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses (2) 0.91% 0.95% 0.93%+
Net investment income 3.82 4.40 3.51%+
- ----------------------------------------------------------------------------------------
Portfolio Turnover Rate 139% 104% 18%
========================================================================================
Average commissions paid
on equity security transactions(3) $ 0.06 $ 0.04 --
========================================================================================
</TABLE>
(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) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
(+) Annualized.
(+++) Total return is not annualized, as it may not be representative of the
total return for the year.
(+) Annualized.
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3
<PAGE>
THE FUND'S INVESTMENT PROGRAM
================================================================================
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 SAI.
The investment objectives and certain investment restrictions designated as such
in the SAI 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. The Portfolio
is managed by Travelers Investment Adviser, Inc. ("TIA" or the "Manager").
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%
- --------------------------------------------------------------------------------
4
<PAGE>
of net assets in "illiquid securities". To the extent permitted by applicable
law, Rule 144A Securities will not be 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. The Portfolio is managed by TIA; Putnam
Investment Management, Inc. ("Putnam Management") 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:
- --------------------------------------------------------------------------------
5
<PAGE>
* 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;
* 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
- --------------------------------------------------------------------------------
6
<PAGE>
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 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 Collateralized Mortgage Obligations ("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;
- --------------------------------------------------------------------------------
7
<PAGE>
* debt obligations of supranational entities (described below); and
* debt obligations and other fixed-income securities of foreign and U.S.
corporate issuers.
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.
- --------------------------------------------------------------------------------
8
<PAGE>
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.
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. The Portfolio is managed by TIA; 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,
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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 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
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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
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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.
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.
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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 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
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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 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
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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
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.
SYNTHETIC SECURITY POSITIONS. The Putnam Diversified Income Portfolio may
utilize combinations of futures on bonds and forward currency contracts to
create investment positions that have substantially the same characteristics as
bonds of the same type on which the futures contracts are written. Investment
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positions of this type are generally referred to as "synthetic securities."
For example, in order to establish a synthetic security position for the
Putnam Diversified Income Portfolio that is comparable to owning a Japanese
government bond, Putnam Management might purchase futures contracts on Japanese
government bonds in the desired principal amount and purchase forward currency
contracts for Japanese Yen in an amount equal to the then current purchase price
for such bonds in the Japanese cash market, with each contract having
approximately the same delivery date.
Putnam Management might roll over the futures and forward currency contract
positions before taking delivery in order to continue the Putnam Diversified
Income Portfolio's investment position, or Putnam Management might close out
those positions, thus effectively selling the synthetic security. Further, the
amount of each contract might be adjusted in response to market conditions and
the forward currency contract might be changed in amount or eliminated in order
to hedge against currency fluctuations.
Further while these futures and currency contracts remain open, the Putnam
Diversified Income Portfolio will comply with applicable SEC guidelines to set
aside cash, U.S. government securities or other liquid high grade debt
securities in a segregated account with its custodian in an amount sufficient to
cover its potential obligations under such contracts.
Putnam Management would create synthetic security positions for the Putnam
Diversified Income Portfolio when it believes that it can obtain a better yield
or achieve cost savings in comparison to purchasing actual bonds or when
comparable bonds are not readily available in the market. Synthetic security
positions are subject to the risk that changes in the value of purchased futures
contracts may differ from changes in the value of the bonds that might otherwise
have been purchased in the cash market. Also, while Putnam Management believes
that the cost of creating synthetic security positions generally will be
materially lower than the cost of acquiring comparable bonds in the cash market,
the Putnam Diversified Income Portfolio will incur transaction costs in
connection with each purchase of a futures or a forward currency contract. The
use of futures contracts and forward currency contracts to create synthetic
security positions also is subject to substantially the same risks as those that
exist when these instruments are used in connection with hedging strategies. See
"Futures, Options and Currency Transactions" in the Prospectus and "Options,
Futures Contracts and Related Options," "Interest Rate, Securities Index,
Financial Futures and Currency Futures Contracts," "Options on Futures
Contracts" and "Forward Currency Contracts and Options on Currency" in the
Statement of Additional Information.
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.
The markets in which lower-quality securities or comparable non-rated
securities are traded generally are
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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 TIA
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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<PAGE>
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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<PAGE>
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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<PAGE>
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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<PAGE>
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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<PAGE>
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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<PAGE>
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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<PAGE>
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.
TIA 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 TIA 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. TIA has entered into a
Sub-Administrative Services Agreement with an affiliate (the "Sub-
Administrator") to: (a) assist TIA 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. TIA 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 TIA 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 TIA, 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 TIA, each Portfolio pays TIA 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 TIA 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 agents,
expenses of preparing, printing and distributing all prospectuses, proxy
material, reports and notices to shareholders,
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<PAGE>
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.
TIA 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.
TIA is located at 388 Greenwich Street, New York, New York 10013. TIA 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 TIA pays Alliance Capital an
annual fee calculated at the rate of 0.375% of the Portfolio's average daily net
assets, paid monthly.
Alliance is a global investment adviser providing diversified services to
institutions and individuals through a broad line of investments including more
than 100 mutual funds. Since 1971, Alliance has earned a reputation as a leader
in the investment world, with over $168 billion in assets under management as of
June 30, 1996. Alliance provides investment management services to 33 of the
FORTUNE 100 companies.
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 the subadvisory agreement TIA 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
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<PAGE>
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 Institutional Advisors, 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 $52.3
billion on behalf of approximately 2.2 million investors accounts as of November
29, 1996. As of such date, the MFS organization managed approximately $20.9
billion of assets in fixed income securities. MFS is a 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 has access to the extensive
international equity investment expertise of Foreign & Colonial, and Foreign &
Colonial has access to the extensive U.S. equity investment expertise of MFS.
MFS and Foreign & Colonial each have investment personnel working in each
other's offices in Boston and London, respectively.
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.
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<PAGE>
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 TIA 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. Ms. 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.
BOARD OF DIRECTORS
Overall responsibility for management and supervision of the Fund rests with
the Fund's Board of Directors. The Directors approve all significant agreements
between the Fund and the companies that furnish services to the Fund and each
Portfolio, including agreements with the Fund's distributor, investment
managers, investment sub-advisers, custodian and transfer agent. The Statement
of Additional Information contains background information regarding each
Director and executive officer of the Fund.
PORTFOLIO TRANSACTIONS AND DISTRIBUTION
TIA 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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<PAGE>
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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<PAGE>
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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<PAGE>
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.
- --------------------------------------------------------------------------------
35
<PAGE>
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.
- --------------------------------------------------------------------------------
36
TRAVELERS SERIES FUND INC.
388 Greenwich Street
New York, New York 10013
1-800-842-8573
Travelers Series Fund Inc. (the "Fund"), the investment underlying
certain variable annuity and variable life insurance contracts, is an
investment company which offers shares of beneficial interest of twelve
different Portfolios, four of which are offered herein:
Smith Barney Income and Growth Portfolio
Smith Barney International Equity Portfolio
Smith Barney High Income Portfolio
Smith Barney Money Market Portfolio
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.
Shares of the Smith Barney Money Market Portfolio are not insured or
guaranteed by the U.S. Government. There is no assurance that the Portfolio
will be able to maintain a stable net asset value of $1.00 per share.
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, 1997 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 FEBRUARY 28, 1997.
TABLE OF CONTENTS
Page
FINANCIAL HIGHLIGHTS 1
THE FUND'S INVESTMENT PROGRAM 5
Smith Barney Income and Growth Portfolio 5
Smith Barney International Equity Portfolio 5
Smith Barney High Income Portfolio 7
Smith Barney Money Market Portfolio 8
SPECIAL INVESTMENT TECHNIQUES AND RISK CONSIDERATIONS 9
DIVIDENDS, DISTRIBUTIONS AND TAXES 18
REDEMPTION OF SHARES 18
PERFORMANCE 18
MANAGEMENT 19
SHARES OF THE FUND 21
DETERMINATION OF NET ASSET VALUE 22
APPENDIX A A-1
FINANCIAL HIGHLIGHTS
The following information for the three-year period ended October 31, 1996
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 1996 financial
statements and the independent auditors' report thereon appear in the October
31, 1996 Annual Report to Shareholders.
For a share of each capital stock outstanding throughout the period:
Smith Barney
Income & Growth
1996 1995 1994 (1)
Net Asset Value, Beginning of Period $ 12.12 $ 10.14 $ 10.00
Income From Operations:
Net investment income (2) 0.32 0.28 0.11
Net realized and unrealized gain 2.62 1.76 0.03
Total Income from Operations 2.94 2.04 0.14
Less Distributions From:
Net investment income (0.17) (0.06)
Net realized gains (0.05)
Total Distributions (0.22) (0.06)
Net Asset Value, End of Period $ 14.84 $12.12 $ 10.14
Total Return 24.55% 20.21%
1.40%
Net Assets, End of Period (000's) $ 138,712 $ 39,364 $ 6,377
Ratios to Average Net Assets:
Expenses (2) 0.73% 0.73%
0.73%
Net investment income 2.35 2.70 2.82
Portfolio Turnover Rate 32% 38% 2%
Average Commissions Paid On Equity Security Transactions (3) $ 0.06 $
0.07
(1) For the period from June 16, 1994 (commencement of operations) to
October 31, 1994.
