<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
AUGUST 1, 1997
EXCELSIOR INSTITUTIONAL TRUST
73 TREMONT STREET
BOSTON, MASSACHUSETTS 02108
(617) 557-8000
EXCELSIOR INSTITUTIONAL TRUST
EXCELSIOR INSTITUTIONAL EQUITY FUND
EXCELSIOR INSTITUTIONAL VALUE EQUITY FUND
EXCELSIOR INSTITUTIONAL OPTIMUM GROWTH FUND
EXCELSIOR INSTITUTIONAL BALANCED FUND
EXCELSIOR INSTITUTIONAL INTERNATIONAL EQUITY FUND
EXCELSIOR INSTITUTIONAL INCOME FUND
EXCELSIOR INSTITUTIONAL TOTAL RETURN BOND FUND
Excelsior Institutional Trust (the "Trust") is comprised of eight funds.
This Statement of Additional Information describes the shares of seven funds -
Excelsior Institutional Equity Fund (the "Equity Fund"), Excelsior Institutional
Value Equity Fund (the "Value Equity Fund"), Excelsior Institutional Optimum
Growth Fund (the "Optimum Growth Fund"), Excelsior Institutional Balanced Fund
(the "Balanced Fund"), Excelsior Institutional International Equity Fund (the
"International Equity Fund"), Excelsior Institutional Income Fund (the "Income
Fund") and Excelsior Institutional Total Return Bond Fund (the "Total Return
Bond Fund") (each, a "Fund"; collectively, the "Funds"). This Statement of
Additional Information relates to Trust Shares ("Trust Shares") of the Value
Equity Fund, Optimum Growth Fund, Balanced Fund and International Equity Fund,
and to the other series of shares in all of the Funds that do not bear the
expenses of 12b-1 fees (the "Institutional Shares" and, collectively with the
Trust Shares, the "Shares").
Table of Contents Page
- ----------------- ----
Excelsior Institutional Trust 2
Investment Objectives, Policies and Restrictions 3
Performance Information 35
Determination of Net Asset Value; Valuation of Securities 40
Additional Purchase, Exchange, and Redemption Information 41
Management of the Trust 43
Independent Auditors 55
Counsel 56
Taxation 56
Description of the Trust; Fund Shares 59
Miscellaneous 60
Financial Statements 61
<PAGE>
Appendix A A-1
This Statement of Additional Information sets forth information which may be
of interest to investors but which is not necessarily included in the Funds'
Prospectuses as they may be amended from time to time (the "Prospectuses").
This Statement of Additional Information should be read only in conjunction with
the Prospectuses, copies 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 Prospectuses, are
used herein as defined in the Prospectuses.
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 Institutional Shares and Trust Shares of the Trust are
continuously sold to institutional investors and individuals, respectively.
Shares of the Trust are divided into eight separate series, seven of which are
described herein. Additional series may be added to the Trust from time to
time.
United States Trust Company of New York ("U.S. Trust New York") and U.S. Trust
Company of Connecticut ("U.S. Trust Connecticut" and, collectively with U.S.
Trust New York, "U.S. Trust") serve as the investment adviser to the Equity
Fund, Value Equity Fund, Optimum Growth 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 and International Equity Fund. The
daily management of the security holdings of these Funds is performed by the
investment managers named below, acting as sub-advisers:
Balanced Fund...........................Becker Capital Management, Inc.
International Equity Fund.........Harding, Loevner Management, L.P.
-2-
<PAGE>
INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
INVESTMENT OBJECTIVES
The investment objective of each Fund is described in the Prospectuses. 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 Prospectuses.
OTHER INVESTMENT CONSIDERATIONS - EQUITY FUND, VALUE EQUITY FUND AND OPTIMUM
GROWTH FUND
The Equity, Value Equity and Optimum Growth Funds invest 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 each Fund's objective, 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.
-3-
<PAGE>
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 Funds' 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.
-4-
<PAGE>
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 sub-adviser 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
-5-
<PAGE>
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
-6-
<PAGE>
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.
SECURITIES LENDING
When a Fund lends its portfolio securities, it continues to receive interest
or dividends on the securities lent and may simultaneously earn interest on the
investment of the cash loan collateral, which will be invested in readily
marketable, high-quality, short-term obligations. Although voting rights, or
rights to consent, attendant to securities lent pass to the borrower, such loans
may be called at any time and will be called so that the securities may be voted
by a Fund if a material event affecting the investment is to occur.
