Rule 497(e)-- File Nos. 33-78264, 811-8490
STATEMENT OF ADDITIONAL INFORMATION
OCTOBER 2, 1995
AS AMENDED JANUARY 2, 1996
EXCELSIOR INSTITUTIONAL TRUST
EXCELSIOR INSTITUTIONAL EQUITY FUND
EXCELSIOR INSTITUTIONAL INCOME FUND
EXCELSIOR INSTITUTIONAL TOTAL RETURN BOND FUND
EXCELSIOR INSTITUTIONAL BOND INDEX FUND
EXCELSIOR INSTITUTIONAL BALANCED FUND
EXCELSIOR INSTITUTIONAL EQUITY GROWTH FUND
EXCELSIOR INSTITUTIONAL INTERNATIONAL EQUITY FUND
Excelsior Institutional Trust (the "Trust") is comprised of nine funds,
seven of which are active and two of which are inactive. This Statement of
Additional Information describes the shares of the seven active funds -
Excelsior Institutional Equity Fund (the "Equity Fund"), Excelsior Institutional
Income Fund (the "Income Fund"), Excelsior Institutional Total Return Bond Fund
(the "Total Return Bond Fund"), Excelsior Institutional Bond Index Fund (the
"Bond Index Fund"), Excelsior Institutional Balanced Fund (the "Balanced Fund"),
Excelsior Institutional Equity Growth Fund (the "Equity Growth Fund") and
Excelsior Institutional International Equity Fund (the "International Equity
Fund") (each, a "Fund"; collectively, the "Funds").
Table of Contents Page
Excelsior Institutional Trust 2
Investment Objectives, Policies and Restrictions 3
Performance Information 34
Determination of Net Asset Value; Valuation of Securities 39
Additional Purchase, Exchange, and Redemption Information 41
Management of the Trust 42
Independent Auditors 53
Taxation 53
Description of the Trust; Fund Shares 56
Financial Statements 60
Appendix A-1
Excelsior Institutional Trust
73 Tremont Street
Boston, Massachusetts 02108
(617) 557-8000
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This Statement of Additional Information sets forth information which may
be of interest to investors but which is not necessarily included in the Funds'
Prospectus as it may be amended from time to time (the "Prospectus"). This
Statement of Additional Information should be read only in conjunction with the
Prospectus, a copy of which may be obtained by an investor without charge by
contacting the Trust at its address shown above or by calling (800) 909-1989.
Terms used but not defined herein, which are defined in the Prospectus, are used
herein as defined in the Prospectus.
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND IS
AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF PRECEDED OR
ACCOMPANIED BY AN EFFECTIVE
PROSPECTUS.
EXCELSIOR INSTITUTIONAL TRUST
The Trust is an open-end diversified management investment company which
was organized as a business trust under the laws of the State of Delaware on
April 27, 1994. The shares of the Trust are continuously sold to institutional
investors. Shares of the Trust are divided into nine separate series, seven of
which are described herein. As of the date hereof, there are two additional
inactive series of the Trust. Additional series may be added to the Trust from
time to time.
United States Trust Company of New York ("U.S. Trust") is the investment
adviser for the Equity Fund, Income Fund and Total Return Bond Fund. U.S. Trust
makes decisions with respect to and places orders for all purchases and sales of
portfolio securities for these Funds.
United States Trust Company of the Pacific Northwest ("U.S. Trust Pacific")
is the investment adviser for the Balanced Fund, Equity Growth Fund and
International Equity Fund. The daily management of the security holdings of
these Funds is performed by the investment managers named below, acting as
subadvisers:
Balanced Fund...................Becker Capital Management, Inc.
Equity Growth Fund..............Luther King Capital Management
International Equity Fund.......Harding, Loevner Management, L.P.
The Trust seeks to achieve the investment objective of the Bond Index
Fund by investing all of that Fund's investable assets in the Bond Index
Portfolio, a series of Federated Investment Portfolios (the "Federated
Portfolios"). Federated Management is the investment adviser for the Bond Index
Portfolio. The daily management of the security holdings of the Bond Index
Portfolio is performed by U.S. Trust, acting as subadviser. Because the Bond
Index Fund invests through the Bond Index Portfolio, all references in this
Statement of Additional Information to the Bond Index Fund include the Bond
Index Portfolio, except as otherwise noted.
INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
INVESTMENT OBJECTIVES
The investment objective of each Fund is described in the Prospectus.
There can, of course, be no assurance that a Fund will achieve its investment
objective.
INVESTMENT POLICIES
The following supplements the discussions of the various investments of
and techniques employed by the Funds set forth in the Prospectus.
OTHER INVESTMENT CONSIDERATIONS - EQUITY FUND
The Equity Fund invests primarily in common stocks but may purchase both
preferred stocks and securities convertible into common stock at the discretion
of U.S. Trust. While current income is secondary to the Fund's objective of
long-term capital appreciation, the Trust expects that the broad and diversified
strategies utilized by U.S. Trust will result in somewhat more current income
than would be generated if U.S. Trust utilized a single strategy more narrowly
focused on rapid growth of principal and involving exposure to higher levels of
risk.
U.S. Trust's investment philosophy is to identify investment values
available in the market at attractive prices. Investment value arises from the
ability to generate earnings or from the ownership of assets or resources.
Underlying earnings potential and asset values are frequently demonstrable but
not recognized in the market prices of the securities representing their
ownership. U.S. Trust employs the following three different but closely
interrelated portfolio strategies to focus and organize its search for
investment values.
1. Problem/Opportunity Companies. Important investment opportunities often
occur where companies develop solutions to large, complex, fundamental problems,
such as declining industrial productivity; rising costs and declining sources of
energy; the economic imbalances and value erosion caused by years of high
inflation and interest rates; the soaring costs and competing priorities of
providing health care; and the accelerating interdependence and "shrinking size"
of the world.
Solutions or parts of solutions to large problems may be generated by
established companies or comparatively new companies of all sizes through the
development of new products, technologies or services, or through new
applications of older ones.
Investment in such companies represents a wide range of investment
potential, current income return rates, and exposure to fundamental and market
risks. Income generated by the Equity Fund's investments in these companies
would be expected to be moderate, characterized by lesser rates than those of a
fund whose sole objective is current income, and somewhat higher rates than
those of a higher-risk growth fund.
2. Transaction Value Companies. In the opinion of U.S. Trust, the stock
market frequently values the aggregate ownership of a company at a substantially
lower figure than its component assets would be worth if they were sold off
separately over time. Such assets may include intangible assets such as product
and market franchises, operating know-how, or distribution systems, as well as
such tangible properties as oil reserves, timber, real estate, or production
facilities. Investment opportunities in these companies are determined by the
magnitude of difference between economic worth and current market price.
Market undervaluations are often corrected by purchase and sale,
restructuring of the company, or market recognition of a company's actual worth.
The recognition process may well occur over time, however, incurring a form of
time-exposure risk. Success from investing in these companies is often great,
but may well be achieved only after a waiting period of inactivity.
Income derived from investing in undervalued companies is expected to be
moderately greater than that derived from investments in either the
problem/opportunity or early life cycle companies.
3. Early Life Cycle Companies. Investments in early life cycle companies
tend to be narrowly focused on an objective of higher rates of capital
appreciation. They correspondingly will involve a significantly greater degree
of risk and the reduction of current income to a negligible level. Such
investments will not be limited to new, small companies engaged only in frontier
technology, but will seek opportunities for maximum appreciation through the
full spectrum of business operations, products, services, and asset values.
Consequently, the Equity Fund's investments in early life cycle companies are
primarily in younger, small to medium-sized companies in the early stages of
their development. Such companies are usually more flexible in trying new
approaches to problem-solving and in making new or different employment of
assets. Because of the high risk level involved, the ratio of success among such
companies is lower than the average, but for those companies which succeed, the
magnitude of investment reward is potentially higher.
INVESTMENTS AND INVESTMENT TECHNIQUES
GOLD BULLION - INTERNATIONAL EQUITY FUND
The International Equity Fund may purchase gold bars primarily of standard
weight (approximately 400 troy ounces) at the best available prices in the New
York bullion market. However, the subadviser will have discretion to purchase or
sell gold bullion in other markets, including foreign markets, if better prices
can be obtained. Gold bullion is valued by the Fund at the mean between the
closing bid and asked prices in the New York bullion market as of the close of
the New York Stock Exchange each business day. When there is no readily
available market quotation for gold bullion, the bullion will be valued by such
method as determined by the Trust's Board of Trustees to best reflect its fair
value. For purpose of determining net asset value, gold will be valued in U.S.
dollars.
BANK OBLIGATIONS
Domestic commercial banks organized under federal law are supervised and
examined by the Comptroller of the Currency and are required to be members of
the Federal Reserve System. Domestic banks organized under state law are
supervised and examined by state banking authorities but are members of the
Federal Reserve System only if they elect to join. In addition, state banks are
subject to federal examination and to a substantial body of federal law and
regulation. As a result of federal or state laws and regulations, domestic
banks, among other things, generally are required to maintain specified levels
of reserves, are limited in the amounts which they can loan to a single
borrower, and are subject to other regulations designed to promote financial
soundness. However, not all of such laws and regulations apply to the foreign
branches of domestic banks.
Obligations of foreign branches and subsidiaries of domestic banks and
domestic and foreign branches of foreign banks, such as certificates of deposit
("CDs") and time deposits ("TDs"), may be general obligations of the parent
banks in addition to the issuing branch, or may be limited by the terms of a
specific obligation and governmental regulation. Such obligations are subject to
different risks than are those of domestic banks. These risks include foreign
economic and political developments, foreign governmental restrictions that may
adversely affect payment of principal and interest on the obligations, foreign
exchange controls and foreign withholding and other taxes on interest income.
Foreign branches and subsidiaries are not necessarily subject to the same or
similar regulatory requirements that apply to domestic banks, such as mandatory
reserve requirements, loan limitations, and accounting, auditing and financial
record keeping requirements. In addition, less information may be publicly
available about a foreign branch of a domestic bank or about a foreign bank than
about a domestic bank.
Obligations of United States branches of foreign banks may be general
obligations of the parent bank in addition to the issuing branch, or may be
limited by the terms of a specific obligation and by federal or state regulation
as well as governmental action in the country in which the foreign bank has its
head office. A domestic branch of a foreign bank with assets in excess of $1
billion may be subject to reserve requirements imposed by the Federal Reserve
System or by the state in which the branch is located if the branch is licensed
in that state.
In addition, branches licensed by the Comptroller of the Currency and
branches licensed by certain states may be required to: (1) pledge to the
regulator, by depositing assets with a designated bank within the state, a
certain percentage of their assets as fixed from time to time by the appropriate
regulatory authority; and (2) maintain assets within the state in an amount
equal to a specified percentage of the aggregate amount of liabilities of the
foreign bank payable at or through all of its agencies or branches within the
state.
U.S. GOVERNMENT AND AGENCY SECURITIES
Securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities include U.S. Treasury securities, which differ only in their
interest rates, maturities and times of issuance. Treasury Bills have initial
maturities of one year or less; Treasury Notes have initial maturities of one to
ten years; and Treasury Bonds generally have initial maturities of greater than
ten years. Some obligations issued or guaranteed by U.S. Government agencies and
instrumentalities, for example, Government National Mortgage Association
pass-through certificates, are supported by the full faith and credit of the
U.S. Treasury; others, such as those of the Federal Home Loan Banks, by the
right of the issuer to borrow from the Treasury; others, such as those issued by
the Federal National Mortgage Association, by discretionary authority of the
U.S. Government to purchase certain obligations of the agency or
instrumentality; and others, such as those issued by the Student Loan Marketing
Association, only by the credit of the agency or instrumentality. While the U.S.
Government provides financial support to such U.S. Government-sponsored agencies
or instrumentalities, no assurance can be given that it will always do so, since
it is not so obligated by law.
COMMERCIAL PAPER
Commercial paper consists of short-term (usually from 1 to 270 days)
unsecured promissory notes issued by corporations in order to finance their
current operations. A variable amount master demand note (which is a type of
commercial paper) represents a direct borrowing arrangement involving
periodically fluctuating rates of interest under an agreement between a
commercial paper issuer and an institutional lender pursuant to which the lender
may determine to invest varying amounts.
Each Fund may purchase three types of commercial paper, as classified by
exemption from registration under the Securities Act of 1933, as amended (the
"1933 Act"). The three types include open market, privately placed, and letter
of credit commercial paper. Trading of such commercial paper is conducted
primarily by institutional investors through investment dealers or directly
through the issuers. Individual investor participation in the commercial paper
market is very limited.
OPEN MARKET. "Open market" commercial paper refers to the commercial paper
of any industrial, commercial, or financial institution which is openly traded,
including directly issued paper. "Open market" paper's 1933 Act exemption is
under Section 3(a)(3) which limits the use of proceeds to current transactions,
limits maturities to 270 days and requires that the paper contain no provision
for automatic rollovers.
PRIVATELY PLACED. "Privately placed" commercial paper relies on the
exemption from registration provided by Section 4(2) of the 1933 Act, which
exempts transactions by an issuer not involving any public offering. The
commercial paper may only be offered to a limited number of accredited
investors. "Privately placed" commercial paper has no maturity restriction and
may be considered illiquid. See "Illiquid Securities" below.
LETTER OF CREDIT. "Letter of credit" commercial paper is exempt from
registration under Section 3(a)(2) of the 1933 Act. It is backed by an
irrevocable or unconditional commitment by a bank to provide funds for repayment
of the notes. Unlike "open market" and "privately placed" commercial paper,
"letter of credit" paper has no limitations on purchases.
LENDING OF PORTFOLIO SECURITIES
Each Fund has the authority to lend portfolio securities to brokers,
dealers and other financial organizations. By lending its securities, a Fund can
increase its income by continuing to receive income on the loaned securities as
well as by either investing the cash collateral in short-term securities subject
to payment of a rebate fee to the borrower or by obtaining a fee from the
borrower when U.S. Government obligations are used as collateral. There may be
risks of delay in receiving additional collateral or risks of delay in recovery
of the securities or even loss of rights in the collateral should the borrower
of the securities fail financially. A Fund will adhere to the following
conditions whenever its securities are loaned: (i) the Fund must receive at
least 100% cash collateral or equivalent securities from the borrower; (ii) the
borrower must increase this collateral whenever the market value of the loaned
securities including accrued interest exceeds the level of the collateral; (iii)
the Fund must be able to terminate the loan at any time subject to prior notice;
(iv) the Fund must receive a reasonable return on the loan, as well as any
dividends, interest or other distributions on the loaned securities, and any
increase in market value; (v) the Fund may pay only reasonable custodian fees in
connection with the loan; and (vi) voting rights on the loaned securities may
pass to the borrower. However, if a material event adversely affecting the
loaned securities were to occur, the Fund would terminate the loan and regain
the right to vote the securities.
VARIABLE RATE AND FLOATING RATE SECURITIES
Each Fund may purchase floating and variable rate demand notes and bonds,
which are obligations ordinarily having stated maturities in excess of 397 days,
but which permit the holder to demand payment of principal at any time, or at
specified intervals not exceeding 397 days, in each case upon not more than 30
days' notice. Variable rate demand notes include master demand notes which are
obligations that permit a Fund to invest fluctuating amounts, which may change
daily without penalty, pursuant to direct arrangements between the Fund, as
lender, and the borrower. The interest rates on these notes fluctuate from time
to time. The issuer of such obligations normally has a corresponding right,
after a given period, to prepay in its discretion the outstanding principal
amount of the obligations plus accrued interest upon a specified number of days'
notice to the holders of such obligations. The interest rate on a floating rate
demand obligation is based on a known lending rate, such as a bank's prime rate,
and is adjusted automatically each time such rate is adjusted. The interest rate
on a variable rate demand obligation is adjusted automatically at specified
intervals. Frequently, such obligations are collateralized by letters of credit
or other credit support arrangements provided by banks. Because these
obligations are direct lending arrangements between the lender and borrower, it
is not contemplated that such instruments generally will be traded, and there
generally is no established secondary market for these obligations, although
they are redeemable at face value. Accordingly, where these obligations are not
secured by letters of credit or other credit support arrangements, a Fund's
right to redeem is dependent on the ability of the borrower to pay principal and
interest on demand. Such obligations frequently are not rated by credit rating
agencies and a Fund may invest in obligations which are not so rated only if its
investment managers determine that at the time of investment the obligations are
of comparable quality to the other obligations in which the Fund may invest. The
respective subadvisers of the Funds will consider on an ongoing basis the
creditworthiness of the issuers of the floating and variable rate demand
obligations held by the Funds. Each Fund will not invest more than 15% of the
value of its net assets in floating or variable rate demand obligations as to
which it cannot exercise the demand feature on not more than seven days' notice
if there is no secondary market available for these obligations, and in other
securities that are not readily marketable. See "Investment Restrictions" below.
PARTICIPATION INTERESTS
Each Fund may purchase from financial institutions participation interests
in securities in which such Fund may invest. A participation interest gives a
Fund an undivided interest in the security in the proportion that the Fund's
participation interest bears to the total principal amount of the security.
These instruments may have fixed, floating or variable rates of interest, with
remaining maturities of 13 months or less. If the participation interest is
unrated, or has been given a rating below that which is permissible for purchase
by the Fund, the participation interest will be backed by an irrevocable letter
of credit or guarantee of a bank, or the payment obligation otherwise will be
collateralized by U.S. Government securities, or, in the case of unrated
participation interests, the investment managers of a Fund must have determined
that the instrument is of comparable quality to those instruments in which the
Fund may invest. For certain participation interests, a Fund will have the right
to demand payment, on not more than seven days' notice, for all or any part of
the Fund's participation interest in the security, plus accrued interest. As to
these instruments, the Fund intends to exercise its right to demand payment only
upon a default under the terms of the security, as needed to provide liquidity
to meet redemptions, or to maintain or improve the quality of its investment
portfolio. Each Fund will not invest more than 15% of its net assets in
participation interests that do not have this demand feature, and in other
securities that are not readily marketable. Currently, no Fund intends to invest
more than 5% of its net assets in participation interests during the current
year. See "Investment Restrictions" below.
ILLIQUID SECURITIES
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the 1933 Act, securities which are otherwise not readily
marketable and repurchase agreements having a maturity of longer than seven
days. Securities which have not been registered under the 1933 Act are referred
to as private placements or restricted securities and are purchased directly
from the issuer or in the secondary market. Mutual funds do not typically hold a
significant amount of these restricted or other illiquid securities because of
the potential for delays on resale and uncertainty in valuation. Limitations on
resale may have an adverse effect on the marketability of portfolio securities
and a mutual fund might be unable to dispose of restricted or other illiquid
securities promptly or at reasonable prices and might thereby experience
difficulty satisfying redemptions within seven days. A mutual fund might also
have to register such restricted securities in order to dispose of them which,
if possible at all, would result in additional expense and delay. Adverse market
conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the 1933 Act, including
repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale of such investments to the
general public or to certain institutions may not be indicative of their
liquidity.
The Securities and Exchange Commission (the "SEC") has adopted Rule 144A,
which allows a broader institutional trading market for securities otherwise
subject to restriction on their resale to the general public. Rule 144A
establishes a "safe harbor" from the registration requirements of the 1933 Act
for resales of certain securities to qualified institutional buyers.