(2) Smith Barney Mutual 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 Smith
Barney Income and Growth Portfolio for $13,120 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 Smith Barney Income and Growth
Portfolio would have been as follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
1995 $ 0.02 0.94%
1994 0.05 2.08
(3) As of September 1995, the Securities and Exchange Commission ("SEC")
instituted new guidelines requiring the disclosure of average commissions
per share.
( Annualized.
() Total return is not annualized, as it may not be representative of the
total return for the year.
For a share of each capital stock outstanding throughout the period:
Smith Barney
International Equity
1996 1995 1994 (1)
Net Asset Value, Beginning of Period $ 10.48 $ 10.55 $ 10.00
Income (Loss) From Operations:
Net investment income (loss) (2) 0.02 0.03 * (0.03)
Net realized and unrealized gain (loss) 1.69 (0.10) 0.58
Total Income (loss) from Operations 1.71 (0.07) 0.55
Less Distributions From:
Net investment income (0.01)
Net realized gains
Total Distributions (0.01)
Net Asset Value, End of Period $ 12.18 $ 10.48 $ 10.55
Total Return 16.36% (0.66)%
5.50%
Net Assets, End of Period (000's) $ 143,323 $ 53,538 $ 13,811
Ratios to Average Net Assets:
Expenses(2) 1.10% 1.44%
1.20%
Net investment income (loss) 0.23 0.25
(0.73)
Portfolio Turnover Rate 41% 29%
Average Commissions Paid On Equity Security Transactions(3) $ 0.02 $
0.01
(1) For the period from June 16, 1994 (commencement of operations) to
October 31, 1994.
(2) The Manager has waived a portion of its fees for the year ended October
31, 1994 for the Smith Barney International Equity Portfolio. If such fees
were not waived, the effect of the per share increase in net investment
loss for the Smith Barney International Equity Portfolio would have been
$0.03 and the ratio of expenses to average net assets would have been
2.00%.
In addition, during the year ended October 31, 1995, the Smith Barney
International Equity Portfolio has earned credits from the custodian, which
reduces service fees incurred. When the credits are taken into
consideration the ratio of expenses to average net assets is 1.21%; prior
year numbers have not been restated to reflect these adjustments.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
(*) Includes realized gains and losses from foreign currency transactions.
() Annualized.
() Total return is not annualized, as it may not be representative of the
total return for the year.
For a share of each capital stock outstanding throughout the period:
Smith Barney High Income
1996 1995 1994 (1)
Net Asset Value, Beginning of Period $ 11.26 $ 10.07 $ 10.00
Income (Loss) From Operations:
Net investment income (2) 1.14 0.93 0.29
Net realized and unrealized gain (loss) 0.19 0.48 (0.22)
Total Income (loss) from Operations 1.33 1.41 0.07
Less Distributions From:
Net investment income (0.50) (0.22)
Total Distributions (0.50) (0.22)
Net Asset Value, End of Period $ 12.09 $ 11.26 $ 10.07
Total Return 12.17% 14.30%
0.70%
Net Assets, End of Period (000's) $ 65,955 $ 20,450 $ 3,395
Ratios to Average Net Assets:
Expenses (2) 0.84% 0.70%
0.69%
Net investment income 9.79 9.54 7.55
Portfolio Turnover Rate 104% 57% 15%
(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 Smith Barney High Income Portfolio for $17,664
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
Smith Barney High Income Portfolio would have been as follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
1995 $ 0.04 1.07%
1994 0.07 2.60
Annualized.
() Total return is not annualized, as it may not be representative of the
total return for the year.
For a share of each capital stock outstanding throughout the period:
Smith Barney Money Market
1996 1995 1994 (1)
Net Asset Value, Beginning of Period $ 1.00 $ 1.00 $ 1.00
Income From Operations:
Net investment income (2) 0.049 0.052 0.014
Net realized and unrealized (loss)
Total Income from Operations 0.049 0.052 0.014
Less Distributions From:
Net investment income (0.049) (0.052) (0.014)
Total Distributions (0.049) (0.052) (0.014)
Net Asset Value, End of Period $ 1.00 $ 1.00 $ 1.00
Total Return 5.05% 5.35%
1.46%
Net Assets, End of Period (000's) $ 99,150 $ 37,487 $ 5,278
Ratios to Average Net Assets:
Expenses (2) 0.65% 0.65%
0.66%
Net investment income 4.86 5.26 3.83
(1) For the period from June 16, 1994 (commencement of operations) to
October 31, 1994.
(2) The Manager has reimbursed the Smith Barney Money Market Portfolio for
$15,423 in expenses for the period ended October 31, 1994. If such fees
were not waived and expenses not reimbursed, the per share decrease in net
investment income and the ratio of expenses to average net assets for the
Smith Barney Money Market Portfolio would have been as follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
1996 $ 0.001 0.74%
1995 0.003 0.94
1994 0.005 2.11
() Annualized.
() Total return is not annualized, as it may not be representative of the
total return for the year.
THE FUND'S INVESTMENT PROGRAM
The Fund consists of twelve investment portfolios, four 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 ("SAI").
The investment objectives and certain investment restrictions designated
as such in the SAI 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.
Smith Barney Income and Growth Portfolio
Investment Objectives
The investment objectives of the Smith Barney Income and Growth
Portfolio are current income and long-term growth of income and capital.
The Portfolio attempts to achieve its objectives by investing primarily,
but not exclusively, in common stocks. The Portfolio is managed by Smith
Barney Mutual Funds Management Inc. ("SBMFM" or the "Manager") (See
"Management -- Smith Barney Mutual Funds Management Inc.").
Investment Policies
The Smith Barney Income and Growth Portfolio invests primarily in common
stocks offering a current return from dividends and in interest-paying debt
obligations (such as U.S. Government securities, investment grade bonds and
debentures) and high quality short-term debt obligations (such as
commercial paper and repurchase agreements collateralized by U.S.
Government securities with broker/dealers or other financial institutions).
At least 65% of the Portfolio's assets will at all times be invested in
equity securities. The Portfolio may also purchase preferred stocks and
convertible securities. In the selection of common stock investments,
emphasis is generally placed on issues with established dividend records as
well as potential for price appreciation. From time to time, however, a
portion of the assets may be invested in non-dividend paying stocks. Under
unusual economic or market conditions as determined by the Manager, for
defensive purposes the Portfolio may temporarily invest all or a major
portion of its assets in short-term U.S. Government securities. A higher
percentage of debt securities may also be held when deemed advisable by the
Manager. To the extent the Portfolio's assets are invested for temporary
defensive purposes, such assets will not be invested in a manner designed
to achieve the Portfolio's investment objectives.
The Portfolio may make investments in foreign securities, though
management currently intends to limit such investments to 5% of the
Portfolio's assets, and an additional 10% of its assets may be invested in
sponsored American Depositary Receipts, which are certificates issued by
U.S. banks representing the right to receive securities of a foreign issuer
deposited with that bank or a correspondent bank. The Portfolio will
ordinarily purchase foreign securities that are traded in the U.S. It may,
however, also purchase the securities of foreign issuers directly in
foreign markets. The Portfolio may also lend up to 20% of the value of its
total assets and may purchase or sell securities on a when-issued or
delayed delivery basis.
Smith Barney International Equity Portfolio
Investment Objective
The investment objective of the Smith Barney International Equity
Portfolio is to provide a total return on its assets from growth of capital
and income. The Portfolio seeks to achieve its objective by investing at
least 65% of its assets in a diversified portfolio of equity securities of
established non-U.S. issuers. The Portfolio is managed by SBMFM.
Investment Policies
Under normal market conditions, the Smith Barney International Equity
Portfolio will invest at least 65% of its assets in a diversified portfolio
of equity securities consisting of dividend and non-dividend paying common
stock, preferred stock, convertible debt and rights and warrants to such
securities and up to 35% of its assets in bonds, notes and debt securities
(consisting of securities issued in Eurocurrency markets or obligations of
the United States or foreign governments and their political subdivisions)
of established non- U.S. issuers. Investments may be made for capital
appreciation or for income or any combination of both for the purpose of
achieving a higher overall return than might otherwise be obtained solely
from investing for growth of capital or for income. There is no limitation
on the percent or amount of the Portfolio's assets which may be invested
for growth or income and, therefore, from time to time the investment
emphasis may be placed solely or primarily on growth of capital or solely
or primarily on income.
In seeking to achieve its objective, the Portfolio presently expects to
invest its assets primarily in common stocks of established non-U.S.
companies that, in the opinion of the Manager, have potential for growth of
capital. However, there is no requirement that the Portfolio invests
exclusively in common stocks or other equity securities, and, when the
Manager believes that the return on debt securities will equal or exceed
the return on common stocks, the Portfolio may, in seeking its objective of
total return, substantially increase its holdings (up to a maximum of 35%
of its assets) in debt securities. In determining whether the Portfolio
will be invested for capital appreciation or for income or any combination
of both, the Manager regularly analyzes a broad range of international
equity and fixed income markets in order to assess the degree of risk and
level of return that can be expected from each market.
The Portfolio will generally invest its assets broadly among countries
and will normally have represented in the portfolio business activities in
not less than three different countries. Except as stated below, the
Portfolio will invest at least 65% of its assets in companies organized or
governments located in any area of the world other than the U.S., such as
the Far East (e.g., Japan, Hong Kong, Singapore, Malaysia), Western Europe
(e.g., United Kingdom, Germany, the Netherlands, France, Italy,
Switzerland), Eastern Europe (e.g. Hungary, Poland, The Czech Republic and
the countries of the former Soviet Union), Central and South America (e.g.,
Mexico, Chile and Venezuela), Australia, Canada and such other areas and
countries as the Manager may determine from time to time. Allocation of the
Portfolio's investments will depend upon the relative attractiveness of the
international markets and particular issuers. Concentration of the
Portfolio assets in one or a few countries or currencies will subject the
Portfolio to greater risks than if the Portfolio's assets were not
geographically concentrated.