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
-7-
<PAGE>
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
investment managers 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 deemed illiquid. 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 deemed illiquid. Currently, no Fund intends to invest
more than 5% of its net assets in participation interests during the current
year. See "Investment Restrictions" below.
-8-
<PAGE>
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
-9-
<PAGE>
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 or other liquid assets 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 objectives, 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
-10-
<PAGE>
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 Investors Service, Inc. ("Moody's") and Standard & Poor's
Ratings Group ("S&P") described in the Prospectuses 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 Prospectuses. 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.
-11-
<PAGE>
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,
-12-
<PAGE>
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.
-13-
<PAGE>
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 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
-14-
<PAGE>
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 Prospectuses 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
-15-
<PAGE>
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 deemed illiquid, 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 liquid assets 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.
-16-
<PAGE>
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.
ASSET-BACKED SECURITIES
If permitted pursuant to its investment objectives and policies, a Fund may
invest in asset-backed securities including, but not limited to, interests in
pools of receivables, such as motor vehicle installment purchase obligations and
credit card receivables, equipment leases, manufactured housing (mobile home)
leases, or home equity loans. These securities may be in the form of pass-
through instruments or asset-backed bonds. The securities are issued by non-
governmental entities and carry no direct or indirect government guarantee.
The credit characteristics of asset-backed securities differ in a number of
respects from those of traditional debt securities. The credit quality of most
asset-backed securities depends primarily upon the credit quality of the assets
underlying such securities, how well the entity issuing the securities is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement to such
securities.
Credit card receivables are generally unsecured and debtors are entitled to
the protection of a number of state and federal consumer credit laws, many of
which give such debtors the right to set off certain amounts owed on the credit
cards, thereby reducing the balance due. Most issuers of asset-backed
securities backed by motor vehicle installment purchase obligations permit the
servicer of such receivable to retain possession of the underlying obligations.
If the servicer sells these obligations to another party, there is a risk that
the purchaser would acquire an interest superior to that of the holders of the
related asset-backed securities. Further, if a vehicle is registered in one
state and is then re-registered because the owner and obligor moves to another
state, such re-registration could defeat the original security interest in the
vehicle in certain cases. In addition, because of the large number of vehicles
involved in a typical issuance and technical requirements under state laws, the
trustee for the holders of asset-backed securities backed by automobile
receivables may not have a proper security interest in all of the obligations
backing such receivables. Therefore, there is the possibility that recoveries
on repossessed collateral may not, in some cases, be available to support
payments on these securities.
-17-
<PAGE>
ADRS, EDRS AND GDRS
Each of the Equity, Value Equity, Optimum Growth, Balanced and International
Equity Funds may invest indirectly in the securities of foreign issuers through
sponsored and unsponsored American Depository Receipts ("ADRs"), European
Depository Receipts ("EDRs"), Global Depository Receipts ("GDRs") and other
similar instruments. ADRs typically are issued by an American bank or trust
company and evidence ownership of underlying securities issued by a foreign
corporation. EDRs, which are sometimes referred to as Continental Depository
Receipts, are receipts issued in Europe, typically by foreign banks and trust
companies, that evidence ownership of either foreign or domestic underlying
securities. GDRs are depository receipts structured like global debt issues to
facilitate trading on an international basis. Unsponsored ADR, EDR and GDR
programs are organized independently and without the cooperation of the issuer
of the underlying securities. As a result, available information concerning the
issuer may not be as current as for sponsored ADRs, EDRs and GDRs, and the
prices of unsponsored ADRs, EDRs and GDRs may be more volatile than if such
instruments were sponsored by the issuer.
The International Equity Fund may also invest indirectly in foreign securities
through share entitlement certificates. Share entitlement certificates are
securities issued by a foreign entity evidencing ownership of underlying
securities issued by foreign corporations. Share entitlement certificates are
transferrable securities similar to depository receipts which are structured
like global debt issues to facilitate trading on an international basis. The
holder of a share entitlement certificate holds a fully collateralized
obligation of the issuer the value of which is linked directly to that of the
underlying foreign security.
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
-18-
<PAGE>
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
-19-
<PAGE>
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
or other liquid assets 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
-20-
<PAGE>
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.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may result in losses in excess of the amount invested in the
contract.
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
-21-
<PAGE>
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.
-22-
<PAGE>
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 liquid assets 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
-23-
<PAGE>
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 other liquid
assets 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
-24-
<PAGE>
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 non-
business hours in the United States, (iv) the imposition of different exercise
and settlement terms and procedures and margin requirements than in the United
States, and (v) lesser trading volume.