Each Fund's investment managers will monitor the liquidity of Rule 144A
securities for that Fund under the supervision of the Trust's Board of Trustees.
In reaching liquidity decisions, the investment managers will consider, among
other things, the following factors: (1) the frequency of trades and quotes for
the security, (2) the number of dealers and other potential purchasers wishing
to purchase or sell the security, (3) dealer undertakings to make a market in
the security and (4) the nature of the security and of the marketplace trades
(e.g., the time needed to dispose of the security, the method of soliciting
offers and the mechanics of the transfer).
UNSECURED PROMISSORY NOTES
Each Fund may also purchase unsecured promissory notes ("Notes") which are
not readily marketable and have not been registered under the 1933 Act, provided
such investments are consistent with such Fund's investment objectives and
policies. Each Fund will invest no more than 15% of its net assets in such Notes
and in other securities that are not readily marketable (which securities would
include floating and variable rate demand obligations as to which the Fund
cannot exercise the demand feature described above and as to which there is no
secondary market). Currently, no Fund intends to invest any of its assets in
unsecured promissory notes during the coming year. See "Investment Restrictions"
below.
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS
Repurchase agreements are agreements by which a person purchases a
security and simultaneously commits to resell that security to the seller (which
is usually a member bank of the Federal Reserve System or a member firm of the
New York Stock Exchange (or a subsidiary thereof)) at an agreed-upon date within
a number of days (usually not more than seven) from the date of purchase. The
resale price reflects the purchase price plus an agreed-upon market rate of
interest which is unrelated to the coupon rate or maturity of the purchased
security. A repurchase agreement involves the obligation of the seller to pay
the agreed-upon price, which obligation is in effect secured by the value of the
underlying security, usually U.S. Government or government agency issues. Under
the Investment Company Act of 1940, as amended (the "1940 Act"), repurchase
agreements may be considered to be loans by the buyer. A Fund's risk is limited
to the ability of the seller to pay the agreed upon amount on the delivery date.
If the seller defaults, the underlying security constitutes collateral for the
seller's obligation to pay although a Fund may incur certain costs in
liquidating this collateral and in certain cases may not be permitted to
liquidate this collateral. All repurchase agreements entered into by the Funds
are fully collateralized, with such collateral being marked to market daily.
Each Fund may borrow funds for temporary or emergency purposes, such as
meeting larger than anticipated redemption requests, and not for leverage. One
means of borrowing is by agreeing to sell portfolio securities to financial
institutions such as banks and broker-dealers and to repurchase them at a
mutually agreed date and price (a "reverse repurchase agreement"). At the time a
Fund enters into a reverse repurchase agreement it will place in a segregated
custodial account cash, U.S. Government securities or high-grade debt
obligations having a value equal to the repurchase price, including accrued
interest. Reverse repurchase agreements involve the risk that the market value
of the securities sold by the Fund may decline below the repurchase price of
those securities.
MUNICIPAL OBLIGATIONS - INCOME FUND AND TOTAL RETURN BOND FUND
The Income Fund and Total Return Bond Fund may, when deemed appropriate by
U.S. Trust in light of the Funds' investment objective, invest in municipal
obligations. Although yields on municipal obligations can generally be expected
under normal market conditions to be lower than yields on corporate and U.S.
Government obligations, from time to time municipal securities have
outperformed, on a total return basis, comparable corporate and federal debt
obligations as a result of prevailing economic, regulatory or other
circumstances. Dividends paid by the Income Fund and Total Return Bond Fund that
are derived from interest on municipal securities would be taxable to the Funds'
investors for federal income tax purposes.
Municipal obligations include debt obligations issued by governmental
entities to obtain funds for various public purposes, including the construction
of a wide range of public facilities, the refunding of outstanding obligations,
the payment of general operating expenses, and the extension of loans to public
institutions and facilities. Private activity bonds that are issued by or on
behalf of public authorities to finance various privately operated facilities
are included within the term "municipal obligations" only if the interest paid
thereon is exempt from regular federal income tax and not treated as a specific
tax preference item under the federal alternative minimum tax.
The two principal classifications of municipal obligations are "general
obligation" and "revenue" issues, but the Funds' securities holdings may include
"moral obligation" issues, which are normally issued by special-purpose
authorities. There are, of course, variations in the quality of municipal
obligations, both within a particular classification and between
classifications, and the yields on municipal obligations depend upon a variety
of factors, including general market conditions, the financial condition of the
issuer, conditions of the municipal bond market, the size of a particular
offering, the maturity of the obligation, and the rating of the issue. The
ratings of Moody's and S&P described in the Prospectus and Appendix A hereto
represent the opinion of the respective rating agencies as to the quality of
municipal obligations. It should be emphasized that these ratings are general
and are not absolute standards of quality, and municipal obligations with the
same maturity, interest rate, and rating may have different yields while
municipal obligations of the same maturity and interest rate with different
ratings may have the same yield.
The payment of principal and interest on most municipal obligations
purchased by the Funds will depend upon the ability of the issuers to meet their
obligations. Each state, the District of Columbia, each of their political
subdivisions, agencies, instrumentalities and authorities, and each multistate
agency of which a state is a member, is a separate "issuer" as that term is used
in this Statement of Additional Information and in the Prospectus. The
non-governmental user of facilities financed by private activity bonds is also
considered to be an "issuer". An issuer's obligations are subject to the
provisions of bankruptcy, insolvency, and other laws affecting the rights and
remedies of creditors, such as the Federal Bankruptcy Code, and laws, if any,
which may be enacted by federal or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations or upon the ability of municipalities to levy
taxes. The power or ability of an issuer to meet its obligations for the payment
of interest on and principal of its municipal obligations may be materially
adversely affected by litigation or other conditions.
Private activity bonds are or have been issued to obtain funds to provide,
among other things, privately operated housing facilities, pollution control
facilities, convention or trade show facilities, mass transit, airport, port or
parking facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. Private activity bonds are also
issued to privately held or publicly owned corporations in the financing of
commercial or industrial facilities. State and local governments are authorized
in most states to issue private activity bonds for such purposes in order to
encourage corporations to locate within their communities. The principal and
interest on these obligations may be payable from the general revenues of the
users of such facilities.
Among other instruments, the Funds may purchase short-term general
obligation notes, tax anticipation notes, bond anticipation notes, revenue
anticipation notes, tax-exempt commercial paper, construction loan notes and
other forms of short-term loans. Such instruments are issued with a short-term
maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements or other revenues. In addition, the Funds may invest in long-term
tax-exempt instruments, such as municipal bonds and private activity bonds, to
the extent consistent with the maturity restrictions applicable to it.
Opinions relating to the validity of municipal obligations and to the
exemption of interest thereon from federal income tax are rendered by bond
counsel to the respective issuers at the time of issuance. Neither the Trust nor
U.S. Trust will review the proceedings relating to the issuance of municipal
obligations or the basis for such opinions.
STAND-BY COMMITMENTS - INCOME FUND AND TOTAL RETURN BOND FUND
The Income Fund and Total Return Bond Fund may acquire "stand-by
commitments" with respect to municipal obligations held by them. Under a
stand-by commitment, a dealer or bank agrees to purchase from a Fund, at the
Fund's option, specified municipal obligations at a specified price. The amount
payable to a Fund upon its exercise of a stand-by commitment is normally (i) the
Fund's acquisition cost of the municipal obligations (excluding any accrued
interest which the Fund paid on their acquisition), less any amortized market
premium or plus any amortized market or original issue discount during the
period the Fund owned the securities, plus (ii) all interest accrued on the
securities since the last interest payment date during that period. Stand-by
commitments are exercisable by a Fund at any time before the maturity of the
underlying municipal obligations, and may be sold, transferred or assigned by
the Fund only with the underlying instruments.
The Income Fund and Total Return Bond Fund expect that stand-by
commitments will generally be available without the payment of any direct or
indirect consideration. However, if necessary or advisable, either Fund may pay
for a stand-by commitment either separately in cash or by paying a higher price
for securities which are acquired subject to the commitment (thus reducing the
yield to maturity otherwise available for the same securities). Where a Fund has
paid any consideration directly or indirectly for a stand-by commitment, its
cost will be reflected as unrealized depreciation for the period during which
the commitment was held by the Fund.
The Income Fund and Total Return Bond Fund intend to enter into stand-by
commitments only with banks and broker/dealers which, in U.S. Trust's opinion,
present minimal credit risks. In evaluating the creditworthiness of the issuer
of a stand-by commitment, U.S. Trust will review periodically the issuer's
assets, liabilities, contingent claims and other relevant financial information.
FOREIGN SECURITIES
If permitted pursuant to its investment objective and policies, each Fund
may invest its assets in securities of foreign issuers. Investing in securities
issued by companies whose principal business activities are outside the United
States may involve significant risks not present in domestic investments. For
example, there is generally less publicly available information about foreign
companies, particularly those not subject to the disclosure and reporting
requirements of the U.S. securities laws. Foreign issuers are generally not
bound by uniform accounting, auditing and financial reporting requirements
comparable to those applicable to domestic issuers. Investments in foreign
securities also involve the risk of possible adverse changes in investment or
exchange control regulations, expropriation or confiscatory taxation, brokerage
or other taxation, limitation on the removal of funds or other assets of a Fund,
political or financial instability or diplomatic and other developments which
would affect such investments. Further, economies of particular countries or
areas of the world may differ from the economy of the United States.
It is anticipated that in most cases the best available market for foreign
securities would be on exchanges or in over-the-counter markets located outside
the United States. Foreign stock markets, while growing in volume and
sophistication, are generally not as developed as those in the United States,
and securities of some foreign issuers (particularly those located in developing
countries) may be less liquid and more volatile than securities of comparable
United States companies. Foreign security trading practices, including those
involving securities settlement where a Fund's assets may be released prior to
receipt of payment, may expose a Fund to increased risk in the event of a failed
trade or the insolvency of a foreign broker-dealer. In addition, foreign
brokerage commissions are generally higher than commissions on securities traded
in the United States and may be non-negotiable. In general, there is less
overall governmental supervision and regulation of foreign securities exchanges,
brokers and listed companies than in the United States.
Each Fund may invest in foreign securities that impose restrictions on
transfer within the United States or to United States persons. Although
securities subject to such transfer restrictions may be marketable abroad, they
may be less liquid than foreign securities of the same class that are not
subject to such restrictions.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
Because each Fund, if consistent with its investment objectives and
policies, may buy and sell securities denominated in currencies other than the
U.S. dollar and receive interest, dividends and sale proceeds in currencies
other than the U.S. dollar, each such Fund from time to time may enter into
foreign currency exchange transactions to convert to and from different foreign
currencies and to convert foreign currencies to and from the U.S. dollar. The
Funds either enter into these transactions on a spot (i.e., cash) basis at the
spot rate prevailing in the foreign currency exchange market or use forward
contracts to purchase or sell foreign currencies.
A forward foreign currency exchange contract is an obligation by a Fund to
purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract. Forward foreign currency exchange
contracts establish an exchange rate at a future date. These contracts are
transferable in the interbank market conducted directly between currency traders
(usually large commercial banks) and their customers. A forward foreign currency
exchange contract generally has no deposit requirement and is traded at a net
price without commission. A Fund maintains with its custodian a segregated
account of high grade liquid assets in an amount at least equal to its
obligations under each forward foreign currency exchange contract. Neither spot
transactions nor forward foreign currency exchange contracts eliminate
fluctuations in the prices of the Fund's securities or in foreign exchange
rates, or prevent loss if the prices of these securities should decline.
Each Fund may enter into forward foreign currency exchange contracts for
hedging purposes in an attempt to protect against changes in foreign currency
exchange rates between the trade and settlement dates of specific securities
transactions or changes in foreign currency exchange rates that would adversely
affect a portfolio position or an anticipated investment position. Since
consideration of the prospect for currency parities will be incorporated into
the investment managers' long-term investment decisions, the Funds will not
routinely enter into foreign currency hedging transactions with respect to
security transactions; however, the investment managers believe that it is
important to have the flexibility to enter into foreign currency hedging
transactions when they determine that the transactions would be in a Fund's best
interest. Although these transactions tend to minimize the risk of loss due to a
decline in the value of the hedged currency, at the same time they tend to limit
any potential gain that might be realized should the value of the hedged
currency increase. The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible because the
future value of such securities in foreign currencies will change as a
consequence of market movements in the value of such securities between the date
the forward contract is entered into and the date it matures. The projection of
currency market movements is extremely difficult, and the successful execution
of a hedging strategy is highly uncertain.
At or before the maturity of a forward foreign currency exchange contract
when a Fund has agreed to deliver a foreign currency, the Fund may sell a
portfolio security and make delivery of the currency, or retain the security and
offset its contractual obligation to deliver the currency by purchasing a second
contract pursuant to which the Fund will obtain, on the same maturity date, the
same amount of the currency which it is obligated to deliver. If the Fund
retains the portfolio security and engages in an offsetting transaction, the
Fund, at the time of execution of the offsetting transaction, will incur a gain
or a loss to the extent that movement has occurred in forward contract prices.
Should forward prices decline during the period between a Fund's entering into a
forward contract for the sale of a currency, and the date it enters into an
offsetting contract for the purchase of the currency, the Fund will realize a
gain to the extent the price of the currency it has agreed to sell exceeds the
price of the currency it has agreed to purchase. Should forward prices increase,
the Fund will suffer a loss to the extent of the price of the currency it has
agreed to sell is less than the price of the currency it has agreed to purchase
in the offsetting contract.
While these contracts are not presently regulated by the Commodity Futures
Trading Commission ("CFTC"), the CFTC may in the future assert authority to
regulate forward contracts. In such event a Fund's ability to utilize forward
contracts in the manner set forth in the Prospectus may be restricted. Forward
contracts may reduce the potential gain from a positive change in the
relationship between the U.S. dollar and foreign currencies. Unanticipated
changes in currency prices may result in poorer overall performance for a Fund
than if it had not entered into such contracts. The use of foreign currency
forward contracts may not eliminate fluctuations in the underlying U.S. dollar
equivalent value of the prices of or rates of return on a Fund's foreign
currency denominated portfolio securities and the use of such techniques will
subject the Fund to certain risks.
The matching of the increase in value of a forward contract and the
decline in the U.S. dollar-equivalent value of the foreign currency-denominated
asset that is the subject of the hedge generally will not be precise. In
addition, a Fund may not always be able to enter into foreign currency forward
contracts at attractive prices and this will limit a Fund's ability to use such
contract to hedge or cross-hedge its assets. Also, with regard to a Fund's use
of cross-hedges, there can be no assurance that historical correlations between
the movement of certain foreign currencies relative to the U.S. dollar will
continue. Thus, at any time poor correlation may exist between movements in the
exchange rates of the foreign currencies underlying a Fund's cross-hedges and
the movements in the exchange rates of the foreign currencies in which the
Fund's assets that are the subject of such cross-hedges are denominated.
GUARANTEED INVESTMENT CONTRACTS
Each Fund may invest in guaranteed investment contracts ("GICs") issued by
insurance companies. Pursuant to such contracts, a Fund makes cash contributions
to a deposit fund of the insurance company's general account. The insurance
company then credits to the fund guaranteed interest. The GICs provide that this
guaranteed interest will not be less than a certain minimum rate. The insurance
company may assess periodic charges against a GIC for expenses and service costs
allocable to it, and the charges will be deducted from the value of the deposit
fund. Because a Fund may not receive the principal amount of a GIC from the
insurance company on seven days' notice or less, the GIC is considered an
illiquid investment and, together with other instruments in a Fund which are not
readily marketable, will not exceed 15% of the Fund's net assets. The term of a
GIC will be 13 months or less. In determining average weighted portfolio
maturity, a GIC will be deemed to have a maturity equal to the longer of the
period of time remaining until the next readjustment of the guaranteed interest
rate or the period of time remaining until the principal amount can be recovered
from the issuer through demand. Currently, each Fund intends to invest 5% or
less of its respective net assets in GICs during the current year.
WHEN-ISSUED SECURITIES
If permitted pursuant to its investment objectives and policies, a Fund
may purchase securities on a "when-issued" or on a "forward delivery" basis. It
is expected that, under normal circumstances, such Fund would take delivery of
such securities. Prior to committing to the purchase of a security on a
when-issued or on a forward delivery basis, the Funds will establish procedures
consistent with the relevant policies of the SEC. Those policies currently
recommend that an amount of a Fund's assets equal to the amount of the purchase
commitment be held aside or segregated to be used to pay for the commitment.
Therefore, the Funds expect always to have cash, cash equivalents, or high
quality debt securities sufficient to cover any purchase commitments or to limit
any potential risk. Although the Funds do not intend to make such purchases for
speculative purposes and intend to adhere to SEC policies, purchases of
securities on a when issued or forward delivery basis may involve additional
risks than other types of securities purchases. For example, a Fund may have to
sell assets which have been set aside in order to meet redemptions. Also, if a
Fund determines it is advisable as a matter of investment strategy to sell the
when-issued or forward delivery securities, the Fund would be required to meet
its obligations from its then available cash flow or the sale of securities, or,
although it would not normally expect to do so, from the sale of the when-issued
or forward delivery securities themselves (which may have a value greater or
less than the Fund's payment obligation).
When a Fund engages in when-issued or forward delivery transactions, it
relies on the other party to consummate the trade. Failure of such other party
to do so may result in the Fund's incurring a loss or missing an opportunity to
obtain a price considered to be advantageous.
The market value of the securities underlying a when-issued purchase or a
forward commitment to purchase securities and any subsequent fluctuations in
their market value are taken into account when determining the market value of a
Fund starting on the day the Fund agrees to purchase the securities. The Fund
does not earn interest on the securities it has committed to purchase until they
are paid for and delivered on the settlement date.
ZERO COUPON OBLIGATIONS
A Fund may acquire zero coupon obligations when consistent with its
investment objective and policies. Such obligations have greater price
volatility than coupon obligations and will not result in payment of interest
until maturity. Since [interest] income is accrued throughout the term of the
zero coupon obligation but is not actually received until maturity, a Fund,
which is required for tax purposes to distribute to its shareholders a certain
percentage of its income, may have to sell other securities to distribute the
income prior to maturity of the zero coupon obligation.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
General. The successful use of such instruments by a Fund may depend in
part upon its investment managers' skill and experience with respect to such
instruments. Should interest or exchange rates move in an unexpected manner, the
Fund may not achieve the anticipated benefits of futures contracts or options on
futures contracts or may realize losses and thus will be in a worse position
than if such strategies had not been used. In addition, the correlation between
movements in the price of futures contracts or options on futures contracts and
movements in the price of the securities and currencies hedged or used for cover
will not be perfect and could produce unanticipated losses.
Futures Contracts. If permitted pursuant to its investment objectives and
policies, a Fund may enter into contracts for the purchase or sale for future
delivery of securities or foreign currencies, or contracts based on financial
indices. U.S. futures contracts have been designed by exchanges which have been
designated "contracts markets" by the CFTC, and must be executed through a
futures commission merchant, or brokerage firm, which is a member of the
relevant contract market. Futures contracts trade on a number of exchange
markets, and, through their clearing corporations, the exchanges guarantee
performance of the contracts as between the clearing members of the exchange. A
Fund may enter into futures contracts which are based on debt securities that
are backed by the full faith and credit of the U.S. Government, such as
long-term U.S. Treasury Bonds, Treasury Notes, Government National Mortgage
Association modified pass-through mortgage-backed securities and three-month
U.S. Treasury Bills. A Fund may also enter into futures contracts which are
based on fixed income securities issued by entities other than the U.S.
