As filed with the Securities and Exchange Commission on November 6, 1998
FILE NO. 811-08642
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT
UNDER
THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 7
THE NEW YORK TAX EXEMPT BOND PORTFOLIO
(Exact Name of Registrant as Specified in
Charter)
60 State Street, Suite 1300, Boston, Massachusetts 02109
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (617) 557-0700
Margaret W. Chambers, c/o Funds Distributor, Inc.
60 State Street, Suite 1300, Boston, Massachusetts 02109
(Name and Address of Agent for Service)
Copy to:John E. Baumgardner, Jr., Esq.
Sullivan & Cromwell
125 Broad Street
New York, NY 10004
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EXPLANATORY NOTE
This Registration Statement has been filed by the Registrant pursuant
to Section 8(b) of the Investment Company Act of 1940, as amended. However,
beneficial interests in the Registrant are not being registered under the
Securities Act of 1933, as amended (the "1933 Act"), because such interests will
be issued solely in private placement transactions that do not involve any
"public offering" within the meaning of Section 4(2) of the 1933 Act.
Investments in the Registrant may only be made by other investment companies,
insurance company separate accounts, common or commingled trust funds or similar
organizations or entities that are "accredited investors" within the meaning of
Regulation D under the 1933 Act. This Registration Statement does not constitute
an offer to sell, or the solicitation of an offer to buy, any beneficial
interests in the Registrant.
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PART A
Responses to Items 1 through 3 and 5A have been omitted pursuant to
paragraph 4 of Instruction F of the General Instructions to Form N-1A.
ITEM 4. GENERAL DESCRIPTION OF REGISTRANT.
The New York Tax Exempt Bond Portfolio (the "Portfolio") is a no-load
non-diversified open-end management investment company which was organized as a
trust under the laws of the State of New York on June 16, 1993. Beneficial
interests in the Portfolio are issued solely in private placement transactions
that do not involve any "public offering" within the meaning of Section 4(2) of
the Securities Act of 1933, as amended (the "1933 Act"). Investments in the
Portfolio may only be made by other investment companies, insurance company
separate accounts, common or commingled trust funds or similar organizations or
entities that are "accredited investors" within the meaning of Regulation D
under the 1933 Act. This Registration Statement does not constitute an offer to
sell, or the solicitation of an offer to buy, any "security" within the meaning
of the 1933 Act.
Investments in the Portfolio are not deposits or obligations of, or
guaranteed or endorsed by any bank. Interests in the Portfolio are not federally
insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board
or any other governmental agency. An investment in the Portfolio is subject to
risk, as the net asset value of the Portfolio will fluctuate with changes in the
value of the Portfolio's holdings. There can be no assurance that the investment
objective of the Portfolio will be achieved.
The Portfolio is advised by J.P. Morgan Investment Management Inc. ("JPMIM"
or the "Advisor").
Part B contains more detailed information about the Portfolio,
including information related to (i) the investment policies and restrictions of
the Portfolio, (ii) the Trustees, officers, Advisor and administrators of the
Portfolio, (iii) portfolio transactions, (iv) rights and liabilities of
investors and (v) the audited financial statements of the Portfolio at March 31,
1998. (Which are incorporated by reference in their entirety to the Portfolio's
N-30D filing made on June 3, 1998).
The investment objective of the Portfolio is described below, together
with the policies employed to attempt to achieve this objective. Additional
information about the investment policies of the Portfolio appears in Part B,
under Item 13.
THE NEW YORK TAX EXEMPT BOND PORTFOLIO
This Portfolio invests primarily in bonds and other fixed income
securities. The Portfolio's goal is to provide a high level of tax exempt income
for New York residents consistent with moderate risk of capital. This goal can
be changed without the approval of interest holders.
J.P. MORGAN
Known for its commitment to proprietary research and its disciplined
investment strategies, J.P. Morgan is the asset management choice for many of
the world's most respected corporations, financial institutions, governments,
and individuals. Today, J.P. Morgan employs over 300 analysts and portfolio
managers around the world and has more than $275 billion in assets under
management, including assets managed by the Portfolio's advisor, J.P. Morgan
Investment Management Inc.
BEFORE YOU INVEST
Investors considering the Portfolio should understand that:
- The value of the Portfolio will fluctuate over time. You could lose money
if you
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sell when the Portfolio's price is lower than when you invested.
- - There is no assurance that the Portfolio will meet its investment goal.
- - Future returns will not necessarily resemble past performance.
- - The Portfolio invests a portion of assets in non-investment-grade bonds ("junk
bonds"), which offer higher potential yields but have a higher risk of default
and are more sensitive to market risk than investment-grade bonds.
- - The Portfolio does not represent a complete investment program.
FIXED INCOME MANAGEMENT APPROACH
The Portfolio invests primarily in bonds and other fixed income
securities.
The Portfolio's investment philosophy, developed by its advisor,
emphasizes the potential for consistently enhancing performance while managing
risk.
FIXED INCOME INVESTMENT PROCESS
J.P. Morgan seeks to generate an information advantage through the
depth of its global fixed-income research and the sophistication of its
analytical systems. Using a team-oriented approach, J.P. Morgan seeks to gain
insights in a broad range of distinct areas and takes positions in many
different ones, helping the Portfolio to limit exposure to concentrated sources
of risk.
In managing the Portfolio, J.P. Morgan employs a three-step process
that combines sector allocation, fundamental research for identifying portfolio
securities, and duration management.
SECTOR ALLOCATION The sector allocation team meets monthly, analyzing
the fundamentals of a broad range of sectors in which the Portfolio may invest.
The team seeks to enhance performance and manage risk by underweighting or
overweighting sectors.
SECURITY SELECTION Relying on the insights of different specialists,
including credit analysts, quantitative researchers, and dedicated fixed income
traders, the portfolio managers make buy and sell decisions according to the
Portfolio's goal and strategy.
DURATION MANAGEMENT Forecasting teams use fundamental economic factors
to develop strategic forecasts of the direction of interest rates. Based on
these forecasts, strategists establish the Portfolio's target duration (a
measure of average weighted maturity of the securities held by the Portfolio and
a common measurement of sensitivity to interest rate movements), typically
remaining relatively close to the duration of the market as a whole, as
represented by the Portfolio's benchmark. The strategists closely monitor the
Portfolio and make tactical adjustments as necessary.
The Portfolio's goal is to provide high after-tax income for New York
residents consistent with moderate risk of capital.
INVESTMENT APPROACH
The Portfolio invests primarily in New York municipal securities that it
believes have the potential to provide high current income which is free from
federal, state, and New York City personal income taxes for New York residents.
The Portfolio may also invest to a limited extent in securities of other states
or territories. To the extent that the Portfolio invests in municipal securities
of other states, the income from such securities would be free from federal
personal income taxes for New York residents but would be subject to New York
State and New York City personal income taxes. For non-New York residents, the
income from New York municipal securities is free from federal personal income
taxes only. The Portfolio may also invest in taxable securities. The Portfolio's
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securities may be of any maturity, but under normal market conditions the
Portfolio's duration (duration is a measure of average weighted maturity of the
securities held by a portfolio and a common measurement of sensitivity to
interest rate movements) will generally range between three and seven years,
similar to that of the Lehman Brothers 1-16 Year Municipal Bond Index. At least
90% of assets must be invested in securities that, at the time of purchase, are
rated investment-grade (BBB/Baa or better) or are the unrated equivalent. No
more than 10% of assets may be invested in securities rated B or BB.
RISKS/RETURN SUMMARY
The Portfolio's share price and total return will vary in response to changes in
interest rates. How well the Portfolio's performance compares to that of similar
fixed income funds will depend on the success of the investment process. Because
most of the Portfolio's investments will typically be from issuers in the State
of New York, its performance will be affected by the fiscal and economic health
of that state and its municipalities. The Portfolio is non-diversified and may
invest more than 5% of assets in a single issuer, which could further
concentrate its risks. To the extent that the Portfolio seeks higher returns by
investing in non-investment-grade bonds, often called junk bonds, it takes on
additional risks, since these bonds are more sensitive to economic news and
their issuers have a less secure financial condition.
RISK AND REWARD ELEMENTS
This table discusses the main elements that make up the Portfolio's
overall risk and reward characteristics. It also outlines the Portfolio's
policies toward various securities, including those that are designed to help
the Portfolio manage risk.
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POTENTIAL RISKS POTENTIAL REWARDS POLICIES TO BALANCE
RISK AND REWARD
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MARKET CONDITIONS
- -The Portfolio's price -Bonds have generally -Under normal
yield and total return will outperformed money circumstances the
fluctuate in response market investments Portfolio plans to remain
to bond market movements over the long term, fully invested in bonds
with less risk than and other fixed income
- -The value of most bonds stocks securities
will fall when interest
rates rise; the longer -Most bonds will rise -The Portfolio seeks to
a bond's maturity and the in value when interest limit risk and enhance
lower its credit quality, rates fall yields through careful
the more its value typically management, sector
falls -Asset-backed securities allocation, individual
can offer attractive securities selection and
- -Asset-backed securities returns duration management
(securities representing
an interest in, or secured -During severe market
by, a pool of assets such downturns, the Portfolio
as receivables) could has the option of
generate capital losses investing up to 100% of
or periods of low yields assets in investment-
if they are paid off grade short-term
substantially earlier or securities
later than anticipated
-J.P. Morgan monitors
- -Adverse market conditions interest rate trends, as
may from time to time cause well as geographic and
the Portfolio to take temporary demographic information
defensive positions that are related to asset-backed
inconsistent with its principal securities and
investment strategies and may prepayments
hinder a fund from achieving its
investment objective
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POTENTIAL RISKS POTENTIAL REWARDS POLICIES TO BALANCE
RISK AND REWARD
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MANAGEMENT CHOICES
- -The Portfolio could -The Portfolio could -J.P. Morgan focuses
underperform its outperform its its active management
benchmark due to its benchmark due to on those areas where it
sector, securities, these same choices believes its commitment
or duration choices to research can most
enhance returns and
manage risks in a
consistent way
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CREDIT QUALITY
- -The default of an issuer -Investment-grade bonds -The Portfolio maintains
would leave the Portfolio have a lower risk of its own policies for
with unpaid interest or default balancing credit quality
principal against potential yields
-Junk bonds offer higher and gains in light of
- -Junk bonds (those rated yields and higher its investment goals
BB/Ba or lower) have a potential gains
higher risk of default, -J.P. Morgan develops its
tend to be less liquid, own ratings of unrated
and may be more difficult securities and makes a
to value credit quality determination
for unrated securities
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ILLIQUID HOLDINGS
- -The Portfolio could have -These holdings may offer -The Portfolio may not
difficulty valuing these more attractive yields or invest more than 15%
holdings precisely potential growth than of net assets in
comparable widely traded illiquid holdings
- -The Portfolio could be securities
unable to sell these -To maintain adequate
holdings at the time liquidity to meet
or price desired redemptions, the
Portfolio may hold
investment-grade
short-term securities
(including repurchase
agreements) and, for
temporary or
extraordinary purposes,
may borrow from banks up
to 331/3% of the value
of its assets
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WHEN-ISSUED AND DELAYED
DELIVERY SECURITIES
- -When the Portfolio buys -The Portfolio can take -The Portfolio uses
securities before issue advantage of attractive segregated accounts to
or for delayed delivery, transaction opportunities offset leverage risk
it could be exposed to
leverage risk if it does
not use segregated
accounts
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POTENTIAL RISKS POTENTIAL REWARDS POLICIES TO BALANCE
RISK AND REWARD
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SHORT-TERM TRADING
- -Increased trading would -The Portfolio could -The Portfolio anticipates
raise the Portfolio's realize gains in a a portfolio turnover rate
transaction costs short period of time rate of approximately 75%
- -Increased short-term -The Portfolio could -The Portfolio generally
capital gains distributions protect against losses avoids short-term
would raise investors' if a bond is overvalued trading, except to take
income tax liability and its value later advantage of attractive
falls or unexpected
opportunities
The Portfolio is also permitted to enter into futures and options transactions,
however, these transactions result in taxable gains or losses so it is expected
that the Portfolio will utilize them infrequently.
INVESTMENTS
This table discusses the customary types of securities which can be held by the
Portfolio. In each case the principal types of risk (along with their
definitions) are listed.
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ASSET-BACKED SECURITIES Interests in a stream of payments from specific assets,
such as auto or credit card receivables.
Risk: credit, interest rate, market, prepayment
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BANK OBLIGATIONS Negotiable certificates of deposit, time deposits and bankers'
acceptances.
Risk: credit, liquidity
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COMMERCIAL PAPER Unsecured short term debt issued by banks or corporations.
These securities are usually discounted and are rated by S&P or Moody's.
Risk: credit, interest rate, liquidity, market
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PRIVATE PLACEMENTS Bonds or other investments that are sold directly to an
institutional investor.
Risk: credit, interest rate, liquidity, market, valuation
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REPURCHASE AGREEMENTS Contracts whereby the seller of a security agrees to
repurchase the same security from the buyer on a particular date and at a
specific price
Risk: credit
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SYNTHETIC VARIABLE RATE INSTRUMENTS Debt instruments whereby the issuer agrees
to exchange one security for another in order to change the maturity or quality
of a security in the Portfolio.
Risk: credit, interest rate, leverage, liquidity, market
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TAX EXEMPT MUNICIPAL SECURITIES Securities, generally issued as general
obligation and revenue bonds, whose interest is exempt from federal taxation and
state and/or local taxes in the state where the securities were issued.
Risk: credit, interest rate, market, natural event, political
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U.S. GOVERNMENT SECURITIES Debt instruments (Treasury bills, notes, and bonds)
guaranteed by the U.S. government for the timely payment of principal and
interest.
Risk: interest rate
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ZERO COUPON, PAY-IN-KIND, AND DEFERRED PAYMENT SECURITIES Securities offering
non-cash or delayed-cash payment. Their prices are typically more volatile than
those of some other debt instruments and involve certain special tax
considerations.
Risk: credit, interest rate, liquidity, market, valuation
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RISK RELATED TO CERTAIN SECURITIES HELD BY THE NEW YORK TOTAL RETURN BOND
PORTFOLIO:
CREDIT RISK The risk a financial obligation will not be met by the issuer of a
security or the counterparty to a contract, resulting in a loss to the
purchaser.
INTEREST RATE RISK The risk a change in interest rates will adversely affect the
value of an investment. The value of fixed income securities generally moves in
the opposite direction of interest rates (decreases when interest rates rise and
increases when interest rates fall).
LEVERAGE RISK The risk of gains or losses disproportionately higher than the
amount invested
LIQUIDITY RISK The risk the holder may not be able to sell the security at the
time or price it desires.
MARKET RISK The risk that when the market as a whole declines, the value of a
specific investment will decline proportionately. This systematic risk is common
to all investments and the mutual funds that purchase them.
NATURAL EVENT RISK The risk of a natural disaster, such as a hurricane or
similar event, wil cause severe economic losses and default in payments by the
issuer of the security.
POLITICAL RISK The risk governmental policies or other political actions will
negatively impact the value of the investment.
PREPAYMENT RISK The risk declining interest rates will result in unexpected
prepayments, causing the value of the investment to fall.
VALUATION RISK The risk the estimated value of a security does not match the
actual amount that can be realized if the security is sold.
ITEM 5. MANAGEMENT OF THE PORTFOLIO.
The Board of Trustees provides broad supervision over the affairs of
the Portfolio. The Portfolio has retained the services of JPMIM as investment
adviser and Morgan Guaranty Trust Company of New York ("Morgan"), as
administrative services agent. The Portfolio has retained the services of Funds
Distributor, Inc. ("FDI") as co-administrator (the "Co-Administrator").
The Portfolio has not retained the services of a principal underwriter
or distributor, since interests in the Portfolio are offered solely in private
placement transactions. FDI, acting as agent for the Portfolio, serves as
exclusive placement
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agent of interests in the Portfolio. FDI receives no additional
compensation for serving in this capacity.
The Portfolio has entered into an Amended and Restated Portfolio Fund
Services Agreement, dated July 11, 1996, with Pierpont Group, Inc. ("Pierpont
Group") to assist the Trustees in exercising their overall supervisory
responsibilities for the Portfolio. The fees to be paid under the agreement
approximate the reasonable cost of Pierpont Group in providing these services to
the Portfolio and other registered investment companies subject to similar
agreements with Pierpont Group. Pierpont Group was organized in 1989 at the
request of the Trustees of the J.P. Morgan Family of Funds (formerly The
Pierpont Family of Funds) for the purpose of providing these services at cost to
those funds. See Item 14 in Part B. The principal offices of Pierpont Group are
located at 461 Fifth Avenue, New York, New York 10017.
INVESTMENT ADVISOR. The Portfolio has retained the services of JPMIM as
investment advisor. JPMIM, a wholly owned subsidiary of J.P. Morgan & Co.
Incorporated ("J.P. Morgan"), a bank holding company organized under the laws of
Delaware. Through offices in New York City and abroad, J.P. Morgan, through the
Advisor and other subsidiaries, offers a wide range of services to governmental,
institutional, corporate and individual customers and acts as investment adviser
to individual and institutional clients with combined assets under management of
approximately $285 billion. JPMIM provides investment advice and portfolio
management services to the Portfolio. Subject to the supervision of the
Portfolio's Trustees, JPMIM, as Advisor, makes the Portfolio's day-to-day
investment decisions, arranges for the execution of portfolio transactions and
generally manages the Portfolio's investments. See Item 16 in Part B.
The Advisor uses a sophisticated, disciplined, collaborative process
for managing all asset classes. For fixed income portfolios, this process
focuses on the systematic analysis of real interest rates, sector
diversification and quantitative and credit analysis. The Portfolio managers
making investments in domestic fixed income securities work in conjunction with
fixed income, credit, capital market and economic research analysts, as well as
traders and administrative officers.
The portfolio management team is led by Robert W. Meiselas, vice
president, who has been at J.P. Morgan since 1987, and by Elaine B. Young, vice
president, who joined J.P. Morgan from Scudder, Stevens & Clark, Inc. in 1994
where she was a municipal bond trader and fixed income portfolio manager. Both
have been on the team since June of 1997.
As compensation for the services rendered and related expenses borne by
JPMIM under the Investment Advisory Agreement with the Portfolio, the Portfolio
has agreed to pay JPMIM a fee which is computed daily and may be paid monthly at
the annual rate of 0.30% of the Portfolio's average daily net assets.
CO-ADMINISTRATOR. Pursuant to a Co-Administration Agreement with the
Portfolio, FDI serves as the Co-Administrator for the Portfolio. FDI (i)
provides office space, equipment and clerical personnel for maintaining the
organization and books and records of the Portfolio; (ii) provides officers for
the Portfolio; (iii) files Portfolio regulatory documents and mails Portfolio
communications to Trustees and investors; and (iv) maintains related books and
records. See Administrative Services Agent below.
For its services under the Co-Administration Agreement, the Portfolio
has agreed to pay FDI fees equal to its allocable share of an annual
complex-wide charge of $425,000 plus FDI's out-of-pocket expenses. The amount
allocable to the Portfolio is based on the ratio of its net assets to the
aggregate net assets of the Portfolio and certain other investment companies
subject to similar agreements with FDI.
ADMINISTRATIVE SERVICES AGENT. Pursuant to the Administrative Services
Agreement with the Portfolio, Morgan provides certain administrative and related
services to the Portfolio, including services related to tax compliance,
financial statements, calculation of performance data, oversight of service
providers and certain regulatory and Board of Trustees matters.
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Under the Administrative Services Agreement, the Portfolio has agreed
to pay Morgan fees equal to its allocable share of an annual complex-wide
charge. This charge is calculated daily based on the aggregate net assets of the
Portfolio and certain other registered investment companies managed by the
Advisor in accordance with the following annual schedule: 0.09% on the first $7
billion of their aggregate average daily net assets and 0.04% of their aggregate
average daily net assets in excess of $7 billion, less the complex-wide fees
payable to FDI.
PLACEMENT AGENT. FDI, a registered broker-dealer, also serves as
exclusive placement agent for the Portfolio. FDI is a wholly owned indirect
subsidiary of Boston Institutional Group, Inc. FDI's principal business address
is 60 State Street, Suite 1300, Boston, Massachusetts 02109.
CUSTODIAN. State Street Bank and Trust Company ("State Street"), 225
Franklin Street, Boston, Massachusetts 02110 serves as the Portfolio's custodian
and fund accounting and transfer agent. State Street keeps the books of account
for the Portfolio.
EXPENSES. In addition to the fees payable to the service providers
identified above, the Portfolio is responsible for usual and customary expenses
associated with its operations. Such expenses include organization expenses,
legal fees, accounting and audit expenses, insurance costs, the compensation and
expenses of the Trustees, registration fees under federal securities laws,
extraordinary expenses and brokerage expenses.
J.P. Morgan has agreed that it will reimburse the Portfolio to the
extent necessary to maintain the Portfolio's total operating expenses at the
annual rate of no more than 0.50% of the Portfolio's average daily net assets.
This limit does not cover extraordinary expenses during the period. This
reimbursement arrangement can be changed or terminated at any time at the option
of J.P. Morgan. For the fiscal year ended March 31, 1998, the Portfolio's total
expenses were 40% of its average net assets.
ITEM 6. CAPITAL STOCK AND OTHER SECURITIES.
The Portfolio is organized as a trust under the laws of the State of
New York. Under the Declaration of Trust, the Trustees are authorized to issue
beneficial interests in the Portfolio. Each investor is entitled to a vote in
proportion to the amount of its investment in the Portfolio. Investments in the
Portfolio may not be transferred, but an investor may withdraw all or any
portion of its investment at any time at net asset value. Investors in the
Portfolio (e.g., other investment companies, insurance company separate accounts
and common and commingled trust funds) will each be liable for all obligations
of the Portfolio. However, the risk of an investor in the Portfolio incurring
financial loss on account of such liability is limited to circumstances in which
both inadequate insurance existed and the Portfolio itself was unable to meet
its obligations.
As of June 30, 1998, the J.P. Morgan Institutional New York Tax Exempt
Bond Fund, (formerly J.P. Morgan Institutional New York Total Return Bond Fund)
and the J.P. Morgan New York Tax Exempt Bond Fund, (formerly J.P. Morgan New
York Total Return Bond Fund) (series of J.P. Morgan Institutional Funds and J.P.
Morgan Funds, respectively) (the "Funds") owned 61% and 39%, respectively, of
the outstanding beneficial interests in the Portfolio. So long as the Funds
control the Portfolio, they may take actions without the approval of any other
holders of beneficial interest, if any, in the Portfolio.
Each investor in the Portfolio is entitled to a vote in proportion to
the amount of its investment in the Portfolio. Investments in the Portfolio have
no preemptive or conversion rights and are fully paid and nonassessable, except
as set forth below. The Portfolio is not required and has no current intention
of holding annual meetings of investors, but the Portfolio will hold special
meetings of investors when in the judgment of the Trustees it is necessary or
desirable to submit matters for an investor vote. Changes in fundamental
policies will be submitted to investors for
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approval. Investors have under certain circumstances (e.g., upon
application and submission of certain specified documents to the Trustees by a
specified percentage of the outstanding interests in the Portfolio) the right to
communicate with other investors in connection with requesting a meeting of
investors for the purpose of removing one or more Trustees. Investors also have
the right to remove one or more Trustees without a meeting by a declaration in
writing by a specified percentage of the outstanding interests in the Portfolio.
Upon liquidation of the Portfolio, investors would be entitled to share pro rata
in the net assets of the Portfolio available for distribution to investors.
The net asset value of the Portfolio is determined each business day
other than the holidays listed in Part B ("Portfolio Business Day"). This
determination is made once each Portfolio Business Day as of the close of
trading on the NYSE (normally 4:00pm eastern time)(the "Valuation Time").
The "net income" of the Portfolio will consist of (i) all income
accrued, less the amortization of any premium, on the assets of the Portfolio,
less (ii) all actual and accrued expenses of the Portfolio determined in
accordance with generally accepted accounting principles. Interest income
includes discount earned (including both original issue and market discount) on
discount paper accrued ratably to the date of maturity and any net realized
gains or losses on the assets of the Portfolio. All the net income of the
Portfolio is allocated pro rata among the investors in the Portfolio.
The end of the Portfolio's fiscal year is March 31.
Under the anticipated method of operation of the Portfolio, the
Portfolio will not be subject to any income tax. However, each investor in the
Portfolio will be taxable on its share (as determined in accordance with the
governing instruments of the Portfolio) of the Portfolio's ordinary income and
capital gain in determining its income tax liability. The determination of such
share will be made in accordance with the Internal Revenue Code of 1986, as
amended (the "Code"), and regulations promulgated thereunder.
It is intended that the Portfolio's assets, income and distributions
will be managed in such a way that an investor in the Portfolio will be able to
satisfy the requirements of Subchapter M of the Code, assuming that the investor
invested all of its assets in the Portfolio.
Investor inquiries may be directed to FDI at 60 State Street, Boston,
Massachusetts 02109 or by calling FDI at (617) 557-0700.
ITEM 7. PURCHASE OF SECURITIES.
Beneficial interests in the Portfolio are issued solely in private
placement transactions that do not involve any "public offering" within the
meaning of Section 4(2) of the 1933 Act. Investments in the Portfolio may only
be made by other investment companies, insurance company separate accounts,
common or commingled trust funds, or similar organizations or entities which are
"accredited investors" as defined in Rule 501 under the 1933 Act. This
Registration Statement does not constitute an offer to sell, or the solicitation
of an offer to buy, any "security" within the meaning of the 1933 Act.
An investment in the Portfolio may be made without a sales load. All
investments are made at net asset value next determined after an order is
received in "good order" by the Portfolio. The net asset value of the Portfolio
is determined at the Valuation Time on each Portfolio Business Day.
There is no minimum initial or subsequent investment in the Portfolio.
However, because the Portfolio intends to be as fully invested at all times as
is reasonably practicable in order to enhance the yield on its assets,
investments must be made in federal funds (i.e., monies credited to the account
of the Custodian by a Federal Reserve Bank).