Under unusual economic or market conditions as determined by the
Manager, for defensive purposes the Portfolio may temporarily invest all or
a major portion of its assets in U.S. Government securities or in debt or
equity securities of companies incorporated in and having their principal
business activities in the United States. To the extent the Portfolio's
assets are invested for temporary defensive purposes, such assets will not
be invested in a manner designed to achieve the Portfolio's investment
objective.
In determining the appropriate distribution of investments among various
countries and geographic regions, the Manager ordinarily considers the
following factors: prospects for relative economic growth between
countries; expected levels of inflation; government policies influencing
business conditions; the outlook for currency relationships; and the range
of individual investment opportunities available to international
investors. In the future, if any other relevant factors arise they will
also be considered. In analyzing companies for investment, the Manager
ordinarily looks for one or more of the following characteristics: an
above-average earnings growth per share; high return on invested capital;
healthy balance sheet; sound financial and accounting policies and overall
financial strength; strong competitive advantages; effective research and
product development and marketing; efficient service; pricing flexibility;
strength of management; and general operating characteristics which will
enable the company to compete successfully in its market place. Ordinarily,
the Manager will not view a company as being sufficiently well established
to be considered for inclusion in the Portfolio unless the company,
together with any predecessors, has been operating for at least three
fiscal years. However, the Portfolio may invest up to 5% of its assets in
such "unseasoned" issuers.
It is expected that Portfolio securities will ordinarily be traded on a
stock exchange or other market in the country in which the issuer is
principally based, but may also be traded on markets in other countries
including, in many cases, the United States securities exchanges and
over-the-counter markets.
In order to protect the dollar equivalent value of its portfolio
securities against declines resulting from currency value fluctuations and
changes in interest rate or other market changes, the Portfolio may enter
into the following hedging transactions: forward foreign currency
contracts, interest rate and currency swaps and financial instrument and
market index futures contracts and related options contracts. In addition,
the Portfolio may engage in leveraging, enter into repurchase agreements
and lend portfolio securities.
To the extent that the Portfolio's assets are not otherwise invested as
described above, the assets may be held in cash, in any currency, or
invested in U.S. as well as foreign high quality money market instruments
and equivalents.
Smith Barney High Income Portfolio
Investment Objectives
The primary investment objective of the Smith Barney High Income
Portfolio is to seek high current income. Capital appreciation is a
secondary objective. The Portfolio is managed by SBMFM.
Investment Policies
The Smith Barney High Income Portfolio will seek to achieve its
investment objectives by investing, under normal circumstances, at least
65% of its assets in high-yielding corporate debt obligations and preferred
stock. Although the Portfolio may invest in securities of any maturity,
under current market conditions the Portfolio intends that its portfolio
will have an average remaining maturity of between five and ten years. The
Manager may adjust the Portfolio's average maturity when, based on interest
rate trends and other market conditions, it deems it appropriate to do so.
Up to 35% of the Portfolio's assets may be invested in common stock or
common stock equivalents, including convertible securities, options,
warrants and rights. Equity investments may be made in securities of
companies of any size depending on the relative attractiveness of the
company and the economic sector in which it operates. Fixed income
securities purchased by the Portfolio will generally be rated in the lower
rating categories of nationally recognized securities rating organizations,
as low as C by Moody's or D by S&P, or in non-rated income securities that
the Manager determines to be of comparable quality. The Portfolio will not
purchase securities rated lower than B by both Moody's and S&P, if,
immediately after such purchase, more than 10% of the Portfolio's total
assets are invested in such securities.
The Portfolio invests significantly 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 in securities rated higher than Ba by Moody's
and BB by S&P without limitation when the difference in yields between
quality classifications is relatively narrow.
For temporary defensive purposes when the Manager anticipates adverse
market conditions, the Portfolio may invest all or a major portion of its
assets in securities rated higher than Ba by Moody's and BB by S&P.
Investments in higher rated issues may serve to lessen a decline in net
asset value but may also affect the amount of current income produced by
the Portfolio, since the yields from such issues are usually lower than
those from lower rated issues. A general description of Moody's and S&P's
ratings of corporate bonds is set forth in Appendix A. The Portfolio may
also invest without limitation in money market instruments, including
commercial paper of domestic and foreign corporations, certificates of
deposit, bankers' acceptances and other obligations of banks, repurchase
agreements and short-term obligations issued or guaranteed by the United
States government or its agencies. The yield on these securities will tend
to be lower than the yield on other securities to be purchased by the
Portfolio. 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 lend portfolio securities equal in value to not more
than 20% of its total assets and purchase or sell securities on a
when-issued or delayed-delivery basis. The Portfolio does not intend to
leverage its investments although it reserves the right to do so. The
Portfolio may hedge against possible declines in the value of its
investments by entering into interest rate futures contracts and related
options, swaps and other financial instruments.
The Portfolio may invest up to 20% of its assets in the securities of
foreign issuers that are denominated in currencies other than the U.S.
dollar and may invest without limitation in securities of foreign issuers
that are denominated in U.S. dollars.
In connection with the investment objectives and policies described
above, the Portfolio may, but is not required to, utilize various
investment techniques to earn income, facilitate portfolio management and
mitigate risk. These investment techniques utilize interest rate and
currency futures contracts, put and call options on such futures contracts,
currency exchange transactions, illiquid securities, securities of
unseasoned issuers and securities of foreign governments and corporations
including those of developing countries. Any or all of such investment
techniques available to the Manager may be used at any time and there is no
particular strategy that dictates the use of one technique rather than
another, since the use of any investment technique is a function of
numerous variables including market conditions.
Smith Barney Money Market Portfolio
Investment Objectives
The investment objectives of the Smith Barney Money Market Portfolio are
maximum current income and preservation of capital. The Portfolio is
managed by SBMFM.
Investment Policies
The Smith Barney Money Market Portfolio seeks to achieve its objectives
by investing in bank obligations and high quality commercial paper,
corporate obligations and municipal obligations, in addition to U.S.
Government securities and related repurchase agreements. Shares of the
Portfolio are not insured or guaranteed by the U.S. Government. The
Portfolio has adopted certain investment policies to assure that, to the
extent reasonably possible, the Portfolio's price per share will not change
from $1.00, although no assurance can be given that this goal will be
achieved on a continuous basis. In order to minimize fluctuations in market
price the Portfolio will not purchase a security with a remaining maturity
of greater than 13 months (or that is deemed to have a remaining maturity
of greater than 13 months) or maintain a dollar-weighted average portfolio
maturity in excess of 90 days (securities used as collateral for repurchase
agreements are not subject to these restrictions). The Portfolio's
investments will be limited to U.S. dollar-denominated instruments that its
Board of Directors determines present minimal credit risks and which are
"Eligible Securities" at the time of acquisition by the Portfolio. The term
Eligible Securities includes securities rated by the "Requisite NRSROs" in
one of the two highest short-term rating categories, securities of issuers
that have received such ratings with respect to other short-term debt
securities and comparable unrated securities. "Requisite NRSROs" means (a)
any two nationally recognized statistical rating organizations ("NRSROs")
that have issued a rating with respect to a security or class of debt
obligations of an issuer, or (b) one NRSRO, if only one NRSRO has issued
such a rating at the time that the Portfolio acquires the security. The
NRSROs currently designated as such by the Securities and Exchange
Commission (the "SEC") are S&P, Moody's, Fitch Investors Services, Inc.,
Duff and Phelps Inc., IBCA Limited and its affiliate, IBCA, Inc. and
Thomson BankWatch. See Appendix A for a discussion of the ratings
categories of the NRSROs.
The Portfolio may enter into repurchase agreements collateralized by
U.S. Government securities with any broker/dealer or other financial
institution that is deemed creditworthy by the Manager, under guidelines
approved by the Fund's Board of Directors. The Portfolio will not enter
into a repurchase agreement on behalf of the Portfolio if, as a result
thereof, more than 10% of the Portfolio's net assets (taken at current
value) at that time would be subject to repurchase agreements maturing in
more than seven days.
The following are also permitted investments for the Portfolio:
High Quality Commercial Paper. The Portfolio's purchase of commercial
paper is restricted to direct obligations of issuers that at the time of
purchase are Eligible Securities that are rated by at least one NRSRO in
the highest category for short-term debt securities or comparable unrated
securities. The Portfolio may invest without limit in the commercial paper
of foreign issuers.
High Quality Corporate Obligations. Obligations of corporations that
are: (1) rated AA or better by S&P or Aa or better by Moody's or (2) issued
by an issuer that has a class of short-term debt obligations that are
comparable in priority and security with the obligation and that have been
rated in one of the two highest rating categories for short-term debt
obligations. The Portfolio will only invest in corporate obligations with
remaining maturities of 13 months or less.