OPTIONS ON 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.
-25-
<PAGE>
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
-26-
<PAGE>
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 Board of 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
-27-
<PAGE>
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
-28-
<PAGE>
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' Prospectuses, 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 sub-
adviser 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' Prospectuses 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 Prospectuses 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.
-29-
<PAGE>
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:
(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 Equity, Income, Total Return Bond, Balanced and International
Equity Funds will not purchase securities while borrowings exceed 5% of their
respective 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); or
-30-
<PAGE>
(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.
With respect to the Equity, Income, Total Return Bond, Balanced and
International Equity Funds, none of the above-referenced fundamental investment
restrictions 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.
Non-Fundamental Restrictions. Each Fund will not as a matter of operating
----------------------------
policy:
(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 than 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 sub-adviser of the Fund, if after the
purchase of the securities of such issuer
-31-
<PAGE>
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, to be included in the overall 5% limit on investments in
warrants, may be invested in warrants which are 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; or
(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.
Policies (i) through (viii) may be changed by the Board of Trustees
of the Trust without shareholder approval.
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
-32-
<PAGE>
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 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 Sub-Advisory 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 Sub-Advisory Agreements authorize the investment
managers, to the extent permitted by law and subject to the review of the
Trust's Board of Trustees, 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.
-33-
<PAGE>
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 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.
For the fiscal period from June 1, 1996 through March 31, 1997, the following
Funds paid the following approximate brokerage commissions: Equity Fund:
$71,134; Value Equity Fund: $59,569; Optimum Growth Fund: $11,787; Balanced
Fund: $38,746; and International Equity Fund: $95,258.
For the fiscal period from June 1, 1996 through March 31, 1997, the Value
Equity Fund paid brokerage commissions aggregating $2,177 to UST Securities,
Inc., an affiliate of U.S. Trust. The percentage of total brokerage commissions
paid by the Fund to UST Securities, Inc. during the fiscal period ended March
31, 1997 was 3.65%; and the percentage of the total amount of the Fund's
brokerage transactions involving the payment of commissions that was effected
through UST Securities, Inc. during that period was 6.16%.
For the fiscal year ended May 31, 1996, the following Funds/1/ paid the
following approximate brokerage commissions: Equity Fund: $60,370; Balanced
Fund: $62,957; and International Equity Fund: $70,769.
The following Funds/1/ paid the following approximate brokerage commissions
for their respective fiscal periods from commencement of operations/2/ through
May 31 1995: Equity Fund: $27,636; Balanced Fund: $43,886; and International
Equity Fund: $33,014.
- ----------
/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.
/2/ The Funds commenced operations on the following dates: Equity and Income
Funds, January 16, 1995; Total Return Bond Fund, January 19, 1995; Balanced
Fund, July 11, 1994; and International Equity Fund, January 24, 1995.
-34-
<PAGE>
The Trust is required to identify any securities of its regular brokers or
dealers (as defined in Rule 10b-1 under the 1940 Act) or their parents held by
the Funds as of the close of the most recent fiscal year. As of March 31, 1997,
the following Funds held the following securities of the Trust's regular brokers
or dealers or their parents: (a) the Equity Fund held the following security:
50,485 shares of common stock of Morgan Stanley Group, Inc.; (b) the Optimum
Growth Fund held the following security: 10,000 shares of common stock of
Merrill Lynch & Co., Inc.; (c) the Income Fund held a Dillon Read repurchase
agreement with a par value of $1,443,296; and (d) the Total Return Bond Fund
held a Dillon Read repurchase agreement with a par value of $17,522,698.
PERFORMANCE INFORMATION
STANDARD PERFORMANCE INFORMATION
From time to time, performance quotations of the Funds' Institutional Shares
or Trust Shares may be included in advertisements, sales literature or
shareholder reports. These performance figures are calculated in the following
manner:
YIELD. The Income and Total Return Bond Funds may quote the standardized
effective 30-day (or one month) yield for their respective Institutional Shares,
calculated in accordance with the method prescribed by the SEC for mutual funds.
Such yield will be calculated for each Fund's Institutional Shares according to
the following formula:
Yield = 2 (ab/cd + 1)/to the power of 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
-35-
<PAGE>
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 its Institutional Shares and Trust Shares with respect to the fixed income
portion of its portfolio, calculated in the same manner as specified above.