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The Portfolio may, at its own option, accept securities in payment for
investments in its beneficial interests. The securities delivered in kind are
valued by the method described in Net Asset Value as of the business day prior
to the day the Portfolio receives the securities. Securities may be accepted in
payment for beneficial interests only if they are, in the judgment of Morgan,
appropriate investments for the Portfolio. In addition, securities accepted in
payment for beneficial interests must: (i) meet the investment objective and
policies of the Portfolio; (ii) be acquired by the Portfolio for investment and
not for resale; (iii) be liquid securities which are not restricted as to
transfer either by law or liquidity of market; and (iv) have a value which is
readily ascertainable as evidenced by a listing on a stock exchange, OTC market
or by readily available market quotations from a dealer in such securities. The
Portfolio reserves the right to accept or reject at its own option any and all
securities offered in payment for beneficial interests.
The Portfolio and FDI reserve the right to cease accepting investments
at any time or to reject any investment order.
Each investor in the Portfolio may add to or reduce its investment in
the Portfolio on each Portfolio Business Day. At the Valuation Time on each such
day, the value of each investor's beneficial interest in the Portfolio will be
determined by multiplying the net asset value of the Portfolio by the
percentage, effective for that day, which represents that investor's share of
the aggregate beneficial interests in the Portfolio. Any additions or
reductions, which are to be effected at the Valuation Time on such day, will
then be effected. The investor's percentage of the aggregate beneficial
interests in the Portfolio will then be recomputed as the percentage equal to
the fraction (i) the numerator of which is the value of such investor's
investment in the Portfolio to the Valuation Time on such day plus or minus, as
the case may be, the amount of net additions to or reductions in the investor's
investment in the Portfolio effected as of the Valuation Time, and (ii) the
denominator of which is the aggregate net asset value of the Portfolio as of the
Valuation Time on such day, plus or minus, as the case may be, the amount of net
additions to or reductions in the aggregate investments in the Portfolio by all
investors in the Portfolio. The percentage so determined will then be applied to
determine the value of the investor's interest in the Portfolio as of the
Valuation Time on the following Portfolio Business Day.
ITEM 8. REDEMPTION OR REPURCHASE.
An investor in the Portfolio may reduce all or any portion of its
investment at the net asset value next determined after a request in "good
order" is furnished by the investor to the Portfolio. The proceeds of a
reduction will be paid by the Portfolio in federal funds normally on the next
Portfolio Business Day after the reduction is effected, but in any event within
seven days. Investments in the Portfolio may not be transferred.
The right of any investor to receive payment with respect to any
reduction may be suspended or the payment of the proceeds therefrom postponed
during any period in which the New York Stock Exchange (the "NYSE") is closed
(other than weekends or holidays) or trading on the NYSE is restricted or, to
the extent otherwise permitted by the 1940 Act, if an emergency exists.
The Portfolio reserves the right under certain circumstances, such as
accommodating requests for substantial withdrawals or liquidations, to pay
distributions in kind to investors (i.e., to distribute portfolio securities as
opposed to cash). If securities are distributed, an investor could incur
brokerage, tax or other charges in converting the securities to cash. In
addition, distribution in kind may result in a less diversified portfolio of
investments or adversely affect the liquidity of the Portfolio or the investor's
portfolio, as the case may be.
ITEM 9. PENDING LEGAL PROCEEDINGS.
Not applicable.
<PAGE>
PART B
ITEM 10. COVER PAGE.
Not applicable.
ITEM 11. TABLE OF CONTENTS. PAGE
General Information and History . . . . . . . . . . . B-1
Investment Objective and Policies . . . . . . . . . . B-1
Management of the Portfolio . . . . . . . . . . . . . B-16
Control Persons and Principal Holders
of Securities . . . . . . . . . . . . . . . . . . . . B-21
Investment Advisory and Other Services . . . . . . . .B-21
Brokerage Allocation and Other Practices . . . . . .. B-25
Capital Stock and Other Securities . . . . . . . . .. B-27
Purchase, Redemption and Pricing of
Securities Being Offered . . . . . . . . . . . . . .. B-28
Tax Status . . . . . . . . . . . . . . . . . . . . . .B-29
Underwriters . . . . . . . . . . . . . . . . . . . .. B-31
Calculations of Performance Data . . . . . . . . . .. B-31
Financial Statements . . . . . . . . . . . . . . . ...B-31
ITEM 12. GENERAL INFORMATION AND HISTORY.
Not applicable.
ITEM 13. INVESTMENT OBJECTIVE AND POLICIES.
The investment objective of The New York Tax Exempt Bond Portfolio (the
"Portfolio") is to provide a high level of tax exempt income for New York
residents consistent with moderate risk of capital.
The Portfolio attempts to achieve its investment objective by investing
primarily in municipal securities issued by New York State and its political
subdivisions and by agencies, authorities and instrumentalities of New York and
its political subdivisions. These securities earn income exempt from federal and
New York State and local income taxes but, in certain circumstances, may be
subject to alternative minimum tax. In addition, the Portfolio may invest in
municipal securities issued by states other than New York, by territories and
possessions of the United States and by the District of Columbia and their
political subdivisions, agencies and instrumentalities. These securities earn
income exempt from federal income taxes but, in certain circumstances, may be
subject to alternative minimum tax. The Portfolio is advised by J.P. Morgan
Investment Management Inc. ("JPMIM" or the "Advisor"). In order to seek to
enhance the Portfolio's after tax return, the Portfolio may also invest in
securities which earn income subject to New York and/or federal income taxes.
These securities include U.S. government securities, corporate securities and
municipal securities issued on a taxable basis.
The following discussion supplements the information regarding the
investment objective of the Portfolio and the policies to be employed to achieve
this objective as set forth above and in Part A.
TAX EXEMPT OBLIGATIONS
The Portfolio may invest in bonds issued by or on behalf of New York
State, other states, territories and possessions of the United States and their
political subdivisions, agencies, authorities and instrumentalities. These
obligations may be general obligation bonds secured by the issuer's pledge of
its full faith, credit and taxing power for the payment of principal and
interest, or they may be revenue bonds payable from specific revenue sources,
but not generally backed by the issuer's taxing power. Under normal
circumstances, the Portfolio will invest at least 65% of its total assets in
municipal securities issued by New York State and its political subdivisions
<PAGE>
and their agencies, authorities and instrumentalities. The Portfolio
may also invest in debt obligations of municipal issuers other than New York.
The municipal securities in which the Portfolio invests are primarily municipal
bonds and municipal notes.
The Portfolio will invest in tax exempt obligations. Because of the
Portfolio's significant investment in New York municipal securities, its
performance will be affected by the condition of New York's economy, as well as
the fiscal condition of the State, its agencies and municipalities. The New York
State economy has shown signs of recovery fueled by the strength of downstate
financial services. However, the State's performance continues to lag national
averages. Despite strong revenue performance during fiscal 1997 budget
imbalances and limited reserves remain as structural concerns. The Advisor
currently views the New York economy and financial condition as fundamentally
stable. However, the possibility of a disruption to economic and financial
conditions which would adversely affect the creditworthiness and marketability
of New York municipal securities continues to exist. For a more detailed
discussion of the risks associated with investing in New York municipal
securities, see "Additional Information Regarding New York Municipal
Obligations". A description of the various types of tax exempt obligations which
may be purchased by the Portfolio appears below. See "Quality and
Diversification Requirements."
MUNICIPAL BONDS. Municipal bonds are debt obligations issued by the
states, territories and possessions of the United States and the District of
Columbia, by their political subdivisions and by duly constituted authorities
and corporations. For example, states, territories, possessions and
municipalities may issue municipal bonds to raise funds for various public
purposes such as airports, housing, hospitals, mass transportation, schools,
water and sewer works. They may also issue municipal bonds to refund outstanding
obligations and to meet general operating expenses. Public authorities issue
municipal bonds to obtain funding for privately operated facilities, such as
housing and pollution control facilities, for industrial facilities or for water
supply, gas, electricity or waste disposal facilities.
Municipal bonds may be general obligation or revenue bonds. General
obligation bonds are secured by the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable from revenues derived from particular facilities, from the proceeds of a
special excise tax or from other specific revenue sources. They are not
generally payable from the general taxing power of a municipality.
MUNICIPAL NOTES. The Portfolio may also invest in municipal notes of
various types, including notes issued in anticipation of receipt of taxes, the
proceeds of the sale of bonds, other revenues or grant proceeds, as well as
municipal commercial paper and municipal demand obligations such as variable
rate demand notes and master demand obligations. The interest rate on variable
rate demand notes is adjustable at periodic intervals as specified in the notes.
Master demand obligations permit the investment of fluctuating amounts at
periodically adjusted interest rates. They are governed by agreements between
the municipal issuer and Morgan Guaranty Trust Company of New York ("Morgan"),
an affiliate of the Advisor, acting as agent, for no additional fee. Although
master demand obligations are not marketable to third parties, the Portfolio
considers them to be liquid because they are payable on demand. There is no
specific percentage limitation on these investments. Municipal notes are
subdivided into three categories of short-term obligations: municipal notes,
municipal commercial paper and municipal demand obligations.
Municipal notes are short-term obligations with a maturity at the time
of issuance ranging from six months to five years. The principal types of
municipal notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, grant anticipation notes and project notes. Notes sold in
anticipation of collection of taxes, a bond sale, or receipt of other revenues
are usually general obligations of the issuing municipality or agency.
Municipal commercial paper typically consists of very short-term
unsecured negotiable promissory notes that are sold to meet seasonal working
capital or interim construction financing needs of a municipality or agency.
While these obligations are intended to be paid from general revenues or
refinanced with long-term debt, they frequently are backed by letters of credit,
lending agreements, note repurchase agreements or other credit facility
agreements offered by banks or institutions.
<PAGE>
Municipal demand obligations are subdivided into two types: variable rate
demand notes and master demand obligations.
Variable rate demand notes are tax exempt municipal obligations or
participation interests that provide for a periodic adjustment in the interest
rate paid on the notes. They permit the holder to demand payment of the notes,
or to demand purchase of the notes at a purchase price equal to the unpaid
principal balance, plus accrued interest either directly by the issuer or by
drawing on a bank letter of credit or guaranty issued with respect to such note.
The issuer of the municipal obligation may have a corresponding right to prepay
at its discretion the outstanding principal of the note plus accrued interest
upon notice comparable to that required for the holder to demand payment. The
variable rate demand notes in which the Portfolio may invest are payable, or are
subject to purchase, on demand usually on notice of seven calendar days or less.
The terms of the notes provide that interest rates are adjustable at intervals
ranging from daily to six months, and the adjustments are based upon the prime
rate of a bank or other appropriate interest rate index specified in the
respective notes. Variable rate demand notes are valued at amortized cost; no
value is assigned to the right of the Portfolio to receive the par value of the
obligation upon demand or notice.
Master demand obligations are tax exempt municipal obligations that
provide for a periodic adjustment in the interest rate paid and permit daily
changes in the amount borrowed. The interest on such obligations is, in the
opinion of counsel for the borrower, excluded from gross income for federal
income tax purposes. For a description of the attributes of master demand
obligations, see "Money Market Instruments" below.
Premium Securities. During a period of declining interest rates, many
municipal securities in which the Portfolio invests likely will bear coupon
rates higher than current market rates, regardless of whether the securities
were initially purchased at a premium. In general, such securities have market
values greater than the principal amounts payable on maturity, which would be
reflected in the net asset value of the Portfolio. The values of such "premium"
securities tend to approach the principal amount as they near maturity.
Puts. The Portfolio may purchase without limit, municipal bonds or
notes together with the right to resell the bonds or notes to the seller at an
agreed price or yield within a specified period prior to the maturity date of
the bonds or notes. Such a right to resell is commonly known as a "put." The
aggregate price for bonds or notes with puts may be higher than the price for
bonds or notes without puts. Consistent with the Portfolio's investment
objective and subject to the supervision of the Trustees, the purpose of this
practice is to permit the Portfolio to be fully invested in tax exempt
securities while preserving the necessary liquidity to purchase securities on a
when-issued basis, to meet unusually large redemptions, and to purchase at a
later date securities other than those subject to the put. The principal risk of
puts is that the writer of the put may default on its obligation to repurchase.
The Advisor will monitor each writer's ability to meet its obligations under
puts.
Puts may be exercised prior to the expiration date in order to fund
obligations to purchase other securities or to meet redemption requests. These
obligations may arise during periods in which proceeds from sales of interests
in the Portfolio and from recent sales of portfolio securities are insufficient
to meet obligations or when the funds available are otherwise allocated for
investment. In addition, puts may be exercised prior to the expiration date in
order to take advantage of alternative investment opportunities or in the event
the Advisor revises its evaluation of the creditworthiness of the issuer of the
underlying security. In determining whether to exercise puts prior to their
expiration date and in selecting which puts to exercise, the Advisor considers
the amount of cash available to the Portfolio, the expiration dates of the
available puts, any future commitments for securities purchases, alternative
investment opportunities, the desirability of retaining the underlying
securities in the Portfolio and the yield, quality and maturity dates of the
<PAGE>
underlying securities.
The Portfolio values any municipal bonds and notes subject to puts with
remaining maturities of less than 60 days by the amortized cost method. If the
Portfolio were to invest in municipal bonds and notes with maturities of 60 days
or more that are subject to puts separate from the underlying securities, the
puts and the underlying securities would be valued at fair value as determined
in accordance with procedures established by the Board of Trustees. The Board of
Trustees would, in connection with the determination of the value of a put,
consider, among other factors, the creditworthiness of the writer of the put,
the duration of the put, the dates on which or the periods during which the put
may be exercised and the applicable rules and regulations of the Securities and
Exchange Commission (the "SEC"). Prior to investing in such securities, the
Portfolio, if deemed necessary based upon the advice of counsel, will apply to
the SEC for an exemptive order, which may not be granted, relating to the
amortized valuation of such securities.
Since the value of the put is partly dependent on the ability of the
put writer to meet its obligation to repurchase, the Portfolio's policy is to
enter into put transactions only with municipal securities dealers who are
approved by the Advisor. Each dealer will be approved on its own merits, and it
is the Portfolio's general policy to enter into put transactions only with those
dealers which are determined to present minimal credit risks. In connection with
such determination, the Trustees will review regularly the Advisor's list of
approved dealers, taking into consideration, among other things, the ratings, if
available, of their equity and debt securities, their reputation in the
municipal securities markets, their net worth, their efficiency in consummating
transactions and any collateral arrangements, such as letters of credit,
securing the puts written by them. Commercial bank dealers normally will be
members of the Federal Reserve System, and other dealers will be members of the
National Association of Securities Dealers, Inc. or members of a national
securities exchange. Other put writers will have outstanding debt rated Aa or
better by Moody's Investors Service, Inc. ("Moody's") or AA or better by
Standard & Poor's Ratings Group ("Standard & Poor's"), or will be of comparable
quality in the Advisor's opinion or such put writers' obligations will be
collateralized and of comparable quality in the Advisor's opinion. The Trustees
have directed the Advisor not to enter into put transactions with any dealer
which in the judgment of the Advisor become more than a minimal credit risk. In
the event that a dealer should default on its obligation to repurchase an
underlying security, the Portfolio is unable to predict whether all or any
portion of any loss sustained could subsequently be recovered from such dealer.
Entering into a put with respect to a tax exempt security may be
treated, depending upon the terms of the put, as a taxable sale of the tax
exempt security by the Portfolio with the result that, while the put is
outstanding, the Portfolio will no longer be treated as the owner of the
security and the interest income derived with respect to the security will be
treated as taxable income to the Portfolio.
NON-MUNICIPAL SECURITIES
The Portfolio may invest in bonds and other debt securities of domestic
issuers to the extent consistent with its investment objective and policies. The
Portfolio may invest in non-municipal securities including obligations of the
U.S. government and its agencies and instrumentalities, bank obligations, debt
securities of corporate issuers, asset-backed securities and repurchase
agreements. The Portfolio will invest in non-municipal securities when, in the
opinion of the Advisor, these securities will enhance the after tax income to
investors who are subject to federal and New York State income taxes in the
highest tax bracket. Under normal circumstances, the Portfolio's holdings of
non-municipal securities and municipal securities of tax-exempt issuers outside
New York State will not exceed 35% of its total assets. A description of these
investments appears below. See "Quality and Diversification Requirements." For
information on short-term investments in these securities, see "Money Market
Instruments."
ZERO COUPON, PAY-IN-KIND AND DEFERRED PAYMENT SECURITIES. While
interest payments are not made on such securities, holders of such securities
are deemed to have received "phantom income." Because the Portfolio will
distribute "phantom income" to shareholders, to the extent that shareholders
elect to receive dividends in
<PAGE>
cash rather than reinvesting such dividends in additional shares, the
Portfolio will have fewer assets with which to purchase income producing
securities.
ASSET-BACKED SECURITIES. Asset-backed securities directly or indirectly
represent a participation interest in, or are secured by and payable from, a
stream of payments generated by particular assets such as motor vehicle or
credit card receivables or other asset-backed securities collateralized by such
assets. Payments of principal and interest may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution unaffiliated with the entities issuing the securities. The
asset-backed securities in which the Portfolio may invest are subject to the
Portfolio's overall credit requirements. However, asset-backed securities, in
general, are subject to certain risks. Most of these risks are related to
limited interests in applicable collateral. For example, credit card debt
receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
give such debtors the right to set off certain amounts on credit card debt
thereby reducing the balance due. Additionally, if the letter of credit is
exhausted, holders of asset-backed securities may also experience delays in
payments or losses if the full amounts due on underlying sales contracts are not
realized.
MONEY MARKET INSTRUMENTS
The Portfolio will invest in money market instruments that meet the quality
requirements described below except that short-term municipal obligation of New
York State issuers may be rated MIG-2 by Moody's or SP-2 by Standard & Poor's.
Under normal circumstances, the Portfolio will purchase these securities to
invest temporary cash balances or to maintain liquidity to meet withdrawals.
However, the Portfolio may also invest in money market instruments as a
temporary defensive measure taken during, or in anticipation of, adverse market
conditions. A description of the various types of money market instruments that
may be purchased by the Portfolio appears below. Also see "Quality and
Diversification Requirements."
BANK OBLIGATIONS. The Portfolio may invest in negotiable certificates of
deposit, time deposits and bankers' acceptances of (i) banks, savings and loan
associations and savings banks which have more than $2 billion in total and are
organized under the laws of the United States or any state, (ii) foreign
branches of these banks of equivalent size (Euros) and (iii) U.S. branches of
foreign banks of equivalent size (Yankees). The Portfolio will not invest in
obligations for which the Advisor, or any of its affiliated persons, is the
ultimate obligor or accepting bank.
COMMERCIAL PAPER. The Portfolio may invest in commercial paper,
including master demand obligations. For a description of master demand
obligations, see "Tax Exempt Obligations--Municipal Notes" above. The monies
loaned to the borrower come from accounts managed by the Advisor or its
affiliates, pursuant to arrangements with such accounts. Interest and principal
payments are credited to such accounts. The Advisor, acting as a fiduciary on
behalf of its clients, has the right to increase or decrease the amount provided
to the borrower under an obligation. The borrower has the right to pay without
penalty all or any part of the principal amount then outstanding on an
obligation together with interest to the date of payment. Since these
obligations typically provide that the interest rate is tied to the Federal
Reserve commercial paper composite rate, the rate on master demand obligations
is subject to change. Repayment of a master demand obligation to participating
accounts depends on the ability of the borrower to pay the accrued interest and
principal of the obligation on demand which is continuously monitored by the
Advisor. Since master demand obligations typically are not rated by credit
rating agencies, the Portfolio may invest in such unrated obligations only if at
the time of an investment the obligation is determined by the Advisor to have a
credit quality which satisfies the Portfolio's quality restrictions. See
"Quality and Diversification Requirements." It is possible that the issuer of a
master demands obligation could be a client of Morgan, an affiliate of the
Advisor, to whom Morgan, in its capacity as a commercial bank, has made a loan.
REPURCHASE AGREEMENTS. The Portfolio may enter into repurchase agreements
with brokers, dealers or banks that meet the credit guidelines approved by the
Portfolio's Trustees. In a repurchase agreement, the Portfolio buys a security
<PAGE>
from a seller that has agreed to repurchase the same security at a mutually
agreed upon date and price. The resale price normally is in excess of the
purchase price, reflecting an agreed upon interest rate. This interest rate is
effective for the period of time the Portfolio is invested in the agreement and
is not related to the coupon rate on the underlying security. A repurchase
agreement may also be viewed as a fully collateralized loan of money by the
Portfolio to the seller. The period of these repurchase agreements will usually
be short, from overnight to one week, and at no time will the Portfolio invest
in repurchase agreements for more than thirteen months. The securities which are
subject to repurchase agreements, however, may have maturity dates in excess of
thirteen months from the effective date of the repurchase agreement. The
Portfolio will always receive securities as collateral whose market value is,
and during the entire term of the agreement remains, at least equal to 100% of
the dollar amount invested by the Portfolio in the agreement plus accrued
interest, and the Portfolio will make payment for such securities only upon
physical delivery or upon evidence of book entry transfer to the account of the
custodian. If the seller defaults, 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. In addition, if
bankruptcy proceedings are commenced with respect to the seller of the security,
realization upon disposal of the collateral by the Portfolio may be delayed or
limited.
The Portfolio may make investments in other debt securities, including
without limitation corporate bonds and other obligations described in this Part
B.
U.S. TREASURY SECURITIES. The Portfolio may invest in direct obligations of
the U.S. Treasury, including Treasury bills, notes and bonds, all of which are
backed as to principal and interest payments by the full faith and credit of the
United States.
ADDITIONAL U.S. GOVERNMENT OBLIGATIONS. The Portfolio may invest in
obligations issued or guaranteed by U.S. Government agencies or
instrumentalities. These obligations may or may not be backed by the "full faith
and credit" of the United States. Securities which are backed by the full faith
and credit of the United States include obligations of the Government National
Mortgage Association, the Farmers Home Administration, and the Export-Import
Bank. In the case of securities not backed by the full faith and credit of the
United States, the Portfolio must look principally to the federal agency issuing
or guaranteeing the obligation for ultimate repayment and may not be able to
assert a claim against the United States itself in the event the agency or
instrumentality does not meet its commitments. Securities in which the Portfolio
may invest that are not backed by the full faith and credit of the United States
include, but are not limited to: (i) obligations of the Tennessee Valley
Authority, the Federal Home Loan Mortgage Corporation, the Federal Home Loan
Banks and the U.S. Postal Service, each of which has the right to borrow from
the U.S. Treasury to meet its obligations; (ii) securities issued by the Federal
National Mortgage Association, which are supported by the discretionary
authority of the U.S. Government to purchase the agency's obligations; and (iii)
obligations of the Federal Farm Credit System and the Student Loan Marketing
Association, each of whose obligations may be satisfied only by the individual
credits of the issuing agency.
ADDITIONAL INVESTMENTS
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Portfolio may purchase
securities on a when-issued or delayed delivery basis. For example, delivery of
and payment for these securities can take place a month or more after the date
of the purchase commitment. The purchase price and the interest rate payable, if
any, on the securities are fixed on the purchase commitment date or at the time
the settlement date is fixed. The value of such securities is subject to market
fluctuation and for money market instruments and other fixed income securities
no interest accrues to the Portfolio until settlement takes place. At the time
the Portfolio makes the commitment to purchase securities on a when-issued or
delayed delivery basis, it will record the transaction, reflect the value each
day of such securities in determining its net asset value and, if applicable,
calculate the maturity for the purposes of average maturity from that date. At
the time of settlement a when-issued security may be valued at less than the
purchase price. To facilitate such acquisitions, the Portfolio will maintain
with the custodian a segregated account with liquid assets, consisting of cash,
U.S. Government securities or other appropriate securities, in an
<PAGE>
amount at least equal to such commitments. On delivery dates for such
transactions, the Portfolio will meet its obligations from maturities or sales
of the securities held in the segregated account and/or from cash flow. If the
Portfolio chooses to dispose of the right to acquire a when-issued security
prior to its acquisition, it could, as with the disposition of any other
portfolio obligation, incur a gain or loss due to market fluctuation. Also, the
Portfolio may be disadvantaged if the other party to the transaction defaults.
It is the current policy of the Portfolio not to enter into when-issued
commitments exceeding in the aggregate 15% of the market value of the
Portfolio's total assets, less liabilities other than the obligations created by
when-issued commitments.
INVESTMENT COMPANY SECURITIES. Securities of other investment
companies may be acquired by the Portfolio to the extent permitted under the
1940 Act or any order pursuant thereto. These limits currently require that, as
determined immediately after a purchase is made, (i) not more than 5% of the
value of the Portfolio's total assets will be invested in the securities of any
one investment company, (ii) not more than 10% of the value of its total assets
will be invested in the aggregate in securities of investment companies as a
group, and (iii) not more than 3% of the outstanding voting stock of any one
investment company will be owned by the Portfolio. As a shareholder of another
investment company, the Portfolio would bear, along with other shareholders, its
pro rata portion of the other investment company's expenses, including advisory
fees. These expenses would be in addition to the advisory and other expenses
that the Portfolio bears directly in connection with its own operations. The
Portfolio has applied for exemptive relief from the SEC to permit the Portfolio
to invest in affiliated investment companies. If the requested relief is
granted, the Portfolio would then be permitted to invest in affiliated funds,
subject to certain conditions specified in the applicable order.