Bank Obligations. Obligations (including certificates of deposit,
bankers' acceptances and fixed time deposits) and securities backed by
letters of credit of U.S. banks or other U.S. financial institutions that
are members of the Federal Reserve System or the Federal Deposit Insurance
Corporation ("FDIC") (including obligations of foreign branches of such
members) if either: (a) the principal amount of the obligation is insured
in full by the FDIC, or (b) the issuer of such obligation has capital,
surplus and undivided profits in excess of $100 million or total assets of
$1 billion (as reported in its most recently published financial statements
prior to the date of investment). Under current FDIC regulations, the
maximum insurance payable as to any one certificate of deposit is $100,000;
therefore, certificates of deposit in denominations greater than $100,000
that are purchased by the Smith Barney Money Market Portfolio will not be
fully insured. The Portfolio currently intends to limit its investment in
fixed time deposits with an ultimate maturity of from two business to six
month and will invest in such time deposits only if, when combined with
other illiquid assets of the Portfolio, not more than 10% of its assets
would be invested in all such instruments. The Portfolio may also invest in
securities of foreign branches of U.S. banks. Such investments involve
considerations that are not ordinarily associated with investing in
domestic certificates of deposit. (See "Foreign Securities.") The Portfolio
may invest in instruments issued by domestic banks, including those issued
by their branches outside the United States and subsidiaries located in
Canada, and instruments issued by foreign banks through their branches
located in the United States and the United Kingdom. In addition, the
Portfolio may invest in fixed time deposits of foreign banks issued through
their branches located in Grand Cayman Island, London, Nassau, Tokyo and
Toronto.
The purchase of obligations of foreign banks will involve similar
investment and risk considerations that are applicable to investing in
obligations of foreign branches of U.S. banks. (See "Foreign Securities.")
These factors will be carefully considered by the Manager in selecting
investments for the Portfolio.
High Quality Municipal Obligations. Debt obligations of states, cities,
counties, municipalities, municipal agencies and regional districts rated
SP-1+ or A-1 or AA or better by S&P or MIG 2, VMIG 2, or Prime-1 or Aa or
better by Moody's or, if not rated, are determined by the Sub-Adviser to be
of comparable quality. At certain times, supply/demand imbalances in the
tax-exempt market cause municipal obligations to yield more than taxable
obligations of equivalent credit quality and maturity length. The purchase
of these securities could enhance the Portfolio's yield. The Portfolio will
not invest more than 10% of its total assets in municipal obligations.
The Portfolio may, to a limited degree, engage in short-term trading to
attempt to take advantage of short-term market variations, or may dispose
of the portfolio security prior to its maturity if it believes such
disposition advisable or it needs to generate cash to satisfy redemptions.
In such cases, the Portfolio may realize a gain or loss.
As a matter of fundamental policy, the Portfolio may borrow money from
banks for temporary purposes but only in an amount up to 10% of the value
of its total assets and may pledge its assets in an amount up to 10% of the
value of its total assets only to secure such borrowings. The Portfolio
will borrow money only to accommodate requests for the redemption of shares
while effecting an orderly liquidation of portfolio securities or to clear
securities transactions and not for leveraging purposes. The Portfolio may
also lend its portfolio securities to brokers, dealers and other financial
organizations. Such loans, if and when made, may not exceed 20% of the
Portfolio's total assets, taken at value.
Notwithstanding any of the foregoing investment restrictions, the Smith
Barney Money Market Portfolio may invest up to 100% of its assets in U.S.
Government securities.
SPECIAL INVESTMENT TECHNIQUES AND RISK CONSIDERATIONS
Foreign Securities. Each of the Portfolios may purchase securities
issued by foreign governments, corporations or banks. The Smith Barney
Money Market Portfolio may also purchase securities of foreign branches of
U.S. banks and of domestic and foreign branches of foreign 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 a
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.
Securities of Emerging Markets. Because of the special risks associated
with investing in emerging markets, an investment in the Smith Barney
International Equity and the Smith Barney High Income Portfolios may 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
investment adviser 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 investment 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 principal 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 the 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, the 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 the 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 the
Portfolio due to subsequent declines in 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 the 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 the 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.
Lower-Quality and Non-Rated Securities. The Smith Barney High Income
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 the Smith
Barney High Income Portfolio.
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 the Portfolio, with a commensurate effect on the value of the
Portfolio's shares.
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 the
Portfolio to purchase and also may restrict the ability of the 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. The 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 Portfolio. If an issuer exercises these rights during
periods of declining interest rates, the 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 the Portfolio as initial criteria for
the selection of portfolio securities, but the Portfolio also will rely
upon the independent advice of the Manager 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 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.
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.
When-Issued, Delayed Delivery and Forward Commitment Securities. The
Smith Barney Income and Growth, Smith Barney International Equity and Smith
Barney High Income Portfolios may each 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 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 except the Smith Barney Money
Market 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 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.
Short Sales Against the Box. The Smith Barney High Income Portfolio may
make short sales of securities in order to reduce market exposure and/or to
increase its income if, at all times when a short position is open, the
Portfolio owns an equal or greater amount of such securities or owns
preferred stock, debt or warrants convertible or exchangeable into an equal
or greater number of the shares of the securities sold short. Short sales
of this kind are referred to as short sales "against the box."
Securities of Unseasoned Issuers. Securities in which the Smith Barney
High Income Portfolio may invest may lack a significant operating history
and be dependent on products or services without an established market
share.
Borrowing and Leverage. Each Portfolio may borrow from banks, on a
secured or unsecured basis. If the Portfolio borrows and uses the proceeds
to make additional investments, income and appreciation from such
investments will improve its performance if they exceed the associated
borrowing costs but impair its performance if they are less than such
borrowing costs. This speculative factor is known as "leverage." Only the
Smith Barney International Equity Portfolio will utilize leverage. Should
the Portfolio engage in leverage, immediately after such borrowing the
value of its assets, including the amount borrowed, less liabilities, must
be equal to at least 300% of the amount borrowed, plus all outstanding
borrowings.
Leverage creates an opportunity for increased returns to shareholders of
the Portfolio but, at the same time, creates special risk considerations.
For example, leverage may exaggerate changes in the net asset value of the
Portfolio's shares and in the Portfolio's yield. Although the principal or
stated value of such borrowings will be fixed, the portfolio assets may
change in value during the time the borrowing is outstanding. Leverage will
create interest or dividend expenses for the Portfolio which can exceed the
income from the assets retained. To the extent the income or other gain
derived from securities purchased with borrowed funds exceeds the interest
and other charges the Portfolio will have to pay in respect thereof, the
Portfolio's net income or other gain will be greater than if leverage had
not been used. Conversely, if the income or other gain from the incremental
assets is not sufficient to cover the cost of leverage, the net income or
other gain of the Portfolio will be less than if leverage had not been
used. If the amount of income from the incremental securities is
insufficient to cover the cost of borrowing, securities might have to be
liquidated to obtain required funds. Depending on market or other
conditions, such liquidations could be disadvantageous to the Portfolio.
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.
Futures, Options and Currency Transactions. Consistent with its
investment objective and policies, the Smith Barney International Equity
and the Smith Barney High Income Portfolios may each enter into contracts
for the purchase or sale for future delivery of fixed-income securities,
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 Smith Barney
International Equity and Smith Barney High Income Portfolios, 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 a 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. The Smith Barney International Equity and
the Smith Barney High Income Portfolios may each 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 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.
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 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 the
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 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, each of the Smith Barney International
Equity and the Smith Barney High Income Portfolios 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 a 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,
a 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.
A 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 a Portfolio's investment exposure
from one type of investment to another. For example, if a 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 a 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 a 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. A
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
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.
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 (except the Smith Barney Money Market 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. The historical portfolio
turnover rates for each Portfolio (except the Smith Barney Money Market
Portfolio) are included in the Financial Highlights tables above. A higher
rate of portfolio turnover may result in higher transaction costs,
including brokerage commissions. Portfolio turnover rates for the Smith
Barney Money Market Portfolio are not relevant because of the short-term
nature of the investments owned by the Portfolio.
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 except the Smith Barney Money Market 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). The Smith Barney Money Market
Portfolio intends to declare daily and pay monthly substantially all of its
taxable income and to make distributions of net realized capital gains, if
any, at least annually. 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 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
Smith Barney Mutual Funds Management Inc.
SBMFM 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 SBMFM 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, bookkeeping, accounting and administrative services, office
space and equipment, and the services of the officers and employees of the
Fund.
By written agreement the research and other departments and staff of
Smith Barney Inc. ("Smith Barney") furnish SBMFM with information, advice
and assistance and are available for consultation on the Fund's Portfolios,
thus Smith Barney may also be considered an investment adviser to the Fund.
Smith Barney's services are paid for by SBMFM on the basis of direct and
indirect costs to Smith Barney of performing such services; there is no
charge to the Fund for such services.
For the services provided by SBMFM, each Portfolio pays SBMFM an annual
management fee calculated at a rate equal to the following percentage of
its average daily net assets, paid monthly.
Smith Barney Income and Growth Portfolio 0.65%
Smith Barney International Equity Portfolio 0.90%
Smith Barney High Income Portfolio 0.60%
Smith Barney Money Market Portfolio 0.60%
Although the management fee paid by the Smith Barney International
Equity Portfolio is greater than that paid by most mutual funds, management
has determined that the 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 SBMFM 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
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.
SBMFM was incorporated in 1968 under the laws of the State of Delaware.
It is a wholly-owned subsidiary of Smith Barney Holdings Inc. ("SBH"), the
parent company of Smith Barney. SBH is a 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. SBMFM, Smith Barney
and SBH are each located at 388 Greenwich Street, New York, New York 10013.