Government, including foreign government securities, corporate debt securities,
or contracts based on financial indices including any index of U.S. Government
securities, foreign government securities or corporate debt securities.
Purchases or sales of stock index futures contracts are used to attempt to
protect a Fund's current or intended stock investments from broad fluctuations
in stock prices. For example, the Fund may sell stock index futures contracts in
anticipation of or during a decline in the market value of the Fund's
securities. If such decline occurs, the loss in value of portfolio securities
may be offset, in whole or part, by gains on the futures position. When a Fund
is not fully invested in the securities market and anticipates a significant
market advance, it may purchase stock index futures contracts in order to gain
rapid market exposure that may, in part or entirely, offset increases in the
cost of securities that the Fund intends to purchase. As such purchases are
made, the corresponding positions in stock index futures contracts will be
closed out. In a substantial majority of these transactions, the Fund will
purchase such securities upon termination of the futures position, but under
unusual market conditions, a long futures position may be terminated without a
related purchase of securities.
At the same time a futures contract is purchased or sold, the Fund must
allocate cash or securities as a deposit payment ("initial deposit"). It is
expected that the initial deposit would be approximately 1/2% to 5% of a
contract's face value. Daily thereafter, the futures contract is valued and the
payment of "variation margin" may be required, since each day the Fund would
provide or receive cash that reflects any decline or increase in the contract's
value.
At the time of delivery of securities pursuant to such a contract,
adjustments are made to recognize differences in value arising from the delivery
of securities with a different interest rate from that specified in the
contract. In some (but not many) cases, securities called for by a futures
contract may not have been issued when the contract was written.
Although futures contracts by their terms call for the actual delivery or
acquisition of securities, in most cases the contractual obligation is fulfilled
before the date of the contract without having to make or take delivery of the
securities. The offsetting of a contractual obligation is accomplished by buying
(or selling, as the case may be) on a commodities exchange an identical futures
contract calling for delivery in the same month. Such a transaction, which is
effected through a member of an exchange, cancels the obligation to make or take
delivery of the securities. Since all transactions in the futures market are
made, offset or fulfilled through a clearinghouse associated with the exchange
on which the contracts are traded, a Fund will incur brokerage fees when it
purchases or sells futures contracts.
The purpose of the acquisition or sale of a futures contract, in the case
of a Fund which holds or intends to acquire fixed-income securities, is to
attempt to protect the Fund from fluctuations in interest or foreign exchange
rates without actually buying or selling fixed-income securities or foreign
currencies. For example, if interest rates were expected to increase, a Fund
might enter into futures contracts for the sale of debt securities. Such a sale
would have much the same effect as selling an equivalent value of the debt
securities owned by the Fund. If interest rates did increase, the value of the
debt security in a Fund would decline, but the value of the futures contracts to
the Fund would increase at approximately the same rate, thereby keeping the net
asset value of the Fund from declining as much as it otherwise would have. The
Fund could accomplish similar results by selling debt securities and investing
in bonds with short maturities when interest rates are expected to increase.
However, since the futures market is more liquid than the cash market, the use
of futures contracts as an investment technique allows a Fund to maintain a
defensive position without having to sell its portfolio securities.
Similarly, when it is expected that interest rates may decline, futures
contracts may be purchased to attempt to hedge against anticipated purchases of
debt securities at higher prices. Since the fluctuations in the value of futures
contracts should be similar to those of debt securities, a Fund could take
advantage of the anticipated rise in the value of debt securities without
actually buying them until the market had stabilized. At that time, the futures
contracts could be liquidated and the Fund could then buy debt securities on the
cash market. To the extent a Fund enters into futures contracts for this
purpose, the assets in the segregated asset account maintained to cover the
Fund's obligations with respect to such futures contracts will consist of cash,
cash equivalents or high quality liquid debt securities from its portfolio in an
amount equal to the difference between the fluctuating market value of such
futures contracts and the aggregate value of the initial and variation margin
payments made by the Fund with respect to such futures contracts.
The ordinary spreads between prices in the cash and futures market, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial deposit and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close futures contracts through offsetting
transactions which could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced, thus producing distortion. Third, from
the point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of distortion, a
correct forecast of general interest rate trends by the investment managers may
still not result in a successful transaction.
In addition, futures contracts entail risks. Although the investment
managers believe that use of such contracts will benefit the Funds, if the
judgment of the investment managers about the general direction of interest
rates is incorrect, a Fund's overall performance would be poorer than if it had
not entered into any such contract. For example, if a Fund has hedged against
the possibility of an increase in interest rates which would adversely affect
the price of debt securities held by it and interest rates decrease instead, the
Fund will lose part or all of the benefit of the increased value of its debt
securities which it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if a Fund has insufficient
cash, it may have to sell debt securities to meet daily variation margin
requirements. Such sales of bonds may be, but will not necessarily be, at
increased prices which reflect the rising market. A Fund may have to sell
securities at a time when it may be disadvantageous to do so.
Options on Futures Contracts. If permitted pursuant to its investment
objectives and policies, a Fund may purchase and write options on futures
contracts for hedging purposes. The purchase of a call option on a futures
contract is similar in some respects to the purchase of a call option on an
individual security. Depending on the pricing of the option compared to either
the price of the futures contract upon which it is based or the price of the
underlying debt securities, it may or may not be less risky than ownership of
the futures contract or underlying debt securities. As with the purchase of
futures contracts, when a Fund is not fully invested it may purchase a call
option on a futures contract to hedge against a market advance due to declining
interest rates.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the security or foreign currency which is
deliverable upon exercise of the futures contract. If the futures price at
expiration of the option is below the exercise price, a Fund will retain the
full amount of the option premium which provides a partial hedge against any
decline that may have occurred in the Fund's portfolio holdings. The writing of
a put option on a futures contract constitutes a partial hedge against
increasing prices of the security or foreign currency which is deliverable upon
exercise of the futures contract. If the futures price at expiration of the
option is higher than the exercise price, the Fund will retain the full amount
of the option premium which provides a partial hedge against any increase in the
price of securities which the Fund intends to purchase. If a put or call option
the Fund has written is exercised, the Fund will incur a loss which will be
reduced by the amount of the premium it receives. Depending on the degree of
correlation between changes in the value of its portfolio securities and changes
in the value of its futures positions, the Fund's losses from existing options
on futures may to some extent be reduced or increased by changes in the value of
portfolio securities.
The purchase of a put option on a futures contract is similar in some
respects to the purchase of protective put options on portfolio securities. For
example, a Fund may purchase a put option on a futures contract to hedge its
portfolio against the risk of rising interest rates.
The amount of risk a Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option
also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the option purchased.
The Board of Trustees of the Trust has adopted the requirement that
futures contracts and options on futures contracts be used either (i) as a hedge
without regard to any quantitative limitation, or (ii) for other purposes to the
extent that immediately thereafter the aggregate amount of initial margin
deposits on all (non-hedge) futures contracts of the Fund and premiums paid on
outstanding (non-hedge) options on futures contracts owned by the Fund does not
exceed 5% of the market value of the net assets of the Fund. In addition, the
aggregate market value of the outstanding futures contracts purchased by the
Fund may not exceed 50% of the market value of the total assets of the Fund.
Neither of these restrictions will be changed by the Trust's Board of Trustees
without considering the policies and concerns of the various applicable federal
and state regulatory agencies.
Options on Foreign Currencies. If permitted pursuant to its investment
objectives and policies, a Fund may purchase and write options on foreign
currencies for hedging purposes in a manner similar to that in which futures
contracts on foreign currencies, or forward contracts, will be utilized. For
example, a decline in the dollar value of a foreign currency in which portfolio
securities are denominated will reduce the dollar value of such securities, even
if their value in the foreign currency remains constant. In order to protect
against such diminutions in the value of portfolio securities, the Fund may
purchase put options on the foreign currency. If the value of the currency does
decline, a Fund will have the right to sell such currency for a fixed amount in
dollars and will thereby offset, in whole or in part, the adverse effect on its
portfolio which otherwise would have resulted.
Conversely, where a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, the Fund may purchase call options thereon. The
purchase of such options could offset, at least partially, the effects of the
adverse movements in exchange rates. As in the case of other types of options,
however, the benefit to the Fund deriving from purchases of foreign currency
options will be reduced by the amount of the premium and related transaction
costs. In addition, where currency exchange rates do not move in the direction
or to the extent anticipated, the Fund could sustain losses on transactions in
foreign currency options which would require it to forego a portion or all of
the benefits of advantageous changes in such rates.
A Fund may write options on foreign currencies for the same types of
hedging purposes. For example, where a Fund anticipates a decline in the dollar
value of foreign currency denominated securities due to adverse fluctuations in
exchange rates it could, instead of purchasing a put option, write a call option
on the relevant currency. If the expected decline occurs, the options will most
likely not be exercised, and the diminution in value of portfolio securities
will be offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, the Fund
could write a put option on the relevant currency which, if rates move in the
manner projected, will expire unexercised and allow the Fund to hedge such
increased cost up to the amount of the premium. As in the case of other types of
options, however, the writing of a foreign currency option will constitute only
a partial hedge up to the amount of the premium, and only if rates move in the
expected direction. If this does not occur, the option may be exercised and the
Fund would be required to purchase or sell the underlying currency at a loss
which may not be offset by the amount of the premium. Through the writing of
options on foreign currencies, the Fund also may be required to forego all or a
portion of the benefits which might otherwise have been obtained from favorable
movements in exchange rates.
Each Fund may write covered call options on foreign currencies. A call
option written on a foreign currency by a Fund is "covered" if the Fund owns the
underlying foreign currency covered by the call or has an absolute and immediate
right to acquire that foreign currency without additional cash consideration (or
for additional cash consideration held in a segregated account by its custodian)
upon conversion or exchange of other foreign currency held by it. A call option
is also covered if the Fund has a call on the same foreign currency and in the
same principal amount as the call written where the exercise price of the call
held (a) is equal to or less than the exercise price of the call written or (b)
is greater than the exercise price of the call written if the difference is
maintained by the Fund in cash, U.S. Government securities and other high
quality liquid debt securities in a segregated account with its custodian.
Each Fund may write call options on foreign currencies that are not
covered for cross-hedging purposes. A call option on a foreign currency is for
cross-hedging purposes if it is not covered, but is designed to provide a hedge
against a decline in the U.S. dollar value of a security which the Fund owns or
has the right to acquire and which is denominated in the currency underlying the
option due to an adverse change in the exchange rate. In such circumstances, the
Fund collateralizes the option by maintaining in a segregated account with its
custodian, cash or U.S. Government securities or other high quality liquid debt
securities in an amount not less than the value of the underlying foreign
currency in U.S. dollars marked to market daily.
Additional Risks of Options on Futures Contracts, Forward Contracts and
Options on Foreign Currencies. Unlike transactions entered into by a Fund in
futures contracts, options on foreign currencies and forward contracts are not
traded on contract markets regulated by the CFTC or (with the exception of
certain foreign currency options) by the SEC. To the contrary, such instruments
are traded through financial institutions acting as market-makers, although
foreign currency options are also traded on certain national securities
exchanges, such as the Philadelphia Stock Exchange and the Chicago Board Options
Exchange, subject to SEC regulation. Similarly, options on currencies may be
traded over-the-counter. In an over-the-counter trading environment, many of the
protections afforded to exchange participants will not be available. For
example, there are no daily price fluctuation limits, and adverse market
movements could therefore continue to an unlimited extent over a period of time.
Although the purchaser of an option cannot lose more than the amount of the
premium plus related transaction costs, this entire amount could be lost.
Moreover, the option writer and a trader of forward contracts could lose amounts
substantially in excess of their initial investments, due to the margin and
collateral requirements associated with such positions.
Options on foreign currencies traded on national securities exchanges are
within the jurisdiction of the SEC, as are other securities traded on such
exchanges. As a result, many of the protections provided to traders on organized
exchanges will be available with respect to such transactions. In particular,
all foreign currency option positions entered into on a national securities
exchange are cleared and guaranteed by the Options Clearing Corporation ("OCC"),
thereby reducing the risk of counterparty default. Further, a liquid secondary
market in options traded on a national securities exchange may be more readily
available than in the over-the-counter market, potentially permitting a Fund to
liquidate open positions at a profit prior to exercise or expiration, or to
limit losses in the event of adverse market movements.
The purchase and sale of exchange-traded foreign currency options,
however, is subject to the risks of the availability of a liquid secondary
market described above, as well as the risks regarding adverse market movements,
margining of options written, the nature of the foreign currency market,
possible intervention by governmental authorities and the effects of other
political and economic events. In addition, exchange-traded options on foreign
currencies involve certain risks not presented by the over-the-counter market.
For example, exercise and settlement of such options must be made exclusively
through the OCC, which has established banking relationships in applicable
foreign countries for this purpose. As a result, the OCC may, if it determines
that foreign governmental restrictions or taxes would prevent the orderly
settlement of foreign currency option exercises, or would result in undue
burdens on the OCC or its clearing member, impose special procedures on exercise
and settlement, such as technical changes in the mechanics of delivery of
currency, the fixing of dollar settlement prices or prohibitions on exercise.
As in the case of forward contracts, certain options on foreign currencies
are traded over-the-counter and involve liquidity and credit risks which may not
be present in the case of exchange-traded currency options. A Fund's ability to
terminate over-the-counter options will be more limited than with
exchange-traded options. It is also possible that broker-dealers participating
in over-the-counter options transactions will not fulfill their obligations.
Until such time as the staff of the SEC changes its position, each Fund will
treat purchased over-the-counter options and assets used to cover written
over-the-counter options as illiquid securities. With respect to options written
with primary dealers in U.S. Government securities pursuant to an agreement
requiring a closing purchase transaction at a formula price, the amount of
illiquid securities may be calculated with reference to the repurchase formula.
In addition, futures contracts, options on futures contracts, forward
contracts and options on foreign currencies may be traded on foreign exchanges.
Such transactions are subject to the risk of governmental actions affecting
trading in or the prices of foreign currencies or securities. The value of such
positions also could be adversely affected by (i) other complex foreign
political and economic factors, (ii) lesser availability than in the United
States of data on which to make trading decisions, (iii) delays in a Fund's
ability to act upon economic events occurring in foreign markets during
nonbusiness hours in the United States, (iv) the imposition of different
exercise and settlement terms and procedures and margin requirements than in the
United States, and (v) lesser trading volume.
OPTIONS ON SECURITIES
If permitted pursuant to its investment objectives and policies, a Fund
may write (sell) covered call and put options to a limited extent on its
portfolio securities ("covered options"). However, a Fund may forgo the benefits
of appreciation on securities sold or may pay more than the market price on
securities acquired pursuant to call and put options written by the Fund.
When a Fund writes a covered call option, it gives the purchaser of the
option the right to buy the underlying security at the price specified in the
option (the "exercise price") by exercising the option at any time during the
option period. If the option expires unexercised, the Fund will realize income
in an amount equal to the premium received for writing the option. If the option
is exercised, a decision over which a Fund has no control, the Fund must sell
the underlying security to the option holder at the exercise price. By writing a
covered call option, a Fund forgoes, in exchange for the premium less the
commission ("net premium"), the opportunity to profit during the option period
from an increase in the market value of the underlying security above the
exercise price.
When a Fund writes a covered put option, it gives the purchaser of the
option the right to sell the underlying security to the Fund at the specified
exercise price at any time during the option period. If the option expires
unexercised, the Fund will realize income in the amount of the premium received
for writing the option. If the put option is exercised, a decision over which a
Fund has no control, the Fund must purchase the underlying security from the
option holder at the exercise price. By writing a covered put option, a Fund, in
exchange for the net premium received, accepts the risk of a decline in the
market value of the underlying security below the exercise price. A Fund will
only write put options involving securities for which a determination is made at
the time the option is written that the Fund wishes to acquire the securities at
the exercise price.
A Fund may terminate its obligation as the writer of a call or put option
by purchasing an option with the same exercise price and expiration date as the
option previously written. This transaction is called a "closing purchase
transaction." Where a Fund cannot effect a closing purchase transaction, it may
be forced to incur brokerage commissions or dealer spreads in selling securities
it receives or it may be forced to hold underlying securities until an option is
exercised or expires.
When a Fund writes an option, an amount equal to the net premium received
by the Fund is included in the liability section of the Fund's Statement of
Assets and Liabilities as a deferred credit. The amount of the deferred credit
will be subsequently marked to market to reflect the current market value of the
option written. The current market value of a traded option is the last sale
price or, in the absence of a sale, the mean between the closing bid and asked
price. If an option expires on its stipulated expiration date or if the Fund
enters into a closing purchase transaction, the Fund will realize a gain (or
loss if the cost of a closing purchase transaction exceeds the premium received
when the option was sold), and the deferred credit related to such option will
be eliminated. If a call option is exercised, the Fund will realize a gain or
loss from the sale of the underlying security and the proceeds of the sale will
be increased by the premium originally received. The writing of covered call
options may be deemed to involve the pledge of the securities against which the
option is being written. Securities against which call options are written will
be segregated on the books of the custodian for the Fund.
A Fund may purchase call and put options on any securities in which it may
invest. A Fund would normally purchase a call option in anticipation of an
increase in the market value of such securities. The purchase of a call option
would entitle the Fund, in exchange for the premium paid, to purchase a security
at a specified price during the option period. A Fund would ordinarily have a
gain if the value of the securities increased above the exercise price
sufficiently to cover the premium and would have a loss if the value of the
securities remained at or below the exercise price during the option period.
A Fund would normally purchase put options in anticipation of a decline in
the market value of securities in its portfolio ("protective puts") or
securities of the type in which it is permitted to invest. The purchase of a put
option would entitle a Fund, in exchange for the premium paid, to sell a
security, which may or may not be held in the Fund's portfolio, at a specified
price during the option period. The purchase of protective puts is designed
merely to offset or hedge against a decline in the market value of the Fund's
portfolio securities. Put options also may be purchased by a Fund for the
purpose of affirmatively benefiting from a decline in the price of securities
which the Fund does not own. A Fund would ordinarily recognize a gain if the
value of the securities decreased below the exercise price sufficiently to cover
the premium and would recognize a loss if the value of the securities remained
at or above the exercise price. Gains and losses on the purchase of protective
put options would tend to be offset by countervailing changes in the value of
underlying portfolio securities.
Each Fund has adopted certain other non-fundamental policies concerning
option transactions which are discussed below. A Fund's activities in options
may also be restricted by the requirements of the Internal Revenue Code of 1986,
as amended (the "Code"), for its qualification as a regulated investment
company.
The hours of trading for options on securities may not conform to the
hours during which the underlying securities are traded. To the extent that the
option markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying securities
markets that cannot be reflected in the option markets. It is impossible to
predict the volume of trading that may exist in such options, and there can be
no assurance that viable exchange markets will develop or continue.
Each Fund may engage in over-the-counter options transactions with
broker-dealers who make markets in these options. At present, approximately ten
broker-dealers, including several of the largest primary dealers in U.S.