REVERSE REPURCHASE AGREEMENTS. The Portfolio may enter into reverse
repurchase agreements. In a reverse repurchase agreement, the Portfolio sells a
security and agrees to repurchase the same security at a mutually agreed upon
date and price, reflecting the interest rate effective for the term of the
agreement. For purposes of the 1940 Act, a reverse repurchase agreement is also
considered as the borrowing of money by the Portfolio and, therefore, a form of
leverage. Leverage may cause any gains or losses for the Portfolio to be
magnified. The Portfolio will invest the proceeds of borrowings under reverse
repurchase agreements. In addition, the Portfolio will enter into a reverse
repurchase agreement only when the interest income to be earned from the
investment of the proceeds is greater than the interest expense of the
transaction. The Portfolio will not invest the proceeds of a reverse repurchase
agreement for a period which exceeds the duration of the reverse repurchase
agreement. The Portfolio will establish and maintain with the Custodian a
separate account with a segregated portfolio of securities in an amount at least
equal to its purchase obligations under its reverse repurchase agreements. See
"Investment Restrictions" for the Portfolio's limitations on reverse repurchase
agreements and bank borrowings.
LOANS OF PORTFOLIO SECURITIES. Subject to applicable investment
restrictions, the Portfolio is permitted to lend securities in an amount up to
331/3% of the value of the Portfolio's total assets. The Portfolio may lend its
securities if such loans are secured continuously by cash or equivalent
collateral or by a letter of credit in favor of the Portfolio at least equal at
all times to 100% of the market value of the securities loaned, plus accrued
interest. While such securities are on loan, the borrower will pay the Portfolio
any income accruing thereon. Loans will be subject to termination by the
Portfolio in the normal settlement time, generally three business days after
notice, or by the borrower on one day's notice. Borrowed securities must be
returned when the loan is terminated. Any gain or loss in the market price of
the borrowed securities which occurs during the term of the loan inures to the
Portfolio and its respective investors. The Portfolio may pay reasonable
finders' and custodial fees in connection with a loan. In addition, the
Portfolio will consider all facts and circumstances including the
creditworthiness of the borrowing financial institution, the Portfolio will not
make any loans in excess of one year. The Portfolio will not lend its securities
to any officer, Trustee, Director, employee or other affiliate of the Portfolio,
the Advisor or the exclusive placement agent, unless otherwise permitted by
applicable law.
<PAGE>
ILLIQUID INVESTMENTS; PRIVATELY PLACED AND OTHER UNREGISTERED
SECURITIES. The Portfolio may not acquire any illiquid securities if, as a
result thereof, more than 15% of the Portfolio's net assets would be in illiquid
investments. Subject to this non-fundamental policy limitation, the Portfolio
may acquire investments that are illiquid or have limited liquidity, such as
private placements or investments that are not registered under the Securities
Act of 1933, as amended (the "1933 Act"), and cannot be offered for public sale
in the United States without first being registered under the 1933 Act. An
illiquid investment is any investment that cannot be disposed of within seven
days in the normal course of business at approximately the amount at which it is
valued by the Portfolio. The price the Portfolio pays for illiquid securities or
receives upon resale may be lower than the price paid or received for similar
securities with a more liquid market. Accordingly the valuation of these
securities will reflect any limitations on their liquidity.
The Portfolio may also purchase Rule 144A securities sold to
institutional investors without registration under the 1933 Act. These
securities may be determined to be liquid in accordance with guidelines
established by the Advisor approved by the Trustees. The Trustees will monitor
the Advisor's implementation of these guidelines on a periodic basis.
As to illiquid investments, the Portfolio is subject to a risk that
should the Portfolio decide to sell them when a ready buyer is not available at
a price the Portfolio deems representative of their value, the value of the
Portfolio's net assets could be adversely affected. Where an illiquid security
must be registered under the 1933 Act, before it may be sold, the Portfolio may
be obligated to pay all or part of the registration expenses, and a considerable
period may elapse between the time of the decision to sell and the time the
Portfolio may be permitted to sell a security under an effective registration
statement. If, during such a period, adverse market conditions were to develop,
the Portfolio might obtain a less favorable price than prevailed when it decided
to sell.
SYNTHETIC VARIABLE RATE INSTRUMENTS. The Portfolio may invest in
certain synthetic variable rate instruments. Such instruments generally involve
the deposit of a long-term tax exempt bond in a custody or trust arrangement and
the creation of a mechanism to adjust the long-term interest rate on the bond to
a variable short-term rate and a right (subject to certain conditions) on the
part of the purchaser to tender it periodically to a third party at par. Morgan
will review the structure of synthetic variable rate instruments to identify
credit and liquidity risks (including the conditions under which the right to
tender the instrument would no longer be available) and will monitor those
risks. In the event that the right to tender the instrument is no longer
available, the risk to the Portfolio will be that of holding the long-term bond.
In the case of some types of instruments credit enhancement is not provided, and
if certain events, which may include (a) default in the payment of principal or
interest on the underlying bond, (b) downgrading of the bond below investment
grade or (c) a loss of the bond's tax exempt status, occur, then (i) the put
will terminate, and (ii) the risk to the Portfolio will be that of holding a
long-term bond.
QUALITY AND DIVERSIFICATION REQUIREMENTS
The Portfolio is registered as a non-diversified investment company
which means that the Portfolio is not limited by the 1940 Act in the proportion
of its assets that may be invested in the obligations of a single issuer. Thus,
the Portfolio may invest a greater proportion of its assets in the securities of
a smaller number of issuers and, as a result, may be subject to greater risk
with respect to its portfolio securities. The Portfolio, however, will comply
with the diversification requirements imposed by the Internal Revenue Code of
1986, as amended (the "Code"), to allow investors in the Portfolio to qualify as
regulated investment companies under Subchapter M of the Code.
It is the current policy of the Portfolio that under normal
circumstances at least 90% of total assets will consist of securities that at
the time of purchase are rated Baa or better by Moody's or BBB or better by
Standard & Poor's. The remaining 10% of total assets may be invested in
securities that are rated B or better by
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Moody's or Standard & Poor's. In each case, the Portfolio may invest in
securities which are unrated if, in Morgan's opinion, such securities are of
comparable quality. Securities rated Baa by Moody's or BBB by Standard & Poor's
are considered investment grade, but have some speculative characteristics.
Securities rated Ba or B by Moody's and BB or B by Standard & Poor's are below
investment grade and considered to be speculative with regard to payment of
interest and principal. These standards must be satisfied at the time an
investment is made. If the quality of the investment later declines, the
Portfolio may continue to hold the investment.
For purposes of diversification under the Code and concentration under
the 1940 Act, identification of the issuer of municipal bonds or notes depends
on the terms and conditions of the obligation. If the assets and revenues of an
agency, authority, instrumentality or other political subdivision are separate
from those of the government creating the subdivision and the obligation is
backed only by the assets and revenues of the subdivision, such subdivision is
regarded as the sole issuer. Similarly, in the case of an industrial development
revenue bond or pollution control revenue bond, if the bond is backed only by
the assets and revenues of the subdivision, such subdivision is regarded as the
sole issuer. Similarly, in the case of an industrial development revenue bond or
pollution control revenue bond, if the bond is backed only by the assets and
revenues of the nongovernmental user, the nongovernmental user is regarded as
the sole issuer. If in either case the creating government or another entity
guarantees an obligation, the guaranty is regarded as a separate security and
treated as an issue of such guarantor. Since securities issued or guaranteed by
states or municipalities are not voting securities, there is no limitation on
the percentage of a single issuer's securities which the Portfolio may own so
long as it does not invest more than 5% of its total assets that are subject to
the diversification limitation in the securities of such issuer, except
obligations issued or guaranteed by the U.S. Government. Consequently, the
Portfolio may invest in a greater percentage of the outstanding securities of a
single issuer than would an investment company which invests in voting
securities. See "Investment Restrictions" below.
The Portfolio invests principally in a portfolio of "investment grade"
tax exempt securities. An investment grade bond is rated, on the date of
investment, within the four highest ratings of Moody's, currently Aaa, Aa, A and
Baa or of Standard & Poor's, currently AAA, AA, A and BBB, while high grade debt
is rated, on the date of the investment, within the two highest of such ratings.
Investment grade municipal notes are rated, on the date of investment, MIG-1 or
MIG-2 by Standard & Poor's or SP-1 and SP-2 by Moody's. Investment grade
municipal commercial paper is rated, on the date of investment, Prime 1 or Prime
2 by Moody's and A-1 or A-2 by Standard & Poor's. The Portfolio may also invest
up to 10% of its total assets in securities which are "below investment grade."
Such securities must be rated, on the date of investment, B or better by Moody's
or Standard & Poor's, or of comparable quality. The Portfolio may invest in debt
securities which are not rated or other debt securities to which these ratings
are not applicable, if in the opinion of the Advisor, such securities are of
comparable quality to the rated securities discussed above. In addition, at the
time the Portfolio invests in any taxable commercial paper, bank obligation or
repurchase agreement, the issuer must have outstanding debt rated A or higher by
Moody's or Standard & Poor's, the issuer's parent corporation, if any, must have
outstanding commercial paper rated Prime-1 by Moody's or A-1 by Standard &
Poor's, or if no such ratings are available, the investment must be of
comparable quality in the Advisor's opinion.
BELOW INVESTMENT GRADE DEBT. Certain lower rated securities purchased
by the Portfolio, such as those rated Ba or B by Moody's or BB or B by Standard
& Poor's (commonly known as junk bonds), may be subject to certain risks with
respect to the issuing entity's ability to make scheduled payments of principal
and interest and to greater market fluctuations. While generally providing
higher coupons or interest rates than investments in higher quality securities,
lower quality fixed income securities involve greater risk of loss of principal
and income, including the possibility of default or bankruptcy of the issuers of
such securities, and have greater price volatility, especially during periods of
economic uncertainty or change. These lower quality fixed income securities tend
to be affected by economic changes and short-term corporate and industry
developments to a greater extent than higher quality securities, which react
primarily to fluctuations in the general level of
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interest rates. To the extent that the Portfolio invests in such lower quality
securities, the achievement of its investment objective may be more dependent on
the Advisor's own credit analysis.
Lower quality fixed income securities are affected by the market's
perception of their credit quality, especially during times of adverse
publicity, and the outlook for economic growth. Economic downturns or an
increase in interest rates may cause a higher incidence of default by the
issuers of these securities, especially issuers that are highly leveraged. The
market for these lower quality fixed income securities is generally less liquid
than the market for investment grade fixed income securities. It may be more
difficult to sell these lower rated securities to meet redemption requests, to
respond to changes in the market, or to value accurately the Portfolio's
portfolio securities for purposes of determining the Portfolio's net asset
value. See Appendix A for more detailed information on these ratings.
In determining suitability of investment in a particular unrated
security, the Advisor takes into consideration asset and debt service coverage,
the purpose of the financing, history of the issuer, existence of other rated
securities of the issuer, and other relevant conditions, such as comparability
to other issuers.
OPTIONS AND FUTURES TRANSACTIONS
The Portfolio may (a) purchase and sell exchange traded and
over-the-counter ("OTC") put and call options on fixed income securities and
indexes of fixed income securities, (b) purchase and sell futures contracts on
fixed income securities and indexes of fixed income securities and (c) purchase
and sell put and call options on futures contracts on fixed income securities
and indexes of fixed income securities.
The Portfolio may use futures contracts and options for hedging and
risk management purposes. The Portfolio may not use futures contracts and
options for speculation.
The Portfolio may utilize options and futures contracts to manage its
exposure to changing interest rates and/or security prices. Some options and
futures strategies, including selling futures contracts and buying puts, tend to
hedge the Portfolio's investments against price fluctuations. Other strategies,
including buying futures contracts, writing puts and calls, and buying calls,
tend to increase market exposure. Options and futures contracts may be combined
with each other or with forward contracts in order to adjust the risk and return
characteristics of the Portfolio's overall strategy in a manner deemed
appropriate to the Advisor and consistent with the Portfolio's objective and
policies. Because combined options positions involve multiple trades, they
result in higher transaction costs and may be more difficult to open and close
out.
The use of options and futures is a highly specialized activity which
involves investment strategies and risks different from those associated with
ordinary portfolio securities transactions, and there can be no guarantee that
their use will increase the Portfolio's return. While the use of these
instruments by the Portfolio may reduce certain risks associated with owning its
portfolio securities, these techniques themselves entail certain other risks. If
the Advisor applies a strategy at an inappropriate time or judges market
conditions or trends incorrectly, options and futures strategies may lower the
Portfolio's return. Certain strategies limit the Portfolio's possibilities to
realize gains as well as limiting its exposure to losses. The Portfolio could
also experience losses if the prices of its options and futures positions were
poorly correlated with its other investments, or if it could not close out its
positions because of an illiquid secondary market. In addition, the Portfolio
will incur transaction costs, including trading commissions and option premiums,
in connection with its futures and options transactions and these transactions
could significantly increase the Portfolio's turnover rate.
The Portfolio may purchase and sell put and call options on securities
and indexes of securities, or futures contracts or options on futures contracts,
if such options are written by other persons and if (i) the aggregate premiums
paid on all such options which are held at any time to not exceed 20% of the
Portfolio's net assets, and (ii) the aggregate margin deposits required on all
such futures or options
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thereon held at any time to not exceed 5% of the Portfolio's assets. In
addition, the Portfolio will not purchase or sell (write) futures contracts,
options on futures contracts or commodity options for risk management purposes
if, as a result, the aggregate initial margin and options premiums required to
establish these positions exceed 5% of the net asset value of the Portfolio.
OPTIONS
PURCHASING PUT AND CALL OPTIONS. By purchasing a put option, the
Portfolio obtains the right (but not the obligation) to sell the instrument
underlying the option at a fixed strike price. In return for this right, the
Portfolio pays the current market price for the option (known as the option
premium). Options have various types of underlying instruments, including
specific securities, indexes of securities, indexes of securities, indexes of
securities prices, and futures contracts. The Portfolio may terminate its
position in a put option it has purchased by allowing it to expire or by
exercising the option. The Portfolio may also close out a put option position by
entering into an offsetting transaction, if a liquid market exits. If the option
is allowed to expire, the Portfolio will lose the entire premium it paid. If the
Portfolio exercises a put option on a security, it will sell the instrument
underlying the option at the strike price. If the Portfolio exercises an option
on an index, settlement is in cash and does not involve the actual sale of
securities. If an option is American style, it may be exercised on any day up to
its expiration date. A European style option may be exercised only on its
expiration date.
The buyer of a typical put option can expect to realize a gain if the
underlying instrument falls substantially. However, if the price of the
instrument underlying the option does not fall enough to offset the cost of
purchasing the option, a put buyer can expect to suffer a loss (limited to the
amount of the premium paid, plus related transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the instrument underlying the option at the option's
strike price. A call buyer typically attempts to participate in potential price
increases of the instrument underlying the option with risk limited to the cost
of the option if security prices fall. At the same time, the buyer can expect to
suffer a loss if security prices do not rise sufficiently to offset the cost of
the option.
SELLING (WRITING) PUT AND CALL OPTIONS. When the Portfolio writes a put
option, it takes the opposite side of the transaction from the option's
purchaser. In return for receipt of the premium, a Portfolio assumes the
obligation to pay the strike price for the instrument underlying the option if
the party to the option chooses to exercise it. The Portfolio may seek to
terminate its position in a put option it writes before exercise by purchasing
an offsetting option in the market at its current price. If the market is not
liquid for a put option the Portfolio has written, however, the Portfolio must
continue to be prepared to pay the strike price while the option is outstanding,
regardless of price changes, and must continue to post margin as discussed
below.
If the price of the underlying instrument rises, a put writer would
generally expect to profit, although its gain would be limited to the amount of
the premium it received. If security prices remain the same over time, it is
likely that the writer will also profit, because it should be able to close out
the option at a lower price. If security prices fall, the put writer would
expect to suffer a loss. This loss should be less than the loss from purchasing
and holding the underlying instrument directly, however, because the premium
received for writing the option should offset a portion of the decline.
Writing a call option obligates the Portfolio to sell or deliver the
option's underlying instrument in return for the strike price upon exercise of
the option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. Through receipt of the option
premium a call writer offsets part of the effect of a price decline. At the same
time, because a call writer must be prepared
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to deliver the underlying instrument in return for the strike price, even if its
current value is greater, a call writer gives up some ability to participate in
security price increases.
The writer of an exchange traded put or call option on a security, an
index of securities or a futures contract is required to deposit cash or
securities or a letter of credit as margin and to make mark to market payments
of variation margin as the position becomes unprofitable.
OPTIONS ON INDEXES. The Portfolio may purchase put and call options on
any securities index based on securities in which the Portfolio may invest.
Options on securities indexes are similar to options on securities, except that
the exercise of securities index options is settled by cash payment and does not
involve the actual purchase or sale of securities. In addition, these options
are designed to reflect price fluctuations in a group of securities or segment
of the securities market rather than price fluctuations in a single security.
The Portfolio, in purchasing or selling index options, is subject to the risk
that the value of its portfolio securities may not change as much as index
because the Portfolio's investments generally will not match the composition of
an index.
For a number of reasons, a liquid market may not exist and thus the
Portfolio may not be able to close out an option position that it has previously
entered into. When the Portfolio purchases an OTC option, it will be relying on
its counterparty to perform its obligations, and the Portfolio may incur
additional losses if the counterparty is unable to perform.
EXCHANGE TRADED AND OTC OPTIONS. All options purchased or sold by the
Portfolio will be traded on a securities exchange or will be purchased or sold
by securities dealers (OTC options) that meet creditworthiness standards
approved by the Portfolio's Board of Trustees. While exchange-traded options are
obligations of the Options Clearing Corporation, in the case of OTC options, the
Portfolio relies on the dealer from which it purchased the option to perform if
the option is exercised. Thus, when the Portfolio purchases an OTC option, it
relies on the dealer from which it purchased the option to make or take delivery
of the underlying securities. Failure by the dealer to do so would result in the
loss of the premium paid by the Portfolio as well as loss of the expected
benefit of the transaction.
Provided that the Portfolio has arrangements with certain qualified
dealers who agree that the Portfolio may repurchase any option it writes for a
maximum price to be calculated by a predetermined formula, the Portfolio may
treat the underlying securities used to cover written OTC options as liquid. In
these cases, the OTC option itself would only be considered illiquid to the
extent that the maximum repurchase price under the formula exceeds the intrinsic
value of the option.
FUTURES CONTRACTS
When the Portfolio purchases a futures contract, it agrees to purchase
a specified quantity of an underlying instrument at a specified future date or
to make a cash payment based on the value of a securities index. When the
Portfolio sells a futures contract, it agrees to sell a specified quantity of
the underlying instrument at a specified future date or to receive a cash
payment based on the value of a securities index. The price at which the
purchase and sale will take place is fixed when the Portfolio enters into the
contract. Futures can be held until their delivery dates or the position can be
(and normally is) closed out before then. There is no assurance, however, that a
liquid market will exist when the Portfolio wishes to close out a particular
position.
When the Portfolio purchases a futures contract, the value of the
futures contract tends to increase and decrease in tandem with the value of its
underlying instrument. Therefore, purchasing futures contracts will tend to
increase the Portfolio's exposure to positive and negative price fluctuations in
the underlying instrument, much as if it had purchased the underlying instrument
directly. When the Portfolio sells a futures contract, by contrast, the value of
its futures position will tend to move in a direction contrary to the value of
the underlying instrument. Selling futures contracts, therefore, will tend to
offset both positive and negative
<PAGE>
market price changes, much as if the underlying instrument had been sold.
The purchaser or seller of a futures contract is not required to
deliver or pay for the underlying instrument unless the contract is held until
the delivery date. However, when the Portfolio buys or sells a futures contract
it will be required to deposit "initial margin" with its Custodian in a
segregated account in the name of its futures broker, known as a futures
commission merchant (FCM). Initial margin deposits are typically equal to a
small percentage of the contract's value. If the value of either party's
position declines, that party will be required to make additional "variation
margin" payments equal to the change in value on a daily basis. The party that
has a gain may be entitled to receive all or a portion of this amount. The
Portfolio may be obligated to make payments of variation margin at a time when
it is disadvantageous to do so. Furthermore, it may not always be possible for
the Portfolio to close out its futures positions. Until it closes out a futures
position, the Portfolio will be obligated to continue to pay variation margin.
Initial and variation margin payments do not constitute purchasing on margin for
purposes of the Portfolio's investment restrictions. In the event of the
bankruptcy of an FCM that holds margin on behalf of the Portfolio, the Portfolio
may be entitled to return of margin owed to it only in proportion to the amount
received by the FCM's other customers, potentially resulting in losses to the
Portfolio.
The Portfolio will segregate liquid assets in connection with its use
of options and futures contracts to the extent required by the staff of the
Securities and Exchange Commission. Securities held in a segregated account
cannot be sold while the futures contract or option is outstanding. Unless they
are replaced with other suitable assets. As a result, there is a possibility
that segregation of a large percentage of the Portfolio's assets could impede
portfolio management or the Portfolio's ability to meet redemption requests or
other current obligations.
Options on Futures Contracts. The Portfolio may purchase and sell put
and call options, including put and call options on futures contracts. Futures
contracts obligate the buyer to take and the seller to make delivery at a future
date of a specified quantity of a financial instrument or an amount of cash
based on the value of a securities index. Currently, futures contracts are
available on various types of fixed income securities, including but not limited
to U.S. Treasury bonds, notes and bills, Eurodollar certificates of deposit and
on indexes of fixed income securities.
Unlike a futures contract, which requires the parties to buy and sell a
security or make a cash settlement payment based on changes in a financial
instrument or securities index on an agreed date, an option on a futures
contract entitles its holder to decide on or before a future date whether to
enter into such a contract. If the holder decides not to exercise its option,
the holder may close out the option position by entering into an offsetting
transaction or may decide to let the option expire and forfeit the premium
thereon. The purchaser of an option on a futures contract pays a premium for the
option but makes no initial margin payments or daily payments of cash in the
nature of "variation" margin payments to reflect the change in the value of the
underlying contract as does a purchaser or seller of a futures contract.
COMBINED POSITIONS. The Portfolio is permitted to purchase and write
options in combination with each other, or in combination with futures or
forward contracts, to adjust the risk and return characteristics of the overall
position. For example, the Portfolio may purchase a put option and write a call
option on the same underlying instrument, in order to construct a combined
position whose risk and return characteristics are similar to selling a futures
contract. Another possible combined position would involve writing a call option
at one strike price and buying a call option at a lower price, in order to
reduce the risk of the written call option in the event of a substantial price
increase. Because combined options positions involve multiple trades, they
result in higher transaction costs and may be more difficult to open and close
out.
<PAGE>
CORRELATION OF PRICE CHANGES. Because there are a limited number of
types of exchange-traded options and futures contracts, it is likely that the
standardized options and futures contracts available will not match the
Portfolio's current or anticipated investments exactly. The Portfolio may invest
in options and futures contracts based on securities with different issuers,
maturities, or other characteristics from the securities in which it typically
invests, which involves a risk that the options or futures position will not
track the performance of the Portfolio's other investments.
Options and futures contracts prices can also diverge from the prices
of their underlying instruments, even if the underlying instruments match the
Portfolio's investments well. Options and futures contracts prices are affected
by such factors as current and anticipated short term interest rates, changes in
volatility of the underlying instrument, and the time remaining until expiration
of the contract, which may not affect security prices the same way. Imperfect
correlation may also result from differing levels of demand in the options and
futures markets and the securities markets, from structural differences in how
options and futures and securities are traded, or from imposition of daily price
fluctuation limits or trading halts. The Portfolio may purchase or sell options
and futures contracts with a greater or lesser value than the securities it
wishes to hedge or intends to purchase in order to attempt to compensate for
differences in volatility between the contract and the securities, although this
may not be successful in all cases. If price changes in the Portfolio's options
or futures positions are poorly correlated with its other investments, the
positions may fail to produce anticipated gains or result in losses that are not
offset by gains in other investments.
LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS. There is no assurance a
liquid market will exist for any particular option or futures contract at any
particular time even if the contract is traded on an exchange. In addition,
exchanges may establish daily price fluctuation limits for options and futures
contracts and may halt trading if a contract's price moves up or down more than
the limit in a given day. On volatile trading days when the price fluctuation
limit is reached or a trading halt is imposed, it may be impossible for the
Portfolio to enter into new positions or close out existing positions. If the
market for a contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable positions, and
could potentially require the Portfolio to continue to hold a position until
delivery or expiration regardless of changes in its value. As a result, the
Portfolio's access to other assets held to cover its options or futures
positions could also be impaired. (See "Exchange Traded and OTC Options" above
for a discussion of the liquidity of options not traded on an exchange.)
POSITION LIMITS. Futures exchanges can limit the number of futures and
options on futures contracts that can be held or controlled by an entity. If an
adequate exemption cannot be obtained, the Portfolio or the Advisor may be
required to reduce the size of its futures and options positions or may not be
able to trade a certain futures or options contract in order to avoid exceeding
such limits.
ASSET COVERAGE FOR FUTURES CONTRACTS AND OPTIONS POSITIONS.
The Portfolio intends to comply with Section 4.5 of the regulations under the
Commodity Exchange Act, which limits the extent to which the Portfolio can
commit assets to initial margin deposits and option premiums. In addition, the
Portfolio will comply with guidelines established by the SEC with respect to
coverage of options and futures contracts by mutual funds, and if the guidelines
so require, will set aside appropriate liquid assets in a segregated custodial
account in the amount prescribed. Securities held in a segregated account cannot
be sold while the futures contract or option is outstanding, unless they are
replaced with other suitable assets. As a result, there is a possibility that
segregation of a large percentage of the Portfolio's assets could impede
portfolio management or the Portfolio's ability to meet redemption requests or
other current obligations.
SWAPS AND RELATED SWAP PRODUCTS. The Portfolio may engage in swap
transactions, including, but not limited to, interest rate, currency, securities
index, basket, specific security and commodity swaps, interest rate
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caps, floors and collars and options on interest rate swaps
(collectively defined as "swap transactions").
The Portfolio may enter into swap transactions for any legal purpose
consistent with its investment objective and policies, such as for the purpose
of attempting to obtain or preserve a particular return or spread at a lower
cost than obtaining that return or spread through purchases and/or sales of
instruments in cash markets, to protect against currency fluctuations, as a
duration management technique, to protect against any increase in the price of
securities the Portfolio anticipates purchasing at a later date, or to gain
exposure to certain markets in the most economical way possible. The Portfolio
will not sell interest rate caps, floors or collars if it does not own
securities with coupons which provide the interest that the Portfolio may be
required to pay.