SBMFM also acts as investment manager to numerous other investment
companies having aggregate assets as of the date of this Prospectus in
excess of $80 billion. Smith Barney also advises profit-sharing and pension
accounts. Smith Barney and its affiliates may in the future act as
investment advisers for other accounts.
Portfolio Management by SBMFM. Smith Barney serves as the investment
adviser to each of the Portfolios. SBMFM manages the day to day operations
of each Portfolio pursuant to a management agreement entered into by the
Fund on behalf of each Portfolio. Under each management agreement, SBMFM
will (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; (d) employ professional portfolio managers and
securities analysts who provide research services to the Portfolio; and (e)
administer the Portfolio's corporate affairs and, in connection therewith,
furnish the Portfolio with office facilities and with clerical, bookkeeping
and recordkeeping services at such office facilities. In providing those
services, SBMFM will conduct a continual program of investment, evaluation
and, if appropriate, sale and reinvestment of each Portfolio's assets.
Bruce D. Sargent, a Vice President of the Fund, is the portfolio manager
of the Smith Barney Income and Growth Portfolio. Mr. Sargent co-manages the
day to day operations of the Smith Barney Income and Growth Portfolio and
has been involved in equity investing for over 26 years. He currently
manages over $1 billion of assets.
Ayako Weissman, Managing Director of Smith Barney, serves as co-manager
of the Smith Barney Income and Growth Portfolio. Ms. Weissman has been
involved in equity investing for Smith Barney for over 9 years and
currently manages over $250 million of assets.
The Smith Barney International Equity Portfolio is managed by Maurits E.
Edersheim and a team of seasoned international equity portfolio managers,
who collectively have over 125 years of experience. Mr. Edersheim is
Chairman and Advisory Director of Smith Barney World Funds, Inc. and is
Deputy Chairman of Smith Barney International Incorporated. Prior to
joining Smith Barney in 1990, Mr. Edersheim was Deputy Chairman and
Director of Drexel Burnham Lambert Incorporated ("Drexel Burnham"). Mr.
James Conheady and Mr. Jeffrey Russell, both Vice Presidents of the Fund
and Managing Directors of Smith Barney are members of the international
equity team and are responsible for the day-to-day operations of the Smith
Barney International Equity Portfolio, making all of the investment
decisions for the Portfolio since its inception. Together, Mr. Conheady and
Mr. Russell currently manage in excess of $2.8 billion in global equity
assets for other investment companies and managed accounts. Prior to
joining Smith Barney in February 1990, Mr. Conheady was a First Vice
President and Mr. Russell was a Vice President of Drexel Burnham.
Mr. John C. Bianchi, a Managing Director of the Greenwich Street
Advisors division of SBMFM, is responsible for the management of the Smith
Barney High Income Portfolio. Mr. Bianchi has more than fourteen years of
investment advisory experience. He joined Greenwich Street Advisors in
1985. Prior thereto, Mr. Bianchi was employed as a Senior Investment
Analyst at Metropolitan Life Insurance Company, where he worked in all
sectors of the bond market, specializing in high grade and high yield
corporate bonds and notes.
Board of Directors
Overall responsibility for management and supervision of the Fund rests
with the Fund's Board of Directors. The Directors approve all significant
agreements between the Fund and the companies that furnish services to the
Fund and each Portfolio, including agreements with the Fund's distributor,
investment managers, investment sub-advisers, custodian and transfer agent.
The SAI contains background information regarding each Director and
executive officer of the Fund.
Portfolio Transactions and Distribution
SBMFM is subject to the supervision and direction of the Fund's Board of
Directors and manages each Portfolio in accordance with its investment
objective and policies, makes investment decisions for the Portfolio,
places orders to purchase and sell securities and employs 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.
Smith Barney distributes shares of the Fund as principal underwriter. In
addition, the Fund's Board of Directors has determined that transactions
for the Fund may be executed through Smith Barney or any broker-dealer
affiliate of Smith Barney (each, an "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 reasonable
rate consistent with that charged to comparable unaffiliated customers in
similar transactions. The Fund will not deal with Smith Barney in any
transaction in which Smith Barney 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, four of which are
offered herein -- the Smith Barney Income and Growth Portfolio, the Smith
Barney International Equity Portfolio, the Smith Barney High Income
Portfolio and the Smith Barney Money Market Portfolio. 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
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.
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.
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.
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.
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.
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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8
A-7
- --------------------------------------------------------------------------------
PROSPECTUS
TRAVELERS SERIES FUND INC.
Smith Barney Income and Growth Portfolio
Smith Barney International Equity Portfolio
Smith Barney Money Market Portfolio
February Twenty-Eighth
1997
- --------------------------------------------------------------------------------
TRAVELERS SERIES FUND INC.
388 Greenwich Street
New York, New York 10013
1-800-842-8573
The Smith Barney Income and Growth Portfolio, Smith Barney International
Equity Portfolio and the Smith Barney Money Market 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 Investment objectives of the SMITH BARNEY INCOME AND GROWTH PORTFOLIO
are current income and long-term growth of income and capital. The Portfolio
attempts to achieve its objectives by investing primarily, but not exclusively,
in common stocks.
The investment objective of the SMITH BARNEY INTERNATIONAL EQUITY PORTFOLIO
is total return on its assets from growth of capital and income. The Portfolio
seeks to achieve its objective by investing at least 65% of its assets in a
diversified portfolio of equity securities of established non-U.S. issuers.
The investment objectives of the SMITH BARNEY MONEY MARKET PORTFOLIO are
maximum current income and preservation of capital.
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 all three 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.
Shares of the Smith Barney Money Market Portfolio are not insured or
guaranteed by the U.S. Government. There is no assurance that the Portfolio will
be able to maintain a stable net asset value of $1.00 per share.
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 ("SAI"), ALSO
REFERRED TO AS "PART B", DATED FEBRUARY 28, 1997 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 FEBRUARY 28, 1997.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
================================================================================
[S] [C]
FINANCIAL HIGHLIGHTS...................................................... 1
THE FUND'S INVESTMENT PROGRAM............................................. 4
Smith Barney Income and Growth Portfolio.............................. 4
Smith Barney International Equity Portfolio........................... 5
Smith Barney Money Market Portfolio................................... 6
SPECIAL INVESTMENT TECHNIQUES AND RISK CONSIDERATIONS..................... 8
DIVIDENDS, DISTRIBUTIONS AND TAXES........................................ 17
REDEMPTION OF SHARES...................................................... 17
PERFORMANCE............................................................... 18
MANAGEMENT................................................................ 18
SHARES OF THE FUND........................................................ 20
DETERMINATION OF NET ASSET VALUE.......................................... 22
APPENDIX A................................................................ 23
- ----------------------------------------------------------------------------
<PAGE>
FINANCIAL HIGHLIGHTS
================================================================================
The following information for the three-year period ended October 31, 1996
has been audited in conjunction with the annual audits of the financial
statements of the Fund by KPMG Peat Marwick LLP, independent auditors. The 1996
financial statements and the independent auditors' report thereon appear in the
October 31, 1996 Annual Report to Shareholders.
For a share of each capital stock outstanding throughout the period:
<TABLE>
<CAPTION>
Smith Barney Income and Growth
--------------------------------------
1996 1995 1994(1)
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period $ 12.12 $ 10.14 $10.00
- -------------------------------------------------------------------------------
Income From Operations:
Net investment income (2) 0.32 0.28 0.11
Net realized and unrealized gain 2.62 1.76 0.03
- -------------------------------------------------------------------------------
Total Income from Operations 2.94 2.04 0.14
- -------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.17) (0.06) --
Net realized gains (0.05) -- --
- -------------------------------------------------------------------------------
Total Distributions (0.22) (0.06) --
- -------------------------------------------------------------------------------
Net Asset Value, End of Period $ 14.84 $ 12.12 $10.14
- -------------------------------------------------------------------------------
Total Return 24.55% 20.21% 1.40%++
- -------------------------------------------------------------------------------
Net Assets, End of Period (000's) $138,712 $39,364 $6,377
- -------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses (2) 0.73% 0.73% 0.73%+
Net investment income 2.35 2.70 2.82+
- -------------------------------------------------------------------------------
Portfolio Turnover Rate 32% 38% 2%
===============================================================================
Average commissions paid
on equity security transactions (3) $ 0.06 $ 0.07 --
===============================================================================
(1) For the period from June 16, 1994 (commencement of operations) to October
31, 1994
(2) Smith Barney Mutual 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 Smith Barney
Income and Growth Portfolio for $13,120 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 Smith Barney Income and Growth
Portfolio would have been as follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
-------------------------- ---------------------
1995 $0.02 0.94%
1994 0.05 2.08+
(3) As of September 1995, the Securities and Exchange Commission ("SEC")
instituted new guidelines requiring the disclosure of average commissions
per share.
(+) Annualized.
(++) Total return is not annualized, as it may not be representative of the
total return for the year.