Government securities, make these markets. The ability to terminate
over-the-counter option positions is more limited than with exchange-traded
option positions because the predominant market is the issuing broker rather
than an exchange, and may involve the risk that broker-dealers participating in
such transactions will not fulfill their obligations. To reduce this risk, a
Fund will purchase such options only from broker-dealers who are primary
government securities dealers recognized by the Federal Reserve Bank of New York
and who agree to (and are expected to be capable of) entering into closing
transactions, although there can be no guarantee that any such option will be
liquidated at a favorable price prior to expiration. The investment managers
will monitor the creditworthiness of dealers with whom a Fund enters into such
options transactions, under the general supervision of the Trust's Trustees.
OPTIONS ON SECURITIES INDICES
In addition to options on securities, and if permitted pursuant to its
investment objectives and policies, a Fund may also purchase and write (sell)
call and put options on securities indices. Such options give the holder the
right to receive a cash settlement during the term of the option based upon the
difference between the exercise price and the value of the index. Such options
will be used for the purposes described above under "Options on Securities."
Options on securities indices entail risks in addition to the risks of
options on securities. The absence of a liquid secondary market to close out
options positions on securities indices is more likely to occur, although a Fund
generally will only purchase or write such an option if its investment managers
believe the option can be closed out.
Use of options on securities indices also entails the risk that trading in
such options may be interrupted if trading in certain securities included in the
index is interrupted. A Fund will not purchase such options unless its
investment managers believe the market is sufficiently developed such that the
risk of trading in such options is no greater than the risk of trading in
options on securities.
Price movements in the Fund's securities may not correlate precisely with
movements in the level of an index and, therefore, the use of options on indices
cannot serve as a complete hedge. Because options on securities indices require
settlement in cash, the investment managers may be forced to liquidate portfolio
securities to meet a Fund's settlement obligations.
SHORT SALES "AGAINST THE BOX"
In a short sale, a Fund sells a borrowed security and has a corresponding
obligation to the lender to return the identical security. A Fund may engage in
short sales only if at the time of the short sale it owns or has the right to
obtain, at no additional cost, an equal amount of the security being sold short.
This investment technique is known as a short sale "against the box".
In a short sale, the seller does not immediately deliver the securities
sold and is said to have a short position in those securities until delivery
occurs. If a Fund engages in a short sale, the collateral for the short position
will be maintained by its custodian or qualified sub-custodian. While the short
sale is open, a Fund maintains in a segregated account an amount of securities
equal in kind and amount to the securities sold short or securities convertible
into or exchangeable for such equivalent securities. These securities constitute
the Fund's long position.
A Fund will not engage in short sales against the box for investment
purposes. A Fund may, however, make a short sale as a hedge, when it believes
that the price of a security may decline, causing a decline in the value of a
security (or a security convertible or exchangeable for such security), or when
a Fund wants to sell the security at an attractive current price, but also
wishes to defer recognition of gain or loss for federal income tax purposes or
for purposes of satisfying certain tests applicable to regulated investment
companies under the Code. In such case, any future losses in a Fund's long
position should be reduced by a gain in the short position. Conversely, any gain
in the long position should be reduced by a loss in the short position. The
extent to which such gains or losses are reduced depends upon the amount of the
security sold short relative to the amount a Fund owns. There are certain
additional transaction costs associated with short sales against the box, but a
Fund will endeavor to offset these costs with the income from the investment of
the cash proceeds of short sales.
As a non-fundamental operating policy, not more than 40% of a Fund's total
assets would be involved in short sales against the box.
CERTAIN OTHER OBLIGATIONS
In order to allow for investments in new instruments that may be created
in the future, upon the Trust supplementing the Funds' Prospectus, a Fund may
invest in obligations other than those listed previously, provided such
investments are consistent with such Fund's investment objective, policies and
restrictions.
RATING SERVICES
Ratings represent the opinions of rating services as to the quality of the
securities that they undertake to rate. It should be emphasized, however, that
ratings are relative and subjective and are not absolute standards of quality.
Although these ratings are an initial criterion for selection of portfolio
investments, the investment managers also make their own evaluations of these
securities, subject to review by the Board of Trustees of the Trust. After
purchase by a Fund, an obligation may cease to be rated or its rating may be
reduced below the minimum required for purchase by the Fund. Neither event would
require a Fund to dispose of the obligation, but its adviser or subadviser will
consider such an event in its determination of whether the Fund should continue
to hold the obligation. A description of the ratings used herein and in the
Funds' Prospectus is set forth in the Appendix to this Statement of Additional
Information.
Except as stated otherwise, all investment policies and restrictions
described herein are non-fundamental, and may be changed without prior
shareholder approval.
INVESTMENT RESTRICTIONS
The following investment restrictions are "fundamental policies" of each
Fund and may not be changed with respect to a Fund without the approval of a
"majority of the outstanding voting securities" of the Fund. "Majority of the
outstanding voting securities" under the 1940 Act and as used in this Statement
of Additional Information and the Prospectus means, with respect to a Fund, the
lesser of (i) 67% or more of the outstanding voting securities of the Fund
present at a meeting, if the holders of more than 50% of the outstanding voting
securities of the Fund are present or represented by proxy, or (ii) more than
50% of the outstanding voting securities of the Fund.
Shareholders of the Bond Index Fund, which invests through the Bond Index
Portfolio, should be aware that the fundamental policies of the Bond Index
Portfolio may not be changed without the approval of a "majority of the
outstanding voting securities" of such Portfolio, i.e., the holders of the
beneficial interests of the Portfolio. Whenever the Trust is requested to vote
on a fundamental policy of the Bond Index Portfolio, the Trust will hold a
meeting of the Bond Index Fund's shareholders and will cast its vote as
instructed by that Fund's shareholders.
With respect to each fundamental investment restriction and each
non-fundamental investment policy listed below, if a percentage restriction
(other than a restriction as to borrowing) or a rating restriction on investment
or utilization of assets is adhered to at the time an investment is made or
assets are so utilized, a later change in such percentage resulting from changes
in a Fund's total assets or the value of a Fund's securities, or a later change
in the rating of a portfolio security, will not be considered a violation of the
relevant restriction or policy.
As a matter of fundamental policy, each Fund may not (except that no
investment restriction of a Fund shall prevent a Fund from investing all of its
investable assets in an open-end management investment company with
substantially the same investment objective and policies as the Fund):
(1) borrow money or mortgage or hypothecate assets of the Fund, except
that in an amount not to exceed 1/3 of the current value of the Fund's assets
(including such borrowing) less liabilities (not including such borrowing), it
may borrow money, enter into reverse repurchase agreements, and purchase
when-issued securities, and except that it may pledge, mortgage or hypothecate
its assets to secure such borrowings, reverse repurchase agreements, or
when-issued securities, provided that collateral arrangements with respect to
options and futures, including deposits of initial margin and variation margin,
are not considered a pledge of assets for purposes of this restriction, and
except that assets may be pledged to secure letters of credit solely for the
purpose of participating in a captive insurance company sponsored by the
Investment Company Institute. The Fund will not purchase securities while
borrowings exceed 5% of the Fund's total assets;
(2) underwrite securities issued by other persons except insofar as the
Trust or a Fund may technically be deemed an underwriter under the 1933 Act in
selling a portfolio security;
(3) make loans to other persons except (a) through the lending of the
Fund's portfolio securities and provided that any such loans not exceed 30% of
the Fund's total assets (taken at market value), (b) through the use of
repurchase agreements or the purchase of short-term obligations, or (c) by
purchasing debt securities of types distributed publicly or privately;
(4) purchase or sell real estate (including limited partnership interests
in partnerships substantially all of whose assets consist of real estate but
excluding securities secured by real estate or interests therein), interests in
oil, gas or mineral leases, commodities or commodity contracts (except futures
and option contracts) in the ordinary course of business (the Trust may hold and
sell, for a Fund's portfolio, real estate acquired as a result of the Fund's
ownership of securities);
(5) invest 25% or more of its assets in any one industry (excluding U.S.
Government securities), unless, in the case of the Bond Index Fund, the bonds
issued by companies in a single industry were to comprise 25% or more of Lehman
Brothers Aggregate Bond Index, in which case such Fund will invest 25% or more
of its assets in that industry; or
(6) issue any senior security (as that term is defined in the 1940 Act) if
such issuance is specifically prohibited by the 1940 Act or the rules and
regulations promulgated thereunder, provided that collateral arrangements with
respect to options and futures, including deposits of initial deposit and
variation margin, are not considered to be the issuance of a senior security for
purposes of this restriction.
State and Federal Restrictions. In order to comply with certain state and
federal statutes and policies each Fund will not as a matter of operating policy
(except that no operating policy shall prevent a Fund from investing all of its
investable assets in an open-end investment company with substantially the same
investment objective and policies as the Fund):
(i) purchase any security or evidence of interest therein on margin,
except that such short-term credit as may be necessary for the
clearance of purchases and sales of securities may be obtained and
except that deposits of initial deposit and variation margin may be
made in connection with the purchase, ownership, holding or sale of
futures;
(ii) invest for the purpose of exercising control or
management;
(iii) purchase securities issued by any other investment company except by
purchase in the open market where no commission or profit to a sponsor
or dealer results from such purchase other than the customary broker's
commission, or except when such purchase, though not made in the open
market, is part of a plan of merger or consolidation; provided,
however, that securities of any investment company will not be
purchased for the Fund if such purchase at the time thereof would
cause (a) more than 10% of the Fund's total assets (taken at the
greater of cost or market value) to be invested in the securities of
such issuers; (b) more that 5% of the Fund's total assets (taken at
the greater of cost or market value) to be invested in any one
investment company; or (c) more than 3% of the outstanding voting
securities of any such issuer to be held for the Fund;
(iv) purchase securities of any issuer if such purchase at the time thereof
would cause the Fund to hold more than 10% of any class of securities
of such issuer, for which purposes all indebtedness of an issuer shall
be deemed a single class and all preferred stock of an issuer shall be
deemed a single class, except that futures or option contracts shall
not be subject to this restriction;
(v) purchase or retain in the Fund's portfolio any securities issued by an
issuer any of whose officers, directors, trustees or security holders
is an officer or Trustee of the Trust, or is an officer or partner of
the investment adviser or subadviser of the Fund, if after the
purchase of the securities of such issuer for the Fund one or more of
such persons owns beneficially more than 1/2 of 1% of the shares or
securities, or both, all taken at market value, of such issuer, and
such persons owning more than 1/2 of 1% of such shares or securities
together own beneficially more than 5% of such shares or securities,
or both, all taken at market value;
(vi) invest more than 5% of the Fund's net assets in warrants (valued at
the lower of cost or market), but not more than 2% of the Fund's net
assets may be invested in warrants not listed on the New York Stock
Exchange or the American Stock Exchange;
(vii) make short sales of securities or maintain a short position (excluding
short sales if the Fund owns an equal amount of such securities or
securities convertible into or exchangeable for, without payment of
any further consideration, securities of equivalent kind and amount)
if such short sales represent more than 25% of the Fund's net assets
(taken at market value); provided, however, that the value of the
Fund's short sales of securities (excluding U.S. Government
securities) of any one issuer may not be greater than 2% of the value
(taken at market value) of the Fund's net assets or more than 2% of
the securities of any class of any issuer;
(viii) enter into repurchase agreements providing for settlement in more than
seven days after notice, or purchase securities which are not readily
marketable, if, in the aggregate, more than 15% of its net assets
would be so invested; or
(ix) purchase puts, calls, straddles, spreads or any combination thereof,
if by reason of such purchase the value of its aggregate investment in
such securities would exceed 5% of the Fund's total assets.
Policies (i) through (ix) may be changed by the Board of Trustees of the
Trust.
PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSIONS
Except as may be required to ensure satisfaction of certain tests
applicable to regulated investment companies under the Code, portfolio changes
are made without regard to the length of time a security has been held, or
whether a sale would result in the recognition of a profit or loss. Each Fund
may engage in short-term trading to achieve its investment objective(s).
Portfolio turnover may vary greatly from year to year as well as within a
particular year. It is expected that the Income Fund's and Total Return Bond
Fund's turnover rates may remain higher than those of many other investment
companies with similar investment objectives and policies; however, since
brokerage commissions are not normally paid on instruments purchased by these
Funds, portfolio turnover is not expected to have a material effect on the net
asset value of either Fund. Each Fund's portfolio turnover rate may also be
affected by cash requirements for redemptions of shares and by regulatory
provisions which enable a Fund to receive certain favorable tax treatment.
Portfolio turnover will not be a limiting factor in making portfolio decisions.
Portfolio trading is engaged in for a Fund if its investment managers believe
that a transaction net of costs (including custodian charges) will help achieve
the Fund's investment objective.
A Fund's purchase and sales of securities may be principal transactions,
that is, securities may be purchased directly from the issuer or from an
underwriter or market maker for the securities. There usually are no brokerage
commissions paid for such purchases and, therefore, the Funds do not anticipate
paying brokerage commissions in such transactions. Purchases and sales of the
Bond Index Fund's, Income Fund's and Total Return Bond Fund's portfolio
securities will usually be principal transactions without brokerage commissions.
Any transactions for which a Fund pays a brokerage commission will be effected
at the best price and execution available. Purchases from underwriters of
securities include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers serving as market makers include the
spread between the bid and the asked price.
Allocations of transactions, including their frequency, to various dealers
is determined by the investment managers in their best judgment and in a manner
deemed to be in the best interest of the investors in the applicable Fund rather
than by any formula. The primary consideration is prompt execution of orders in
an effective manner at the most favorable price.
The Advisory and Subadvisory Agreements provide that, in executing
portfolio transactions and selecting brokers or dealers, the investment managers
will seek to obtain the best net price and the most favorable execution. The
investment managers shall consider factors they deem relevant, including the
breadth of the market in the security, the price of the security, the financial
condition and execution capability of the broker or dealer, and the
reasonableness of the commission, if any, for the specific transaction and on a
continuing basis.
In addition, the Advisory and Subadvisory Agreements authorize the
investment managers, to the extent permitted by law and subject to the review of
the Trust's Board of Trustees (or Federated Portfolios' Board of Trustees, in
the case of the Bond Index Portfolio), to cause the Funds to pay a broker which
furnishes brokerage and research services a higher commission than that which
might be charged by another broker for effecting the same transaction, provided
that the investment managers determine in good faith that such commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker, viewed in terms of either that particular transaction
or the overall responsibilities of the investment managers to the accounts as to
which it exercises investment discretion. Such brokerage and research services
might consist of reports and statistics on specific companies or industries,
general summaries of groups of stocks and their comparative earnings, or broad
overviews of the stock market and the economy. Such services might also include
reports on global, regional, and country-by-country prospects for economic
growth, anticipated levels of inflation, prevailing and expected interest rates,
and the outlook for currency relationships.
Supplementary research information so received is in addition to and not
in lieu of services required to be performed by the investment managers and does
not reduce the investment advisory fees (if any) payable by the Funds. Such
information may be useful to the investment managers in serving the Funds and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to the investment managers
in carrying out their obligations to the Funds.
Investment decisions for a Fund will be made independently from those for
any other account or investment company that is or may in the future become
managed by its investment managers or any of their affiliates. If, however, a
Fund and other investment companies or accounts managed by the same investment
manager are contemporaneously engaged in the purchase or sale of the same
security, the transactions may be averaged as to price and allocated equitably
to each account. In some cases, this policy might adversely affect the price
paid or received by a Fund or the size of the position obtainable for the Fund.
In addition, when purchases or sales of the same security for a Fund and for
other investment companies managed by the same investment manager occur
contemporaneously, the purchase or sale orders may be aggregated in order to
obtain any price advantages available to large denomination purchases or sales.
Furthermore, in certain circumstances affiliates of the investment managers
whose investment portfolios are managed internally, rather than by the
investment managers, might seek to purchase or sell the same type of investments
at the same time as a Fund. Such an event might also adversely affect that Fund.
The following Funds1/ paid the following approximate brokerage commissions
for their respective fiscal periods from commencement of operations2/ through
May 31, 1995: Equity Fund: $27,636; Balanced Fund: $43,886; Equity Growth Fund:
$163,537; International Equity Fund: $33,014; Bond Index, Income and Total
Return Bond Funds: $0.
PORTFOLIO TURNOVER
Set forth below are the portfolio turnover rates for the Funds3/ for the
indicated periods. A rate of 100% indicates that the equivalent of all of a
Fund's assets have been sold and reinvested in a year. High portfolio turnover
may result in the realization of substantial net capital gains or losses. 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 Taxation below. Portfolio turnover rates from commencement of operations4/
through May 31, 1995 were as follows: Equity Fund, 34%; Income Fund, 34%; Total
Return Bond Fund, 84%; Bond Index Fund, 67%; Balanced Fund, 57%; Equity Growth
Fund, 122%; International Equity Portfolio, 8%.
PERFORMANCE INFORMATION
STANDARD PERFORMANCE INFORMATION
From time to time, quotations of the Funds' performance may be included in
advertisements, sales literature or shareholder reports. These performance
figures are calculated in the following manner:
YIELD. The Bond Index, Income and Total Return Bond Funds may quote the
standardized effective 30-day (or one month) yield for their respective shares,
calculated in accordance with the method prescribed by the Securities and
Exchange Commission for mutual funds. Such yield will be calculated for such
Fund's shares according to the following formula:
Yield = 2 (ab/cd + 1)6
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = average daily number of shares outstanding that were entitled
to receive dividends.
d = maximum offering price per share on the last day
of the period.
For the purpose of determining interest earned during the period (variable
"a" in the formula), each Fund computes the yield to maturity of any debt
obligation held by it based on the market value of the obligation (including
actual accrued interest) at the close of business on the last business day of
each month, or, with respect to obligations purchased during the month, the
purchase price (plus actual accrued interest). Such yield is then divided by
360, and the quotient is multiplied by the market value of the obligation
(including actual accrued interest) in order to determine the interest income on
the obligation for each day of the subsequent month that the obligation is in
the portfolio. It is assumed in the above calculation that each month contains
30 days. Also, the maturity of a debt obligation with a call provision is deemed
to be the next call date on which the obligation reasonably may be expected to
be called or, if none, the maturity date. Each Fund calculates interest gained
on tax-exempt obligations issued without original issue discount and having a
current market discount by using the coupon rate of interest instead of the
yield to maturity. In the case of tax-exempt obligations with original issue
discount, where the discount based on the current market value exceeds the
then-remaining portion of original issue discount, the yield to maturity is the
imputed rate based on the original issue discount calculation. Conversely, where
the discount based on the current market value is less than the remaining
portion of the original issue discount, the yield to maturity is based on the
market value.
Expenses accrued for the period (variable "b" in the formula) include all
recurring fees charged by a Fund to all shareholder accounts in proportion to
the length of the base period and that Fund's mean (or median) account size.
Undeclared earned income will be subtracted from the maximum offering price per
share (variable "d" in the formula).
The Balanced Fund may quote standardized effective 30-day (or one month)
yield for the fixed income portion of its portfolio, calculated in the same
manner as specified above.
TOTAL RETURN. Each Fund's "average annual total return" may be quoted, and
such return is computed by determining the average annual compounded rate of
return during specified periods that equates the initial amount invested to the
ending redeemable value of such investment according to the following formula:
T = [(ERV/P)1/n - 1]
Where: T = average annual total return.