Swap agreements are two-party contracts entered into primarily by
institutional counterparties for periods ranging from a few weeks to several
years. In a standard swap transaction, two parties agree to exchange the returns
(or differentials in rates of return) that would be earned or realized on
specified notional investments or instruments. The gross returns to be exchanged
or "swapped" between the parties are calculated by reference to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested at a particular interest rate, in a particular foreign currency or
commodity, or in a "basket" of securities representing a particular index. The
purchaser of an interest rate cap or floor, upon payment of a fee, has the right
to receive payments (and the seller of the cap is obligated to make payments) to
the extent a specified interest rate exceeds (in the case of a cap) or is less
than (in the case of a floor) a specified level over a specified period of time
or at specified dates. The purchaser of an interest rate collar, upon payment of
a fee, has the right to receive payments (and the seller of the collar is
obligated to make payments) to the extent that a specified interest rate falls
outside an agreed upon range over a specified period of time or at specified
dates. The purchaser of an option on an interest rate swap, upon payment of a
fee (either at the time of purchase or in the form of higher payments or lower
receipts within an interest rate swap transaction) has the right, but not the
obligation, to initiate a new swap transaction of a pre-specified notional
amount with pre-specified terms with the seller of the option as the
counterparty.
The "notional amount" of a swap transaction is the agreed upon basis
for calculating the payments that the parties have agreed to exchange. For
example, one swap counterparty may agree to pay a floating rate of interest
(e.g., 3 month LIBOR) calculated based on a $10 million notional amount on a
quarterly basis in exchange for receipt of payments calculated based on the same
notional amount and a fixed rate of interest on a semi-annual basis. In the
event the Portfolio is obligated to make payments more frequently than it
receives payments from the other party, it will incur incremental credit
exposure to that swap counterparty. This risk may be mitigated somewhat by the
use of swap agreements which call for a net payment to be made by the party with
the larger payment obligation when the obligations of the parties fall due on
the same date. Under most swap agreements entered into by the Portfolio,
payments by the parties will be exchanged on a "net basis", and the
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Portfolio will receive or pay, as the case may be, only the net amount of the
two payments.
The amount of the Portfolio 's potential gain or loss on any swap
transaction is not subject to any fixed limit. Nor is there any fixed limit on
the Portfolio 's potential loss if it sells a cap or collar. If the Portfolio
buys a cap, floor or collar, however, the Portfolio 's potential loss is limited
to the amount of the fee that it has paid. When measured against the initial
amount of cash required to initiate the transaction, which is typically zero in
the case of most conventional swap transactions, swaps, caps, floors and collars
tend to be more volatile than many other types of instruments.
The use of swap transactions, caps, floors and collars involves
investment techniques and risks which are different from those associated with
portfolio security transactions. If the Advisor is incorrect in its forecasts of
market values, interest rates, and other applicable factors, the investment
performance of the Portfolio will be less favorable than if these techniques had
not been used. These instruments are typically not traded on exchanges.
Accordingly, there is a risk that the other party to certain of these
instruments will not perform its obligations to the Portfolio or that the
Portfolio may be unable to enter into offsetting positions to terminate its
exposure or liquidate its position under certain of these instruments when it
wishes to do so.
Such occurrences could result in losses to the Portfolio.
The Advisor will, however, consider such risks and will enter into
swap and other derivatives transactions only when it believes that the risks are
not unreasonable.
The Portfolio will maintain cash or liquid assets in a segregated
account with its custodian in an amount sufficient at all times to cover its
current obligations under its swap transactions, caps, floors and collars. If
the Portfolio enters into a swap agreement on a net basis, it will segregate
assets with a daily value at least equal to the excess, if any, of the
Portfolio's accrued obligations under the swap agreement over the accrued amount
the Portfolio is entitled to receive under the agreement. If the Portfolio
enters into a swap agreement on other than a net basis, or sells a cap, floor or
collar, it will segregate assets with a daily value at least equal to the full
amount of the Portfolio 's accrued obligations under the agreement.
The Portfolio will not enter into any swap transaction, cap, floor, or
collar, unless the counterparty to the transaction is deemed creditworthy by the
Advisor. If a counterparty defaults, the Portfolio may have contractual remedies
pursuant to the agreements related to the transaction. The swap markets in which
many types of swap transactions are traded have grown substantially in recent
years, with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. As a result,
the markets for certain types of swaps (e.g., interest rate swaps) have become
relatively liquid. The markets for some types of caps, floors and collars are
less liquid.
<PAGE>
The liquidity of swap transactions, caps, floors and collars will be as
set forth in guidelines established by the Advisor and approved by the Trustees
which are based on various factors, including (1) the availability of dealer
quotations and the estimated transaction volume for the instrument, (2) the
number of dealers and end users for the instrument in the marketplace, (3) the
level of market making by dealers in the type of instrument, (4) the nature of
the instrument (including any right of a party to terminate it on demand) and
(5) the nature of the marketplace for trades (including the ability to assign or
offset the Portfolio 's rights and obligations relating to the instrument). Such
determination will govern whether the instrument will be deemed within the 15%
restriction on investments in securities that are not readily marketable.
During the term of a swap, cap, floor or collar, changes in the value
of the instrument are recognized as unrealized gains or losses by marking to
market to reflect the market value of the instrument. When the instrument is
terminated, the Portfolio will record a realized gain or loss equal to the
difference, if any, between the proceeds from (or cost of) the closing
transaction and the Portfolio's basis in the contract.
The federal income tax treatment with respect to swap transactions,
caps, floors, and collars may impose limitations on the extent to which the
Portfolio may engage in such transactions.
RISK MANAGEMENT
The Portfolio may employ non-hedging risk management techniques.
Examples of such strategies include synthetically altering the duration of its
portfolio or the mix of securities in its portfolio. For example, if the Advisor
wishes to extend maturities in a fixed income portfolio in order to take
advantage of an anticipated decline in interest rates, but does not wish to
purchase the underlying long-term securities, it might cause the Portfolio to
purchase futures contracts on long-term debt securities. Similarly, if the
Advisor wishes to decrease fixed income securities or purchase equities, it
could cause the Portfolio to sell futures contracts on debt securities and
purchase futures contracts on a stock index. Such non-hedging risk management
techniques are not speculative, but because they involve leverage include, as do
all leveraged transactions, the possibility of losses as well as gains that are
greater than if these techniques involved the purchase and sale of the
securities themselves rather than their synthetic derivatives.
PORTFOLIO TURNOVER. The portfolio turnover rates for the fiscal years
ended March 31, 1997 and 1998 were 35% and 51%, respectively. A rate of 100%
indicates that the equivalent of all of the Portfolio's assets have been sold
and reinvested in a year. High portfolio turnover may result in the realization
of substantial net capital gains. To the extent net short term capital gains are
realized, any distributions resulting from such gains are considered ordinary
income for federal income tax purposes. See Item 20 below.
INVESTMENT RESTRICTIONS
The investment restrictions below have been adopted by the Portfolio.
Except where otherwise noted, these investment restrictions are "fundamental"
policies which, under the 1940 Act, may not be changed without the vote of a
"majority of the outstanding voting securities" (as defined in the 1940 Act) of
the Portfolio. A "majority of the outstanding voting securities" is defined in
the 1940 Act as the lesser of (a) 67% or more of the voting securities present
at a security holders meeting if the holders of more than 50% of the outstanding
voting securities are present or represented by proxy, or (b) more than 50% of
the outstanding voting securities. The percentage limitations contained in the
restrictions below apply at the time of the purchase of securities.
<PAGE>
Unless Sections 8(b)(1) and 13(a) of the 1940 Act or any SEC or SEC
staff interpretations thereof, are amended or modified, the Portfolio may not:
1. Purchase any security which would cause the Portfolio to concentrate
its investments in the securities of issuers primarily engaged in any
particular industry except as permitted by the SEC;
2. Issue senior securities, except as permitted under the Investment
Company Act of 1940 or any rule, order or interpretation thereunder;
3. Borrow money, except to the extent permitted by applicable law;
4. Underwrite securities of other issuers, except to the extent that the
Portfolio, in disposing of portfolio securities, may be deemed an
underwriter within the meaning of the 1933 Act;
5. Purchase or sell real estate, except that, to the extent permitted by
applicable law, the Portfolio may (a) invest in securities or other
instruments directly or indirectly secured by real estate, (b) invest
in securities or other instruments issued by issuers that invest in
real estate, and (c) make direct investments in mortgages;
6. Purchase or sell commodities or commodity contracts unless acquired as
a result of ownership of securities or other instruments issued by
persons that purchase or sell commodities or commodities contracts; but
this shall not prevent the Portfolio from purchasing, selling and
entering into financial futures contracts (including futures contracts
on indices of securities, interest rates and currencies), options on
financial futures contracts (including futures contracts on indices of
securities, interest rates and currencies), warrants, swaps, forward
contracts, foreign currency spot and forward contracts or other
derivative instruments that are not related to physical commodities;
and
7. The Portfolio may make loans to other persons, in accordance with the
Portfolio's investment objective and policies and to the extent
permitted by applicable law.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS. The investment restrictions
described below are not fundamental policies of the Portfolio and may be changed
by the Trustees. These non-fundamental investment policies require that the
Portfolio may not:
1. Acquire any illiquid securities, such as repurchase agreements with
more than seven days to maturity or fixed time deposits with a duration
of over seven calendar days, if as a result thereof, more than 15% of
the market value of the Portfolio's net assets would be in investments
which are illiquid;
2. Purchase securities on margin, make short sales of securities, or
maintain a short position, provided that this restriction shall not be
deemed to be applicable to the purchase or sale of when-issued or
delayed delivery securities, or to short sales that are covered in
accordance with SEC rules; and
3. Acquire securities of other investment companies, except as permitted by
the 1940 Act or any order pursuant thereto.
There will be no violation of any investment restriction if that
restriction is complied with at the time the relevant action is taken
notwithstanding a later change in market value of an investment, in net or total
assets, in the securities rating of the investment, or any other later change.
For purposes of fundamental investment restrictions regarding industry
concentration, the Advisor may classify issuers by industry in accordance with
classifications set forth in the Directory of Companies Filing Annual Reports
With The Securities and Exchange Commission or other sources. In the absence of
such classification or if the Advisor determines in good faith based on its own
information
<PAGE>
that the economic characteristics affecting a particular issuer make it
more appropriately considered to be engaged in a different industry, the Advisor
may classify an issuer accordingly. For instance, personal credit finance
companies and business credit finance companies are deemed to be separate
industries and wholly owned finance companies are considered to be in the
industry of their parents if their activities are primarily related to financing
the activities of their parents.
ITEM 14. MANAGEMENT OF THE PORTFOLIO.
The Trustees and officers of the Portfolio, their business addresses
and principal occupations during the past five years and dates of birth are set
forth below. Their titles may have varied during that period. An asterisk
indicates that a Trustee is an "interested person" (as defined in the 1940 Act)
of the Portfolio.
TRUSTEES AND OFFICERS
Frederick S. Addy - Trustee; Retired; Prior to April 1994, Executive
Vice President and Chief Financial Officer Amoco Corporation. His address is
5300 Arbutus Cove, Austin, Texas 78746, and his date of birth is January 1,
1932.
William G. Burns - Trustee; Retired; Former Vice Chairman and Chief
Financial Officer, NYNEX. His address is 2200 Alaqua Drive, Longwood, Florida
32779, and his date of birth is November 2, 1932.
Arthur C. Eschenlauer - Trustee; Retired; Former Senior Vice President,
Morgan Guaranty Trust Company of New York. His address is 14 Alta Vista Drive,
RD #2, Princeton, New Jersey 08540, and his date of birth is May 23, 1934.
Matthew Healey1 - Trustee, Chairman and Chief Executive Officer; Chairman,
Pierpont Group, Inc. ("Pierpont Group ") since prior to 1993. His address is
Pine Tree Country Club Estates, 10286 St. Andrews Road, Boynton Beach, Florida
33436, and his date of birth is August 23, 1937.
Michael P. Mallardi - Trustee; Retired; Prior to April 1996, Senior Vice
President, Capital Cities/ABC, Inc. and President, Broadcast Group. His address
is 10 Charnwood Drive, Suffern, New York 10901, and his date of birth is March
17, 1934.
The Trustees of the Portfolio are the same as the Trustees of each of
the other Master Portfolios (as defined below), the J.P. Morgan Funds, the J.P.
Morgan Institutional Funds and J.P. Morgan Series Trust. In accordance with
applicable state requirements, a majority of the disinterested Trustees have
adopted written procedures reasonably appropriate to deal with potential
conflicts of interest arising from the fact that the same individuals are
Trustees of the Master Portfolios, the J.P. Morgan Funds and the J.P. Morgan
Institutional Funds, up to and including creating a separate board of trustees.
<PAGE>
Each Trustee is currently paid an annual fee of $75,000 for serving as
Trustee of the Master Portfolios (as defined below), the J.P. Morgan Funds, the
J.P. Morgan Institutional Funds and J.P. Morgan Series Trust and is reimbursed
for expenses incurred in connection with service as a Trustee. The Trustees may
hold various other directorships unrelated to the Portfolio.
Trustee compensation expenses paid by the Portfolio for the calendar
year ended December 31, 1997 are set forth below.
- --------------------------- -------------------------- -------------------------
TOTAL TRUSTEE
COMPENSATION ACCRUED BY
AGGREGATE TRUSTEE THE MASTER PORTFOLIOS(*),
COMPENSATION PAID BY J.P. MORGANFUNDS AND J.P.
NAME OF TRUSTEE THE PORTFOLIO DURING 1997 MORGAN SERIES TRUSTDURING
1997(**)
- -------------------------- --------------------------- -------------------------
- -------------------------- --------------------------- -------------------------
Frederick S. Addy, $377 $72,500
Trustee
- -------------------------- --------------------------- -------------------------
- -------------------------- --------------------------- -------------------------
William G. Burns, $377 $72,500
Trustee
- -------------------------- --------------------------- -------------------------
- -------------------------- --------------------------- -------------------------
Arthur C. Eschenlauer, $377 $72,500
Trustee
- -------------------------- --------------------------- -------------------------
- -------------------------- --------------------------- -------------------------
Matthew Healey, $377 $72,500
Trustee(***), Chairman
and Chief Executive
Officer
- -------------------------- --------------------------- -------------------------
- -------------------------- --------------------------- -------------------------
Michael P. Mallardi, $377 $72,500
Trustee
- -------------------------- --------------------------- -------------------------
(*) Includes the Portfolio and 19 other portfolios (collectively, the
"Master Portfolios") for which JPMIM acts as investment adviser.
(**) No investment company within the fund complex has a pension or
retirement plan. Currently there are 18 investment companies (15 investment
companies comprising the Master Portfolios, the J.P. Morgan Funds, the J.P.
Morgan Institutional Funds and J.P. Morgan Series Trust) in the fund complex.
(***) During 1997, Pierpont Group paid Mr. Healey, in his role as Chairman of
Pierpont Group, compensation in the amount of $147,500, contributed
$22,100 to a defined contribution plan on his behalf and paid $20,500
in insurance premiums for his benefit.
The Trustees of the Portfolio, in addition to reviewing actions of the
Portfolio's various service providers, decide upon matters of general policy. On
January 15, 1994 the Portfolio entered into a Portfolio Fund Services Agreement
with Pierpont Group to assist the Trustees in exercising their overall
supervisory responsibilities for the Portfolio's affairs. Pierpont Group was
organized in July 1989 to provide services for The Pierpont Family of Funds, and
the Trustees are the equal and sole shareholders of Pierpont Group. The
Portfolio has agreed to pay Pierpont Group a fee in an amount representing its
reasonable costs in performing these services to the Portfolio and other
registered investment companies subject to similar agreements with Pierpont
Group. These costs are periodically reviewed by the Trustees.
The aggregate fees paid to Pierpont Group by the Portfolio for the
fiscal years ended March 31, 1996, 1997 and 1998 were $5,530, $5,302 and $5,740,
respectively. The Portfolio has no employees; its executive officers (listed
below), other than the Chief Executive Officer and the officers who are
employees of the Advisor, are provided and compensated by Funds Distributor,
Inc. ("FDI"), a wholly owned, indirect subsidiary of Boston Institutional Group,
Inc. The Portfolio's officers conduct and
<PAGE>
supervise the business operations of the Portfolio.
The officers of the Portfolio, their principal occupations during the
past five years and dates of birth are set forth below. The business address of
each of the officers unless otherwise noted is 60 State Street, Suite 1300,
Boston, Massachusetts 02109.
MATTHEW HEALEY; Chief Executive Officer; Chairman, Pierpont Group,
since prior to 1993. His address is Pine Tree Club Estates, 10286 Saint Andrews
Road, Boynton Beach, FL 33436. His date of birth is August 23, 1937.
MARGARET W. CHAMBERS; Vice President and Secretary. Senior Vice President
and General Counsel of FDI since April, 1998. From August 1996 to March 1998,
Ms. Chambers was Vice President and Assistant General Counsel for Loomis, Sayles
& Company, L.P. From January 1986 to July 1996, she was an associate with the
law firm of Ropes & Gray. Her date of birth is October 12, 1959.
MARIE E. CONNOLLY; Vice President and Assistant Treasurer. President,
Chief Executive Officer, Chief Compliance Officer and Director of FDI, Premier
Mutual Fund Services, Inc., an affiliate of FDI ("Premier Mutual") and an
officer of certain investment companies distributed or administered by FDI.
Prior to July 1994, she was President and Chief Compliance Officer of FDI. Her
date of birth is August 1, 1957.
DOUGLAS C. CONROY; Vice President and Assistant Treasurer. Assistant Vice
President and Assistant Department Manager of Treasury Services and
Administration of FDI and an officer of certain investment companies distributed
or administered by FDI. Prior to April 1997, Mr. Conroy was Supervisor of
Treasury Services and Administration of FDI. From April 1993 to January 1995,
Mr. Conroy was a Senior Fund Accountant for Investors Bank & Trust Company. His
date of birth is March 31, 1969.
KAREN JACOPPO-WOOD; Vice President and Assistant Secretary. Vice President
and Senior Counsel of FDI and an officer of certain investment companies
distributed or administered by FDI. From June 1994 to January 1996, Ms.
Jacoppo-Wood was a Manager of SEC Registration at Scudder, Stevens & Clark, Inc.
Prior to May 1994, Ms. Jacoppo-Wood was a senior paralegal at The Boston Company
Advisors, Inc. ("TBCA"). Her date of birth is December 29, 1966.
CHRISTOPHER J. KELLEY; Vice President and Assistant Secretary. Vice
President and Senior Associate General Counsel of FDI and Premier Mutual and an
officer of certain investment companies distributed or administered by FDI. From
April 1994 to July 1996, Mr. Kelley was Assistant Counsel at Forum Financial
Group. Prior to April 1994, Mr. Kelley was employed by Putnam Investments in
legal and compliance capacities. His date of birth is December 24, 1964.
MARY A. NELSON; Vice President and Assistant Treasurer. Vice President and
Manager of Treasury Services and Administration of FDI and Premier Mutual and an
officer of certain investment companies distributed or administered by FDI.
Prior to August 1994, Ms. Nelson was an Assistant Vice President and Client
Manager for The Boston Company, Inc. Her date of birth is April 22, 1964.
MARY JO PACE; Assistant Treasurer. Vice President, Morgan Guaranty Trust
Company of New York. Ms. Pace serves in the Funds Administration group as a
Manager for the Budgeting and Expense Processing Group. Prior to September 1995,
Ms. Pace served as a Fund Administrator for Morgan Guaranty Trust Company of New
York. Her address is 522 Fifth Avenue, New York, New York 10036. Her date of
birth is March 13, 1966.
STEPHANIE D. PIERCE; Vice President and Assistant Secretary. Vice President
and Client Development Manager for FDI since April 1998. From April 1997 to
March 1998, Ms. Pierce was employed by Citibank, NA as an officer of Citibank
and Relationship Manager on the Business and Professional Banking team handling
over 22,000 clients. Address: 200 Park Avenue, New York, NY 10166. Her date of
birth is August 18, 1968.
MICHAEL S. PETRUCELLI; Vice President and Assistant Secretary. Senior Vice
President and Director of Strategic Client Initiatives for FDI since December
1996.
<PAGE>
From December 1989 through November 1996, Mr. Petrucelli was employed with
GE Investments where he held various financial, business development and
compliance positions. He also served as Treasurer of the GE Funds and as
Director of GE Investment Services. Address: 200 Park Avenue, New York, New
York, 10166. His date of birth is May 18, 1961.
GEORGE A. RIO; President and Treasurer. Executive Vice President and Client
Service Director of FDI since April 1998. From June 1995 to March 1998, Mr. Rio
was Senior Vice President and Senior Key Account Manager for Putnam Mutual
Funds. From May 1994 to June 1995, Mr. Rio was Director of Business Development
for First Data Corporation. From September 1983 to May 1994, Mr. Rio was Senior
Vice President & Manager of Client Services and Director of Internal Audit at
The Boston Company. His date of birth is January 2, 1955.
CHRISTINE ROTUNDO; Assistant Treasurer. Vice President, Morgan Guaranty
Trust Company of New York. Ms. Rotundo serves in the Funds Administration group
as a Manager of the Tax Group and is responsible for U.S. mutual fund tax
matters. Prior to September 1995, Ms. Rotundo served as a Senior Tax Manager in
the Investment Company Services Group of Deloitte & Touche LLP. Her address is
522 Fifth Avenue, New York, New York 10036. Her date of birth is September 26,
1965.
The Portfolio's Declaration of Trust provides that it will indemnify
its Trustees and officers against liabilities and expenses incurred in
connection with litigation in which they may be involved because of their
offices with the Portfolio, unless, as to liability to the Portfolio or its
investors, it is finally adjudicated that they engaged in wilful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in
their offices, or unless with respect to any other matter it is finally
adjudicated that they did not act in good faith in the reasonable belief that
their actions were in the best interests of the Portfolio. In the case of
settlement, such indemnification will not be provided unless it has been
determined by a court or other body approving the settlement or other
disposition, or by a reasonable determination, based upon a review of readily
available facts, by vote of a majority of disinterested Trustees or in a written
opinion of independent counsel, that such officers or Trustees have not engaged
in wilful misfeasance, bad faith, gross negligence or reckless disregard of
their duties.
ITEM 15. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES.
As of June 30, 1998, the J.P. Morgan Institutional New York Total
Return Bond Fund and the J.P. Morgan New York Total Return Bond Fund (series of
the J.P. Morgan Institutional Funds and the J.P. Morgan Funds, respectively)
(the "Funds") owned 61% and 39%, respectively, of the outstanding beneficial
interests in the Portfolio. So long as the Funds control the Portfolio, they may
take actions without the approval of any other holders of beneficial interest,
if any, in the Portfolio.
Each of the Funds has informed the Portfolio that whenever it is
requested to vote on matters pertaining to the Portfolio (other than a vote by a
Portfolio to continue the operation of the Portfolio upon the withdrawal of
another investor in the Portfolio), it will hold a meeting of its shareholders
and will cast its vote as instructed by those shareholders.
None of the officers or Trustees of the Portfolio own any of the
outstanding beneficial interests in the Portfolio.
ITEM 16. INVESTMENT ADVISORY AND OTHER SERVICES.
INVESTMENT ADVISOR. The investment advisor to the Portfolio is JPMIM, a
wholly owned subsidiary of J.P. Morgan & Co. Incorporated ("J.P. Morgan"), a
registered investment adviser under the Investment Advisers Act of 1940, as
amended. The Advisor, whose principal offices are at 522 Fifth Avenue, New York,
New York 10036 manages employee benefit funds of corporations, labor unions and
state and local governments and the accounts of other institutional investors,
including investment companies. Certain of the assets of employee benefit
accounts under its management are invested in commingled pension trust funds for
which the Advisor serves as trustee.
<PAGE>
J.P. Morgan, through the Advisor and other subsidiaries, acts as
investment advisor to individuals, governments, corporations, employee benefit
plans, mutual funds and other institutional investors with combined assets under
management of approximately $275 billion.
J.P. Morgan has a long history of service as adviser, underwriter and
lender to an extensive roster of major companies and as a financial advisor to
national governments. The firm, through its predecessor firms, has been in
business for over a century and has been managing investments since 1913.
Morgan, also a wholly owned subsidiary of J.P. Morgan, is a bank
holding company organized under the laws of the State of Delaware. Morgan, whose
principal offices are at 60 Wall Street, New York, New York 10260, is a New York
trust company which conducts a general banking and trust business. Morgan is
subject to regulation by the New York State Banking Department and is a member
bank of the Federal Reserve System. Through offices in New York City and abroad,
Morgan offers a wide range of services, primarily to governmental,
institutional, corporate and high net worth individual customers in the United
States and throughout the world.
The basis of the Advisor's investment process is fundamental investment
research as the firm believes that fundamentals should determine an asset's
value over the long term. J.P. Morgan currently employs over 100 full time
research analysts, among the largest research staffs in the money management
industry, in its investment management divisions located in New York, London,
Tokyo, Frankfurt and Singapore to cover companies, industries and countries on
site. In addition, the investment management divisions employ approximately 300
capital market researchers, portfolio managers and traders.
The investment advisory services the Advisor provides to the Portfolio
are not exclusive under the terms of the Advisory Agreement. The Advisor is free
to and does render similar investment advisory services to others. The Advisor
serves as investment advisor to personal investors and other investment
companies and acts as fiduciary for trusts, estates and employee benefit plans.
Certain of the assets of trusts and estates under management are invested in
common trust funds for which the Advisor serves as trustee. The accounts which
are managed or advised by the Advisor have varying investment objectives and the
Advisor invests assets of such accounts in investments substantially similar to,
or the same as, those which are expected to constitute the principal investments
of the Portfolio. Such accounts are supervised by officers and employees of the
Advisor who may also be acting in similar capacities for the Portfolio. See Item
17 below.