For the 30-day period ended March 31, 1997, the standardized effective yield
for Institutional Shares of the Income and Total Return Bond Funds was as
follows: Income Fund, 6.54%; and Total Return Bond Fund, 6.21%. For the same
30-day period, the standardized effective yield for Institutional Shares of the
Balanced Fund (with respect to its fixed income component) was 3.57%.
TOTAL RETURN. The "average annual total return" for Institutional Shares and
Trust Shares of a Fund 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)/to the power of 1 divided by 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.
Each Fund may also advertise the "aggregate total return" for its
Institutional Shares and Trust Shares which is computed by determining the
aggregate compounded rates of return during specified periods that likewise
equate the initial amount invested to the ending
-36-
<PAGE>
redeemable value of such investment. The formula for calculating aggregate total
return is as follows:
Aggregate Total Return = [(ERV/P)] - 1
The above calculations are 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 a 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.
Based on the foregoing calculations, the aggregate total returns for
Institutional Shares of the Equity, Balanced, International Equity, Income and
Total Return Bond Funds for the period from June 1, 1996 to March 31, 1997 were
10.22%, 8.20%, 2.41%, 5.39% and 5.29%, respectively. The average annual total
returns for Institutional Shares of the Equity, Balanced, International Equity,
Income and Total Return Bond Funds for the period from commencement of
operations* to March 31, 1997 were 17.58%, 13.92%, 14.48%, 7.34% and 8.66%,
respectively.
The aggregate total return for Institutional Shares of the Value Equity and
Optimum Growth Funds for the period from commencement of operations* to March
31, 1997 were 13.91% and 2.23%, respectively. The aggregate total return for
Trust Shares of the Value Equity and Optimum Growth Funds for the period from
commencement of operations* to March 31, 1997 were -6.21% and 3.31%,
respectively.
- ----------------
* The Funds commenced operations on the following dates: Equity and Income
Funds, January 16, 1995; Total Return Bond Fund, January 19, 1995;
Institutional Shares of the Optimum Growth Fund, June 1, 1996; Trust Shares
of the Optimum Growth Fund, July 3, 1996; Balanced Fund, July 11, 1994;
Institutional Shares of the Value Equity Fund, June 1, 1996; Trust Shares
of the Value Equity Fund, January 15, 1997; and International Equity Fund,
January 24, 1995. During the fiscal period ended March 31, 1997, no Trust
Shares of the Balanced and International Equity Funds were outstanding.
PERFORMANCE RESULTS. Any yield or total return quotation provided for
Institutional Shares and Trust Shares of 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
-37-
<PAGE>
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 Institutional Shares and Trust Shares 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. Trust Shares in a Fund have different expenses than
Institutional Shares which may affect performance.
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.
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 Institutional Shares and
Trust Shares 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.
-38-
<PAGE>
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.
-39-
<PAGE>
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 Institutional Shares and Trust
Shares of each Fund each day both the New York Stock Exchange (the "NYSE") is
open for business and the Funds are 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, Martin Luther King, Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas. Daily determinations of net asset value for
each Fund are made at 4:00 p.m. (Eastern time) and are calculated separately for
each class of Shares by dividing the total assets of a Fund that are allocated
to a particular class of Shares less all of its liabilities charged to that
class, by the total number of Shares of the class that are 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 Prospectuses.
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.
-40-
<PAGE>
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.
ADDITIONAL PURCHASE, EXCHANGE, AND REDEMPTION INFORMATION
Shares are continuously offered for sale by Edgewood Services, Inc. (the
"Distributor"). As described in the Prospectuses, Trust Shares and
Institutional Shares are offered to individual investors and institutions,
respectively. Both Institutional Shares and Trust Shares may be purchased
directly from the Distributor or through Shareholder Organizations. Different
types of Customer accounts at certain Shareholder Organizations may be used to
purchase Trust Shares and Institutional 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 Prospectuses, 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 pursuant
to the exchange program described in the Prospectuses.
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.
-41-
<PAGE>
Pursuant to Rule 12b-1 of the 1940 Act, the Trust has adopted a Distribution
Plan (the "Distribution Plan") which permits the Trust Shares of the Value
Equity, Optimum Growth, Balanced and International Equity Funds to bear certain
expenses in connection with the distribution of those Shares. As required by
Rule 12b-1, the Funds' Distribution Plan and related distribution agreement have
been approved, and are subject to annual approval by, a majority of the Trust's
Board of Trustees, and by a majority of the trustees who are not interested
persons of the Trust and have no direct or indirect interest in the operation of
the Distribution Plan or any agreement relating to the Distribution Plan, by
vote cast in person at a meeting called for the purpose of voting on the
Distribution Plan and related agreement. Rule 12b-1 also requires that persons
authorized to direct the disposition of monies payable by a Fund (in the Funds'
case, the Distributor) provide for the trustees' review of quarterly reports on
the amounts expended and the purposes for the expenditures.