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5- or 10-year (or other)
periods at the end of the applicable period (or a fractional
portion thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed
in years.
The calculation is made assuming that (1) all dividends and capital gains
distributions are reinvested on the reinvestment dates at the price per share
existing on the reinvestment date, (2) all recurring fees charged to all
shareholder accounts are included, and (3) for any account fees that vary with
the size of the account, a mean (or median) account size in the Fund during the
periods is reflected. The ending redeemable value (variable "ERV", in the
formula) is determined by assuming complete redemption of the hypothetical
investment after deduction of all nonrecurring charges at the end of the
measuring period.
DISTRIBUTION RATE. Each Fund may also quote its distribution rate.
Distribution rate is calculated by annualizing the per share distribution for
the most recent calendar month and dividing such annualized distribution by the
net asset value per share on the last day of such month. The distribution rate
of a Fund will not be used in advertising unless accompanied by standard
performance measures.
PERFORMANCE RESULTS. Any yield or total return quotation provided for a
Fund should not be considered as representative of the performance of that Fund
in the future since the net asset value of shares of that Fund will vary based
not only on the type, quality and maturities of the securities held by it, but
also on changes in the current value of such securities and on changes in the
expenses of the Fund. These factors and possible differences in the methods used
to calculate yields and total return should be considered when comparing the
yield and total return of a Fund to yields and total rates of return published
for other investment companies or other investment vehicles. Total return
reflects the performance of both principal and income.
Below is set forth historical return information for the Funds for the
periods indicated (in each case the period end is May 31, 1995):
Excelsior Institutional Equity Fund: average annual total return,
commencement of operations(*) to period end: 10.80%; aggregate total return,
commencement of operations(*) to period end: 10.80%.
Excelsior Institutional Income Fund: 30-day yield for the period ending May 31,
1995: 6.46%; average annual total return, commencement of operations(*) to
period end: 7.51%; aggregate total return, commencement of operations(*) to
period end: 7.51%.
Excelsior Institutional Total Return Bond Fund: 30-day yield for the period
ending May 31, 1995: 6.70%; average annual total return, commencement of
operations(*) to period end: 9.40%; aggregate total return, commencement of
operations(*) to period end: 9.40%.
Excelsior Institutional Bond Index Fund: 30-day yield for the period ending
May 31, 1995: 6.74%; average annual total return, commencement of operations(*)
to period end: 11.03%; aggregate total return, commencement of operations(*) to
period end: 11.03%.
Excelsior Institutional Balanced Fund: 30-day yield for the period ending
May 31, 1995: 4.66%; average annual total return, commencement of operations(*)
to period end: 14.59%; aggregate total return, commencement of operations(*) to
period end: 14.59%.
Excelsior Institutional Equity Growth Fund: average annual total return,
commencement of operations(*) to period end: 13.38%; aggregate total return,
commencement of operations(*) to period end: 13.38%.
Excelsior Institutional International Equity Fund: average annual total
return, commencement of operations(*) to period end: 12.57%; aggregate total
return, commencement of operations(*) to period end: 12.57%.
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(*) The Funds commenced operations on the following dates: Equity and Income
Funds, January 16, 1995; Total Return Bond Fund, January 19, 1995; Bond Index,
Balanced and Equity Growth Funds, July 11, 1994; and International Equity Fund,
January 24, 1995.
COMPARISON OF FUND PERFORMANCE
Comparisons of non-standardized performance measures of various
investments are valid only if performance is calculated in the same manner for
each measure in the comparison. Since there are different methods of calculating
performance, investors should consider the effect of the methods used to
calculate performance when comparing the performance of a Fund with performance
quoted with respect to other investment companies or types of investments.
In connection with communicating its performance to current or prospective
shareholders, each Fund also may compare these figures to the performance of
other mutual funds tracked by mutual fund rating services or to unmanaged
indices which may assume reinvestment of dividends but generally do not reflect
deductions for administrative and management costs. Some Funds may invest in
some instruments not eligible for inclusion in such an index, and may be
prohibited from investing in some instruments included in this index.
Evaluations of a Fund's performance made by independent sources may also be used
in advertisements concerning such Fund. Sources for a Fund's performance
information may include, but are not limited to, the following:
Asian Wall Street Journal, a weekly Asian newspaper that often reviews U.S.
mutual funds investing internationally.
Barron's, a Dow Jones and Company, Inc. business and financial weekly that
periodically reviews mutual fund performance data.
Business Week, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds investing abroad.
Changing Times, The Kiplinger Magazine, a monthly investment advisory
publication that periodically features the performance of a variety of
securities.
Consumer Digest, a monthly business/financial magazine that includes a "Money
Watch" section featuring financial news.
Donoghue's Money Fund Report, a weekly publication of the Donoghue Organization,
Inc., of Holliston, Massachusetts, reporting on the performance of the nation's
money market funds, summarizing money market fund activity, and including
certain averages as performance benchmarks, specifically "Donoghue's Money Fund
Average" and "Donoghue's Government Money Fund Average."
Financial Times, Europe's business newspaper, which features from time to time
articles on international or country-specific funds.
Financial World, a general business/financial magazine that includes a "Market
Watch" department reporting on activities in the mutual fund industry.
Forbes, a national business publication that from time to time reports the
performance of specific investment companies in the mutual fund industry.
Fortune, a national business publication that periodically rates the performance
of a variety of mutual funds.
Investor's Daily, a daily newspaper that features financial, economic and
business news.
Lipper Analytical Services, Inc.'s Mutual Fund Performance Analysis, a
weekly publication of industry-wide mutual fund averages by type of fund.
Money, a monthly magazine that from time to time features both specific funds
and the mutual fund industry as a whole.
New York Times, a nationally distributed newspaper which regularly covers
financial news.
Personal Investing News, a monthly news publication that often reports on
investment opportunities and market conditions.
Personal Investor, a monthly investment advisory publication that includes a
"Mutual Funds Outlook" section reporting on mutual fund performance measures,
yields, indices and portfolio holdings.
Success, a monthly magazine targeted to the world of entrepreneurs and growing
business, often featuring mutual fund performance data.
U.S. News and World Report, a national business weekly that periodically reports
mutual fund performance data.
Wall Street Journal, a Dow Jones and Company, Inc. newspaper which regularly
covers financial news.
Weisenberger Investment Companies Services, an annual compendium of information
about mutual funds and other investment companies, including comparative data on
funds' backgrounds, management policies, salient features, management results,
income and dividend records, and price ranges.
Working Women, a monthly publication that features a "Financial Workshop"
section reporting on the mutual fund/financial industry.
World Investor, a European publication that periodically reviews the performance
of U.S. mutual funds investing internationally.
DETERMINATION OF NET ASSET VALUE; VALUATION OF SECURITIES
The Trust determines the net asset value of the shares of each Fund each
day that the New York Stock Exchange (the "NYSE") is open for business (a
"Business Day"). As a result, each Fund will normally determine its net asset
value every weekday except for the following holidays: New Year's Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Columbus Day, Thanksgiving Day and Christmas. Daily determinations of net asset
value for each Fund are made at 4:00 p.m. (Eastern time) by dividing the total
assets of a Fund less all of its liabilities, by the total number of shares of
the Fund outstanding at the time the determination is made. Purchases and
redemptions will be effected at the time of determination of net asset value
next following the receipt of any purchase or redemption order deemed to be in
good order. See "How To Purchase, Exchange and Redeem Shares" in the Prospectus.
Portfolio securities are valued on the basis of market quotations when
they are readily available. Each Fund values mortgage-backed and other debt
securities for which market quotations are not readily available at their fair
value as determined in good faith, utilizing procedures approved by the Board of
Trustees of the Trust, on the basis of valuations provided either by dealers or
a pricing service. Absent unusual circumstances, debt securities having a
remaining maturity of sixty days or less when purchased, and debt securities
originally purchased with maturities in excess of sixty days but which currently
have maturities of sixty days or less, are valued at cost adjusted for
amortization of premiums and accretion of discounts.
Interest rate futures contracts held by a Fund are valued on the basis of
closing market quotations, which are normally available daily. When market
quotations are not readily available, the fair value of these contracts will be
determined in good faith utilizing procedures approved by the Board of Trustees
of the Trust.
A determination of value used in calculating net asset value must be a
fair value determination made in good faith utilizing procedures approved by the
Trust's Board of Trustees. While no single standard for determining fair value
exists, as a general rule, the current fair value of a security would appear to
be the amount which a Fund could expect to receive upon its current sale. Some,
but not necessarily all, of the general factors which may be considered in
determining fair value include: (i) the fundamental analytical data relating to
the investment; (ii) the nature and duration of restrictions on disposition of
the securities; and (iii) an evaluation of the forces which influence the market
in which these securities are purchased and sold. Without limiting or including
all of the specific factors which may be considered in determining fair value,
some of the specific factors include: type of security, financial statements of
the issuer, cost at date of purchase, size of holding, discount from market
value, value of unrestricted securities of the same class at the time of
purchase, special reports prepared by analysts, information as to any
transactions or offers with respect to the security, existence of merger
proposals or tender offers affecting the securities, price and extent of public
trading in similar securities of the issuer or comparable companies, and other
relevant matters.
The Bond Index Fund, as an investor in the Federated Portfolios, may add
to or reduce its investment in the Bond Index Portfolio on each Business Day. As
of 4:00 p.m. (Eastern time) on each such day, the value of each investor's
interest in the Bond Index Portfolio will be determined by multiplying the net
asset value of that Portfolio by the percentage representing that investor's
share of the aggregate beneficial interests in the Portfolio. Any additions or
reductions which are to be effected on that day will then be effected. The
investor's percentage of the aggregate beneficial interests in the Bond Index
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 that
Portfolio as of 4:00 p.m. 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 on such day, and (ii) the denominator of which is the
aggregate net asset value of the Portfolio as of 4:00 p.m. on such day plus or
minus, as the case may be, the amount of the 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 that Portfolio as of 4:00 p.m. on the following Business
Day.
ADDITIONAL PURCHASE, EXCHANGE, AND REDEMPTION INFORMATION
Shares are continuously offered for sale by Edgewood Services, Inc. (the
"Distributor"). As described in the Prospectus, Shares are offered for sale
directly only to institutional investors ("Institutional Investors"). Different
types of Customer accounts at certain Institutional Investors (a "Shareholder
Organization") may be used to purchase Shares, including eligible agency and
trust accounts. Investors purchasing Shares may include officers, directors, or
employees of the particular Shareholder Organization.
As stated in the Prospectus, no sales charge is imposed by the Trust on
the purchase of Shares or reinvestment of dividends or distributions.
Additionally, the Trust does not currently charge any fees for the exchange of
shares of one Fund for another Fund.
Shareholders should be aware, however, that certain Shareholder
Organizations may charge a Customer's account fees for exchange orders and other
cash management services provided. Customers should contact their Shareholder
Organization directly for further information.
The Trust may suspend the right of redemption or postpone the date of
payment for Shares for more than 7 days during any period when (a) trading on
the NYSE is restricted by applicable rules and regulations of the Securities and
Exchange Commission; (b) the NYSE is closed for other than customary weekend and
holiday closings; (c) the Securities and Exchange Commission has by order
permitted such suspension; or (d) an emergency exists as determined by the
Securities and Exchange Commission.
In the event that Shares are redeemed in cash at their net asset value, a
shareholder may receive in payment for such Shares an amount that is more or
less than his original investment due to changes in the market prices of that
Fund's portfolio securities.
OTHER INVESTOR PROGRAMS
As described in the Prospectus, Shares of the Funds may be purchased in
connection with certain Retirement Programs. Customers of Shareholder
Organizations should contact their Shareholder Organization directly to
determine their participation in certain services and programs.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS OF THE TRUST
The Trustees and officers of the Trust, their dates of birth and their
principal occupations during the past five years are set forth below. Their
titles may have varied during that period.
TRUSTEES
RODMAN L. DRAKE -- Trustee; Director, Parsons Brinkerhoff, Inc.,
(engineering firm) (since 1995); President, R.L. Drake & Co. Inc. (investment
and consulting firm) (since 1991); Trustee, Hyperion Total Return Fund, Inc.,
and three other closed-end funds for which Hyperion Capital Management, Inc. is
the investment adviser; Co-Chairman, KMR Power Corporation (power plants) (since
1993); Chairman, Car Rental Systems do Brazil S.A. (Hertz licensee for Brazil)
(since 1994); Managing Director and Chief Executive Officer, Cresap, McCormick &
Paget, Inc. (subsequently, Cresap, a Towers Perrin Company) (from 1980 to 1990);
Director, Alex. Brown & Sons, Inc. (1989 to 1991); Director, Mueller Industries,
Inc. (1992 to 1994). His date of birth is February 2, 1943. His address is c/o
KMR Power Corp., 30 Rockefeller Plaza, Suite 5425, New York, NY 10112.
W. WALLACE MCDOWELL, JR. -- Trustee; Private Investor (since 1994);
Managing Director, Morgan Lewis Githens & Ahn (1991 to 1994); Chairman and Chief
Executive Officer, The Prospect Group, Inc. (1983 to 1990) and Director, U.S.
Homecare Corporation (since 1992), Grossmans, Inc. (since 1993), Children's
Discovery Centers (since 1984), Interactive Technologies, Inc. (since 1992) and
Jack Morton Productions (since 1987). His date of birth is November 7, 1936. His
address is c/o Prospect Capital Corporation, 43 Arch Street, Greenwich,
Connecticut 06830.
JONATHAN PIEL -- Trustee; President and Editor, Scientific American, Inc.
(1969 to 1994); Director, Group for The South Fork, Bridgehampton, New York
(since October 1993); Member, Advisory Committee, Knight Journalism Fellowships,
MIT. His date of birth is November 23, 1938. His address is 558 East 87th
Street, New York, NY 10128.
EXECUTIVE OFFICERS OF THE TRUST
JOSEPH S. MACHI -- President; Director, Proprietary Funds Management,
Federated Administrative Services, since 1991; Manager, Audit Department,
Federated Administrative Services, since 1989. His address is Federated
Investors Tower, Pittsburgh, PA.
JOHN M. CORCORAN -- Assistant Treasurer; Second Vice President, Chase
Global Funds Services Company (since 1993); Audit Manager, Ernst & Young (1987
to 1993). His address is c/o Chase Global Funds Services Company, 73 Tremont
Street, Boston, MA 02108.
MICHAEL LEARY -- Assistant Secretary; Assistant Treasurer, Chase Global
Funds Services Company (since 1993); Audit Manager, Ernst & Young (1988 to
1993). His address is c/o Chase Global Funds Services Company, 73 Tremont
Street, Boston, MA 02108.
Each Trustee is paid an annual fee as follows for serving as Trustee of
the Trust, and is reimbursed for expenses incurred in connection with service as
a Trustee. The compensation paid to the Trustees for the fiscal year ended May
31, 1995 is set forth below. The Trustees may hold various other directorships
unrelated to these funds.
PENSION OR TOTAL
RETIREMENT COMPENSATION
BENEFITS ESTIMATED FROM THE
AGGREGATE ACCRUED AS ANNUAL TRUST AND
COMPENSATION PART OF BENEFITS FUND COMPLEX
FROM THE TRUST UPON PAID TO
TRUST EXPENSES RETIREMENT TRUSTEES
Rodman L. Drake $5,000 None None $5,000
W. Wallace McDowell $5,250 None None $5,250
Jonathan Piel $5,250 None None $5,250
As used in the above compensation table, the term "Fund Complex" shall
refer to the Trust, Excelsior Funds, Inc. (formerly known as UST Master Funds,
Inc.), Excelsior Tax-Exempt Funds, Inc. (formerly known as UST Master Tax-Exempt
Funds, Inc.) and UST Master Variable Series, Inc. The Trust has no pension plan.
TRUSTEES AND OFFICERS OF THE FEDERATED PORTFOLIOS
The Trustees and officers of the Federated Portfolios, their dates of
birth and principal occupations during the past five years are set forth below.
Their titles may have varied during that period. Asterisks indicate those
Trustees who are "interested persons" (as defined in the 1940 Act) of the
Federated Portfolios.
TRUSTEES
JOHN F. DONAHUE* -- Chairman of the Board and Trustee of Federated
Portfolios; Chairman and Trustee, Federated Investors, Federated Advisers,
Federated Management, Federated Research; Chairman and Director, Federated
Research Corp. and Federated Global Research Corp.; Chairman, Passport Research,
Ltd.; Chief Executive Officer and Director, Trustee or Managing General Partner
of 74 investment companies for which subsidiaries of Federated Investors serve
as investment adviser, administrator and/or distributor (the "Federated Fund
Complex"). Mr. Donahue is the father of J. Christopher Donahue, a Trustee and
President of Federated Portfolios. His date of birth is July 28, 1924. His
address is Federated Investors Tower, Pittsburgh, PA.
THOMAS G. BIGLEY -- Director, Oberg Manufacturing Co.; Chairman of the
Board, Children's Hospital of Pittsburgh; Director, Trustee, or Managing General
Partner of 74 investment companies within the Federated Fund Complex; formerly
Senior Partner, Ernst & Young LLP. His date of birth is February 3, 1934 His
address is 28th Floor, One Oxford Centre, Pittsburgh, PA.
JOHN T. CONROY, JR. -- President, Investment Properties Corporation; Senior
Vice President, John R. Wood and Associates, Inc., Realtors; President,
Northgate Village Development Corporation; Partner or Trustee in private real
estate ventures in Southwest Florida; Director, Trustee, or Managing General
Partner of 74 investment companies within the Federated Fund Complex; formerly,
President, Naples Property Management, Inc. His date of birth is June 23, 1937.
His address is Wood/IPC Commercial Department, John R. Wood and Associates,
Inc., Realtors, 3255 Tamiami Trail North, Naples, FL.
WILLIAM J. COPELAND -- Director and member of the Executive Committee,
Michael Baker, Inc; Director, Trustee or Managing General Partner of 74
investment companies within the Federated Fund Complex; formerly, Vice Chairman
and Director, PNC Bank, N.A. and PNC Bank Corp. and Director, Ryan Homes, Inc.
His date of birth is July 4, 1918. His address is One PNC Plaza, 23rd Floor,
Pittsburgh, PA.
JAMES E. DOWD -- Attorney-at-law; Director, The Emerging Germany Fund,
Inc.; Director, Trustee or Managing General Partner of 74 investment companies
within the Federated Fund Complex. His date of birth is May 18, 1922. His
address is 571 Hayward Mill Road, Concord, MA.
LAWRENCE D. ELLIS, M.D.* -- Professor of Medicine and Member, Board of
Trustees, University of Pittsburgh Medical Center - Downtown; Member, Board of
Directors, University of Pittsburgh Medical Center; formerly Hematologist,
Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Director,
Trustee, or Managing General Partner of 74 investment companies within the
Federated Fund Complex. His date of birth is October 11, 1932. His address is
3471 Fifth Avenue, Suite 1111, Pittsburgh, PA.
EDWARD L. FLAHERTY, JR. -- Attorney-at-law; Shareholder, Henny, Kochuba,
Meyer and Flaherty; Director, Eat'N Park Restaurants, Inc. and Statewide
Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of 74
investment companies within the Federated Fund Complex; formerly, Counsel,
Horizon Financial, F.A., Western Region. His date of birth is June 18, 1924. His
address is Henny, Kochuba, Meyer and Flaherty, Two Gateway Center, Suite 674,
Pittsburgh, PA.