Sector weightings are generally similar to a benchmark with the
emphasis on security selection as the method to achieve investment performance
superior to the benchmark. The benchmark for the Portfolio is currently Lehman
Brothers 1-16 Year Municipal Bond Index.
The Portfolio is managed by officers of the Advisor who, in acting for
their customers, including the Portfolio, do not discuss their investment
decisions with any personnel of J.P. Morgan or any personnel of other divisions
of the Advisor or with any of its affiliated persons, with the exception of
certain investment management affiliates of J.P. Morgan.
As compensation for the services rendered and related expenses such as
salaries of advisory personnel borne by the Advisor under the Investment
Advisory Agreement, the Portfolio has agreed to pay the Advisor a fee, which is
computed daily and may be paid monthly, equal to the annual rate of 0.30% of the
Portfolio's average daily net assets. For the fiscal years ended March 31, 1996,
1997 and 1998 the Portfolio paid Morgan $246,966, $380,380 and $513,516,
respectively, in advisory fees.
The Investment Advisory Agreement provides that it will continue in
effect for a period of two years after execution only if specifically approved
annually thereafter (i) by a vote of the holders of a majority of the
Portfolio's outstanding securities or by its Trustees and (ii) by a vote of a
majority of the Trustees who are not
<PAGE>
parties to the Advisory Agreement or "interested persons" as defined by
the 1940 Act cast in person at a meeting called for the purpose of voting on
such approval. The Investment Advisory Agreement will terminate automatically if
assigned and is terminable at any time without penalty by a vote of a majority
of the Trustees of the Portfolio or by a vote of the holders of a majority of
the Portfolio's voting securities on 60 days' written notice to the Advisor and
by the Advisor on 90 days' written notice to the Portfolio.
The Glass-Steagall Act and other applicable laws generally prohibit
banks and their subsidiaries, such as the Advisor, from engaging in the business
of underwriting or distributing securities, and the Board of Governors of the
Federal Reserve System has issued an interpretation to the effect that under
these laws a bank holding company registered under the federal Bank Holding
Company Act or certain subsidiaries thereof may not sponsor, organize, or
control a registered open-end investment company continuously engaged in the
issuance of its shares, such as the Portfolio. The interpretation does not
prohibit a holding company or a subsidiary thereof from acting as investment
advisor and custodian to such an investment company. The Advisor believes that
it may perform the services for the Portfolio contemplated by the Advisory
Agreement without violation of the Glass-Steagall Act or other applicable
banking laws or regulations. State laws on this issue may differ from the
interpretation of relevant federal law, and banks and financial institutions may
be required to register as dealers pursuant to state securities laws. However,
it is possible that future changes in either federal or state statutes and
regulations concerning the permissible activities of banks or trust companies,
as well as further judicial or administrative decisions and interpretations of
present and future statutes and regulations, might prevent the Advisor from
continuing to perform such services for the Portfolio.
If the Advisor were prohibited from acting as investment advisor to the
Portfolio, it is expected that the Trustees of the Portfolio would recommend to
investors that they approve the Portfolio's entering into a new investment
advisory agreement with another qualified investment advisor selected by the
Trustees.
CO-ADMINISTRATOR. Under the Portfolio's Co-Administration Agreement
dated August 1, 1996, FDI serves as the Portfolio's Co-Administrator. The Co-
Administration Agreement may be renewed or amended by the Trustees without an
investor vote. The Co-Administration Agreement is terminable at any time without
penalty by a vote of a majority of the Trustees of the Portfolio on not more
than 60 days' written notice nor less than 30 days' written notice to the other
party. The Co-Administrator may, subject to the consent of the Trustees of the
Portfolio, subcontract for the performance of its obligations, provided,
however, that unless the Portfolio expressly agrees in writing, the
Co-Administrator shall be fully responsible for the acts and omissions of any
subcontractor as it would for its own acts or omissions. See "Administrative
Services Agent" below.
FDI (i) provides office space, equipment and clerical personnel for
maintaining the organization and books and records of the Portfolio; (ii)
provides officers for the Portfolio; (iii) files Portfolio regulatory documents
and mails Portfolio communications to Trustees and investors; and (iv) maintains
related books and records.
For its services under the Co-Administration Agreement, the Portfolio
has agreed to pay FDI fees equal to its allocable share of an annual
complex-wide charge of $425,000 plus FDI's out-of-pocket expenses. The amount
allocable to the Portfolio is based on the ratio of its net assets to the
aggregate net assets of the J.P. Morgan Funds, the J.P. Morgan Institutional
Funds, the Master Portfolios, and certain other investment companies subject to
similar agreements with FDI. The administrative fees paid by the Portfolio to
FDI for the period August 1, 1996 through March 31, 1997 and the fiscal year
ended March 31, 1998 were $1,914 and $2,869, respectively.
The following administrative fees were paid by the Portfolio to Signature
Broker-Dealer Services, Inc. (which provided placement agent and administrative
services to the Portfolio prior to August 1, 1996): For the fiscal year ended
March 31, 1996: $6,648. For the period April 1, 1996 through July 31, 1996:
$4,617.
<PAGE>
ADMINISTRATIVE SERVICES AGENT. The Portfolio has entered into a
Restated Administrative Services Agreement (the "Services Agreement") with
Morgan, pursuant to which Morgan is responsible for certain administrative and
related services provided to the Portfolio.
Under the Services Agreement, effective August 1, 1996, the Portfolio
has agreed to pay Morgan fees equal to its allocable share of an annual
complex-wide charge. This charge is calculated daily based on the aggregate net
assets of the Master Portfolios and J.P. Morgan Series Trust in accordance with
the following annual schedule: 0.09% on the first $7 billion of their aggregate
average daily net assets and 0.04% of their aggregate average daily net assets
in excess of $7 billion, less the complex-wide fees payable to FDI. The portion
of this charge payable by the Portfolio is determined by the proportionate share
that its net assets bear to the total net assets of the J.P. Morgan Funds, the
J.P. Morgan Institutional Funds, the Master Portfolios, the other investors in
the Master Portfolios for which Morgan provides similar services and J.P. Morgan
Series Trust.
Under administrative services agreements in effect with Morgan from
December 29, 1995 through July 31, 1996, the Portfolio paid Morgan a fee equal
to its proportionate share of an annual complex-wide charge. This charge was
calculated daily based on the aggregate net assets of the Master Portfolios in
accordance with the following schedule: 0.06% of the first $7 billion of the
Master Portfolios' aggregate average daily net assets and 0.03% of the Master
Portfolios' aggregate average daily net assets in excess of $7 billion. Prior to
December 29, 1995, the Portfolio had entered into a financial and fund
accounting services agreement with Morgan, the provisions of which included
certain of the activities described above and, prior to September 1, 1995, also
included reimbursement of usual and customary expenses.
For the fiscal years ended March 31, 1996, 1997 and 1998 the Portfolio
paid Morgan $7,691, $37,675 and $52,013, respectively, in administrative
services fees.
CUSTODIAN. State Street Bank and Trust Company ("State Street"), 225
Franklin Street, Boston, Massachusetts 02110, serves as the Portfolio's
custodian and fund accounting and transfer agent. Pursuant to the Custodian
Contract, State Street is responsible for maintaining the books of account and
records of portfolio transactions and holding portfolio securities and cash. In
addition, the Custodian has entered into subcustodian agreements with Bankers
Trust Company for the purpose of holding TENR Notes and with Bank of New York
and Chemical Bank, N.A. for the purpose of holding certain variable rate demand
notes. In the case of foreign assets held outside the United States, the
Custodian employs various sub-custodians, who were approved by the Trustees of
the Portfolio in accordance with the regulations of the SEC. The Custodian
maintains portfolio transaction records, calculates book and tax allocations for
the Portfolio, and computes the value of the interest of each investor. State
Street is responsible for maintaining account records detailing the ownership of
interests in the Portfolio.
INDEPENDENT ACCOUNTANTS. The independent accountants of the Portfolio
are PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036. PricewaterhouseCoopers LLP conducts an annual audit of the financial
statements of the Portfolio, assists in the preparation and/or review of the
Portfolio's federal and state income tax returns and consults with the Portfolio
as to matters of accounting and federal and state income taxation.
EXPENSES. In addition to the fees payable to the service providers
identified above, the Portfolio is responsible for usual and customary expenses
associated with its operations. Such expenses include organization expenses,
legal fees, insurance costs, the compensation and expenses of the Trustees,
registration fees under federal securities laws, and extraordinary expenses
applicable to the Portfolio. Such expenses also include brokerage expenses.
Under fee arrangements prior to September 1, 1995, Morgan as service agent was
responsible for reimbursements to the Portfolio for SBDS's fees as administrator
and the usual and customary expenses described above (excluding organization and
extraordinary expenses, custodian fees and brokerage expenses).
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Morgan has agreed to reimburse the Portfolio to the extent necessary to
maintain the daily total operating expense of the Portfolio at no more than the
annualized rate of 0.50% of the daily net assets of the Portfolio. This
reimbursement arrangement can be changed or terminated at any time at the option
of J.P. Morgan.
THE YEAR 2000 INITIATIVE. With the new millennium rapidly approaching,
organizations are examining their computer systems to ensure they are year 2000
compliant. The issue, in simple terms, is that many existing computer systems
use only two numbers to identify a year in the date field with the assumption
that the first two digits are always 19. As the century is implied in the date,
on January 1, 2000, computers that are not year 2000 compliant will assume the
year is 1900. Systems that calculate, compare, or sort using the incorrect date
will cause erroneous results, ranging from system malfunctions to incorrect or
incomplete transaction processing. If not remedied, potential risks include
business interruption or shutdown, financial loss, reputation loss, and/or legal
liability.
J.P. Morgan has undertaken a firmwide initiative to address the year
2000 issue and has developed a comprehensive plan to prepare, as appropriate,
its computer systems. Each business line has taken responsibility for
identifying and fixing the problem within its own area of operation and for
addressing all interdependencies. A multidisciplinary team of internal and
external experts supports the business teams by providing direction and firmwide
coordination. Working together, the business and multidisciplinary teams have
completed a thorough education and awareness initiative and a global inventory
and assessment of J.P. Morgan's technology and application portfolio to
understand the scope of the year 2000 impact at J.P. Morgan. J.P. Morgan
presently is renovating and testing these technologies and applications in
partnership with external consulting and software development organizations, as
well as with year 2000 tool providers. J.P. Morgan is on target with its plan to
substantially complete renovation, testing, and validation of its key systems by
year-end 1998 and to participate in industry-wide testing (or streetwide
testing) in 1999. J.P. Morgan is also working with key external parties,
including clients, counterparties, vendors, exchanges, depositories, utilities,
suppliers, agents and regulatory agencies, to stem the potential risks the year
2000 problem poses to J.P. Morgan and to the global financial community.
Costs associated with efforts to prepare J.P. Morgan's systems for the
year 2000 approximated $95 million in 1997. In 1998, J.P. Morgan will continue
its efforts to prepare its systems for the year 2000. The total cost to become
year-2000 compliant is estimated at $250 million, for internal systems
renovation and testing, testing equipment, and both internal and external
resources working on the project. Remaining costs will be incurred primarily in
1998. The costs associated with J.P. Morgan becoming year-2000 compliant will be
borne by J.P. Morgan and not the Portfolio.
ITEM 17. BROKERAGE ALLOCATION AND OTHER PRACTICES.
The Advisor places orders for the Portfolio for all purchases and sales
of portfolio securities, enters into repurchase agreements, and may enter into
reverse repurchase agreements and execute loans of portfolio securities on
behalf of the Portfolio. See Item 13 above.
Fixed income and debt securities and municipal bonds and notes are
generally traded at a net price with dealers acting as principal for their own
accounts without a stated commission. The price of the security usually includes
profit to the dealers. In underwritten offerings, securities are purchased at a
fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. On occasion,
certain securities may be purchased directly from an issuer, in which case no
commissions or discounts are paid.
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Portfolio transactions for the Portfolio will be undertaken principally
to accomplish the Portfolio's objective in relation to expected movements in the
general level of interest rates. The Portfolio may engage in short term trading
consistent with its objective.
In connection with portfolio transactions for the Portfolio, the
Advisor intends to seek best execution on a competitive basis for both purchases
and sales of securities.
Subject to the overriding objective of obtaining the best possible
execution of orders, the Advisor may allocate a portion of the Portfolio's
portfolio brokerage transactions to affiliates of the Advisor. In order for
affiliates of the Advisor to effect any portfolio transactions for the
Portfolio, the commissions, fees or other remuneration received by such
affiliates must be reasonable and fair compared to the commissions, fees, or
other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on a
securities exchange during a comparable period of time. Furthermore, the
Trustees of the Portfolio, including a majority of the Trustees who are not
"interested persons," have adopted procedures which are reasonably designed to
provide that any commissions, fees, or other remuneration paid to such
affiliates are consistent with the foregoing standard.
The Portfolio's portfolio securities will not be purchased from or
through or sold to or through the exclusive placement agent or Advisor or any
other "affiliated person" (as defined in the 1940 Act) of the exclusive
placement agent or Advisor when such entities are acting as principals, except
to the extent permitted by law. In addition, the Portfolio will not purchase
securities during the existence of any underwriting group relating thereto of
which the Advisor or an affiliate of the Advisor is a member, except to the
extent permitted by law.
Investment decisions made by the Advisor are the product of many
factors in addition to basic suitability for the particular portfolio or other
client in question. Thus, a particular security may be bought or sold for
certain clients even though it could have been bought or sold for other clients
at the same time. Likewise, a particular security may be bought for one or more
clients when one or more other clients are selling the same security. The
Portfolio may only sell a security to other portfolios or accounts managed by
the Advisor or its affiliates in accordance with procedures adopted by the
Trustees.
On those occasions when the Advisor deems the purchase or sale of a
security to be in the best interests of the Portfolio as well as other
customers, including other Master Portfolios, the Advisor, to the extent
permitted by applicable laws and regulations, may, but is not obligated to,
aggregate the securities to be sold or purchased for the Portfolio with those to
be sold or purchased for other customers in order to obtain best execution,
including lower brokerage commissions if appropriate. In such event, allocation
of the securities so purchased or sold as well as any expenses incurred in the
transaction will be made by the Advisor in the manner it considers to be most
equitable and consistent with its fiduciary obligations to the Portfolio.
In some instances, this procedure might adversely affect the Portfolio.
If the Portfolio effects a closing purchase transaction with respect to
an option written by it, normally such transaction will be executed by the same
broker-dealer who executed the sale of the option. The writing of options by the
Portfolio will be subject to limitations established by each of the exchanges
governing the maximum number of options in each class which may be written by a
single investor or group of investors acting in concert, regardless of whether
the options are written on the same or different exchanges or are held or
written in one or more accounts or through one or more brokers. The number of
options which the Portfolio may write may be affected by options written by the
Advisor for other investment advisory clients. An exchange may order the
liquidation of positions found to be in excess of these limits, and it may
impose certain other sanctions.
ITEM 18. CAPITAL STOCK AND OTHER SECURITIES.
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Under the Declaration of Trust, the Trustees are authorized to issue
beneficial interests in the Portfolio. Investors are entitled to participate pro
rata in distributions of taxable income, loss, gain and credit of the Portfolio.
Upon liquidation or dissolution of the Portfolio, investors are entitled to
share pro rata in the Portfolio's net assets available for distribution to its
investors. Investments in the Portfolio have no preference, preemptive,
conversion or similar rights and are fully paid and nonassessable, except as set
forth below. Investments in the Portfolio may not be transferred. Certificates
representing an investor's beneficial interest in the Portfolio are issued only
upon the written request of an investor.
Each investor is entitled to a vote in proportion to the amount of its
investment in the Portfolio. Investors in the Portfolio do not have cumulative
voting rights, and investors holding more than 50% of the aggregate beneficial
interest in the Portfolio may elect all of the Trustees if they choose to do so
and in such event the other investors in the Portfolio would not be able to
elect any Trustee. The Portfolio is not required and has no current intention to
hold annual meetings of investors but the Portfolio will hold special meetings
of investors when in the judgment of the Portfolio's Trustees it is necessary or
desirable to submit matters for an investor vote. No material amendment may be
made to the Portfolio's Declaration of Trust without the affirmative majority
vote of investors (with the vote of each being in proportion to the amount of
its investment).
The Portfolio may enter into a merger or consolidation, or sell all or
substantially all of its assets, if approved by the vote of two thirds of its
investors (with the vote of each being in proportion to its percentage of the
beneficial interests in the Portfolio), except that if the Trustees recommend
such sale of assets, the approval by vote of a majority of the investors (with
the vote of each being in proportion to its percentage of the beneficial
interests of the Portfolio) will be sufficient. The Portfolio may also be
terminated (i) upon liquidation and distribution of its assets if approved by
the vote of two thirds of its investors (with the vote of each being in
proportion to the amount of its investment) or (ii) by the Trustees by written
notice to its investors.
The Portfolio is organized as a trust under the laws of the State of
New York. Investors in the Portfolio will be held personally liable for its
obligations and liabilities, subject, however, to indemnification by the
Portfolio in the event that there is imposed upon an investor a greater portion
of the liabilities and obligations of the Portfolio than its proportionate
beneficial interest in the Portfolio. The Declaration of Trust also provides
that the Portfolio shall maintain appropriate insurance (for example, fidelity
bonding and errors and omissions insurance) for the protection of the Portfolio,
its investors, Trustees, officers, employees and agents covering possible tort
and other liabilities. Thus, the risk of an investor incurring financial loss on
account of investor liability is limited to circumstances in which both
inadequate insurance existed and the Portfolio itself was unable to meet its
obligations.
The Portfolio's Declaration of Trust further provides that obligations
of the Portfolio are not binding upon the Trustees individually but only upon
the property of the Portfolio and that the Trustees will not be liable for any
action or failure to act, but nothing in the Declaration of Trust protects a
Trustee against any liability to which he would otherwise be subject by reason
of willful misfeasance, bad faith, gross negligence, or reckless disregard of
the duties involved in the conduct of his office.
ITEM 19. PURCHASE, REDEMPTION AND PRICING OF SECURITIES BEING OFFERED.
Beneficial interests in the Portfolio are issued solely in private
placement transactions that do not involve any "public offering" within the
meaning of Section 4(2) of the 1933 Act.
The Portfolio computes its net asset value once daily on Monday through
Friday at the time described in Part A. The net asset value will not be computed
on the days the following legal holidays are observed: New Year's Day, Martin
Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day, and Christmas Day. On days when the U.S.
trading markets close
<PAGE>
early, the Portfolio will close for purchases and redemptions at the same time.
The Portfolio may also close for purchases and redemptions at such other times
as may be determined by the Board of Trustees to the extent permitted by
applicable law. The days on which net asset value is determined are the
Portfolio's business days.
Portfolio securities are valued at the last sale price on the
securities exchange or national securities market on which such securities are
primarily traded. Unlisted securities are valued at the last average of the
quoted bid and asked prices in the OTC market. The value of each security for
which readily available market quotations exist is based on a decision as to the
broadest and most representative market for such security.
Securities or other assets for which market quotations are not readily
available (including certain restricted and illiquid securities) are valued at
fair value in accordance with procedures established by and under the general
supervision and responsibility of the Trustees. Such procedures include the use
of independent pricing services which use prices based upon yields or prices of
securities of comparable quality, coupon, maturity and type; indications as to
values from dealers; and general market conditions. Short-term investments which
mature in 60 days or less are valued at amortized cost if their original
maturity was 60 days or less, or by amortizing their value on the 61st day prior
to maturity, if their original maturity when acquired by the Portfolio was more
than 60 days, unless this is determined not to represent fair value by the
Trustees.
If the Portfolio determines that it would be detrimental to the best
interest of the remaining investors in the Portfolio to make payment wholly or
partly in cash, payment of the redemption price may be made in whole or in part
by a distribution in kind of securities from the Portfolio, in lieu of cash, in
conformity with the applicable rule of the SEC. If interests are redeemed in
kind, the redeeming investor might incur transaction costs in converting the
assets into cash. The method of valuing portfolio securities is described above
and such valuation will be made as of the same time the redemption price is
determined. The Portfolio has elected to be governed by Rule 18f-1 under the
1940 Act pursuant to which the Portfolio is obligated to redeem interests solely
in cash up to the lesser of $250,000 or 1% of the net asset value of the
Portfolio during any 90 day period for any one investor. The Portfolio will not
redeem in kind except in circumstances in which an investor is permitted to
redeem in kind.
ITEM 20. TAX STATUS.
The Portfolio is organized as a New York trust. The Portfolio is not
subject to any income or franchise tax in the State of New York or the
Commonwealth of Massachusetts. However each investor in the Portfolio will be
taxable on its share (as determined in accordance with the governing instruments
of the Portfolio) of the Portfolio's ordinary income and capital gain in
determining its income tax liability. The determination of such share will be
made in accordance with the Code, and regulations promulgated thereunder.
Although, as described above, the Portfolio will not be subject to
federal income tax, it will file appropriate income tax returns.
It is intended that the Portfolio's assets will be managed in such a
way that an investor in the Portfolio will be able to satisfy the requirements
of Subchapter M of the Code.
The Portfolio intends to qualify to allocate tax exempt interest to its
investors by having, at the close of each quarter of its taxable year, at least
50% of the value of its total assets consist of tax exempt securities. Tax
exempt interest is that part of income earned by the Portfolio which consists of
interest received by the Portfolio on tax exempt securities. In view of the
Portfolio's investment policies, it is expected that a substantial portion of
all income will be tax exempt income, although the Portfolio may from time to
time realize net short-term capital gains and
<PAGE>
may invest limited amounts in taxable securities under certain
circumstances.
Gains or losses on sales of portfolio securities will be treated as
long-term capital gains or losses if the securities have been held for more than
one year except in certain cases where, if applicable, a put is acquired or a
call option is written thereon.
Other gains or losses on the sale of securities will be short-term
capital gains or losses. Gains and losses on the sale, lapse or other
termination of options on securities will be treated as gains and losses from
the sale of securities. If an option written by the Portfolio lapses or is
terminated through a closing transaction, such as a repurchase by the Portfolio
of the option from its holder, the Portfolio will realize a short-term capital
gain or loss, depending on whether the premium income is greater or less than
the amount paid by the Portfolio in the closing transaction. If securities are
purchased by the Portfolio pursuant to the exercise of a put option written by
it, the Portfolio will subtract the premium received from its cost basis in the
securities purchased.
Forward currency contracts, options and futures contracts entered into
by the Portfolio may create "straddles" for U.S. federal income tax purposes and
this may affect the character and timing of gains or losses realized by the
Portfolio on forward currency contracts, options and futures contracts or on the
underlying securities. Straddles may also result in the loss of the holding
period of underlying securities for purposes of the 30% of gross income test
described above, and therefore, the Portfolio's ability to enter into forward
currency contracts, options and futures contracts may be limited.
Certain options, futures and foreign currency contracts held by a
Portfolio at the end of each fiscal year will be required to be "marked to
market" for federal income tax purposes--i.e., treated as having been sold at
market value. For options and futures contracts, 60% of any gain or loss
recognized on these deemed sales and on actual dispositions will be treated as
long-term capital gain or loss, and the remainder will be treated as short-term
capital gain or loss regardless of how long the Portfolio has held such options
or futures. Any gain or loss recognized on foreign currency contracts will be
treated as ordinary income.
STATE AND LOCAL TAXES. The Portfolio may be subject to state or local
taxes in jurisdictions in which the Portfolio is deemed to be doing business. In
addition, the treatment of the Portfolio and its investors in those states which
have income tax laws might differ from treatment under the federal income tax
laws. Investors should consult their own tax advisors with respect to any state
or local taxes.
OTHER TAXATION. The investment by an investor in the Portfolio does not
cause the investor to be liable for any income or franchise tax in the State of
New York. Investors are advised to consult their own tax advisers with respect
to the particular tax consequences to them of an investment in the Portfolio.
ITEM 21. UNDERWRITERS.
The exclusive placement agent for the Portfolio is FDI, which receives
no additional compensation for serving in this capacity. Investment companies,
insurance company separate accounts, common and commingled trust funds and
similar organizations and entities may continuously invest in the Portfolio.
ITEM 22. CALCULATIONS OF PERFORMANCE DATA.
Not applicable.
ITEM 23. FINANCIAL STATEMENTS.
The Portfolio's March 31, 1998 annual report filed with the SEC
pursuant to Section 30(b) of the 1940 Act and Rule 30b2-1 thereunder is
incorporated herein by reference (Accession Number 0001047469-98-022533, filed
June 2, 1998).
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APPENDIX A
DESCRIPTION OF SECURITY RATINGS
STANDARD & POOR'S
CORPORATE AND MUNICIPAL BONDS
AAA - Debt rated AAA have the highest ratings assigned by Standard & Poor's
to a debt obligation. Capacity to pay interest and repay principal is
extremely strong.
AA - Debt rated AA have a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in a small
degree.
A - Debt rated A have a strong capacity to pay interest and repay
principal they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher
rated categories.
BBB - Debt rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit 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 for debt in
higher rated categories.
BB - Debt rated BB are regarded as having less near-term vulnerability to
default than other speculative issues. However, they face major ongoing
uncertainties or exposure to adverse business, financial or economic
conditions which could lead to inadequate capacity to meet timely
interest and principal payments.
B - An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to
meet its financial commitment on the obligation. Adverse business,
financial, or economic conditions will likely impair the obligor's
capacity or willingness to meet its financial commitment on the
obligation.
CCC - An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions
for the obligor to meet its financial commitment on the obligation. In
the event of adverse business, financial, or economic conditions, the
obligor is not likely to have the capacity to meet its financial
commitment on the obligation.
CC - An obligation rated CC is currently highly vulnerable to nonpayment.
C - The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments
on this obligation are being continued.
COMMERCIAL PAPER, INCLUDING TAX EXEMPT
A - Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are
further refined with the designations 1, 2, and 3 to indicate the
relative degree of safety.
A-1 - This designation indicates that the degree of safety regarding timely
payment is very strong.