- --------------------------------------------------------------------------------
1
<PAGE>
For a share of each capital stock outstanding throughout the period:
</TABLE>
<TABLE>
<CAPTION>
Smith Barney International Equity
-------------------------------------
1996 1995 1994(1)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period $10.48 $10.55 $10.00
- --------------------------------------------------------------------------------
Income (loss) From Operations:
Net investment income (loss) (2) 0.02 0.03* (0.03)
Net realized and unrealized gain (loss) 1.69 (0.10) 0.58
- --------------------------------------------------------------------------------
Total Income (loss) from Operations 1.71 (0.07) 0.55
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.01) -- --
- --------------------------------------------------------------------------------
Total Distributions (0.01) -- --
- --------------------------------------------------------------------------------
Net Asset Value, End of Period $12.18 $10.48 $10.55
- --------------------------------------------------------------------------------
Total Return 16.36% (0.66)% 5.50%++
- --------------------------------------------------------------------------------
Net Assets, End of Period (000's) $143,323 $53,538 $13,811
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses (2) 1.10% 1.44% 1.20%+
Net investment income 0.23 0.25 (0.73)+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 41% 29% --
================================================================================
Average commissions paid
on equity security transactions (3) $0.02 $0.01 --
================================================================================
(1) For the period from June 16, 1994 (commencement of operations) to October
31, 1994.
(2) The Manager has waived part of its fees for the year ended October 31,
1994. If such fees were not waived and expense not reimbursed, the effect
on the net investment loss and the expense ratios would have been as
follows:
Per Share Expense Ratios
Increase to Net Without Fee Waiver
Investment Loss and Reimbursement
----------------- --------------------
1994 $0.03 2.00%+
In addition, during the years ended October 31, 1996 and 1995, the
Portfolio has earned credits from the custodian which reduce service fees
incurred. When the credits are taken into consideration the expenses ratios
are 1.05% and 1.21%, respectively; prior year numbers have not been
restated to reflect these adjustments.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
* Includes realized gains and losses from foreign currency transactions.
(+) Annualized.
(++) Total return is not annualized, as it may not be representative of the
total return for the year.
- --------------------------------------------------------------------------------
2
<PAGE>
For a share of each capital stock outstanding throughout the period:
</TABLE>
<TABLE>
<CAPTION>
Smith Barney Money Market
-------------------------------------
1996 1995 1994(1)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period $1.00 $1.00 $1.00
- --------------------------------------------------------------------------------
Net investment income (2) 0.049 0.052 0.014
Dividends from net investment income (0.049) (0.052) (0.014)
- --------------------------------------------------------------------------------
Net Asset Value, End of Period $1.00 $1.00 $1.00
- --------------------------------------------------------------------------------
Total Return 5.05% 5.35% 1.46%++
- --------------------------------------------------------------------------------
Net Assets, End of Period (000's) $99,150 $37,487 $5,278
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses (2) 0.65% 0.65% 0.66%+
Net investment income 4.86 5.26 3.83 +
- --------------------------------------------------------------------------------
(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 years ended October
31, 1996 and October 31, 1995 and for the period ended October 31, 1994. In
addition, the Manager reimbursed the Smith Barney Money Market Portfolio
for $15,423 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
Smith Barney Money Market Portfolio would have been as follows:
Expense Ratios
Per Share Decreases Without Fee Waivers
in Net Investment Income and Reimbursement
-------------------------- ---------------------
1996 $0.001 0.74%
1995 0.003 0.94
1994 0.005 2.11+
(+) Annualized.
(++) Total return is not annualized, as it may not be representative of the
total return for the year.
- --------------------------------------------------------------------------------
3
<PAGE>
THE FUND'S INVESTMENT PROGRAM
================================================================================
The Fund consists of twelve investment portfolios, three of which are
offered herein. Each Portfolio has its own investment objective and policies. 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.
Smith Barney Income and Growth Portfolio
Investment Objectives
The investment objectives of the Smith Barney Income and Growth Portfolio
are current income and long-term growth of income and capital. The Portfolio
attempts to achieve its objectives by investing primarily, but not exclusively,
in common stocks. The Portfolio is managed by Smith Barney Mutual Funds
Management Inc. ("SBMFM" or the "Manager") (See "Management-Smith Barney Mutual
Funds Management Inc.").
Investment Policies
The Smith Barney Income and Growth Portfolio invests primarily in common
stocks offering a current return from dividends and in interest-paying debt
obligations (such as U.S. Government securities, investment grade bonds and
debentures) and high quality short-term debt obligations (such as commercial
paper and repurchase agreements collateralized by U.S. Government securities
with broker/dealers or other financial institutions). At least 65% of the
Portfolio's assets will at all times be invested in equity securities. The
Portfolio may also purchase preferred stocks and convertible securities. In the
selection of common stock investments, emphasis is generally placed on issues
with established dividend records as well as potential for price appreciation.
From time to time, however, a portion of the assets may be invested in non-
dividend paying stocks. Under unusual economic or market conditions as
determined by the Manager, for defensive purposes the Portfolio may temporarily
invest all or a major portion of its assets in short-term U.S. Government
securities. A higher percentage of debt securities may also be held when deemed
advisable by the Manager. To the extent the Portfolio's assets are invested for
temporary defensive purposes, such assets will not be invested in a manner
designed to achieve the Portfolio's investment objectives.
The Portfolio may make investments in foreign securities, though management
currently intends to limit such investments to 5% of the Portfolio's assets, and
an additional 10% of its assets may be invested in sponsored American Depositary
Receipts, which are certificates issued by U.S. banks representing the right to
receive securities of a foreign issuer deposited with that bank or a
correspondent bank. The Portfolio will ordinarily purchase foreign securities
that are traded in the U.S. It may, however, also purchase the securities of
foreign issuers directly in foreign markets. The Portfolio may also lend up to
20% of the value of its total assets and may purchase or sell securities on a
when-issued or delayed delivery basis.
- --------------------------------------------------------------------------------
4
<PAGE>
Smith Barney International Equity Portfolio
Investment Objective
The investment objective of the Smith Barney International Equity Portfolio
is to provide a total return on its assets from growth of capital and income.
The Portfolio seeks to achieve its objective by investing at least 65% of its
assets in a diversified portfolio of equity securities of established non-U.S.
issuers. The Portfolio is managed by SBMFM.
Investment Policies
Under normal market conditions, the Smith Barney International Equity
Portfolio will invest at least 65% of its assets in a diversified portfolio of
equity securities consisting of dividend and non-dividend paying common stock,
preferred stock, convertible debt and rights and warrants to such securities and
up to 35% of its assets in bonds, notes and debt securities (consisting of
securities issued in Eurocurrency markets or obligations of the United States or
foreign governments and their political subdivisions) of established non-U.S.
issuers. Investments may be made for capital appreciation or for income or any
combination of both for the purpose of achieving a higher overall return than
might otherwise be obtained solely from investing for growth of capital or for
income. There is no limitation on the percent or amount of the Portfolio's
assets which may be invested for growth or income and, therefore, from time to
time the investment emphasis may be placed solely or primarily on growth of
capital or solely or primarily on income.
In seeking to achieve its objective, the Portfolio presently expects to
invest its assets primarily in common stocks of established non-U.S. companies
that, in the opinion of the Manager, have potential for growth of capital.
However, there is no requirement that the Portfolio invests exclusively in
common stocks or other equity securities, and, when the Manager believes that
the return on debt securities will equal or exceed the return on common stocks,
the Portfolio may, in seeking its objective of total return, substantially
increase its holdings (up to a maximum of 35% of its assets) in debt securities.
In determining whether the Portfolio will be invested for capital appreciation
or for income or any combination of both, the Manager regularly analyzes a broad
range of international equity and fixed income markets in order to asses the
degree of risk and level of return that can be expected from each market.
The Portfolio will generally invest its assets broadly among countries and
will normally have represented in the portfolio business activities in not less
than three different countries. Except as stated below, the Portfolio will
invest at least 65% of its assets in companies organized or governments located
in any area of the world other than the U.S., such as the Far East (e.g., Japan,
Hong Kong, Singapore, Malaysia), Western Europe (e.g., United Kingdom, Germany,
the Netherlands, France, Italy, Switzerland), Eastern Europe (e.g. Hungary,
Poland, The Czech Republic and the countries of the former Soviet Union),
Central and South America (e.g., Mexico, Chile and Venezuela), Australia, Canada
and such other areas and countries as the Manager may determine from time to
time. Allocation of the Portfolio's investments will depend upon the relative
attractiveness of the international markets and particular issuers.
Concentration of the Portfolio assets in one or a few countries or currencies
will subject the Portfolio to greater risks than if the Portfolio's assets were
not geographically concentrated.
Under unusual economic or market conditions as determined by the Manager,
for defensive purposes the Portfolio may temporarily invest all or a major
portion of its assets in U.S. government securities or in debt or equity
securities of companies incorporated in and having their principal business
activities in the United
- --------------------------------------------------------------------------------
5
<PAGE>
States. To the extent the Portfolio's assets are invested for temporary
defensive purposes, such assets will not be invested in a manner designed to
achieve the Portfolio's investment objective.
In determining the appropriate distribution of investments among various
countries and geographic regions, the Manager ordinarily considers the following
factors: prospects for relative economic growth between countries; expected
levels of inflation; government policies influencing business conditions; the
outlook for currency relationships; and the range of individual investment
opportunities available to international investors. In the future, if any other
relevant factors arise they will also be considered. In analyzing companies for
investment, the Manager ordinarily looks for one or more of the following
characteristics: an above-average earnings growth per share; high return on
invested capital; healthy balance sheet; sound financial and accounting policies
and overall financial strength; strong competitive advantages; effective
research and product development and marketing; efficient service; pricing
flexibility; strength of management; and general operating characteristics which
will enable the company to compete successfully in its market place. Ordinarily,
the Manager will not view a company as being sufficiently well established to be
considered for inclusion in the Portfolio unless the company, together with any
predecessors, has been operating for at least three fiscal years. However, the
Portfolio may invest up to 5% of its assets in such "unseasoned" issuers.