PETER E. MADDEN -- Consultant; State Representative, Commonwealth of
Massachusetts; Director, Trustee or Managing General Partner of 74 investment
companies within the Federated Fund Complex; formerly President, State Street
Bank and Trust Company and State Street Boston Corporation. His date of birth is
April 16, 1942. His address is 70 Westcliff Road, Weston, MA.
GREGOR F. MEYER -- Attorney-at-law; Shareholder, Henny, Kochuba, Meyer and
Flaherty; Chairman, Meritcar, Inc.; Director, Eat'N Park Restaurants, Inc.;
Director, Trustee or Managing General Partner of 74 investment companies within
the Federated Fund Complex. His date of birth is October 6, 1926. His address is
Henny, Kochuba, Meyer and Flaherty, Two Gateway Center, Suite 674, Pittsburgh,
PA.
JOHN E. MURRAY, JR., J.D., S.J.D. -- President, Law Professor, Duquesne
University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or
Managing General Partner of 74 investment companies within the Federated Fund
Complex. His date of birth is December 20, 1932. His address is Duquesne
University, Pittsburgh, PA.
WESLEY W. POSVAR -- Professor, International Politics and Management
Consultant; Trustee, Carnegie Endowment for International Peace, RAND
Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation;
Chairman, Czecho Management Center; Director, Trustee or Managing General
Partner of 74 investment companies within the Federated Fund Complex; President
Emeritus, University of Pittsburgh; founding Chairman, National Advisory Council
for Environmental Policy and Technology and Federal Emergency Management
Advisory Board. His date of birth is September 14, 1925. His address is 1202
Cathedral of Learning, University of Pittsburgh, Pittsburgh, PA.
MARJORIE P. SMUTS -- Trustee; Public Relations/Marketing Consultant;
Conference Coordinator, Non-profit entities; Director, Trustee or Managing
General Partner of 74 investment companies within the Federated Fund Complex.
Her date of birth is June 21, 1935. Her address is 4905 Bayard Street,
Pittsburgh, PA.
J. CHRISTOPHER DONAHUE* -- President and Trustee, Federated Portfolios;
President and Trustee, Federated Investors, Federated Advisers, Federated
Management and Federated Research; President and Director, Federated Research
Corp. and Federated Global Research Corp.; President, Passport Research, Ltd.;
Trustee, Federated Administrative Services, Federated Services Company and
Federated Shareholder Services; President or Executive Vice President of 74
investment companies within the Federated Fund Complex; Director, Trustee or
Managing General Partner of certain investment companies within the Federated
Fund Complex. Mr. Donahue is the son of John F. Donahue, Chairman and Trustee of
the Federated Portfolios. His date of birth is April 11, 1949. His address is
Federated Investors Tower, Pittsburgh, PA.
EXECUTIVE OFFICERS OF FEDERATED PORTFOLIOS
RICHARD B. FISHER -- Vice President; Executive Vice President and Trustee,
Federated Investors; Chairman and Director, Federated Securities Corp.;
President or Vice President of certain investment companies within the Federated
Fund Complex; Director or Trustee of certain investment companies within the
Federated Fund Complex. His address is Federated Investors Tower, Pittsburgh,
PA.
EDWARD C. GONZALEZ -- Executive Vice President; Vice Chairman, Treasurer
and Trustee, Federated Investors; Vice President, Federated Advisers, Federated
Management, Federated Research, Federated Research Corp., Federal Global
Research Corp. and Passport Research Ltd.; Executive Vice President and
Director, Federated Securities Corp.; Trustee, Federated Services Company,
Chairman, Treasurer and Trustee, Federated Administrative Services; Trustee or
Director of certain investment companies within the Federated Fund Complex;
Executive Vice President and Treasurer of 74 investment companies within the
Federated Fund Complex. His address is Federated Investors Tower, Pittsburgh,
PA.
JOHN W. MCGONIGLE -- Executive Vice President and Secretary; Executive Vice
President, Secretary, General Counsel and Trustee, Federated Investors; Trustee,
Federated Advisers, Federated Management and Federated Research; Director,
Federated Research, Federated Research Corp., Federal Global Research Corp.;
Trustee, Federated Services Company; Executive Vice President, Secretary and
Trustee, Federated Administrative Services; President and Trustee, Federated
Shareholder Services; Director, Federated Securities Corp.; Executive Vice
President and Secretary of 74 investment companies within the Federated Fund
Complex. His address is Federated Investors Tower, Pittsburgh, PA.
DAVID M. TAYLOR -- Treasurer; Senior Vice President, Controller, and
Trustee, Federated Investors; Vice President, Federated Shareholder Services;
Treasurer of certain investment companies within the Federated Fund Complex. His
address is Federated Investors Tower, Pittsburgh, PA.
Messrs. Fisher, Gonzalez, McGonigle and Taylor may also hold similar
positions for other investment companies affiliated with Federal Investors.
The compensation paid to the Trustees of Federated Portfolios for the year
ended August 31, 1995 is set forth below. The Trustees may hold various other
directorships unrelated to the Federated Portfolios.
PENSION OR TOTAL
RETIREMENT COMPENSATION
BENEFITS FROM
AGGREGATE ACCRUED AS ESTIMATED FEDERATED
COMPENSATION PART OF ANNUAL PORTFOLIOS
FROM FEDERATED BENEFITS AND FUND
FEDERATED PORTFOLIO'S UPON COMPLEX PAID
PORTFOLIOS EXPENSES RETIREMENT TO TRUSTEES
John F. Donahue None None None $ 0
Thomas G. Bigley None None None $ 20,688
John T. Conroy, Jr. None None None $117,202
William J. Copeland None None None $117,202
James E. Dowd None None None $117,202
Lawrence D. Ellis, M.D. None None None $106,460
Edward L. Flaherty, Jr. None None None $117,202
Peter E. Madden None None None $ 90,563
Gregor F. Meyer None None None $106,460
John E. Murray, Jr., S.D., None None None $ 0
S.J.D.
Wesley W. Posvar None None None $106,460
Marjorie P. Smuts None None None $106,460
J. Christopher Donahue None None None $ 0
As used in the above compensation table, the term "Fund Complex" shall
collectively refer to Federated Portfolios and up to 68 other mutual funds for
which subsidiaries of Federated Investors serve as investment adviser,
administrator and/or distributor. Federated Portfolios has no pension plan. It
is expected that each of the Trustees who is not an "interested person" will not
receive compensation from the Federated Portfolios for service as Trustees
during the first fiscal year of the Federated Portfolios, and thereafter shall
be paid such amounts as shall be fixed by the Board of Trustees of Federated
Portfolios.
* * * * *
The Trust Instrument of the 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
Trust unless it is finally adjudicated that they engaged in willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in
their offices, or unless 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 Trust. 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 willful misfeasance, bad faith, gross negligence or reckless
disregard of their duties.
The Declaration of Trust of Federated Portfolios provides that Federated
Portfolios 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 Federated Portfolios unless it is finally
adjudicated that they engaged in willful malfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in their offices.
As of September 15, 1995, U.S. Trust held of record substantially all of
the outstanding shares in each of the Funds, but did not own such shares
beneficially because it did not have discretion to vote or invest such shares.
As of the same date, the officers and Trustees of the Trust and Federated
Portfolios as a group owned less than 1% of the shares of each Fund and the Bond
Index Portfolio. Shareholders owning 25% or more of the outstanding shares of a
Fund may have the ability to take actions without the approval of any other
investor in that Fund.
INVESTMENT ADVISORY SERVICES
U.S. Trust Pacific is responsible for the management of the assets of the
Balanced, Equity Growth and International Equity Funds pursuant to an investment
advisory agreement with the Trust on behalf of such Funds, subject to the
general supervision and guidance of the Board of Trustees of the Trust. U.S.
Trust is responsible for the management of the assets of the Equity, Income and
Total Return Bond Funds pursuant to an investment advisory agreement with the
Trust on behalf of such Funds, subject to the general supervision and guidance
of the Board of Trustees of the Trust. Federated Management is responsible for
the management of the assets of the Bond Index Portfolio, in which the assets of
the Bond Index Fund are invested, pursuant to an investment advisory agreement
with Federated Portfolios, subject to the general supervision and guidance of
the Trustees of the Trust and Federated Portfolios. The investment advisory
agreements described above are referred to herein as "Advisory Agreements," each
an "Advisory Agreement."
Each Advisory Agreement will continue in effect with respect to each Fund
(or the Bond Index Portfolio) as long as such continuance is specifically
approved at least annually by the Board of Trustees of the Trust (or Federated
Portfolios, as the case may be) or by a majority vote of the shareholders in the
applicable Fund (or the Bond Index Portfolio, as the case may be) and, in either
case, by a majority of the Trustees of the Trust (or Federated Portfolios, as
the case may be) who are not parties to the Advisory Agreement or interested
persons of any such party, at a meeting called for the purpose of voting on the
Advisory Agreement. Each Advisory Agreement was approved by the Trust's Board of
Trustees on August 19, 1995. The Bond Index Portfolio's Advisory Agreement was
approved by the Board of Trustees of Federated Portfolios on October 6, 1995.
Each investment adviser and administrator has agreed to waive certain fees.
Shareholder Organizations may charge their customers account fees for investment
and other cash management services.
Each Advisory Agreement provides that the investment adviser may render
services to others, and each Advisory Agreement is terminable by the Trust (or
Federated Portfolios) without penalty on not more than 60 days' nor less than 30
days' written notice when authorized either by majority vote of the Fund (or, in
the case of the Bond Index Fund, a majority vote of the Fund and the other
investors in the Bond Index Portfolio, with the vote of each being in proportion
to the amount of its investment) or by a vote of a majority of the Board of
Trustees of the Trust (or Federated Portfolios), or by the respective investment
adviser on not more than 60 days' nor less than 30 days' written notice, and
will automatically terminate in the event of its assignment. Each Advisory
Agreement provides that neither the investment adviser nor its personnel shall
be liable for any error of judgment or mistake of law or for any loss arising
out of any investment, or for any act or omission in the execution of security
transactions for a Fund (or the Bond Index Portfolio), except for willful
misfeasance, bad faith, gross negligence or reckless disregard of its or their
obligations and duties under the Advisory Agreement.
The Prospectus contains a description of the fees payable to the investment
advisers under the Advisory Agreements. Each investment adviser, if required by
applicable state law, shall reimburse a Fund or waive all or part of its fees up
to, but not exceeding, its investment advisory fees from the Fund. Such
reimbursement, if required, will be equal to the annual expenses of the
appropriate Fund (in the case of the Bond Index Fund, the Fund and the Bond
Index Portfolio) which exceed that expense limitation with the lowest threshold
prescribed by any state in which such Fund is qualified for offer or sale.
Management of the Trust has been advised that the lowest such threshold
currently in effect is 2 1/2% of net assets up to $30,000,000, 2% of the next
$70,000,000 of net assets and 1 1/2% of net assets in excess of that amount.
With respect to the Balanced, Equity Growth, Value Equity Income and
International Equity Funds, U.S. Trust Pacific has entered into an investment
subadvisory agreement (each a "Subadvisory Agreement") with each of the
subadvisers listed below opposite the name of the Fund. For their services under
the Subadvisory Agreements, the subadvisers are entitled to receive from U.S.
Trust Pacific, fees at a maximum annual rate equal to the percentages specified
in the table below of the Fund's average daily net assets.
Compensation Rate
Fund Name Subadviser for Subadviser (%)
Balanced Fund Becker 0.425%
Equity Growth Fund Luther King 0.40%
International Equity Fund Harding Loevner 0.50%
It is the responsibility of each of the above subadvisers to make the
day-to-day investment decisions for its respective Fund, and to place the
purchase and sales orders for securities transactions of such Fund, subject in
all cases to the general supervision of U.S. Trust Pacific. Each subadviser
furnishes at its own expense all services, facilities and personnel necessary in
connection with managing its respective Fund's investments and effecting
securities transactions for such Fund.
With respect to the Bond Index Portfolio, in which all of the investable
assets of the Bond Index Fund have been invested, Federated Management has
entered into an investment subadvisory agreement (the "Subadvisory Agreement")
with U.S. Trust as subadviser. For its services under the Subadvisory Agreement,
U.S. Trust is entitled to receive from Federated Management fees at a maximum
annual rate equal to 0.12% of the Board Index Portfolio's average daily net
assets.
It is the responsibility of U.S. Trust in its capacity as subadviser to
make the day-to-day investment decisions for the Bond Index Portfolio, and to
place the purchase and sales orders for securities transactions of such
Portfolio, subject to the general supervision of Federated Management. U.S.
Trust furnishes at its own expense all services, facilities and personnel
necessary in connection with managing the Bond Index Portfolio's investments and
effecting securities transactions for the Portfolio.
ADMINISTRATORS
U.S. Trust, Chase Global Funds Services Company ("CGFSC") and Federated
Administrative Services ("FAS") serve as the Funds' administrators (the
"Administrators") pursuant to an agreement between the Administrators and the
Trust (the "Administrative Agreement"). The Prospectus contains a description of
the compensation payable to the Administrators under the Administrative
Agreement.
Under the Administrative Agreement, the Administrators have agreed to
maintain office facilities for the Funds, furnish the Funds with statistical and
research data, clerical, accounting and bookkeeping services, and certain other
services required by the Funds, and to compute the net asset value, net income
and realized capital gains or losses, if any, of the respective Funds. The
Administrators prepare annual and semiannual reports to the Securities and
Exchange Commission, prepare Federal and state tax returns, prepare filings with
state securities commissions, arrange for and bear the cost of processing Share
purchase and redemption orders, maintain the Funds' financial accounts and
records, and generally assist in the Funds' operations. Pursuant to the
Administrative Agreement, the Administrators may render fund accounting and
other services to others. The Administrative Agreement terminates automatically
if assigned and may be terminated, without penalty by any party on not less than
90 days' notice. The Administrative Agreements also provide that neither the
Administrators nor their personnel shall be liable for any error of judgment or
mistake of law or for any act or omission in the administration or management of
the Trust, except for willful misfeasance, bad faith or gross negligence in the
performance of their duties, or by reason of reckless disregard of its or their
obligations and duties under said agreement.
Federated Services Company ("FSC"), an affiliate of FAS, also serves as
servicing agent and fund accounting agent to the Trust with respect to the Bond
Index Fund, pursuant to an agreement between FSC and the Trust (the "Servicing
Agent Agreement"), which provides that FSC will perform or provide certain
administrative and fund accounting services to the Bond Index Fund. The
Prospectus contains a description of the compensation payable to the FSC and the
other Administrators.
For the period ended May 31, 1995, fund accounting fees for each Fund
amounted to the following: Equity Fund, $4,493; Income Fund, $4,526; Total
Return Bond Fund, $4,395; Bond Index Fund, $10,667; Balanced Fund, $10,677;
Equity Growth Fund, $10,677; International Equity Fund, $4,263.
For the period ended May 31, 1995, fund accounting and servicing agent fees
for the portfolios of the St. James Portfolios in which each Fund invested all
of its investable assets prior to December 18, 1995 (January 2, 1996, in the
case of the Bond Index Fund) amounted to the following: Equity Fund, $20,368;
Income Fund, $23,776; Total Return Bond, $21,403; Bond Index Fund, $54,279;
Balanced Fund, $72,155; Equity Growth Fund, $66,174; International Equity Fund,
$18,964.
TRANSFER AGENT AND CUSTODIAN
The Chase Manhattan Bank, N.A. ("Chase") serves as custodian of the Funds'
assets pursuant to a custody agreement between Chase and the Trust.
Under such agreement and acting as the Funds' custodian, Chase has agreed
to (i) maintain a separate account or accounts for each of the Funds (ii) make
receipts and disbursements of money on behalf of the Funds; (iii) collect and
receive income and other payments and distributions on account of the Funds'
securities; (iv) respond to correspondence from securities brokers and others
relating to its duties; (v) maintain certain financial accounts and records; and
(vi) make periodic reports to the Trust concerning the Funds' operations. For
the services provided by Chase under the custody agreements, the Trust has
agreed to pay Chase a fee as agreed upon from time to time.
Chase may, at its own expense, open and maintain custody accounts with
respect to the Funds with other banks or trust companies, provided that Chase
shall remain liable under the custody agreement for the performance of all of
its duties under such agreement, notwithstanding any such delegation.
Chase Global Funds Services Company ("CGFSC") serves as transfer agent for
the Funds pursuant to a transfer agency agreement. Under this agreement, CGFSC
will perform the following functions, among others: (i) issue and redeem shares
of the Funds; (ii) address and mail all communications by the Funds to their
shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for their meetings of shareholders; (iii) respond
to correspondence by shareholders and others relating to its duties; (iv)
maintain shareholder accounts; and (v) make periodic reports to the Trust
concerning the Funds' operations. For its transfer agency and dividend
disbursement services, CGFSC is entitled to receive from the Trust such
compensation as may be agreed upon from time to time between the Trust and
CGFSC. In addition, CGFSC is entitled to be reimbursed for its out-of-pocket
expenses for the cost of forms, postage, processing purchase and redemption
orders, handling of proxies, and other similar expenses in connection with the
above services.
CGFSC may delegate its transfer agency obligations to another transfer
agent registered or qualified under applicable law, provided that CGFSC shall
remain liable for the performance of all of its transfer agency duties under the
transfer agency agreement, notwithstanding any such delegation.
BOND INDEX PORTFOLIO - SERVICE PROVIDERS
Investors Bank & Trust Company, 79 Milk Street, 7th Floor, Boston,
Massachusetts, 02205, is Custodian for the cash and securities of the Bond Index
Portfolio.
Federated Securities Corp., Federated Investors Tower, 1001 Liberty Avenue,
Pittsburgh, Pennsylvania, 15222-3779, is Placement Agent for Federated
Portfolios.
Federated Services Company, Federated Investors Tower, 1001 Liberty Avenue,
Pittsburgh, Pennsylvania, 15222-3779, is Portfolio Accountant for Federated
Portfolios.
Federated Administrative Services, a subsidiary of Federated Investors,
provides administrative personnel and services (including certain legal and
financial reporting services) necessary to operate Federated Portfolios.
Federated Administrative Services provides these for each portfolio in Federated
Portfolios at an annual rate as specified below:
Average Aggregate Daily Net
Assets of the
Maximum Administrative Fee portfolio
0.050 of 1% on the first $1 billion
0.045 of 1% on the next $1 billion
0.040 of 1% on the next $1 billion
0.025 of 1% on the next $1 billion
0.010 of 1% on the next $1 billion
0.005 of 1% on assets in excess of $5 billion
The minimum administrative fee is $60,000 annually for each portfolio.
Federated Administrative Services may choose voluntarily to waive a portion of
its fee, and has agreed to waive a portion of its fee for the twelve month
period following January 2, 1996. Dr. Henry J. Gailliot, an officer of Federated
Management, the adviser to the Registrant, holds approximately 20% of the
outstanding common stock and serves as a director of Commercial Data Services,
Inc., a company which provides computer processing services to Federated
Administrative Services.
INDEPENDENT AUDITORS
Ernst & Young LLP are the independent auditors for Excelsior Institutional
Trust and Federated Investment Portfolios, and in each case provides audit
services and assistance and consultation with respect to the preparation of
filings with the Securities and Exchange Commission.