SHORT-TERM TAX-EXEMPT NOTES
SP-1 - The short-term tax-exempt note rating of SP-1 is the highest rating
assigned by Standard & Poor's and has a very strong or strong capacity to pay
principal and interest. Those issues determined to possess overwhelming safety
characteristics are given a "plus" (+) designation.
SP-2 - The short-term tax-exempt note rating of SP-2 has a satisfactory
capacity to pay principal and interest.
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MOODY'S
CORPORATE AND MUNICIPAL BONDS
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risks
appear somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection
of interest and principal payments may be very moderate, and thereby
not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
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COMMERCIAL PAPER, INCLUDING TAX EXEMPT
Prime-1 - Issuers rated Prime-1 (or related supporting institutions)
have a superior capacity for repayment of short-term
promissory obligations. Prime-1 repayment capacity 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
charges and high internal cash generation.
- Well established access to a range of financial markets
and assured sources of alternate liquidity.
SHORT-TERM TAX EXEMPT NOTES
MIG-1 The short-term tax-exempt note rating MIG-1 is the highest
rating assigned by Moody's for notes judged to be the best
quality. Notes with this rating enjoy strong protection from
established cash flows of funds for their servicing or from
established and broad-based access to the market for
refinancing, or both.
MIG-2 - MIG-2 rated notes are of high quality but with margins of
protection not as large as MIG-1.
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APPENDIX B
ADDITIONAL INFORMATION CONCERNING NEW YORK MUNICIPAL OBLIGATIONS
The following information is a summary of special factors affecting
investments in New York municipal obligations. It does not purport to be a
complete description and is based on information from the supplement (dated
January 30, 1998) to the Annual Information Statement of the State of New York
dated August 15, 1997, and other sources of information. The factors affecting
the financial condition of New York State (the "State") and New York City (the
"City") are complex and the following description constitutes only a summary.
General
New York is the third most populous state in the nation and has a
relatively high level of personal wealth. The state's economy is diverse, with a
comparatively large share of the nation's finance, insurance, transportation,
communications and services employment, and a very small share of the nation's
farming and mining activity. The State's location and its excellent air
transport facilities and natural harbors have made it an important link in
international commerce. Travel and tourism constitute an important part of the
economy. Like the rest of the nation, New York has a declining proportion of its
workforce engaged in manufacturing, and an increasing proportion engaged in
service industries.
Services: The services sector, which includes entertainment, personal
services, such as health care and auto repairs, and business-related services,
such as information processing, law and accounting, is the State's leading
economic sector. The services sector accounts for more than three of every ten
nonagricultural jobs in New York and has a noticeably higher proportion of total
jobs than does the rest of the nation.
Manufacturing: Manufacturing employment continues to decline in
importance in New York, as in most other states, and New York's economy is less
reliant on this sector than is the nation. The principal manufacturing
industries in recent years produced printing and publishing materials,
instruments and related products, machinery, apparel and finished fabric
products, electronic and other electric equipment, food and related products,
chemicals and allied products, and fabricated metal products.
Trade: Wholesale and retail trade is the second largest sector in terms
of nonagricultural jobs in New York but is considerably smaller when measured by
income share. Trade consists of wholesale businesses and retail businesses, such
as department stores and eating and drinking establishments.
Finance, Insurance and Real Estate: New York City is the nation's
leading center of banking and finance and, as a result, this is a far more
important sector in the State than in the nation as a whole. Although this
sector accounts for under one-tenth of all nonagricultural jobs in the State, it
contributes over one-sixth of all nonfarm labor and proprietors' income.
Agriculture: Farming is an important part of the economy of large
regions of the State, although it constitutes a very minor part of total State
output. Principal agricultural products of the State include milk and dairy
products, greenhouse and nursery products, apples and other fruits, and fresh
vegetables. New York ranks among the nation's leaders in the production of these
commodities.
Government: Federal, State and local government together are the third
largest sector in terms of nonagricultural jobs, with the bulk of the employment
accounted for by local governments. Public education is the source of nearly
one-half of total state and local government employment.
<PAGE>
The importance of the different sectors of the State's economy relative
to the national economy is shown in the following table, which compares
nonagricultural employment and income by industrial categories for the State and
the nation as a whole. Relative to the nation, the State has a smaller share of
manufacturing and construction and a larger share of service-related industries.
The State's finance, insurance, and real estate share, as measured by income, is
particularly large relative to the nation. The State is likely to be less
affected than the nation as a whole during an economic recession that is
concentrated in manufacturing and construction, but likely to be more affected
during a recession that is concentrated in the service-producing sector.
Economic Outlook
U. S. Economy
The State has updated its mid-year forecast of national and state
economic activity through the end of calendar year 1999. At the national level,
although the current projection is for a faster annual growth rate for 1998 as a
whole and slower annual growth for 1999 than expected in the earlier forecast,
growth in both years is still expected to be substantially slower than it was
during 1997. The revised forecast projects real Gross Domestic Product (GDP)
growth of 2.6 percent in 1998, which is more than a full percentage point lower
than the estimated 1997 growth rate. In 1999, real GDP growth is expected to
fall even further to 2.0 percent. The growth of nominal GDP is projected to
decline from 5.8 percent in 1997 to 4.8 percent in 1998 and 4.3 percent in 1999.
The inflation rate is expected to drop to 2.2 percent in 1998 before rising to
2.5 percent in 1999. The annual rate of job growth is expected to be 2.3 percent
in 1998, equaling the strong growth rate experienced in 1997. In 1999, however,
employment growth is forecast to slow markedly to 1.3 percent. Growth in
personal income and wages is expected to slow in 1998 and again in 1999.
State Economy
At the State level, moderate growth is projected to continue in 1998
and 1999 for employment, wages and personal income, although the growth rates
will lessen gradually during the course of the two years. Personal income is
estimated to grow by 5.4 percent in 1997, fueled in part by a continued large
increase in financial sector bonus payments, and is projected to grow 4.7
percent in 1998 and 4.4 percent in 1999. Increases in bonus payments at year-end
1998 are projected to be modest, a substantial change from the rate of increase
of the last few years. Overall employment growth is expected to continue at a
modest rate, reflecting the slowing growth in the national economy, continued
spending restraint in government, and restructuring in the health care, social
service, and banking sectors.
State Financial Plan
The State Constitution requires the Governor to submit to the
legislature a balanced executive budget which contains a complete plan of
expenditures (the "State Financial Plan") for the ensuing fiscal year and all
moneys and revenues estimated to be available therefor, accompanied by bills
containing all proposed appropriations or reappropriations and any new or
modified revenue measures to be enacted in connection with the executive budget.
A final budget must be approved before the statutory deadline of April 1. The
State Financial Plan is updated quarterly pursuant to law.
1997-98 Fiscal Year
The State's current fiscal year commenced on April 1, 1997, and ends on
March 31, 1998, and is referred to herein as the State's 1997-98 fiscal year.
The State's budget for the 1997-98 fiscal year was adopted by the Legislature on
August 4, 1997, more than four months after the start of the fiscal year. Prior
to adoption of the budget, the Legislature enacted appropriations for
disbursements considered to be necessary for State operations and other
purposes, including necessary appropriations for State-supported debt service.
The State's Financial Plan for the 1997-98 fiscal year was formulated on August
11, 1997 and is based on the State's budget as enacted by the Legislature, as
well as actual results for the first quarter of the current
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fiscal year. The 1997-98 State Financial Plan is expected to be updated in
October and January.
The adopted 1997-98 budget projects an increase in General Fund
disbursements of $1.7 billion or 5.2 percent over 1996-97 levels. The average
annual growth rate over the last three fiscal years is approximately 1.2
percent. State Funds disbursements (excluding federal grants) are projected to
increase by 5.4 percent from the 1996-97 fiscal year. All Governmental Funds
projected to increase by 7.0 percent over the 1996-97 fiscal year. See Exhibit A
to this Annual Information Statement for a description of the State's fund
types.
The 1997-98 State Financial Plan is projected to be balanced on a cash
basis. The Financial Plan projections include a reserve for future needs of $530
million. As compared to the Governor's Executive Budget as amended in February
1997, the State's adopted budget for 1997-98 increases General Fund spending by
$1.7 billion, primarily from increases for local assistance ($1.3 billion).
Resources used to fund these additional expenditures include increased revenues
projected for the 1997-98 fiscal year, increased resources produced in the
1996-97 fiscal year that will be utilized in 1997-98, reestimates of social
service, fringe benefit and other spending, and certain non-recurring resources.
Total non-recurring resources included in the 1997-98 Financial Plan are
projected by DOB to be $270 million, or 0.7 percent of total General Fund
receipts.
The 1997-98 adopted budget includes multi-year tax reductions,
including a State funded property and local income tax reduction program, estate
tax relief, utility gross receipts tax reductions, permanent reductions in the
State sales tax on clothing, and elimination of assessments on medical
providers. These reductions are intended to reduce the overall level of State
and local taxes in New York and to improve the State's competitive position
vis-a-vis other states. The various elements of the State and local tax and
assessment reductions have little or no impact on the 1997-98 Financial Plan,
and do not begin to materially affect the outyear projections until the State's
1999-2000 fiscal year. The adopted 1997-98 budget also makes significant
investments in education, and proposes a new $2.4 billion general obligation
bond proposal for school facilities to be submitted to the voters in November
1997.
The 1997-98 Financial Plan also includes: a projected General Fund
reserve of $530 million; a projected balance of $332 million in the Tax
Stabilization Reserve Fund; and a projected $65 million balance in the
Contingency Reserve Fund.
The projections do not include any subsequent actions that the Governor
may take to exercise his line-item veto (or vetoing any companion legislation)
before signing the 1997-98 budget appropriation bills into law. Under the
Constitution, the Governor may veto any additions to the Executive Budget within
10 days after the submission of appropriation bills for his approval. If the
Governor were to take such action, the resulting impact on the Financial Plan
would be positive.
The economic and financial condition of the State may be affected by
various financial, social, economic and political factors. Those factors can be
very complex, may vary from fiscal year to fiscal year, and are frequently the
result of actions taken not only by the State and its agencies and
instrumentalities, but also by entities, such as the federal government, that
are not under the control of the State. In addition, the State Financial Plan is
based upon forecasts of national and State economic activity. Economic forecasts
have frequently failed to predict accurately the timing and magnitude of changes
in the national and the State economies. The Division of Budget believes that
its projections of receipts and disbursements relating to the current State
Financial Plan, and the assumptions on which they are based, are reasonable.
Actual results, however, could differ materially and adversely from the
projections set forth in this Annual Information Statement, and those
projections may be changed materially and adversely from time to time. See the
section entitled "Special Considerations" below for a discussion of risks and
uncertainties faced by the State.
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Third Quarter Update (current fiscal year)
The State revised the cash-basis 1997-98 State Financial Plan on
January 20, 1998, in conjunction with the release of the Executive Budget for
the 1998-99 fiscal year. The changes from the prior Update reflect actual
results through December 1997, as well as modified economic and spending
projections for the balance of the current fiscal year.
The 1997-98 General Fund Financial Plan continues to be balanced, with
a projected cash surplus of $1.83 billion, an increase of $1.3 billion over the
surplus estimate of $530 million in the prior update. The increase in the
surplus results primarily from higher-than-expected tax receipts, which are
forecast to exceed the October estimate by $1.28 billion.
In order to make the surplus available to help finance 1998-99
requirements, the State plans to accelerate $1.18 billion in income tax refund
payments into 1997-98, or provide reserves for such payments. The balance in the
refund reserve on March 31, 1998 is projected to be $1.647 billion, including
$521 million as a result of LGAC. This acceleration decreases reported personal
income receipts by $1.18 billion in 1997-98, while increasing available personal
income receipts in 1998-99, as these refunds will no longer be a charge against
current revenues in 1998-99. As a result, projections of available receipts in
1997-98 have been increased by only $103 million from the Mid-Year Update.
Compared to the prior update, personal income tax collections for
1997-98 are now projected at $18.50 billion, or $363 million less than projected
in October after accounting for the refund reserve transaction discussed above.
Business tax receipts are projected at $4.98 billion, an increase of $158
million. User tax collections are estimated at $7.06 billion, or $52 million
higher than the prior update, and reflect a projected loss of $20 million in
sales tax receipts from an additional week of sales tax exemption for clothing
and footwear costing less than $500, which was authorized and implemented in
January 1998. Other tax receipts are projected to increase by $103 million over
the prior update and total $1.09 billion for the fiscal year. Miscellaneous
receipts and transfers from other funds are projected to reach $3.57 billion, or
$153 million higher than the Mid-Year Update.
The State projects that disbursements will increase by $565 million
over the Mid-Year Update, with nearly the entire increase attributable to
one-time disbursements of $561 million that pre-pay expenditures previously
scheduled for 1998-99. In the absence of these accelerated payments, projected
General Fund spending in the current year would have remained essentially
unchanged from the Mid-Year Update. The Governor is proposing legislation to use
a portion of the current year surplus to transfer $425 million to pay for
capital projects authorized under the Community Enhancement Facilities
Assistance Program (CEFAP) that were previously planned to be financed with bond
proceeds in 1998-99 and thereafter, and $136 million in costs for an additional
Medicaid payment originally scheduled for 1998-99. Aside from these actions, a
number of other changes produced a net increase of $4 million in projected
disbursements over the Mid-Year Update. These included higher spending in
General State charges ($80 million), largely as a result of litigation
settlements and collective bargaining costs, an increase in General Fund
transfers for education ($70 million) to offset declines in Lottery receipts,
and additional costs associated with a delay of Housing Finance Agency (HFA)
receipts into 1998-99 that were originally planned to offset capital projects
spending ($25 million). These increases were offset in part by projected savings
in Medicaid ($85 million), social services ($75 million), and debt service ($37
million).
The General Fund closing balance is projected to be $465 million at the
end of 1997-98, a decline of $462 million from the Mid-Year Update. The decline
reflects the application of the $530 million undesignated reserve plus
additional surplus monies projected in the January Update to pay for certain
one-time costs in the State's Financial Plan (as described above). The effect of
this action is to help lower the State's projected disbursements in 1998-99.
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The remaining General Fund closing balance will be held in two funds,
the TSRF and CRF. The TSRF is projected to have $400 million on deposit at the
close of the fiscal year, following a required deposit of $15 million and an
extraordinary deposit of $68 million made from the 1997-98 surplus. The CRF is
projected to have a closing balance of $65 million, following an earlier planned
deposit of $24 million in 1997-98. A description of these funds can be found in
Exhibit A, "Glossary of Financial Terms," in the Annual Information Statement.
1998-99 Fiscal Year (Executive Budget Forecast)
The Governor presented his 1998-99 Executive Budget to the Legislature
on January 20, 1998. The Executive Budget contains financial projections for the
State's 1997-98 through 2000-01 fiscal years, detailed estimates of receipts and
a proposed Capital Program and Financing Plan for the 1997-98 through 2002-03
fiscal years. It is expected that the Governor will prepare amendments to his
Executive Budget as permitted under law and that these amendments will be
reflected in a revised Financial Plan to be released on or before February 19,
1998. There can be no assurance that the Legislature will enact into law the
Executive Budget as proposed by the Governor, or that the State's adopted budget
projections will not differ materially and adversely from the projections set
forth in this Update. For a more detailed discussion of the State's budgetary
process and uncertainties involving its forecasts and projections, see "State
Organization- State Financial Procedures" in the Annual Information Statement.
The 1998-99 Financial Plan is projected to be balanced on a cash basis
in the General Fund. Total General Fund receipts, including transfers from other
funds, are projected to be $36.22 billion, an increase of $1.02 billion over
projected receipts in the current fiscal year. Total General Fund disbursements,
including transfers to other funds, are projected to be $36.18 billion, an
increase of $1.02 billion over the projected expenditures (including
prepayments), for the current fiscal year. As compared to the 1997-98 State
Financial Plan, the Executive Budget proposes year-to-year growth in General
Fund spending of 2.89 percent. State Funds spending (i.e., General Fund plus
other dedicated funds, with the exception of federal aid) is projected to grow
by 8.5 percent. Spending from All Governmental Funds (excluding transfers) is
proposed to increase by 7.6 percent from the prior fiscal year.
Current law and programmatic requirements are primarily responsible for
the year-to-year growth in General Fund spending. These include a current law
increase in school aid ($607 million), cost and enrollment growth in handicapped
education ($91 million) and Medicaid ($212 million), and employee contract
increases and inflation adjustments for State agency operations. The Executive
Budget also includes increases of $84 million for corrections programs to cover
new capacity demands and $152 million for mental health programs to finance
current law increases and the expansion of community beds. Other spending growth
reflects a requested increase of $108 million for the Judiciary and $117 million
for long-term debt service. New spending is partially offset by reductions of
$453 million in capital projects transfers due to the financing of CEFAP from
resources available in 1997-98, $37 million in welfare assistance savings, $36
million from lower spending in General State charges, and $68 million in lower
transfers primarily due to the elimination of the Lottery transfer made in
1997-98.
The 1998-99 Financial Plan projects that the State will end 1998-99
with a closing balance in the General Fund of $500 million, which reflects $400
million in the TSRF and $100 million in the CRF, following an anticipated
deposit of $35 million in the latter fund during the year.
Outyear Projections Of Receipts And Disbursements
The Executive Budget projects gaps of approximately $1.75 billion in
1990-00 growing to $3.75 billion in 2000-01.
General Fund receipts are projected at $36.14 billion and $35.75
billion for 1999-00 and 2000-01, respectively. The receipt projections were
prepared on the basis of an economic forecast of a steadily growing national
economy, in an environment of
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low inflation and slow employment growth. The forecast for the State's economic
performance likewise is for slow but steady economic growth. Personal income is
expected to rise between 4.25 and 4.5 percent over this period, with average
total employment growth of slightly less than one percent a year. Private sector
employment is expected to rise slightly more rapidly.
Statutory changes affecting General Fund receipts are dominated by the
dedication of a portion of the income tax to fund school tax reductions under
STAR. Personal income receipts dedicated to STAR are estimated at $1.39 billion
in 1999-00 and at $2.04 billion in 2000-01. The General Fund tax relief provided
by the estate and gift tax reduction program, sales tax reductions and other
1997 enactments further reduce taxes and fees by roughly $1 billion by the last
year of the forecast period. Other 1998-99 budget proposals that lower General
Fund taxes and fees will annualize to approximately $110 million in 1990-00 and
$100 million in 2000-01.
The receipt projections reflect constant law income tax liability
growth of approximately 5.3 percent annually and sales tax growth averaging
slightly less than 5 percent over the period. Constant law business tax
liability is projected to rise slowly over the two years.
Miscellaneous receipt projections reflect $250 million in each of the
outyears as the potential State benefit from a broader national settlement
involving tobacco taxes and health liability.
Disbursements from the General Fund are projected at $37.84 billion in
1999-00 and $39.45 billion in 2000-01, after assuming implementation of spending
proposals contained in the Executive Budget, the value of which is annualized
and assumed to continue. The projections include additional school aid increases
of roughly 7 percent annually to finance present law and implement proposals
enacted under the STAR/School Aid program. Additional funding to implement
welfare reform is also included, as well as funding for mental health community
reinvestment, prison expansion, and other previous multi-year spending
commitments. Growth in General Fund Medicaid spending is projected at just over
6 percent annually. Other spending growth is projected to follow recent trends.
Consistent with past practice, funding is not included for any costs associated
with new collective bargaining agreements after the expiration of the current
round of contracts at the end of the 1998-99 fiscal year.
Savings actions totaling $600 million in 1999-00 and growing to $800
million in 2000-01 are assumed in these spending projections. It is expected
that the 1999-00 Financial Plan will include continued actions by State agencies
to deliver services more efficiently, continued savings from workforce
management efforts, aggressive efforts to maximize federal and other non-General
Fund spending offsets, and other efforts to control State spending.
The Governor is required by law to propose a balanced budget each year.
In order to address any potential remaining budget gap, the Governor is expected
to make additional proposals to bring receipts in line with disbursements. The
State has closed projected budget gaps of $5.0 billion, $3.9 billion and $2.3
billion in its 1995-96, 1996-97 and 1997-98 fiscal years, respectively.
Special Considerations
The Division of the Budget believes that the economic assumptions and
projections of receipts and disbursements accompanying the 1998-99 Executive
Budget are reasonable. However, the economic and financial condition of the
State may be affected by various financial, social, economic and political
factors. Those factors can be very complex, can vary from fiscal year to fiscal
year, and are frequently the result of actions taken not only by the State but
by entities, such as the federal government, that are outside the State's
control. Because of the uncertainty and unpredictability of changes in these
factors, their impact cannot be fully included in the assumptions underlying the
State's projections. For example, there can be no assurance that the Legislature
will enact the Governor's proposals or that the State's actions will be
sufficient to preserve budgetary balance or to align recurring receipts and
disbursements in either 1998-99 or in future fiscal years.
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Uncertainties with regard to the economy present the largest potential
risk to future budget balance in New York State. This risk includes either a
financial market or broader economic "correction" during the period, a risk
heightened by the relatively lengthy expansions currently underway. The
securities industry is more important to the New York economy than the national
economy, and a significant deterioration in stock market performance could
ultimately produce adverse changes in wage and employment levels. In addition, a
normal "forecast error" of one percentage point in the expected growth rate
could cumulatively raise or lower receipts by over $1 billion by the last year
of the 1998 through 2001 projection period. On the other hand, the national or
State economy may continue to perform better than projected, which could produce
beneficial short-term results in State receipts.
An additional risk to the State Financial Plan arises from the
potential impact of certain litigation and federal disallowances now pending
against the State, which could produce adverse effects on the State's
projections of receipts and disbursements. The Financial Plan assumes no
significant federal disallowances or other federal actions that could affect
State finances, but has reserves of $500 million in the event of such an action,
as indicated in the section entitled "General Fund Closing Balance." For more
information on litigation pending against the State, see the section entitled
"Litigation" in this update and in the Annual Information Statement.
On August 11, 1997 President Clinton exercised his line-item veto
powers to cancel a provision in the Federal Balanced Budget Act of 1997 that
would have deemed New York State's health care provider taxes to be approved by
the federal government. New York and several other states have used hospital
rate assessments and other provider tax mechanisms to finance various Medicaid
and health insurance programs since the early 1980s. The State's process of
taxation and redistribution of health care dollars was sanctioned by federal
legislation in 1987 and 1991. However, the federal Health Care Financing
Administration (HCFA) regulations governing the use of provider taxes require
the State to seek waivers from HCFA that grant explicit approval of the provider
taxing system now in place. The State filed the majority of these waivers with
HCFA in 1995 but has yet to receive final approval.
The Balanced Budget Act of 1997 provision passed by Congress was
intended to rectify the uncertainty created by continued inaction on the State's
waiver requests. A federal disallowance of the State's provider tax system could
jeopardize up to $2.6 billion in Medicaid reimbursement received through
December 31, 1998. The President's veto message valued any potential
disallowance at $200 million. The Financial Plan projections do not anticipate
any provider tax disallowance.
On October 9, 1997 the President offered a corrective amendment to the
HCFA regulations governing such taxes. The Governor stated that this proposal
did not appear to address all of the State's concerns, and negotiations are
ongoing between the State and HCFA. In addition, the City of New York and other
affected parties in the health care industry have filed a lawsuit challenging
the constitutionality of the President's line-item veto.
General Portfolio Receipts
The 1998-99 Financial Plan projects General Fund receipts (including
transfers from other funds) of $36.22 billion, an increase of $1.02 billion over
the estimated 1997-98 level. Recurring growth in the State General Fund tax base
is projected to be approximately six percent during 1998-99, after adjusting for
tax law and administrative changes. This growth rate is lower than the rates for
1996-97 or currently estimated for 1997-98, but roughly equivalent to the rate
for 1995-96.
The forecast of General Fund receipts in 1998-99 incorporates several
Executive Budget tax proposals that, if enacted, would further reduce receipts
otherwise available to the General Fund by approximately $700 million during
1998-99. The Executive Budget proposes accelerating school tax relief for senior
citizens under STAR, which is projected to reduce General Fund receipts by $537
million in 1998-99. The proposed reduction supplements STAR tax reductions
already scheduled in law, which are projected at $187 million in 1998-99. The
Budget also proposes several new tax-
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cut initiatives and other funding changes that are projected to further
reduce receipts available to the General Fund by over $200 million. These
initiatives include reducing the fee to register passenger motor vehicles and
earmarking a larger portion of such fees to dedicated funds and other purposes;
extending the number of weeks in which certain clothing purchases are exempt
from sales taxes; more fully conforming State law to reflect recent Federal
changes in estate taxes; continuing lower pari-mutuel tax rates; and
accelerating scheduled property tax relief for farmers from 1999 to 1998. In
addition to the specific tax and fee reductions discussed above, the Executive
Budget also proposes establishing a reserve of $100 million to permit the
acceleration into 1998-99 of other tax reductions that are otherwise scheduled
in law for implementation in future fiscal years.
General Fund receipts in 1998-99 will also be affected by the loss of
certain one-time receipts recorded in 1997-98, the largest of which include
approximately $200 million in retroactive federal reimbursements for prior-year
social service spending recorded as a transfer from other funds and about $55
million in retroactive assessments on Office of Mental Retardation and
Developmental Disabilities facilities that were received in 1997-98 as
miscellaneous receipts. Estimates for 1998-99 also reflect the loss of the
one-time receipts from a tax amnesty program.
Personal income tax collections in the General Fund are projected to
increase by $1.32 billion over 1997-98, from $18.50 billion to $19.82 billion.
The increase reflects growth in constant law liability of over six percent in
1998, down from an estimated 12 percent growth in 1997. Growth in personal
income tax liability in 1997 benefited from a temporary surge in capital-gains
income in response to 1997 reductions in the federal tax rate on such income. In
addition to the General Fund receipts, approximately $724 million in personal
income tax collections will be deposited in special revenue funds to finance the
School Tax Assistance Program (STAR).