It is expected that portfolio securities will ordinarily be traded on a
stock exchange or other market in the country in which the issuer is principally
based, but may also be traded on markets in other countries including, in many
cases, the United States securities exchanges and over-the-counter markets.
In order to protect the dollar equivalent value of its portfolio securities
against declines resulting from currency value fluctuations and changes in
interest rate or other market changes, the Portfolio may enter into the
following hedging transactions: forward foreign currency contracts, interest
rate and currency swaps and financial instrument and market index futures
contracts and related options contracts. In addition, the Portfolio may engage
in leveraging, enter into repurchase agreements and lend portfolio securities.
To the extent that the Portfolio's assets are not otherwise invested as
described above, the assets may be held in cash, in any currency, or invested in
U.S. as well as foreign high quality money market instruments and equivalents.
Smith Barney Money Market Portfolio
Investment Objectives
The investment objectives of the Smith Barney Money Market Portfolio are
maximum current income and preservation of capital. The Portfolio is managed by
SBMFM.
Investment Policies
The Smith Barney Money Market Portfolio seeks to achieve its objectives by
investing in bank obligations and high quality commercial paper, corporate
obligations and municipal obligations, in addition to U.S. Government securities
and related repurchase agreements. Shares of the Portfolio are not insured or
guaranteed by the U.S. Government. The Portfolio has adopted certain investment
policies to assure that, to the extent reasonably possible, the Portfolio's
price per share will not change from $1.00, although no assurance can be given
that this goal will be achieved on a continuous basis. In order to minimize
fluctuations in market price the Portfolio will not purchase a security with a
remaining maturity of greater than 13 months (or that is deemed to have a
remaining maturity of greater than 13 months) or maintain a dollar-weighted
average portfolio maturity in excess of 90 days
- --------------------------------------------------------------------------------
6
<PAGE>
(securities used as collateral for repurchase agreements are not subject to
these restrictions). The Portfolio's investments will be limited to U.S. dollar-
denominated instruments that its Board of Directors determines present minimal
credit risks and which are "Eligible Securities" at the time of acquisition by
the Portfolio. The term Eligible Securities includes securities rated by the
"Requisite NRSROs" in one of the two highest short-term rating categories,
securities of issuers that have received such ratings with respect to other
short-term debt securities and comparable unrated securities. "Requisite NRSROs"
means (a) any two nationally recognized statistical rating organizations
("NRSROs") that have issued a rating with respect to a security or class of debt
obligations of an issuer, or (b) one NRSRO, if only one NRSRO has issued such a
rating at the time that the Portfolio acquires the security. The NRSROs
currently designated as such by the Securities and Exchange Commission (the
"SEC") are S&P, Moody's, Fitch Investors Services, Inc., Duff and Phelps Inc.,
IBCA Limited and its affiliate, IBCA, Inc. and Thomson BankWatch. See Appendix A
for a discussion of the ratings categories of the NRSROs.
The Portfolio may enter into repurchase agreements collateralized by U.S.
Government securities with any broker/dealer or other financial institution that
is deemed creditworthy by the Manager, under guidelines approved by the Fund's
Board of Directors. The Portfolio will not enter into a repurchase agreement on
behalf of the Portfolio if, as a result thereof, more than 10% of the
Portfolio's net assets (taken at current value) at that time would be subject to
repurchase agreements maturing in more than seven days.
The following are also permitted investments for the Portfolio:
High Quality Commercial Paper. The Portfolio's purchase of commercial paper
is restricted to direct obligations of issuers that at the time of purchase are
Eligible Securities that are rated by at least one NRSRO in the highest category
for short-term debt securities or comparable unrated securities. The Portfolio
may invest without limit in the commercial paper of foreign issuers.
High Quality Corporate Obligations. Obligations of corporations that are:
(1) rated AA or better by S&P or Aa or better by Moody's or (2) issued by an
issuer that has a class of short-term debt obligations that are comparable in
priority and security with the obligation and that have been rated in one of the
two highest rating categories for short-term debt obligations. The Portfolio
will only invest in corporate obligations with remaining maturities of 13 months
or less.
Bank Obligations. Obligations (including certificates of deposit, bankers'
acceptances and fixed time deposits) and securities backed by letters of credit
of U.S. banks or other U.S. financial institutions that are members of the
Federal Reserve System or the Federal Deposit Insurance Corporation ("FDIC")
(including obligations of foreign branches of such members) if either: (a) the
principal amount of the obligation is insured in full by the FDIC, or (b) the
issuer of such obligation has capital, surplus and undivided profits in excess
of $100 million or total assets of $1 billion (as reported in its most recently
published financial statements prior to the date of investment). Under current
FDIC regulations, the maximum insurance payable as to any one certificate of
deposit is $100,000; therefore, certificates of deposit in denominations greater
than $100,000 that are purchased by the Smith Barney Money Market Portfolio will
not be fully insured. The Portfolio currently intends to limit its investment in
fixed time deposits with an ultimate maturity of from two business to six months
and will invest in such time deposits only if, when combined with other illiquid
assets of the Portfolio, not more than 10% of its assets would be invested in
all such instruments. The Portfolio may also invest in securities of foreign
branches of U.S. banks. Such investments involve considerations that are not
ordinarily associated with investing in domestic certificates of deposit. (See
"Foreign Securities.") The Portfolio may invest in instruments issued by
domestic banks, including those issued by their branches outside the United
States and subsidiaries located in Canada, and instruments issued by foreign
banks through their branches located in the United States and the United
Kingdom. In addition, the Portfolio may
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invest in fixed time deposits of foreign banks issued through their branches
located in Grand Cayman Island, Nassau, Tokyo and Toronto.
The purchase of obligations of foreign banks will involve similar investment
and risk considerations that are applicable to investing in obligations of
foreign branches of U.S. banks. (See "Foreign Securities.") These factors will
be carefully considered by the Manager in selecting investments for the
Portfolio.
High Quality Municipal Obligations. Debt obligations of states, cities,
counties, municipalities, municipal agencies and regional districts rated SP-1+
or A-1 or AA or better by S&P or MIG 2, VMIG 2, or Prime-1 or Aa or better by
Moody's or, if not rated, are determined by the Sub-Adviser to be of comparable
quality. At certain times, supply/demand imbalances in the tax-exempt market
cause municipal obligations to yield more than taxable obligations of equivalent
credit quality and maturity length. The purchase of these securities could
enhance the Portfolio's yield. The Portfolio will not invest more than 10% of
its total assets in municipal obligations.
The Portfolio may, to a limited degree, engage in short-term trading to
attempt to take advantage of short-term market variations, or may dispose of the
portfolio security prior to its maturity if it believes such disposition
advisable or it needs to generate cash to satisfy redemptions. In such cases,
the Portfolio may realize a gain or loss.
As a matter of fundamental policy, the Portfolio may borrow money from banks
for temporary purposes but only in an amount up to 10% of the value of its total
assets and may pledge its assets in an amount up to 10% of the value of its
total assets only to secure such borrowings. The Portfolio will borrow money
only to accommodate requests for the redemption of shares while effecting an
orderly liquidation of portfolio securities or to clear securities transactions
and not for leveraging purposes. The Portfolio may also lend its portfolio
securities to brokers, dealers and other financial organizations. Such loans, if
and when made, may not exceed 20% of the Portfolio's total assets, taken at
value.
Notwithstanding any of the foregoing investment restrictions, the Smith
Barney Money Market Portfolio may invest up to 100% of its assets in U.S.
Government securities.
SPECIAL INVESTMENT TECHNIQUES AND RISK CONSIDERATIONS
================================================================================
Foreign Securities. Each Portfolio may purchase securities issued by foreign
governments, corporations or banks. The Smith Barney Money Market Portfolio may
also purchase securities of foreign branches of U.S. banks and of domestic and
foreign branches of foreign 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
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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.
Securities of Emerging Markets. Because of the special risks associated with
investing in emerging markets, an investment in the Smith Barney International
Equity Portfolio, may 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 investment
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 investment 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, the 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
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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 the Portfolio to make intended securities purchases due to
settlement problems could cause it to miss attractive investment opportunities.
Inability to dispose of the portfolio security caused by settlement problems
could result either in losses to the Portfolio due to subsequent declines in
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 the 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 the 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.
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.
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.
When-Issued, Delayed Delivery and Forward Commitment Securities. The Smith
Barney Income and Growth 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 the 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
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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. The Portfolio's custodian will maintain, in a
segregated account on behalf of the Portfolio, cash, U.S. Government securities
or other liquid securities 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. The Smith Barney Income and Growth Portfolio and the
Smith Barney International Equity Portfolio can each 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 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 and Leverage. Each Portfolio may borrow from banks, on a secured
or unsecured basis. If the Portfolio borrows and uses the proceeds to make
additional investments, income and appreciation from such investments will
improve its performance if they exceed the associated borrowing costs but impair
its performance if they are less than such borrowing costs. This speculative
factor is known as "leverage". Only the Smith Barney International Equity
Portfolio will utilize leverage. Should any Portfolio engage in leverage,
immediately after such borrowing the value of its assets, including the amount
borrowed, less liabilities, must be equal to at least 300% of the amount
borrowed, plus all outstanding borrowings.