TAXATION
TAXATION OF THE FUNDS
Each series of the Trust is treated as a separate entity for federal income
tax purposes under the Internal Revenue Code of 1986, as amended (the "Code").
Each Fund has elected to be treated and intends to qualify each year as a
"regulated investment company" under Subchapter M of the Code (a "RIC") by
meeting all applicable requirements of Subchapter M, including requirements as
to the nature of the Fund's gross income, the amount of the Fund's
distributions, and the composition and holding period of the Fund's portfolio
assets. Because each Fund intends to distribute all of its net investment income
and net realized capital gains to its shareholders in accordance with the timing
requirements imposed by the Code, it is not expected that the Fund will be
required to pay any federal income or excise taxes, although a Fund's foreign
source income may be subject to foreign withholding taxes. If a Fund fails to
qualify as a RIC in any year, the Fund would incur a regular corporate federal
income tax upon its taxable income, and the Fund's distributions would generally
be taxable as ordinary dividend income to shareholders.
The Trust anticipates that under interpretations of the Internal Revenue
Service, (1) the Bond Index Portfolio will be treated for federal income tax
purposes as a partnership and (2) for purposes of determining whether the Bond
Index Fund satisfies the income and diversification requirements to maintain its
status as a RIC, the Bond Index Fund, as an investor in the Bond Index
Portfolio, will be deemed to own a proportionate share of that Portfolio's
assets and will be deemed to be entitled to that Portfolio's income or loss
attributable to that share. The Bond Index Portfolio has advised the Bond Index
Fund that it intends to conduct its operations so as to enable its investors,
including the Bond Index Fund, to satisfy those requirements.
Any Fund distribution (or, in the case of the Income, Total Return Bond and
Bond Index Funds any distribution of net capital gains or net short-term capital
gains) will have the effect of reducing the per share net asset value of shares
in the Fund by the amount of the distribution. Shareholders purchasing shares
shortly before the record date of any distribution may thus pay the full price
for the shares and then effectively receive a portion of the purchase price back
as a taxable distribution.
Any investment by a Fund in zero coupon bonds, certain securities purchased
at a market discount, and similar instruments will cause a Fund to recognize
income prior to the receipt of cash payments with respect to those securities.
In order to distribute this income and avoid a tax on the Fund, a Fund may be
required to liquidate portfolio securities that it might otherwise have
continued to hold, potentially resulting in additional taxable gain or loss to
the Fund.
While certain of the Funds might invest in municipal securities, the
interest on which might otherwise be exempt from tax, it is generally not
expected that any Fund will satisfy the requirements under the Code to
pass-through such exempt income to shareholders as tax-exempt dividends.
Any Fund's transactions in options, futures contracts, and forward currency
exchange contracts will be subject to special tax rules that may affect the
amount, timing, and character of Fund income and distributions to shareholders.
In addition, foreign exchange gains or losses realized by any Fund will
generally be treated as ordinary income or loss by the Fund. Investment by a
Fund in certain "passive foreign investment companies" may also have to be
limited in order to avoid a tax on the Fund. Such a Fund may elect (if such
election is available) to mark to market any investments in "passive investment
companies" on the last day of each year. This election may cause a Fund to
recognize income prior to the receipt of cash payments with respect to those
investments; in order to distribute this income and avoid tax on the Fund, the
Fund may be required to liquidate portfolio securities that it might otherwise
have continued to hold.
Investment income of a Fund from foreign securities may be subject to
foreign income tax withheld at the source. No Fund (other than the International
Equity Fund, as discussed below) expects to be able to pass through to
shareholders foreign tax credits with respect to such foreign taxes. The United
States has entered into tax treaties with many foreign countries that may
entitle a Fund to a reduced rate of tax or an exemption from tax on such income;
each Fund intends to qualify for treaty-reduced rates where available. It is not
possible, however, to determine a Fund's effective rate of foreign tax in
advance since the amount of the Fund's assets invested within various countries
is not known.
TAXATION OF THE BOND INDEX PORTFOLIO
The Trust anticipates that the Bond Index Portfolio will be treated as a
partnership for federal income tax purposes. As such, the Portfolio is not
subject to federal income taxation. Instead, the Bond Index Fund must take into
account, in computing its federal income tax liability, its share of the Bond
Index Portfolio's income, gains, losses, deductions, credits and tax preference
items, without regard to whether it has received any cash distributions from
that Portfolio.
TAXATION OF DISTRIBUTIONS
Dividends from ordinary income and any distributions from net short-term
capital gains are taxable to shareholders as ordinary income for federal income
tax purposes. Distributions of net capital gains (the excess of net long-term
capital gains over net short-term capital losses), if any, are taxable to
shareholders as long-term capital gains without regard to the length of time the
shareholders have held their shares. A portion of the ordinary income dividends
of a Fund invested in stock of domestic corporations may qualify for the
dividends-received deduction for corporations if the recipient otherwise
qualifies for that deduction with respect to its holding of Shares. Availability
of the deduction for particular shareholders is subject to certain limitations,
and deducted amounts may be subject to the alternative minimum tax and result in
certain basis adjustments. Distributions are taxable as described above whether
paid in cash or reinvested in additional shares. Shareholders will be notified
annually as to the federal tax status of distributions.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax. To
prevent imposition of the excise tax, each Fund must, and intends to, distribute
during each calendar year substantially all of its ordinary income for that year
and substantially all of its capital gain in excess of its capital losses for
that year, plus any undistributed ordinary income and capital gains from
previous years. For this and other purposes, a Fund dividend will be treated as
paid on December 31 if it is declared by a Fund in October, November or December
with a record date in such a month and paid by the Fund during January of the
following calendar year. Accordingly, those distributions will be taxable to
shareholders for the taxable year in which that December 31 falls.
If the International Equity Fund holds more than 50% of its assets in
foreign stock and securities at the close of its taxable year, the Fund may
elect to "pass through" to the Fund's shareholders foreign income taxes paid. If
the Fund so elects, shareholders will be required to treat their pro rata
portion of the foreign income taxes paid by the Fund as part of the amounts
distributed to them by the Fund and thus includable in their gross income for
federal income tax purposes. Shareholders who itemize deductions would then be
allowed to claim a deduction or credit (but not both) on their federal income
tax returns for such amounts, subject to certain limitations. Shareholders who
do not itemize deductions would (subject to such limitations) be able to claim a
credit but not a deduction. No deduction will be permitted to individuals in
computing their alternative minimum tax liability. If the International Equity
Fund does not qualify or elect to "pass through" to the Fund's shareholders
foreign income taxes paid, shareholders will not be able to claim any deduction
or credit for any part of the foreign taxes paid by the Fund.
Withdrawals by the Bond Index Fund from the Bond Index Portfolio generally
will not result in that Fund recognizing any gain or loss for federal income tax
purposes, except that (1) gain will be recognized to the extent that any cash
distributed exceeds the basis of the Fund's interest in the Bond Index Portfolio
prior to the distribution, (2) income or gain will be realized if the withdrawal
is in liquidation of the Fund's entire interest in the Bond Index Portfolio and
includes a disproportionate share of any unrealized receivables held by that
Portfolio, and (3) loss will be recognized if the distribution is in liquidation
of that entire interest and consists solely of cash and/or unrealized
receivables. The basis of the Bond Index Fund's interest in the Bond Index
Portfolio generally equals the amount of cash and the basis of any property that
the Fund invests in the Bond Index Portfolio, increased by the Fund's share of
income from that Portfolio and decreased by the Fund's share of losses from that
Portfolio and the amount of any cash distributions and the basis of any property
distributed from that Portfolio.
OTHER TAXATION
The Trust is organized as a Delaware business trust and, under current law,
neither the Trust nor the Funds are liable for any income or franchise tax in
the State of Delaware, provided that the Funds continue to qualify as RICs for
federal income tax purposes.
The Bond Index Portfolio is organized as series of Federated Investment
Portfolios (the "Federated Portfolios"), a business trust organized under the
laws of the Commonwealth of Massachusetts. The Bond Index Portfolio is not
subject to any income or franchise tax in the Commonwealth of Massachusetts or
the State of Delaware. The investment by the Bond Index Fund in the Bond Index
Portfolio does not cause the Fund to be liable for any income or franchise tax
in the Commonwealth of Massachusetts.
Fund shareholders may be subject to state and local taxes on Fund
distributions to them by a Fund. Shareholders are advised to consult their own
tax advisers with respect to the particular tax consequences to them of an
investment in a Fund.
DESCRIPTION OF THE TRUST; FUND SHARES
The Trust is a Delaware business trust established under a Trust Instrument
dated April 27, 1994. Its authorized capital consists of an unlimited number of
shares of beneficial interest of $0.00001 par value, which may be issued in
separate series. Currently, the Trust has seven active and two inactive series,
although additional series may be established from time to time. Each share of
each series represents an equal proportionate interest in that series with each
other share in that series.
The assets of the Trust received for the issue or sale of the shares of
each series and all income, earnings, profits and proceeds thereof, subject only
to the rights of creditors, are specifically allocated to such series and
constitute the underlying assets of such series. The underlying assets of each
series are segregated on the books of account, and are to be charged with the
liabilities in respect to such series and with such a share of the general
liabilities of the Trust. Expenses with respect to any two or more series are to
be allocated in proportion to the asset value of the respective series except
where allocations of direct expenses can otherwise be fairly made. The officers
of the Trust, subject to the general supervision of the Trustees, have the power
to determine which liabilities are allocable to a given series, or which are
general or allocable to two or more series. In the event of the dissolution or
liquidation of the Trust or any series, the holders of the shares of any series
are entitled to receive as a class the value of the underlying assets of such
shares available for distribution to shareholders.
The Trustees may amend the Trust Instrument without shareholder approval,
except shareholder approval is required for any amendment (a) which affects the
voting rights of shareholders under the Trust Instrument, (b) which affects
shareholders' rights to approve certain amendments to the Trust Instrument, (c)
required to be approved by shareholders by law or the Registration Statement, or
(d) submitted to shareholders for their approval by the Trustees in their
discretion. Pursuant to Delaware business trust law and the Trust Instrument,
the Trustees may, without shareholder approval, (x) cause the Trust to merge or
consolidate with one or more entities, if the surviving or resulting entity is
the Trust or another open-end management investment company registered under the
1940 Act, or a series thereof, that will succeed to or assume the Trust's
registration under the 1940 Act, or (y) cause the Trust to incorporate under the
laws of the State of Delaware.
Shares of a Fund entitle their holder to one vote per share; however,
separate votes are taken by each series on matters affecting an individual
series. For example, a change in investment policy for a series would be voted
upon only by shareholders of the series involved.
The Trust Instrument provides that obligations of the Trust are not binding
upon the Trustees individually but only upon the property of the Trust, that the
Trustees and officers will not be liable for errors of judgment or mistakes of
fact or law, and that the Trust 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 Trust unless it is finally
adjudicated that they engaged in willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in their offices, or
unless 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 Trust. 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 willful misfeasance, bad faith, gross negligence or reckless
disregard of their duties.
Under Delaware law, shareholders of a Delaware business trust are entitled
to the same limitation on personal liability which is extended to shareholders
of private for profit corporations organized under the General Corporation Law
of the State of Delaware. The Trust Instrument contains an express disclaimer of
shareholder liability for acts or obligations of the Trust and provides for
indemnification and reimbursement of expenses out of Fund property for any
shareholder held personally liable for the obligations of a Fund solely by
reason of his being or having been a shareholder. The Trust Instrument also
provides for the maintenance, by or on behalf of the Trust and each Fund, of
appropriate insurance (for example, fidelity bonding and errors and omissions
insurance) for the protection of the Trust and each Fund, their shareholders,
Trustees, officers, employees and agents, covering possible tort and other
liabilities.
DESCRIPTION OF FEDERATED PORTFOLIOS - BENEFICIAL INTERESTS
The Bond Index Portfolio is a series of Federated Portfolios, which is
organized as a trust having separate series under the laws of the Commonwealth
of Massachusetts. Under the Declaration of Trust, the Trustees are authorized to
issue beneficial interests in one or more series (each a "Portfolio").
Currently, there is one Portfolio of Federated Portfolios, the Bond Index
Portfolio. Investors in the Bond Index Portfolio will be held personally liable
for the obligations and liabilities of Federated Portfolios and of the Bond
Index Portfolio but not the obligations and liabilities of any other Portfolio,
subject, however, to indemnification by Federated Portfolios in the event that
there is imposed upon an investor any obligation or liability of the Bond Index
Portfolio or Federated Portfolios. The Declaration of Trust also provides that
Federated Portfolios may maintain appropriate insurance for the protection of
Federated Portfolios, its Trustees, officers, employees and agents, and covering
possible tort and other liabilities. The risk of an investor incurring financial
loss on account of investor liability is limited to circumstances in which the
Bond Index Portfolio or Federated Portfolios are unable to meet their
obligations.
Investors in a Portfolio are entitled to participate pro rata in
distributions of taxable income, loss, gain and credit of their respective
Portfolio only. Upon liquidation or dissolution of a Portfolio, investors are
entitled to share pro rata in that Portfolio's (and no other Portfolio's) net
assets available for distribution to its investors. Federated Portfolios
reserves the right to create and issue additional Portfolios of beneficial
interests, in which case the beneficial interests in each new Portfolio would
participate in that Portfolio only (and no other Portfolio). Investments in a
Portfolio have no preference, preemptive, conversion or similar rights and are
fully paid and nonassesable, except as set forth below. Investments in a
Portfolio may not be transferred.
Each investor is entitled to a vote in proportion to the amount of its
investment in each Portfolio. Investors in a Portfolio do not have cumulative
voting rights, and investors holding a plurality of the aggregate beneficial
interests in all outstanding Portfolios may elect all of the Trustees if they
choose to do so and in such event other investors would not be able to elect any
Trustees. Investors in each Portfolio will vote as a separate class except as to
voting for the election or removal of Trustees, the termination of Federated
Portfolios, as otherwise required by the 1940 Act, or if the matter is
determined by the Trustees to be a matter which affects all Portfolios.
Federated Portfolios' Declaration of Trust may be amended without the vote of
investors, except that investors have the right to approve by affirmative
majority vote any amendment which would adversely affect their voting rights,
alter the procedures to amend the Declaration of Trust of Federated Portfolios,
as required by law or by Federated Portfolios' registration statement, or as
submitted to them by the Trustees.
Federated Portfolios or any Portfolio may enter into a merger or
consolidation, or sell all or substantially all of its assets, if approved (a)
at a meeting of investors by investors representing the lesser or (i) 67% or
more of the beneficial interests in the affected Portfolio present or
represented at such meeting, if investors in more than 50% of all such
beneficial interests are present or represented by proxy, or (ii) more than 50%
of all such beneficial interests, or (b) by an instrument in writing without a
meeting, consented to by investors of the beneficial interests in the affected
Portfolio.
Federated Portfolios' Declaration of Trust provides that obligations of
Federated Portfolios are not binding upon the Trustees individually but only
upon the property of Federated Portfolios 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.
Federated Portfolios' Declaration of Trust further provides that it will
indemnify its Trustees, officers, employees and agents against liabilities and
expenses incurred in connection with litigation in which they may be involved
because of their offices with Federated Portfolios, unless, as to liability to
the Federated Portfolios or its investors, it is finally adjudicated that they
engage in willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in their offices. In the case of settlement,
the by-laws of Federated Portfolios provide that 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 a vote of a majority of disinterested
Trustees or by a written opinion of independent counsel, that such officers or
Trustees have not engaged in willful misfeasance, bad faith, gross negligence or
reckless disregard of their duties.
FINANCIAL STATEMENTS
The Funds' current reports to shareholders as filed with the SEC pursuant
to Section 30(b) of the 1940 Act and Rule 30b2-1 thereunder are hereby
incorporated herein by reference. A copy of each such report will be provided
without charge to each person receiving this Statement of Additional
Information. The Annual Report of the Funds dated May 31, 1995 contains
financial statements of the following Funds and the portfolios of the St. James
Portfolios as of and for the period ended May 31, 1995:
Portfolio of
Fund St. James Portfolios
Excelsior Institutional Equity Fund Equity Portfolio
Excelsior Institutional Income Fund Income Portfolio
Excelsior Institutional Total Return Bond Fund Total Return Bond Portfolio
Excelsior Institutional Bond Index Fund Bond Market Portfolio
Excelsior Institutional Balanced Fund Balanced Portfolio
Excelsior Institutional Equity Growth Fund Equity Growth Portfolio
Excelsior Institutional International Equity Fund International Equity Portfolio
Excelsior Institutional Equity Index Fund Equity Market Portfolio
Excelsior Institutional Small Capitalization Fund Small Cap Portfolio
Excelsior Institutional Value Equity Income Fund Value Equity Income Portfolio
Prior to December 18, 1995 (January 2, 1996 in the case of the Bond Index
Fund) each of the Funds invested its investable assets in the corresponding
portfolio of the St. James Portfolios. Effective December 18, 1995, each of the
Equity, Income, Total Return Bond, Balanced, Equity Growth and International
Equity Funds withdrew its interest in the corresponding portfolio of the St.
James Portfolios, receiving all of each portfolio's securities, and
substantially all of the other net assets of each portfolio, as of that date.
Each of those Funds now directly acquires and manages its own portfolio of
securities.
Effective January 2, 1996, the Bond Index Fund withdrew its interest in the
Bond Market Portfolio of St. James Portfolio, receiving all of that portfolio's
securities, and substantially all of its other net assets, as of that date, and
the Fund invested those securities and other net assets in the Bond Index
Portfolio, a series of Federated Investment Portfolios.
As of December 29, 1995, the Equity Index, Small Capitalization and Value
Equity Income Funds withdrew their investments in the corresponding portfolios
of the St. James Portfolios and liquidated.
<PAGE>
APPENDIX
Description of Security Ratings
STANDARD & POOR'S
Corporate and Municipal Bonds
AAA -- Debt rated "AAA" has the highest rating assigned by Standard & Poor's to
a debt obligation. Capacity to pay interest and repay principal is extremely
strong.
AA -- Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in a small degree.
A -- Debt rated "A" has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB -- Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than for debt in higher rated categories.
BB -- Debt rated "BB" has less near-term vulnerability to default than other
speculative issues. However, it faces 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. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
Plus(+) or Minus(-) -- The ratings from "AA" to "BB" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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 highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus (+) designation.
A-2 -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1".
A-3 -- Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
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 edged". Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa -- Bonds 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 risk 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.
Note: Moody's applies numerical modifiers, 1,2, and 3 in each generic rating
classification from Aa through Bb in its corporate bond rating system. The
modifier 1 indicates that the security rates in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category. Those municipal bonds within the Aa, A, Baa, and Ba categories that
Moody's believes possess the strongest credit attributes within those categories
are designated by the symbols Aa1, A1, Baa1, and Ba1.
Commercial Paper
Prime-1 -- Issuers rated P-1 (or supporting institutions) have a superior
ability for repayment of short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics:
- - Leading market positions in well established industries.
- - High rates of return on funds employed.
- - Conservative capitalization structure 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.
Prime-2 -- Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions.
Ample alternate liquidity is maintained.
Prime-3 -- Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
Not Prime -- Issuers rated "Not Prime" do not fall within any of the Prime
rating categories.