User tax collections and fee receipts are projected to reach $7.2
billion in 1998-99, an increase of $144 million over the current year. The
largest source of receipts in this category is the sales and use tax, which
accounts for nearly 80 percent of projected receipts. Sales tax receipts are the
most responsive to economic trends such as nominal growth in income, prices,
employment, and consumer confidence. The strong growth in income experienced
this year produced continuing growth in the base of the sales and use tax of 5.2
percent in 1997-98. The sales tax growth rate projected for the coming year is
expected to be marginally higher.
The 1998-99 forecast for user taxes and fees also reflects the impact
of scheduled tax reductions that will lower receipts by $38 million, as well as
the impact of two Executive Budget proposals that are projected to lower
receipts by an additional $79 million. The first proposal would divert $30
million in motor vehicle registration fees from the General Fund to the
Dedicated Highway and Bridge Trust Fund; the second would reduce fees for motor
vehicle registrations, which would further lower receipts by $49 million. The
underlying growth of receipts in this category is projected at 4 percent, after
adjusting for these scheduled and recommended changes.
In comparison to the current fiscal year, business tax receipts are
projected to decline slightly in 1998-99, falling from $4.98 billion to $4.96
billion. The decline in this category is largely attributable to scheduled tax
reductions. In total, collections for corporation and utility taxes and the
petroleum business tax are projected to fall by $107 million from 1997-98. The
decline in receipts in these categories is partially offset by growth in the
corporation franchise, insurance and bank taxes, which are projected to grow by
$88 million over the current fiscal year.
Receipts from other taxes, which include taxes on estate and gifts,
real property gains, and pari-mutuel wagering, are projected to total $1.01
billion in 1998-99, a decline of $78 million from the current year. The main
reason for the decline is an expected fall in the number and value of large
estate tax payments from the extraordinary level achieved in 1997-98. The
decline also reflects the first full-year impact of the repeal of the gains tax.
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Miscellaneous receipts, which include license revenues, fee and fine
income, investment income and abandoned property proceeds, as well as the yield
of the largest share of the State's medical provider assessments, are projected
to fall from $1.57 billion in the current year to $1.4 billion in 1998-99, a
decline of $170 million. The decline is largely a result of the loss of over $90
million in one-time transactions and $56 million in statutory reductions in
medical provider assessments.
Transfers to the General Fund from other funds consist primarily of tax
revenues in excess of debt service requirements. Proceeds from the one-cent
sales tax in excess of those used to support debt service payments to the Local
Government Assistance Corporation (LGAC) account for 85 percent of the 1998-99
receipts in this category. LGAC transfers to the General Fund are projected to
increase by $72 million to $1.55 billion in 1998-99, consistent with estimates
for sales and use receipts. Other transfers periodically include non-recurring
transactions, which result in significant annual increases and decreases for
this category. All other transfers are projected to decrease by $250 million to
$270 million in 1998-99. These reflect nearly $200 million in nonrecurring
federal reimbursements that will be unavailable in 1998-99 and thereafter.
Disbursements
The 1998-99 Financial Plan projects General Fund disbursements of $36.18
billion, an increase of $1.02 billion over projected spending for the current
year.
Disbursements from the category of Grants to Local Government
constitute approximately 67.9 percent of all General Fund spending, and include
payments to local governments, non-profit providers and individuals.
Disbursements in this category are projected to increase by $931 million to
$24.55 billion in 1998-99, or 3.9 percent above 1997-98. The largest increases
are for school aid and Medicaid.
School aid is projected at $9.47 billion in 1998-99, an increase of
$607 million on a State fiscal year basis. This increase funds both the balance
of aid payable for the 1997-98 school year and a proposed 1998-99 school year
increase of $518 million. Medicaid costs are estimated to increase $212 million
to $5.68 billion, about the same spending level as in 1994-95. After adjusting
1997-98 spending for the one-time acceleration of a 53rd weekly Medicaid payment
scheduled for 1998-99, Medicaid spending is projected to increase by $348
million or 6.5 percent. The adjustment eliminates this extraordinary payment in
1997-98 for purposes of comparison with 1998-99. Spending in local assistance
programs for higher education, handicapped education, mental hygiene, local
public health and revenue sharing are also proposed to increase.
Support for State operations, which pays for the costs of operating the
Executive, Legislative, and Judicial branches of government, is projected to
increase by $524 million to $6.73 billion, or 8.4 percent higher than 1997-98.
This projected increase is primarily due to costs associated with an additional
27th payroll and current collective bargaining agreements, the loss of Federal
disproportionate share receipts that offset General Fund spending in mental
hygiene programs, and a $108 million requested increase in the Judiciary's
budget. Adjusting for the extra payroll, State operations spending increases by
a projected 6.1 percent. The State workforce is roughly 191,000 at present and
is projected to remain stable over the year.
Total spending in General State charges is projected to decline
slightly from 1997-98 to $2.23 billion. This annual decline reflects projected
decreases in one-time costs for pension and Court of Claims payments, offset by
projected increases for health insurance contributions, social security costs,
and the loss of reimbursements due to a reduction in the fringe benefit rate
charged to positions financed by non-General funds.
Transfers in support of debt service are projected to grow at 5.8
percent in 1998-99, from $2.03 billion to $2.15 billion. Transfers in support of
capital projects for 1998-99 are estimated to total $190 million, a decrease of
$453 million from 1997-98, reflecting the absence of one-time transfers for the
Hudson River Park and CEFAP in 1997-98.
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All other transfers reflect remaining transfers from the General Fund
to other funds. These transfers decline by $68 million to $323 million in
1998-99, reflecting non-recurring transfers in 1997-98 to the State University
Tuition Stabilization Fund ($29 million) and to the Lottery fund to support
school aid as a result of lower-than-projected 1997-98 Lottery receipts ($70
million), offset by a $34 million increase in the State subsidy to the Roswell
Park Cancer Institute.
General Portfolio Closing Portfolio Balance
The State projects a General Fund closing balance of $500 million for
1998-99. The TSRF is projected to have a balance of $400 million (the same as
1997-98) and the CRF a balance of $100 million, following a planned $35 million
deposit to the CRF in 1998-99.
Non-recurring Resources
The Division of the Budget estimates that the 1998-99 Financial Plan
includes approximately $62 million in non-recurring resources, comprising less
than two-tenths of one percent of General Fund disbursements. The non-recurring
resources projected for use in 1998-99 consist of $27 million in retroactive
federal welfare reimbursements for family assistance recipients with HIV/AIDS,
$25 million in receipts from the Housing Finance Agency that were originally
anticipated in 1997-98, and $10 million in other measures, including $5 million
in asset sales.
Special Revenue Funds
For 1998-99, the Financial Plan projects disbursements of $30.16
billion from Special Revenue Funds (SRFs), an increase of $2.32 billion or 8.3
percent over 1997-98. Disbursements in State SRFs are projected at $8.29
billion, an increase of $1.09 billion or 15.2 percent from 1997-98.
Disbursements from federal funds, which account for approximately three-quarters
of all SRF spending, are estimated at $21.87 billion in 1998-99, an increase of
$1.22 billion or 5.9 percent from 1997-98.
The implementation of the first phase of the STAR program accounts for
$724 million of the $1.09 billion increase in proposed State SRF spending in
1998-99. Other projected State SRF spending increases include: $149 million in
additional operating assistance for mass transit systems; $82 million to expand
the Child Health Plus program, which provides health insurance for uninsured
children under 19 years of age; and $138 million for various State agency
activities. Spending from the State Lottery Fund is projected to increase
slightly over 1997-98, while disbursements from the Indigent Care Fund are
projected to remain flat.
The $1.22 billion year-to-year growth in federal SRF spending is
primarily due to increases in Medicaid ($433 million), Children and Family
Assistance Programs ($297 million), education programs ($172 million), the
expanded Child Health Plus program ($144 million), and the welfare program ($50
million).
Capital Projects Funds
Disbursements from Capital Projects funds in 1998-99 are estimated at
$4.82 billion, or $1.07 billion higher than 1997-98. The proposed spending plan
includes: $2.51 billion in disbursements for transportation purposes, including
the State and local highway and bridge program; $815 million for environmental
activities; $379 million for correctional services; $228 million for SUNY and
CUNY; $290 million for mental hygiene projects; and $375 million for CEFAP.
Approximately 28 percent of capital projects are proposed to be
financed by "pay-as-you-go" resources. State-supported bond issuances finance 46
percent of capital projects, with federal grants financing the remaining 26
percent.
<PAGE>
Debt Service Funds
Disbursements from Debt Service Funds are estimated at $3.39 billion in
1998-99, an increase of $281 million in debt service costs from 1997-98. The
increase in debt service is primarily attributable to bonds previously issued in
support of the following: $107 million for transportation purposes in the State
and local highway and bridge programs financed by the Dedicated Highway and
Bridge Trust Fund; $26 million for the mental hygiene programs financed through
the Mental Health Services Fund; $34 million for the environment; $37 million
for public protection purposes; and $43 million for CUNY senior and community
college debt service formerly classified as local assistance in the General
Fund. Debt service for LGAC bonds is projected at $345 million, an increase of
$15 million from 1997-98.
Cash Flow
The projected 1998-99 General Fund cash flow will not depend on either
short-term spring borrowing or the issuance of LGAC bonds. The new-money bond
issuance portion of the LGAC program was completed in 1995-96, and provisions
prohibiting the State from returning to a reliance upon cash flow manipulation
to balance its budget will remain in bond covenants until the LGAC bonds are
retired.
The 1998-99 cash flow projects substantial closing balances in each
quarter of the fiscal year, with excesses in receipts over disbursements in
every quarter of the fiscal year and no monthly balance (prior to March) lower
than $1.5 billion. The closing fund balance is projected at $500 million.
Prior Fiscal Years
Cash-Basis Results for Prior Fiscal Years
The State reports its financial results on two bases of accounting: the
cash basis, showing receipts and disbursements; and the modified accrual basis,
prescribed by generally Accepted Accounting Principles ("GAAP"), showing
revenues and expenditures.
General Fund 1994-95 through 1996-97
The General Fund is the principal operating fund of the State and is
used to account for all financial transactions, except those required to be
accounted for in another fund. It is the State's largest fund and receives most
State taxes and other resources not dedicated to particular purposes. General
Fund moneys are also transferred to other funds, primarily to support certain
capital projects and debt service payments in other fund types. A narrative
description of cash-basis results in the General Fund is presented below,
followed by a tabular presentation of the actual General Fund results for the
prior three fiscal years.
New York State's financial operations have improved during recent
fiscal years. During the period 1989-90 through 1991-92, the State incurred
General Fund operating deficits that were closed with receipts from the issuance
of tax and revenue anticipation notes ("TRANs"). A national recession, followed
by the lingering economic slowdown in New York and the regional economy,
resulted in repeated shortfalls in receipts and three budget deficits during
those years. During its last five fiscal years, however, the State has recorded
balanced budgets on a cash basis, with positive fund balances as described
below.
1996-97 Fiscal Year
The State ended its 1996-97 fiscal year on March 31, 1997 in balance on
a cash basis, with a General Fund cash surplus as reported by DOB of
approximately $1.4 billion. The cash surplus was derived primarily from
higher-than-expected revenues and lower-than-expected spending for social
services programs. The Governor in his Executive Budget applied $1.05 billion of
the cash surplus amount to finance the 1997-98 Financial Plan when enacted by
the State Legislature.
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The General Fund closing fund balance was $433 million. Of that amount,
$317 million was in the TSRF, after a required deposit of $15 million and an
additional deposit of $65 million in 1996-97. The TSRF can be used in the event
of any future General Fund deficit, as provided under the State Constitution and
State Finance Law. In addition, $41 million remains on deposit in the CRF. This
fund assists the State in financing any extraordinary litigation costs during
the fiscal year. The remaining $75 million reflects amounts on deposit in the
Community Projects Fund. This fund was created to fund certain legislative
initiatives. The General Fund closing fund balance does not include $1.86
billion in the tax refund reserve account, of which $521 million was made
available as a result of the Local Government Assistance Corporation ("LGAC")
financing program and was required to be on deposit as of March 31, 1997.
General Fund receipts and transfers from other funds for the 1996-97
fiscal year totaled $33.04 billion, an increase of 0.7 percent from the previous
fiscal year (excluding deposits into the tax refund reserve account). General
Fund disbursements and transfers to other funds totaled $32.90 billion for the
1996-97 fiscal year, an increase of 0.7 percent from the 1995-96 fiscal year.
1995-96 Fiscal Year
The State ended its 1995-96 fiscal year on March 31, 1996 with a
General Fund cash surplus, as reported by DOB, of $445 million. Of that amount,
$65 million was deposited into the TSRF, and $380 million was used to reduce
1996-97 Financial Plan liabilities.
The General Fund closing fund balance was $287 million, an increase of
$129 million from 1994-95 levels. The $129 million change in fund balance is
attributable to the $65 million voluntary deposit to the TSRF, a $15 million
required deposit to the TSRF, a $40 million deposit to the CRF, and a $9 million
deposit to the Revenue Accumulation Fund. The closing fund balance included $237
million on deposit in the TSRF. In addition, $41 million was on deposit in the
CRF. The remaining $9 million reflected amounts then on deposit in the Revenue
Accumulation Fund. The General Fund closing balance does not include $678
million in the tax refund reserve account of which $521 million was made
available as a result of the LGAC financing program and was required to be on
deposit as of March 31, 1996.
General Fund receipts and transfers from other funds totaled $32.81
billion, a decrease of 1.1 percent from 1994-95 levels. General Fund
disbursements and transfers to other funds totaled $32.68 billion for the
1995-96 fiscal year, a decrease of 2.2 percent from 1994-95 levels.
1994-95 Fiscal Year
The State ended its 1994-95 fiscal year with the General Fund in
balance. There was a $241 million decline in the fund balance reflecting the
planned use of $264 million from the CRF, partially offset by the required
deposit of $23 million to the TSRF. In addition, $278 million was on deposit in
the tax refund reserve account, $250 million of which was deposited to continue
the process of restructuring the State's cash flow as part of the LGAC program.
The closing fund balance of $158 million reflects $157 million in the TSRF and
$1 million in the CRF.
General Fund receipts and transfers from other funds totaled $33.16
billion, an increase of 2.9 percent from 1993-94 levels. General Fund
disbursements and transfers to other funds totaled $33.40 billion for the
1994-95 fiscal year, an increase of 4.7 percent from the previous fiscal year.
Other Governmental Funds (1994-95 through 1996-97)
Activity in the three other governmental funds has remained relatively
stable over the last three fiscal years, with federally-funded programs
comprising approximately two-thirds of these funds. The most significant change
in the structure of these funds has been the redirection of a portion of
transportation-related revenues from the General Fund to two new dedicated funds
in the Special Revenue and Capital Projects fund types. These revenues are used
to support the capital programs
<PAGE>
of the Department of Transportation and the Metropolitan Transportation
Authority ("MTA").
In the Special Revenue Funds, disbursements increased from $24.38
billion to $26.02 billion over the last three years, primarily as a result of
increased costs for the federal share of Medicaid. Other activity reflected
dedication of taxes to a new fund for mass transportation, new lottery games,
and new fees for criminal justice programs.
Disbursements in the Capital Projects Funds declined from $3.62 billion
to $3.54 billion over the last three years, as spending for miscellaneous
capital programs decreased, partially offset by increases for mental hygiene,
health and environmental programs. The composition of this fund type's receipts
also changed as the dedicated transportation taxes began to be deposited,
general obligation bond proceeds declined substantially, federal grants remained
stable, and reimbursements from public authority bonds (primarily transportation
related) increased. The increase in the negative fund balance in 1994-95
resulted from delays in reimbursements caused by delays in the timing of public
authority bond sales.
Activity in the Debt Service Funds reflected increased use of bonds
during the three-year period for improvements to the State's capital facilities
and the continued implementation of the LGAC fiscal reform program. The
increases were moderated by the refunding savings achieved by the State over the
last several years using strict present value savings criteria. The growth in
LGAC debt service was offset by reduced short-term borrowing costs reflected in
the General Fund.
Litigation
State Finance Policies
Insurance Law
Proceedings have been brought by two groups of petitioners challenging
regulations promulgated by the Superintendent of Insurance that established
excess medical malpractice premium rates for the 1986-87 through 1995-96 and
1996-97 fiscal years, respectively (New York State Health Maintenance
Organization Conference, Inc., et al. v. Muhl, et al. ["HMO"], and New York
State Conference of Blue Cross and Blue Shield Plans, et al. v. Muhl, et al.
["Blue Cross `I' and `II'"], Supreme Court, Albany County). By order filed
January 22, 1997, the Court in Blue Cross I permitted the plaintiffs in HMO to
intervene and dismissed the challenges to the rates for the period prior to
1995-96. By decision dated July 24, 1997, the Court in Blue Cross I held that
the determination made by the Superintendent in establishing the 1995-96 rate
was arbitrary and capricious and directed that premiums paid pursuant to that
determination be returned to the payors. The State has appealed this decision.
Office of Mental/Health Patient-Care Costs
Two actions, Balzi, et al. v. Surles, et al., commenced in November
1985 in the United States District Court for the Southern District of New York,
and Brogan, et al. v. Sullivan, et al., commenced in May 1990 in the United
States District Court for the Western District of New York, now consolidated,
challenge the practice of using patients' Social Security benefits for the costs
of care of patients of State Office of Mental Health facilities. The cases have
been settled by a stipulation and order dated January 7, 1998.
State Programs
Medicaid
Several cases, including Port Jefferson Health Care Facility, et al. v.
Wing (Supreme Court, Suffolk County), challenge the constitutionally of Public
Health Law 2807-d, which imposes a tax on the gross receipts hospitals and
residential health care facilities receive from all patient care services.
Plaintiffs allege that the tax assessments were not uniformly applied, in
violation of federal regulations. In a decision dated June 30, 1997, the Court
held that the 1.2 percent and 3.8 percent assessments on gross receipts imposed
pursuant to Public health Law 2807-d(2)(b)(ii)
<PAGE>
and 2807-d(2)(b)(iii), respectively, are unconstitutional. An order entered
August 27, 1997 enforced the terms
of the decision. The State has appealed that order.
Shelter Allowance
In an action commenced in March 1987 against State and New York City
officials (Jiggetts, et al. v. Bane, et al., Supreme Court, New York County),
plaintiffs allege that the shelter allowance granted to recipients of public
assistance is not adequate for proper housing. In a decision dated April 16,
1997, the Court held that the shelter allowance promulgated by the Legislature
and enforced through Department of Social Services regulations is not reasonably
related to the cost of rental housing in New York City and results in
homelessness to families in New York City. A judgment was entered on July 25,
1997, directing, inter alia, that the State (i) submit a proposed schedule of
shelter allowances (for the Aid to Department Children program and any successor
program) that bears a reasonable relation to the cost of housing in New York
City; and (ii) compel the New York City Department of Social Services to pay
plaintiffs a monthly shelter allowance in the full amount of their contract
rents, provided they continue to meet the eligibility requirements for public
assistance, until such time as a lawful shelter allowance is implemented, and
provide interim relief to other eligible recipients of Aid to Department
Children under the interim relief system established in this case. The State has
sought relief from each and every provision of this judgment except that portion
directing the continued provision of interim relief.
Tax Law
In Matter of the Petition of Consolidated Rail Corporation v. Tax
Appeals Tribunal (Appellate Division, Third Department, commenced December 22,
1995), petitioner, a rail freight corporation that purchases diesel motor fuel
out of State and imports the fuel into the State for use, distribution, storage
or sale in the State, contended that the assessment of the petroleum business
tax imposed pursuant to Tax Law 301-a to such fuel purchases violated the
Commerce Clause of the United States Constitution. Petitioner contended that the
application of Section 301-a to the interstate transaction, but not to
purchasers who purchase fuel within the State for use, distribution, storage or
sale within the State, discriminates against interstate commerce. In a decision
dated July 17, 1997, the Appellate Division, Third Department, dismissed the
petition. Petitioner appealed to the Court of Appeals. On December 4, 1997, the
Court of Appeals dismissed the appeal, sua sponte, upon the ground that no
substantial Constitutional question was directly involved.
In New York Association of Convenience Stores, et al. v. Urbach, et
al., petitioners, New York Association of Convenience Stores, National
Association of Convenience Stores, M.W.S. Enterprises, Inc. and Sugarcreek
Stores, Inc. seek to compel respondents, the Commissioner of Taxation and
Finance and the Department of Taxation and Finance, to enforce sales and excise
taxes imposed pursuant to Tax Law Articles 12-A, 20 and 28 on tobacco products
and motor fuel sold to non-Indian consumers on Indian reservations. In orders
dated August 13, 1996 and August 24, 1996, the Supreme Court, Albany County,
ordered, inter alia, that there be equal implementation and enforcement of said
taxes for sales to non-Indian consumers on and off Indian reservations, and
further ordered that, if respondents failed to comply within 120 days, no
tobacco products or motor fuel could be introduced onto Indian reservations
other than for Indian consumption or, alternatively, the collection and
enforcement of such taxes would be suspended statewide. Respondents appealed to
the Appellate Division, Third Department, and invoked CPLR 5519(a)(1), which
provides that the taking of the appeal stayed all proceedings to enforce the
orders pending the appeal. Petitioner's motion to vacate the stay was denied. In
a decision entered May 8, 1997, the Third Department modified the orders by
deleting the portion thereof that provided for the statewide suspension of the
enforcement and collection of the sales and excise taxes on motor fuel and
tobacco products. The Third Department held, inter alia, that petitioners had
not sought such relief in their petition and that it was an error for the
Supreme Court to have awarded such undemanded relief without adequate notice of
its intent to do so. On May 22, 1997, respondents appealed to the Court of
Appeals on other grounds, and again invoked the statutory stay. On October 23,
1997, the Court of Appeals granted petitioners' motion for leave to cross-appeal
from the portion of the Third Department's decision that deleted the statewide
suspension of
<PAGE>
the enforcement and collection of the sales and excise taxes on motor fuel
and tobacco.
Civil Rights Claims
In an action commenced in 1980 (United States, et al. v. Yonkers Board
of Education, et al.), the United States District Court for the Southern
District of New York found, in 1985, that Yonkers and its public schools were
intentionally segregated. In 1986, the District Court ordered Yonkers to develop
and comply with a remedial educational improvement plan ("EIP I"). On January
19, 1989, the District Court granted motions by Yonkers and the NAACP to add the
State Education Department, the Yonkers Board of Education, and the State Urban
Development Corporation as defendants, based on allegations that they had
participated in the perpetuation of the segregated school system. On August 30,
1993, the District Court found that vestiges of a dual school system continued
to exist in Yonkers. On March 27, 1995, the District Court made factual findings
regarding the role of the State and the other State defendants (the "State") in
connection with the creation and maintenance of the dual school system, but
found no legal basis for imposing liability. On September 3, 1996, the Court of
Appeals, based on the District Court's factual findings, held the State
defendants liable under 42 USC 1983 and the Equal Educational Opportunity
Act, 20 USC 1701, et seq., for the unlawful dual school system,
because the State, inter alia, had taken no action to force the school district
to desegregate despite its actual or constructive knowledge of de jure
segregation. By Order dated October 8, 1997, the District Court held that
vestiges of the prior segregated school system continued to exist and that,
based on the State's conduct in creating and maintaining that system, the State
is liable for eliminating segregation and its vestiges in Yonkers and must fund
a remedy to accomplish that goal. Yonkers presented a proposed educational
improvement plan ("EIP II") to eradicate these vestiges of segregation. The
October 8, 1997 Order of the District Court ordered that EIP II be implemented
and directed that, within 10 days of the entry of the Order, the State make
available to Yonkers $450,000 to support planning activities to prepare the EIP
II budget for 1997-98 and the accompanying capital facilities plan. A final
judgment to implement EIP II was entered on October 14, 1997. The State intends
to appeal that judgment. Additionally, the Court adopted a requirement that the
State pay to Yonkers $9 million as its pro rata share of the funding of EIP I
for the 1996-97 school year. The requirement for State funding of EIP I has not
yet been reduced to an order.
Contract and Tort Claims
In Inter-Power of New York, Inc. v. State of New York, commenced
November 16, 1994 in the Court of Claims, plaintiffs alleged that by reason of
the failure of the State's Department of Environmental Conservation to provide
in a timely manner accurate and complete data, plaintiff was unable to complete
by the projected completion date a cogeneration facility, and thereby suffered
damages. The parties have agreed to settle this case for $29 million.
Authorities and Localities
Public Authorities
The fiscal stability of the State is related in part to the fiscal
stability of its public authorities. For the purposes of this Interim Annual
Information Statement, public authorities refer to public benefit corporations
created pursuant to State law, other than local authorities. Public authorities
are not subject to the constitutional restrictions on the incurrence of debt
which apply to the State itself and may issue bonds and notes within the amounts
and restrictions set forth in legislative authorization. The State's access to
the public credit markets could be impaired and the market price of its
outstanding debt may be materially and adversely affected if any of its public
authorities were to default on their respective obligations, particularly those
using the financing techniques referred to as State-supported or State-related
debt under the section entitled "Debt and Other Financing Activities" in this
Interim Annual Information Statement. As of September 30, 1996, there were 17
public authorities that had outstanding debt of $100 million or more, and the
aggregate outstanding debt, including refunding bonds, of all State
<PAGE>
authorities was $75.4 billion, only a portion of which constitutes
State-supported or State-related debt.
There are numerous public authorities with various responsibilities,
including those which finance, construct and/or operate revenue producing public
facilities. Public authority operating expenses and debt service costs are
generally paid by revenues generated by the projects financed or operated, such
as tolls charged for the use of highways, bridges or tunnels, rentals charged
for housing units, and charges for occupancy at medical care facilities. In
addition, State legislation authorizes several financing techniques for public
authorities that are described under the section entitled "Debt and Other
Financing Activities." Also, there are statutory arrangements providing for
State local assistance payments otherwise payable to localities to be made under
certain circumstances to public authorities. Although the State has no
obligation to provide additional assistance to localities whose local assistance
payments have been paid to public authorities under these arrangements, if local
assistance payments are diverted the affected localities could seek additional
State assistance. Some authorities also receive moneys from State appropriations
to pay for the operating costs of certain of their programs. As described below,
the MTA receives the bulk of this money in order to provide transit and commuter
services.