Leverage creates an opportunity for increased returns to shareholders of the
Smith Barney International Equity Portfolio but, at the same time, creates
special risk considerations. For example, leverage may exaggerate changes in the
net asset value of the Portfolio's shares and in the Portfolio's yield. Although
the principal or stated value of such borrowings will be fixed, the portfolio
assets may change in value during the time the borrowing is outstanding.
Leverage will create interest or dividend expenses for the Portfolio which can
exceed the income from the assets retained. To the extent the income or other
gain derived from securities purchased with borrowed funds exceeds the interest
and other charges the Portfolio will have to pay in respect thereof, the
Portfolio's net income or other gain will be greater than if leverage had not
been used. Conversely, if the income or other gain from the incremental assets
is not sufficient to cover the cost of leverage, the net income or other gain of
the Portfolio will be less than if leverage had not been used. If the amount of
income from the incremental securities is insufficient to cover the cost of
borrowing, securities might have to be liquidated to obtain required funds.
Depending on market or other conditions, such liquidations could be
disadvantageous to the Portfolio.
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
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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.
Futures, Options and Currency Transactions. Consistent with its investment
objective and policies, the Smith Barney International Equity Portfolio may
enter into contracts for the purchase or sale for future delivery of fixed-
income securities, 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 the 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 the
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 Smith Barney International Equity Portfolio 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
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, the Portfolio will incur
brokerage fees when it buys or sells futures contracts.
The 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
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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. The Smith Barney International Equity
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. The 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 the 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 currency contract to buy that foreign
currency for a fixed U.S. dollar amount ("position hedge"). The 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"). The
Portfolio may invest in forward currency contracts with stated contract values
of up to the value of the Portfolio's assets.
The 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.
The 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. Because the Smith Barney International Equity Portfolio may
invest substantially in securities denominated in currencies other than the U.S.
dollar, or may hold foreign currencies, the Portfolio 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 the Portfolio's shares and also may affect the value
of dividends and interest earned by the Portfolio and gains and losses realized
by the Portfolio. 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.
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Options on Securities and on Foreign Currencies. In an effort to reduce
fluctuations in net asset value or to increase its portfolio return, the Smith
Barney International Equity Portfolio 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 Portfolio may write and buy options on the
same types of securities that it 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 the 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 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.
The Portfolio also may write a covered call option to cross-hedge if it 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 the 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.
The 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
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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 the Portfolio's investments in options on foreign
currencies.
The 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 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 Smith Barney International Equity 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 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.
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<PAGE>
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, the 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
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, the 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.
The 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,
the 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.
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,
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<PAGE>
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 (except the Smith Barney Money Market 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. The historical portfolio turnover rates for
each Portfolio (except the Smith Barney Money Market Portfolio) are included in
the Financial Highlights tables above. A higher rate of portfolio turnover may
result in higher transaction costs, including brokerage commissions. Portfolio
turnover rates for the Smith Barney Money Market Portfolio are not shown because
of the short-term nature of the investments owned by the Portfolio.
DIVIDENDS, DISTRIBUTIONS AND TAXES
================================================================================
Each Portfolio intends to qualify as a "regulated investment company" under
Subchapter M of the Internal Revenue Code (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. The Smith Barney International Equity 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). The Smith Barney Money Market Portfolio intends to declare
daily and pay monthly substantially all of its taxable income and to make
distributions of net realized capital gains, if any, at least annually. 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 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.
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<PAGE>
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 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
================================================================================
Smith Barney Mutual Funds Management Inc.
SBMFM 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 SBMFM 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, bookkeeping, accounting and
administrative services, office space and equipment, and the services of the
officers and employees of the Fund.
By written agreement the research and other departments and staff of Smith
Barney Inc. ("Smith Barney") furnish SBMFM with information, advice and
assistance and are available for consultation on the Fund's Portfolios, thus
Smith Barney may also be considered an investment adviser to the Fund. Smith
Barney's services are paid for by SBMFM on the basis of direct and indirect
costs to Smith Barney of performing such services; there is no charge to the
Fund for such services.
For the services provided by SBMFM, each Portfolio pays SBMFM an annual
management fee calculated at a rate equal to the following percentage of its
average daily net assets, paid monthly.
Smith Barney Income and Growth Portfolio 0.65%
Smith Barney International Equity Portfolio 0.90%
Smith Barney Money Market Portfolio 0.60%
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<PAGE>
Although the management fee paid by the Smith Barney International Equity
Portfolio is greater than that paid by most mutual funds, management has
determined that the fee is comparable to the fee charged by other investment
advisers of mutual funds that have similar investment objectives and policies.
The management agreement further provides that all other expenses not
specifically assumed by SBMFM under the management agreement on behalf of the
Portfolio are borne by the Fund. Expenses payable by the Fund include, but are
not limited to, all charges of custodians and shareholder servicing 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 the Portfolio; general corporate
expenses are allocated on the basis of relative net assets.
SBMFM was incorporated in 1968 under the laws of the state of Delaware. It
is a wholly-owned subsidiary of Smith Barney Holdings Inc. ("SBH"), the parent
company of Smith Barney. SBH is a 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. SBMFM, Smith Barney and SBH are each located at 388
Greenwich Street, New York, New York 10013. SBMFM also acts as investment
manager to numerous other investment companies having aggregate assets as of the
date of this Prospectus in excess of $80 billion. Smith Barney also advises
profit-sharing and pension accounts. Smith Barney and its affiliates may in the
future act as investment advisers for other accounts.
Portfolio Management by SBMFM. SBMFM serves as the investment adviser to
each Portfolio. SBMFM manages the day to day operations of each Portfolio
pursuant to a management agreement entered into by the Fund on behalf of each
Portfolio. Under each management agreement, SBMFM will (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; (d)
employ professional portfolio managers and securities analysts who provide
research services to the Portfolio; and (e) administer the Portfolio's corporate
affairs and, in connection therewith, furnish the Portfolio with office
facilities and with clerical, bookkeeping and recordkeeping services at such
office facilities. In providing those services, SBMFM will conduct a continual
program of investment, evaluation and, if appropriate, sale and reinvestment of
each Portfolio's assets.
Bruce D. Sargent, a Vice President of the Fund, is the portfolio manager of
the Smith Barney Income and Growth Portfolio. Mr. Sargent co-manages the day to
day operations of the Portfolio and has been involved in equity investing for
over 26 years. He currently manages over $1 billion of assets.
Ayako Weissman, Managing Director of Smith Barney, serves as co-manager of
the Portfolio. Ms. Weissman has been involved in equity investing for Smith
Barney for over 9 years and currently manages over $250 million of assets.
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<PAGE>
The Smith Barney International Equity Portfolio is managed by Maurits E.
Edersheim and a team of seasoned international equity portfolio managers, who
collectively have over 125 years of experience. Mr. Edersheim is Chairman and
Advisory Director of Smith Barney World Funds, Inc. and is Deputy Chairman of
Smith Barney International Incorporated. Prior to joining Smith Barney in 1990,
Mr. Edersheim was Deputy Chairman and Director of Drexel Burnham Lambert
Incorporated ("Drexel Burnham"). Mr. James Conheady and Mr. Jeffrey Russell,
both Vice Presidents of the Fund and Managing Directors of Smith Barney are
members of the international equity team, and are responsible for the day-to-day
operations of the Smith Barney International Equity Portfolio, making all of the
investment decisions for the Portfolio since inception. Together, Mr. Conheady
and Mr. Russell currently manage in excess of $2.8 billion in global equity
assets for other investment companies and managed accounts. Prior to joining
Smith Barney in February 1990, Mr. Conheady was a First Vice President and Mr.
Russell was a Vice President of Drexel Burnham.
BOARD OF DIRECTORS
Overall responsibility for management and supervision of the Fund rests with
the Fund's Board of Directors. The Directors approve all significant agreements
between the Fund and the companies that furnish services to the Fund and each
Portfolio, including agreements with the Fund's distributor, investment
managers, investment sub-advisers, custodian and transfer agent. The Statement
of Additional Information contains background information regarding each
Director and executive officer of the Fund.
PORTFOLIO TRANSACTIONS AND DISTRIBUTION
SBMFM is 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.
Smith Barney distributes shares of the Fund as principal underwriter. In
addition, the Fund's Board of Directors has determined that transactions for the
Fund may be executed through Smith Barney or any broker-dealer affiliate of
Smith Barney (each, an "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 reasonable rate consistent with that charged to comparable
unaffiliated customers in similar transactions. The Fund will not deal with
Smith Barney in any transaction in which Smith Barney 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 Smith Barney
Income and Growth Portfolio, the Alliance Growth Portfolio, the AIM Capital
Appreciation Portfolio, the Van Kampen American Capital Enterprise Portfolio,
the
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<PAGE>
Smith Barney International Equity Portfolio, the Smith Barney Pacific Basin
Portfolio, the TBC Managed Income Portfolio, the Putnam Diversified Income
Portfolio, the G.T. Global Strategic Income Portfolio, the Smith Barney High
Income Portfolio, the MFS Total Return Portfolio and the Smith Barney Money
Market Portfolio. 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 contract owners 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 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 contract owners
and those given by variable life insurance contract owners. 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, contract owners would
presumably no longer have the economies of scale resulting from a larger
combined mutual fund.
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<PAGE>
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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<PAGE>
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.
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<PAGE>
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.
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.
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<PAGE>
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.
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
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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.
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.
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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.
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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Prospectus
L 12410 Travelers Series Fund Inc. SB Ed. 2-97
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