FITCH INVESTORS SERVICE
Corporate Bond Ratings
AAA -- Securities of this rating are regarded as strictly high-grade, broadly
marketable, suitable for investment by trustees and fiduciary institutions, and
liable to but slight market fluctuation other than through changes in the money
rate. The factor last named is of importance varying with the length of
maturity. Such securities are mainly senior issues of strong companies, and are
most numerous in the railway and public utility fields, though some industrial
obligations have this rating. The prime feature of an AAA rating is showing of
earnings several times or many times interest requirements with such stability
of applicable earnings that safety is beyond reasonable question whatever
changes occur in conditions. Other features may enter in, such as a wide margin
of protection through collateral security or direct lien on specific property as
in the case of high class equipment certificates or bonds that are first
mortgages on valuable real estate. Sinking funds or voluntary reduction of the
debt by call or purchase are often factors, while guarantee or assumption by
parties other than the original debtor may also influence the rating.
AA -- Securities in this group are of safety virtually beyond question, and as a
class are readily salable while many are highly active. Their merits are not
greatly unlike those of the AAA class, but a security so rated may be of junior
though strong lien - in many cases directly following an AAA security - or the
margin of safety is less strikingly broad. The issue may be the obligation of a
small company, strongly secured but influenced as to ratings by the lesser
financial power of the enterprise and more local type of market.
A -- Securities of this rating are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB -- Securities of this rating are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
Plus(+) or Minus(-) -- Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
Commercial Paper Ratings
F-1+ -- Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1 -- Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than the strongest
issue.
F-2 -- Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as great
as for issues assigned "F-1+" and F-1" ratings.
F-3 -- Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate, however,
near-term adverse changes could cause these securities to be rated below
investment grade.
DUFF & PHELPS RATINGS
Corporate Bond Ratings
AAA -- Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S.
Treasury Funds.
AA+, AA, AA- -- High credit quality. Protection factors are strong. Risk is
modest but may vary slightly from time to time because of economic conditions.
A+, A, A- -- Protection factors are average but adequate. However, risk factors
are more variable and greater in periods of economic stress.
BBB+, BBB, BBB- -- Below average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
Commercial Paper Ratings
Duff 1+ -- Highest certainty of timely payment. Short term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding, and safety is just below risk free U.S. Treasury short term
obligations.
Duff 1 -- Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are minor.
Duff 1- -- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
Duff 2 -- Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
Duff 3 -- Satisfactory liquidity and other protection factors qualify issue as
to investment grade. Risk factors are larger and subject to more variation.
Nevertheless, timely payment is expected.
<PAGE>
ADMINISTRATORS
Federated Administrative Services
Federated Investors Tower
1001 Liberty Avenue
Pittsburgh, PA 15222-3779
Chase Global Funds Services Company
73 Tremont Street
Boston, MA 02108
United States Trust Company of New York
114 West 47 Street
New York, NY 10036
INVESTMENT MANAGERS
United States Trust Company
of New York
114 West 47th Street
New York, NY 10036
United States Trust Company of
The Pacific Northwest
4380 Southwest
Macadam Avenue,
Suite 450
Portland, OR 97201
Becker Capital Management, Inc.
2185 Pacwest Center
Portland, OR 97204
Luther King Capital Management
301 Commerce Street, Suite 1600
Fort Worth, TX 76102
Harding, Loevner Management, L.P.
50 Division Street, Suite 401
Somerville, NJ 08876
Federated Management
Federated Investors Tower
1001 Liberty Avenue
Pittsburgh, PA 15222-3799
TRANSFER AGENT
Chase Global Funds Services Company
73 Tremont Street
Boston, MA 02108
INDEPENDENT AUDITORS
Ernst & Young LLP
200 Clarendon Street
Boston, MA 02116
DISTRIBUTOR
Edgewood Services, Inc.
Federated Investors Tower
Pittsburgh, PA 15222
EXCELSIOR INSTITUTIONAL TRUST
EXCELSIOR INSTITUTIONAL EQUITY FUND
EXCELSIOR INSTITUTIONAL INCOME FUND
EXCELSIOR INSTITUTIONAL TOTAL RETURN BOND FUND
EXCELSIOR INSTITUTIONAL BOND INDEX FUND
EXCELSIOR INSTITUTIONAL BALANCED FUND
EXCELSIOR INSTITUTIONAL EQUITY GROWTH FUND
EXCELSIOR INSTITUTIONAL INTERNATIONAL EQUITY FUND
STATEMENT OF ADDITIONAL
INFORMATION
OCTOBER 2, 1995
1/Each of the Funds paid such brokerage commissions through the
corresponding portfolio of the St. James Portfolios (the "Portfolio Series") in
which such Fund had invested all of its investable assets prior to December 18,
1995 (January 2, 1996, in the case of the Bond Index Fund).
2/The Funds commenced operations on the following dates: Equity and Income
Funds, January 16, 1995; Total Return Bond Fund, January 19, 1995; Bond Index,
Balanced and Equity Growth Funds, July 11, 1994; and International Equity Fund,
January 24, 1995.
3/The turnover rates indicated are for the portfolios of the Portfolio
Series corresponding to the Funds.
4/See footnote 2 above.
Rule 497(e)--File Nos. 33-78264, 811-8490
Excelsior Institutional Equity Fund
Excelsior Institutional Income Fund
Excelsior Institutional Total Return Bond Fund
Excelsior Institutional Bond Index Fund
Excelsior Institutional Balanced Fund
Excelsior Institutional Equity Growth Fund
Excelsior Institutional International Equity Fund
Supplement dated January 2, 1996 to Prospectus dated October 1, 1995
as amended October 6, 1995
RESTRUCTURING
The shareholders of the Equity Fund, Income Fund, Total Return Bond Fund,
Bond Index Fund, Balanced Fund, Equity Growth Fund and International Equity Fund
approved, at a meeting held on November 15, 1995, a restructuring of the Funds
from a master/feeder structure to a more traditional single-tier mutual fund
structure, except with respect to the Bond Index Fund, as more fully described
below. This restructuring was completed as of January 2, 1996.
As part of the restructuring, the Trust has engaged with respect to each
Fund (other than Bond Index Fund) the investment adviser which had previously
provided investment advisory services to the Fund indirectly through the
master/feeder structure, and, with respect to Balanced Fund, Equity Growth Fund
and International Equity Fund, the investment subadviser which had previously
provided investment subadvisory services to the Fund indirectly through the
master/feeder structure. Each investment adviser and subadviser has entered into
an agreement with respect to the provision of investment advisory or subadvisory
services under terms and conditions (including the rates of the advisory or
subadvisory fees) that are identical in all material respects to those pursuant
to which they had previously provided such services to the Funds indirectly
through the master/feeder structure, except that the new agreements are dated as
of the effective date of the restructuring, and except that the Trust, on behalf
of the Funds, is a party to the new agreements.
Concurrently with the restructuring, the new expense structure for each
Fund, as set forth in the Prospectus, as amended, went into effect. In addition,
three series of the Trust, the Equity Index Fund, the Small Capitalization Fund
and the Value Equity Income Fund were terminated.
THE BOND INDEX FUND
The Bond Index Fund, like the other Funds, has also withdrawn from the
existing master/feeder structure, but, as approved by its shareholders at the
meeting held on November 15, 1995, has invested all of its investable assets in
the Bond Index Portfolio, and therefore operates in a two-tier master/feeder
structure. Bond Index Portfolio is a series of Federated Investment Portfolios
("Federated Portfolios"), which is an open-end management investment company,
organized as a Massachusetts business trust as of September 29, 1995. The Bond
Index Portfolio, which is the only active series of Federated Portfolios, has
adopted the same investment objective, restrictions and policies as the Bond
Index Fund.
Federated Management is responsible for the management of the assets of the
Bond Index Portfolio, pursuant to an investment advisory agreement (the
"Federated Advisory Agreement") with Federated Portfolios on behalf of the Bond
Index Portfolio. Federated Management has delegated daily management of the
security holdings of the Bond Index Portfolio to U.S. Trust, acting as
subadviser.
Subject to the general guidance and policies set by the Trustees of
Federated Portfolios, Federated Management provides general supervision over the
investment management functions performed by U.S. Trust. Federated Management
closely monitors U.S. Trust's application of the Bond Index Portfolio's
investment policies and strategies, and regularly evaluates U.S. Trust's
investment results and trading practices.
For its services under the Federated Advisory Agreement, Federated
Management is entitled to receive from the Bond Index Portfolio a fee accrued
daily and paid monthly at an annual rate equal to 0.25% of the Bond Index
Portfolio's average daily net assets. Federated Management has agreed to waive
all investment advisory fees with respect to the Bond Index Portfolio. This
waiver may be terminated at any time, although Federated Investors has agreed to
maintain total operating expenses (after waivers and reimbursements) of the Bond
Index Portfolio at no greater than 0.20% of average net assets for the twelve
month period following January 2, 1996. Federated Management, which has its
principal offices at Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh,
Pennsylvania 15222, is a Delaware business trust. Federated Management is an
indirect, wholly-owned subsidiary of Federated Investors, a Delaware business
trust which, together with its affiliates, has approximately $70 billion in
assets under management. Federated Management acts as investment adviser to 25
investment companies with multiple portfolios or series.
Pursuant to an investment subadvisory agreement, U.S. Trust makes the
day-to-day investment decisions and portfolio selections for the Bond Index
Portfolio, consistent with general guidelines and policies established by
Federated Management and the Board of Trustees of Federated Portfolios. For the
investment management services U.S. Trust provides to the Bond Index Portfolio,
U.S. Trust is compensated only by Federated Management and receives no fees
directly from Federated Portfolios. For its services under the subadvisory
agreement, U.S. Trust is entitled to receive from Federated Management a fee
accrued daily and paid monthly at an annual rate equal to 0.12% of the Bond
Index Portfolio's average daily net assets. U.S. Trust has agreed to waive all
investment advisory fees with respect to the Bond Index Portfolio, which waiver
may be terminated at any time. U.S. Trust furnishes at its own expense all
services, facilities and personnel necessary in connection with managing the
Bond Index Portfolio's investments and effecting securities transactions for the
Portfolio. For information on U.S. Trust please see "Investment Managers Equity
Fund, Income Fund and Total Return Bond Fund" in the Prospectus.
Bruce Tavel, Senior Vice President, and Cyril M. Theccanat, Vice President
of U.S. Trust, Structured Investment Management Department, are primarily
responsible for the day-to-day management of the Bond Index Portfolio. Mr.
Theccanat has been managing structured investment portfolios at U.S. Trust since
January, 1990. Prior to this, Mr. Theccanat was a Vice President of Drexel
Burnham Lambert, responsible for interest rate and foreign exchange risk
management. Mr. Tavel designs, develops and implements analytic procedures and
services utilizing quantitative and financial information. He has over 17 years
of experience in the execution of decision support systems at U.S. Trust and
previously at Lehman Asset Management, where he was Director of Institutional
Computer Services.
Federated Services Company, a Delaware business trust whose address is
Federated Investors Tower, 1001 Liberty Avenue, Pittburgh, PA 15222-3779, serves
as transfer agent, dividend disbursing agent and custody procurement agent for
Federated Portfolios. The fee paid to the transfer agent is based upon the size,
type and number of accounts and transactions made by shareholders. Federated
Services Company also maintains Federated Portfolio's accounting records. The
fee for this service (of which the Bond Index Portfolio bears its pro rata
share) is based upon the level of Federated Portfolios' average net assets for
the period plus out-of-pocket expenses. Federated Services Company is a
wholly-owned subsidiary of Federated Investors.
Federated Securities Corp. is the placement agent for investments in the
Bond Index Portfolio. Federated Securities Corp. is located at Federated
Investors Tower, 1001 Liberty Avenue, Pittsburgh, Pennsylvania 15222-3779. It is
a Pennsylvania corporation organized on November 14, 1969, and is the principal
distributor for a number of investment companies. Federated Securities Corp.
receives no fee for its services as placement agent for the Bond Index
Portfolio. Federated Securities Corp. is a wholly-owned subsidiary of Federated
Investors.
Federated Administrative Services ("FAS") provides administrative personnel
and services (including certain legal and financial reporting services)
necessary to operate the Bond Index Portfolio. FAS is entitled to receive a fee
from the Bond Index Portfolio accrued daily and paid monthly at a annual rate of
up to 0.05% of the average daily net assets of the Bond Index Portfolio, subject
to a minimum of $60,000 (unless waived). From time to time FAS may waive all or
a portion of the administrative fee, and has agreed to waive a portion of the
administrative fee for the twelve month period following January 2, 1996.
Investors Bank & Trust Company, 79 Milk Street, Boston, Massachusetts 02205
serves as custodian of the Bond Index Portfolio's assets.
The net asset value of the Bond Index Fund is determined and the shares of
the Fund (the "Shares") are priced for purchases and redemptions at the close of
regular trading hours on the New York Stock Exchange (the "NYSE"), currently
4:00 p.m. (Eastern time). Net asset value and pricing for the Bond Index Fund
are determined on each day the NYSE is open for trading ("Business Day").
Currently, the days on which the Fund is closed (other than weekends) are New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Columbus Day, Thanksgiving Day and Christmas. Net asset value per Share for
purposes of pricing sales and redemptions is calculated by dividing the value of
all securities and other assets belonging to the Fund, less the liabilities
charged to the Fund, by the number of its outstanding Shares.
Assets in the Bond Index Fund which are traded on a recognized domestic
exchange or are quoted on a national securities market are valued at the last
sale price on the securities exchange on which such securities are primarily
traded or at the last sale price on such national securities market. Securities
in the Bond Index Fund which are traded only on over-the-counter markets are
valued on the basis of closing over-the-counter bid prices. Restricted
securities, securities for which market quotations are not readily available,
and other assets are valued at fair value, pursuant to guidelines adopted by the
Board of Trustees of the Trust. Absent unusual circumstances, debt securities
maturing in 60 days or less are valued at amortized cost.
As stated above, the Bond Index Fund invests through Bond Index Portfolio,
a series of Federated Portfolios, which is a business trust organized under the
laws of the Commonwealth of Massachusetts. The interests in Federated Portfolios
are divided into separate series or portfolios (each a "Portfolio",
collectively, the "Portfolios"). Investors in each Portfolio of Federated
Portfolios will vote separately or together in the same manner as shareholders
of the Trust's series. Federated Portfolios' Declaration of Trust provides that
the Bond Index Fund and other entities investing in the Bond Index Portfolio and
the other Portfolios of Federated Portfolios (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 in which they invest and the
overall obligations of Federated Portfolios. However, the Trustees of the Trust
believe that the risk of the Bond Index Fund incurring financial loss on account
of such liability is limited to circumstances in which the Bond Index Portfolio
or Federated Portfolios were unable to meet their obligations, and that neither
the Bond Index Fund nor its shareholders will be exposed to a material risk of
liability by reason of the Fund's investment in the Bond Index Portfolio.
The Bond Index Fund invests in the Bond Index Portfolio through Signature
Financial Group Inc.'s two-tier structure known as the Hub and Spoke(R)
financial services method. See "Special Information Concerning Hub and Spoke(R)
Structure".
For descriptions of the investment objectives, policies and restrictions of
the Bond Index Portfolio, see "Investment Objectives and Policies" in the
Prospectus and in the Statement of Additional Information.
ADMINISTRATORS
The following replaces the sections entitled "Servicing Plan" and
"Servicing Agent" in the Prospectus:
U.S. Trust, located at 114 West 47th Street, New York, NY 10036, Chase
Global Fund Services Company ("CGFSC"), located at 73 Tremont Street, Boston,
Massachusetts 02108, and Federated Administrative Services ("FAS"), a
wholly-owned subsidiary of Federated Investors located at Federated Investors
Tower, 1001 Liberty Avenue, Pittsburgh, Pennsylvania, 15222-3779, serve as the
Funds' administrators (the "Administrators"). The Administrators supervise the
affairs of the Trust, including, among other responsibilities, the negotiation
of contracts and fees with, and the monitoring of performance and billings of,
the various service providers of the Trust; provide equipment and clerical
personnel necessary for maintaining the organization of the Trust; prepare and
distribute all materials in connection with meetings of Trustees and investors;
prepare and file all documents required for compliance by the Trust with
applicable laws and regulations; and arrange for the maintenance of Fund
accounting and record-keeping of the Trust.
Federated Services Company ("FSC"), an affiliate of FAS, also serves as
servicing agent and fund accounting agent to the Trust with respect to the Bond
Index Fund, pursuant to an agreement between FSC and the Trust (the "Servicing
Agent Agreement"), which provides that FSC will perform or provide certain
administrative and fund accounting services to the Bond Index Fund.
As compensation for providing these services and facilities to the Trust,
the Administrators and FSC (with respect to the Bond Index Fund only) are
jointly entitled to an annual fee, computed daily and paid monthly from each of
the Funds (other than the International Equity Fund), based on the combined
average daily net assets of the Funds, Excelsior Funds, Inc. (formerly known as
UST Master Funds, Inc.), and Excelsior Tax-Exempt Funds, Inc. (formerly known as
UST Master Tax-Exempt Funds, Inc.) (collectively the "Fund Complex") as follows:
Combined Average Daily Net
Assets of the Funds Complex Annual Fee
first $200 million 0.200%
next $200 million 0.175%
over $400 million 0.150%
Administrative fees payable to the Administrators and FSC by each of the
above Funds are determined in proportion to their pro rata share of the total
average daily net assets of all of the funds in the Fund Complex at the time of
determination. The Administrators are jointly entitled to an annual fee from the
International Equity Fund, computed daily and paid monthly, at the annual rate
of 0.20% of the average daily net assets of such Fund. From time to time the one
or more of the Administrators or FSC may waive all or a portion of the
administrative fee payable to them by the Funds, which waiver may be terminated
at any time. For the fiscal year ended May 31, 1995, Signature Financial
Services, Inc., the former servicing agent, was entitled to receive fees under
the compensation arrangements then in place for administrative services (other
than fund accounting services) at an annual rate of up to 0.07% of the average
daily net assets of the portfolios in which the Funds were then invested. For
its fund accounting services for the same period Signature Financial Services,
Inc. was entitled to receive a per annum fee from each Fund and each portfolio
in which the Funds were then invested equal to $12,000 and $50,000 respectively.
CUSTODIAN AND TRANSFER AGENT
The following replaces the section entitled "Custodian and Transfer Agent"
in the Prospectus:
The Chase Manhattan Bank, N.A. ("Chase") serves as custodian of the Funds'
assets. Communications to the custodian should be directed to The Chase
Manhattan Bank, N.A., Mutual Funds Service Division, 770 Broadway, New York, NY
10003. Chase Global Funds Services Company ("CGFSC"), 73 Tremont Street, Boston,
Massachusetts 02108, serves as the transfer agent for the Funds, providing
transfer agency, dividend disbursement and registrar services. CGFSC is a
subsidiary of Chase.
DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
The following replaces the first paragraph of the section entitled
"Dividends And Capital Gains Distributions" in the Prospectus:
Dividends equal to all or substantially all of each Fund's net investment
income will be declared and paid as follows: For the Equity, Balanced and Equity
Growth Funds, dividends will be declared and paid at least quarterly; for the
Income, Total Return Bond and Bond Index Funds, dividends will be declared daily
and paid at least monthly; for the International Equity Fund, dividends will be
declared and paid at least once a year.