Metropolitan Transportation Authority
The MTA oversees the operation of subway and bus lines in New York City
by its affiliates, the New York City Transit Authority and the Manhattan and
Bronx Surface Transit Operating Authority (collectively, the "TA"). The MTA
operates certain commuter rail and bus services in the New York Metropolitan
area through MTA's subsidiaries, the Long Island Rail Road Company, the
Metro-North Commuter Railroad Company, and the Metropolitan Suburban Bus
Authority. In addition, the Staten Island Rapid Transit Operating Authority, an
MTA subsidiary, operates a rapid transit line on Staten Island. Through its
affiliated agency, the Triborough Bridge and Tunnel Authority (the "TBTA"), the
MTA operates certain intrastate toll bridges and tunnels. Because fare revenues
are not sufficient to finance the mass transit portion of these operations, the
MTA has depended on, and will continue to depend on, operating support from the
State, local governments and TBTA, and, to the extent available, federal
operating assistance, including loans, grants and subsidies. If current revenue
projections are not realized and/or operating expenses exceed current
projections, the TA or commuter railroads may be required to seek additional
State assistance, raise fares or take other actions.
Since 1980, the State has enacted several taxes--including a surcharge
on the profits of banks, insurance corporations and general business
corporations doing business in the 12-county Metropolitan Transportation Region
served by the MTA and a special one-quarter of 1 percent regional sales and use
tax-that provide revenues for mass transit purposes, including assistance to the
MTA. Since 1987 State law has required that the proceeds of a one-quarter of 1
percent mortgage recording tax paid on certain mortgages in the Metropolitan
Transportation Region be deposited in a special MTA fund for operating or
capital expenses. In 1993, the State dedicated a portion of certain additional
State petroleum business tax receipts to fund operating or capital assistance to
the MTA. For the 1997-98 fiscal year, State assistance to the MTA is projected
to total approximately $1.2 billion, an increase of $76 million over the 1996-97
fiscal year.
State legislation accompanying the 1996-97 adopted State budget
authorized the MTA, TBTA and TA to issue an aggregate of $6.5 billion in bonds
to finance a portion of the $12.17 billion MTA capital plan for the 1995 through
1999 calendar years (the "1995-99 Capital Program"). In July 1997, the Capital
Program Review Board ("CPRB") approved the 1995-99 Capital Program, which
supersedes the overlapping portion of the MTA's 1992-96 Capital Program. The
1995-99 Capital Program is the fourth capital plan since the Legislature
authorized procedures for the adoption, approval and amendment of MTA capital
programs and is designed to upgrade the performance of the MTA's transportation
systems by investing in new rolling stock, maintaining replacement schedules for
existing assets and bringing the MTA system into a state of good repair. The
1995-99 Capital Program assumes the issuance of an estimated $5.1 billion in
bonds under this $6.5 billion aggregate bonding authority. The remainder of the
plan is projected to be financed through assistance from the State, the federal
government,
<PAGE>
and the City of New York, and from various other revenues generated from actions
taken by the MTA.
There can be no assurance that all the necessary governmental actions
for future capital programs will be taken, that funding sources currently
identified will not be decreased or eliminated, or that the 1995-99 Capital
Program, or parts thereof, will not be delayed or reduced. Should funding levels
fall below current projections, the MTA would have to revise its 1995-99 Capital
Program accordingly. If the 1995-99 Capital Program is delayed or reduced,
ridership and fare revenues may decline, which could, among other things, impair
the MTA's ability to meet its operating expenses without additional assistance.
The City of New York
The fiscal health of the State may also be affected by the fiscal
health of New York City ("the City"), which continues to require significant
financial assistance from the State. The City depends on State aid both to
enable the City to balance its budget and to meet its cash requirements. The
State could also be affected by the ability of the City and certain entities
issuing debt for the benefit of the City to market their securities successfully
in the public credit markets.
The City has achieved balanced operating results for each of its fiscal
years since 1981 as reported in accordance with the then-applicable GAAP
standards. The City's financial plans are usually prepared quarterly, and the
annual financial report for its most recent completed fiscal year is prepared at
the end of October of each year. For current information on the City's four-year
financial plan and its most recent financial disclosure, contact the Office of
the Comptroller, Municipal Building, Room 517, One Centre Street, New York, NY
10007, Attention: Deputy Comptroller for Finance.
Fiscal Oversight
In response to the City's fiscal crisis in 1975, the State took action
to assist the City in returning to fiscal stability. Among those actions, the
State established NYC MAC to provide financing assistance to the City; the New
York State Financial Control Board (the "Control Board") to oversee the City's
financial affairs; and the Office of the State Deputy Comptroller for the City
of New York ("OSDC") to assist the Control Board in exercising its powers and
responsibilities. A "Control Period" existed from 1975 to 1986 during which the
City was subject to certain statutorily-prescribed fiscal controls. Although the
Control Board terminated the Control Period in 1986 when certain statutory
conditions were met and suspended certain Control Board powers, upon the
occurrence or "substantial likelihood and imminence" of the occurrence of
certain events, including (but not limited to) a City operating deficit of more
than $100 million or impaired access to the public credit markets, the Control
Board is required by law to reimpose a Control Period.
Currently, the City and its Covered Organizations (i.e., those which
received or may receive moneys from the City directly, indirectly or
contingently) operate under a four-year financial plan (the "Financial Plan")
which the City prepares annually and periodically updates. The City's Financial
Plan includes it capital, revenue and expense projections and outlines proposed
gap-closing programs for years with projected budget gaps. The City's
projections set forth in the Financial Plan are based on various assumptions and
contingencies, some of which are uncertain and may not materialize. Unforeseen
developments and changes in major assumptions could significantly affect the
city's ability to balance its budget as required by State law and to meet its
annual cash flow and financing requirements.
Implementation of the Financial Plan is also dependent upon the ability
to the City and certain entities issuing debt for the benefit of the city to
market their securities successfully. The City issues securities to finance,
refinance and rehabilitate infrastructure and other capital needs, as well as
for seasonal financing needs. In order to help the City to avoid exceeding its
State Constitutional general debt limit, the State created the New York City
Transitional Finance Authority to finance a portion of the City's capital
program. Despite this additional financing mechanism, the City currently
projects that, if no further action is taken, it will
<PAGE>
reach its debt limit in City fiscal year 1999-2000. On June 2, 1997, an action
was commenced seeking a declaratory judgment declaring the legislation
establishing the Transitional Finance Authority to be unconstitutional. If such
legislation were voided, projected contracts for City capital projects would
exceed the City's debt limit during fiscal year 1997-98. Future developments
concerning the City or entities issuing debt for the benefit of the City, and
public discussion of such developments, as well as prevailing market conditions
and securities credit ratings, may affect the ability or cost to sell securities
issued by the City or such entities and may also affect the market for their
outstanding securities.
Monitoring Agencies
The staffs of the Control Board, OSDC and the City Comptroller issue
periodic reports on the City's Financial Plans which analyze the City's
forecasts of revenues and expenditures, cash flow, and debt service requirements
for, and Financial Plan compliance by, the City and its Covered Organizations.
According to recent staff reports, while economic recovery in New York City has
been slower than in other regions of the country, a surge in Wall Street
profitability resulted in increased tax revenues and generated a substantial
surplus for the City in City fiscal year 1996-97. Although several sectors of
the City's economy have expanded recently, especially tourism and business and
professional services, City tax revenues remain heavily dependent on the
continued profitability of the securities industries and the course of the
national economy. These reports have also indicated that recent City budgets
have been balanced in part through the use of non-recurring resources; that the
City's Financial Plan tends to rely on actions outside its direct control; that
the City has not yet brought its long-term expenditure growth in line with
recurring revenue growth; and that the City is therefore likely to continue to
face substantial gaps between forecast revenues and expenditures in future years
that must be closed with reduced expenditures and/or increased revenues. In
addition to these monitoring agencies, the Independent Budget Office ("IBO") has
been established pursuant to the City Charter to provide analysis to elected
officials and the public on relevant fiscal and budgetary issues affecting the
City. Copies of the most recent Control Board, OSDC, City Comptroller, and IBO
staff reports are available by contacting the Control Board at 270 Broadway,
21st Floor, New York, NY 10007, Attention: Executive Director; OSDC at 270
Broadway, 23rd Floor, New York, NY 10007, Attention: Deputy Comptroller; the
City Comptroller at Municipal Building, Room 517, One Centre Street, New York,
NY 10007, Attention: Deputy Comptroller for Finance; and the IBO at 110 William
Street, 14th Floor, New York, NY 10038, Attention: Director.
Other Localities
Certain localities outside New York City have experienced financial
problems and have requested and received additional State assistance during the
last several State fiscal years. The potential impact on the State of any future
requests by localities for additional assistance is not included in the
projections of the State's receipts and disbursements for the State's 1997-98
fiscal year.
Fiscal difficulties experienced by the City of Yonkers resulted in the
re-establishment of the Financial Control Board of the City of Yonkers by the
State in 1984. That Board is charged with oversight of the fiscal affairs of
Yonkers. Future actions taken by the State to assist Yonkers could result in
increased State expenditures for extraordinary local assistance.
Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the City
of Troy in 1994. The Supervisory Board's powers were increased in 1995, when
Troy MAC was created to help Troy avoid default on certain obligations. The
legislation creating Troy MAC prohibits the City of Troy from seeking federal
bankruptcy protection while Troy MAC bonds are outstanding. Troy MAC has issued
bonds to effect a restructuring of the City of Troy's obligations.
Eighteen municipalities received extraordinary assistance during the
1996 legislative session through $50 million in special appropriations targeted
for distressed cities, aid that was largely continued in 1997. Twenty-eight
municipalities are scheduled to share the more than $32 million in targeted
<PAGE>
unrestricted aid allocated in the 1997-98 budget. An additional $21 million will
be dispersed among all cities, towns and villages, a 3.97 percent increase in
General Purpose State Aid.
Municipalities and school districts have engaged in substantial
short-term and long-term borrowings. In 1995, the total indebtedness of all
localities in the State other than New York City was approximately $19.0
billion. A small portion (approximately $102.3 million) of that indebtedness
represented borrowing to finance budgetary deficits and was issued pursuant to
State enabling legislation. State law requires the Comptroller to review and
make recommendations concerning the budgets of those local government units
other than New York City authorized by State law to issue debt to finance
deficits during the period that such deficit financing is outstanding. Eighteen
localities had outstanding indebtedness for deficit financing at the close of
their fiscal year ending in 1995.
From time to time, federal expenditure reductions could reduce, or in
some cases eliminate, federal funding of some local programs and accordingly
might impose substantial increased expenditure requirements on affected
localities. If the State, the City or any of the public authorities were to
suffer serious financial difficulties jeopardizing their respective access to
the public credit markets, the marketability of notes and bonds issued by
localities within the State could be adversely affected. Localities also face
anticipated and potential problems resulting from certain pending litigation,
judicial decisions and long-range economic trends. Long-range potential problems
of declining urban population, increasing expenditures and other economic trends
could adversely affect localities and require increasing State assistance in the
future.
<PAGE>
PART C
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(A) FINANCIAL STATEMENTS
The financial statements included in Part B, Item 23 of this Registration
Statement are as follows:
Schedule of Investments as March 31, 1998 Statement of Assets and
Liabilities at March 31, 1998 Statement of Operations for the period ended March
31, 1998 Statement of Changes in Net Assets for the fiscal years ended March 31,
1997 and March 31, 1998 Supplementary Data Notes to Financial Statements at
March 31, 1998
(B) EXHIBITS
1 Declaration of Trust of the Registrant.1
2 Amended and Restated By-Laws of the Registrant.3
5 Investment Advisory Agreement between the Registrant and Morgan Guaranty
Trust Company of New York ("Morgan").1
5(a) Investment Advisory Agreement between the Registrant and J.P. Morgan
Investment Management Inc.5
8 Custodian Contract between the Registrant and State Street Bank and Trust
Company ("State Street").4
9(a) Co-Administration Agreement between the Registrant and Funds
Distributor, Inc.4
9(b) Transfer Agency and Service Agreement between the Registrant and State
Street.1
9(c) Restated Administrative Services Agreement between the Registrant and
Morgan.4
9(d) Fund Services Agreement, as amended, between the Registrant and
Pierpont Group, Inc.4
13 Investment representation letters of initial investors.4
27 Financial Data Schedule.5
- -------------------
1 Incorporated herein by reference from Amendment No. 1 to Registrant's
Registration Statement on Form N-1A (the "Registration Statement") as
filed with the Securities and Exchange Commission ("SEC")on July 31,
1995.
(Accession No. 0000922326-95-000019).
2 Incorporated herein by reference from Amendment No. 3 to Registrant's
Registration Statement as filed with the SEC on August 1, 1996.
(Accession No. 0000935490-96-000077).
3 Incorporated herein by reference from Amendment No. 4 to Registrant's
Registration Statement as filed with the SEC on May 12, 1997.
(Accession No.0001016964-97-000076).
4 Incorporated herein by reference from Amendment No. 5 to Registrant's
Registration Statement as filed with the SEC on July 14, 1997.
(Accession No. 0001016964-97-006119).
5 Filed herewith.
<PAGE>
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
Not applicable.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
TITLE OF CLASS: Beneficial Interests
NUMBER OF RECORD HOLDERS : 2 (as of October 31, 1998)
ITEM 27. INDEMNIFICATION.
Reference is hereby made to Article V of the Registrant's Declaration
of Trust, filed as an Exhibit hereto.
The Trustees and officers of the Registrant and the personnel of the
Registrant's co-administrator are insured under an errors and omissions
liability insurance policy. The Registrant and its officers are also insured
under the fidelity bond required by Rule 17g-1 under the Investment Company Act
of 1940, as amended.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
JPMIM is a Delaware corporation which is a wholly-owned subsidiary of J.P.
Morgan & Co. Incorporated.
JPMIM is a registered investment adviser under the Investment Advisers
Act of 1940, as amended, and is a wholly owned subsidiary of J.P. Morgan & Co.
Incorporated. JPMIM manages employee benefit funds of corporations, labor unions
and state and local governments and the accounts of other institutional
investors, including investment companies.
To the knowledge of the Registrant, none of the directors or executive
officers of JPMIM is or has been during the past two fiscal years engaged in any
other business, profession, vocation or employment of a substantial nature,
except that certain officers and directors of JPMIM also hold various positions
with, and engage in business for, J.P.
Morgan & Co. Incorporated, which owns all the outstanding stock of JPMIM.
ITEM 29. PRINCIPAL UNDERWRITERS.
Not applicable.
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
The accounts and records of the Registrant are located, in whole or in
part, at the office of the Registrant and the following locations:
J.P. Morgan Investment Management Inc. and Morgan Guaranty Trust Company of
New York, 522 Fifth Avenue, New York, New York 10036 and/or 60 Wall Street, New
York, New York 10260-0060 (records relating to its functions as investment
adviser and administrative services agent).
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110 or 40 King Street West, Toronto, Ontario, Canada M5H 3Y8
(records relating to its functions as custodian and fund accounting and transfer
agent).
Funds Distributor, Inc., 60 State Street, Suite 1300, Boston,
Massachusetts 02109 (records relating to its functions as co-administrator and
exclusive placement agent).
Pierpont Group, Inc., 461 Fifth Avenue, New York, New York 10017
(records relating to its assisting the Trustees in carrying out their duties in
supervising the Registrant's affairs).
ITEM 31. MANAGEMENT SERVICES.
Not applicable.
<PAGE>
ITEM 32. UNDERTAKINGS.
Not applicable.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Investment Company Act of 1940, as
amended, the Registrant has duly caused this Registration Statement on Form N-1A
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of New York, on the 6th day of November, 1998.
THE NEW YORK TAX EXEMPT BOND PORTFOLIO
By: /s/ Michael S. Petrucelli
--------------------------------
Michael S. Petrucelli
Vice President and Assistant Secretary
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description of Exhibit
- ----------- ----------------------
EX-5(a) Investment Advisory Agreement with J.P. Morgan Investment
Management Inc.
EX-27 Financial Data Schedule
THE NEW YORK TOTAL RETURN BOND PORTFOLIO
INVESTMENT ADVISORY AGREEMENT
Agreement, made this 28th day of October, 1998, between The New York
Total Return Bond Portfolio, a trust organized under the law of the State of New
York (the "Portfolio") and J.P. Morgan Investment Management, Inc., a Delaware
corporation (the "Advisor"),
WHEREAS, the Portfolio is an open-end diversified management investment
company registered under the Investment Company Act of 1940, as amended (the
"1940 Act"); and
WHEREAS, the Portfolio desires to retain the Advisor to render
investment advisory services to the Portfolio, and the Advisor is willing to
render such services;
NOW, THEREFORE, this Agreement
W I T N E S S E T H:
that in consideration of the premises and mutual promises hereinafter set forth,
the parties hereto agree as follows:
1. The Portfolio hereby appoints the Advisor to act as investment
adviser to the Portfolio for the period and on the terms set forth in this
Agreement. The Advisor accepts such appointment and agrees to render the
services herein set forth, for the compensation herein provided.
2. Subject to the general supervision of the Trustees of the Portfolio,
the Advisor shall manage the investment operations of the Portfolio and the
composition of the Portfolio's holdings of securities and investments, including
cash, the purchase, retention and disposition thereof and agreements relating
thereto, in accordance with the Portfolio's investment objectives and policies
as stated in the Registration Statement (as defined in paragraph 3(d) of this
Agreement) and subject to the following understandings:
(a) the Advisor shall furnish a continuous investment program for the
Portfolio and determine from time to time what investments or securities will be
purchased, retained, sold or lent by the Portfolio, and what portion of the
assets will be invested or held uninvested as cash;
(b) the Advisor shall use the same skill and care in the management of
the Portfolio's investments as it uses in the administration of other accounts
for which it has investment responsibility as agent;
(c) the Advisor, in the performance of its duties and obligations under
this Agreement, shall act in conformity with the Declaration of Trust, By-Laws
and Registration Statement of the Portfolio and with the instructions and
directions of the Trustees of the Portfolio and will conform to and comply with
the requirements of the 1940 Act and all other applicable federal and state laws
and regulations;
(d) the Advisor shall determine the securities to be purchased, sold or
lent by the Portfolio and as agent for the Portfolio will effect portfolio
transactions pursuant to its determinations either directly with the issuer or
with any broker and/or dealer in such securities; in placing orders with brokers
and/or dealers the Advisor intends to seek best price and execution for
purchases and sales; the Advisor shall also determine whether or not the
Portfolio shall enter into repurchase or reverse repurchase agreements;
<PAGE>
On occasions when the Advisor deems the purchase or sale of a security
to be in the best interest of the Portfolio as well as other customers of the
Advisor, the Advisor may, to the extent permitted by applicable laws and
regulations, but shall not be obligated to, aggregate the securities to be so
sold or purchased in order to obtain best execution, including lower brokerage
commissions, if applicable. In such event, allocation of the securities so
purchased or sold, as well as the expenses incurred in the transaction, will be
made by the Advisor in the manner it considers to be the most equitable and
consistent with its fiduciary obligations to the Portfolio;
(e) the Advisor shall maintain books and records with respect to the
Portfolio's securities transactions and shall render to the Portfolio's Trustees
such periodic and special reports as the Trustees may reasonably request; and
(f) the investment management services of the Advisor to the Portfolio
under this Agreement are not to be deemed exclusive, and the Advisor shall be
free to render similar services to others.
3. The Portfolio has delivered copies of each of the following
documents to the Advisor and will promptly notify and deliver to it all future
amendments and supplements, if any:
(a) Declaration of Trust of the Portfolio (such Declaration of Trust,
as presently in effect and as amended from time to time, is herein called the
"Declaration of Trust");
(b) By-Laws of the Portfolio (such By-Laws, as presently in effect and
as amended from time to time, are herein called the "By-Laws");
(c) Certified resolutions of the Trustees of the Portfolio authorizing
the appointment of the Advisor and approving the form of this Agreement;
(d) The Portfolio's Notification of Registration on Form N-8A and
Registration Statement on Form N-1A (No. 811-8642) each under the 1940 Act (the
"Registration Statement") as filed with the Securities and Exchange Commission
(the "Commission") on April 1, 1994, all amendments thereto.
4. The Advisor shall keep the Portfolio's books and records required to
be maintained by it pursuant to paragraph 2(e). The Advisor agrees that all
records which it maintains for the Portfolio are the property of the Portfolio
and it will promptly surrender any of such records to the Portfolio upon the
Portfolio's request. The Advisor further agrees to preserve for the periods
prescribed by Rule 31a-2 of the Commission under the 1940 Act any such records
as are required to be maintained by the Advisor with respect to the Portfolio by
Rule 31a-1 of the Commission under the 1940 Act.
5. During the term of this Agreement the Advisor will pay all expenses
incurred by it in connection with its activities under this Agreement, other
than the cost of securities and investments purchased for the Portfolio
(including taxes and brokerage commissions, if any).
6. For the services provided and the expenses borne pursuant to this
Agreement, the Portfolio will pay to the Advisor as full compensation therefor a
fee at an annual rate equal to .30% of the Portfolio's average daily net assets.
This fee will be computed daily and payable as agreed by the Portfolio and the
Advisor, but no more frequently than monthly.
7. The Advisor shall not be liable for any error of judgment or mistake
of law or for any loss suffered by the Portfolio in connection with the matters
to
<PAGE>
which this Agreement relates, except a loss resulting from a breach of
fiduciary duty with respect to the receipt of compensation for services (in
which case any award of damages shall be limited to the period and the amount
set forth in Section 36(b)(3) of the 1940 Act) or a loss resulting from willful
misfeasance, bad faith or gross negligence on its part in the performance of its
duties or from reckless disregard by it of its obligations and duties under this
Agreement.
8. This Agreement shall continue in effect for a period of more than
two years from the date hereof only so long as such continuance is specifically
approved at least annually in conformity with the requirements of the 1940 Act;
provided, however, that this Agreement may be terminated by the Portfolio at any
time, without the payment of any penalty, by vote of a majority of all the
Trustees of the Portfolio or by vote of a majority of the outstanding voting
securities of the Portfolio on 60 days' written notice to the Advisor, or by the
Advisor at any time, without the payment of any penalty, on 90 days' written
notice to the Portfolio. This Agreement will automatically and immediately
terminate in the event of its assignment (as defined in the 1940 Act).
9. The Advisor shall for all purposes herein be deemed to be an
independent contractor and shall, unless otherwise expressly provided herein or
authorized by the Trustees of the Portfolio from time to time, have no authority
to act for or represent the Portfolio in any way or otherwise be deemed an agent
of the Portfolio.
10. This Agreement may be amended by mutual consent, but the consent of
the Portfolio must be approved (a) by vote of a majority of those Trustees of
the Portfolio who are not parties to this Agreement or interested persons of any
such party, cast in person at a meeting called for the purpose of voting on such
amendment, and (b) by vote of a majority of the outstanding voting securities of
the Portfolio.
11. Notices of any kind to be given to the Advisor by the Portfolio
shall be in writing and shall be duly given if mailed or delivered to the
Advisor at 522 Fifth Avenue, New York, New York 10036, Attention: Funds
Management, or at such other address or to such other individual as shall be
specified by the Advisor to the Portfolio. Notices of any kind to be given to
the Portfolio by the Advisor shall be in writing and shall be duly given if
mailed or delivered to the Portfolio at 60 State Street, 13th Floor, Boston,
Massachusetts 02109, Attention: Treasurer, or at such other address or to such
other individual as shall be specified by the Portfolio to the Advisor.
12. The Trustees have authorized the execution of this Agreement in
their capacity as Trustees and not individually and the Advisor agrees that
neither the shareholders nor the Trustees nor any officer, employee,
representative or agent of the Portfolio shall be personally liable upon, or
shall resort be had to their private property for the satisfaction of,
obligations given, executed or delivered on behalf of or by the Portfolio, that
the shareholders, trustees, officers, employees, representatives and agents of
the Portfolio shall not be personally liable hereunder, and that it shall look
solely to the property of the Portfolio for the satisfaction of any claim
hereunder.
13. This Agreement may be executed in one or more counterparts, each of
which shall be deemed to be an original.
14. This Agreement shall be governed by and construed in accordance
with the laws of the State of New York.
IN WITNESS WHEREOF, the parties hereto have caused this instrument to
be executed by their officers designated below as of the 28th day of October,
1998.
THE NEW YORK TOTAL RETURN BOND PORTFOLIO
By: /s/ George A. Rio
George A. Rio
President
J.P. MORGAN INVESTMENT MANAGEMENT, INC.
By: /s/ Diane J. Minardi
Diane J. Minardi
Vice President
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
This schedule contains summary financial data extracted from the annual report
on Form N-SAR dated March 31, 1998 for The New York Total Return Bond Portfolio
and is qualified in its entirety by reference to such annual report.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<INVESTMENTS-AT-COST> 191923
<INVESTMENTS-AT-VALUE> 198284
<RECEIVABLES> 2977
<ASSETS-OTHER> 90
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 201351
<PAYABLE-FOR-SECURITIES> 4262
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 77
<TOTAL-LIABILITIES> 4339
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 0
<SHARES-COMMON-STOCK> 0
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 0000
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0000
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 0
<NET-ASSETS> 0
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8603
<OTHER-INCOME> 0
<EXPENSES-NET> 689
<NET-INVESTMENT-INCOME> 7914
<REALIZED-GAINS-CURRENT> 1112
<APPREC-INCREASE-CURRENT> 4862
<NET-CHANGE-FROM-OPS> 13888
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 49088
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 50
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 0
<AVERAGE-NET-ASSETS> 171172
<PER-SHARE-NAV-BEGIN> 0
<PER-SHARE-NII> 0
<PER-SHARE-GAIN-APPREC> 0
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 0
<EXPENSE-RATIO> .40
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