Under the Distribution Plan, the Trust Shares of Value Equity, Optimum Growth,
Balanced and the International Equity Funds may compensate the Distributor
monthly for its services which are intended to result in the sale of Trust
Shares. The compensation may not exceed the annual rate of .75% of the average
daily net asset value of each Fund's outstanding Trust Shares. Trust Shares of
each Fund currently bear the expenses of such distribution fees at the annual
rate of .35% of the average daily net asset value of the Fund's outstanding
Trust Shares. The Distributor may also use the distribution fees to defray
direct and indirect marketing expenses such as: (i) the expense of preparing,
printing and distributing promotional materials and prospectuses (other than
prospectuses used for regulatory purposes or for distribution to existing
shareholders); (ii) the expense of other advertising via radio, television or
other print or electronic media; and (iii) the expense of payments to financial
institutions ("Distribution Organizations") for distribution assistance
(including sales incentives). Payments under the Distribution Plan are not tied
directly to out-of-pocket expenses and therefore may be used by the Distributor
as it chooses (for example, to defray its overhead expenses).
Any material amendment to the Trust's arrangements with Distribution
Organizations must be approved by a majority of the Trust's Board of Trustees
(including a majority of the disinterested trustees). Any change in the
Distribution Plan that would materially increase the distribution expenses of
Trust Shares requires approval by holders of those Shares, but otherwise, the
Distribution Plan may be amended by the trustees, including a majority of the
disinterested trustees. So long as the Distribution Plan is in effect, the
selection and nomination of the members of the Trust's Board of Trustees who are
not "interested persons" (as defined in the 1940 Act) of the Trust will be
committed to the discretion of such non-interested trustees.
The Distribution Plan will continue in effect for successive one year periods,
provided that such continuance is specifically approved by the vote of a
majority of the trustees who are not parties to the Distribution Plan or
interested persons of any such party and who have no direct or indirect
financial interest in the Distribution Plan or any related agreement and the
vote of a majority of the entire Board of Trustees. The Distribution Plan and
related
-42-
<PAGE>
agreement may be terminated as to a particular Fund by a vote of a majority of
the Trust's disinterested trustees or by vote of the holders of a majority of
the Trust Shares of the Fund.
For the fiscal period ended March 31, 1997, the Trust Shares of the Value
Equity and Optimum Growth Funds bore distribution fees under the Distribution
Plan of $43 and $3,232, respectively, to compensate the Distributor for
distribution-related services.
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 SEC; (b) the NYSE is
closed for other than customary weekend and holiday closings; (c) the SEC has by
order permitted such suspension; or (d) an emergency exists as determined by the
SEC.
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 Prospectuses, Trust Shares and Institutional Shares of the
Funds may be purchased in connection with certain Retirement Programs.
Customers of Shareholder Organizations may obtain information on the
availability of, and the procedures and fees relating to, such programs directly
from their Shareholder Organizations.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS OF THE TRUST
Trustees and Officers
- ---------------------
The trustees and officers of the Companies, their addresses, ages, principal
occupations during the past five years, and other affiliations are as follows:
-43-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with the During Past 5 Years and
Name and Address Trust Other Affiliations
- ---------------- ------- ----------------------
<S> <C> <C>
Frederick S. Wonham/*/ Chairman of the Retired; Director of Excelsior Funds,
238 June Road Board, President and Inc. and Excelsior Tax-Exempt
Stamford, CT 06903 Treasurer Funds, Inc. (since 1995); Trustee of
Age: 66 Excelsior Funds and the Trust (since
1995); Vice Chairman of U.S. Trust
Corporation and U.S. Trust New
York (from February 1990 until
September 1995); and Chairman,
U.S. Trust Connecticut (from March
1993 to May 1997).
Alfred C. Tannachion* Trustee Retired; Director of Excelsior Funds,
6549 Pine Meadows Drive Inc. and Excelsior Tax-Exempt
Spring Hill, FL 34606 Funds, Inc. (since 1985); Chairman
Age 71 of the Board, President and
Treasurer of UST Master Variable
Series, Inc. (from 1994 to June
1997); and Trustee of the Trust
(since 1995).
Donald L. Campbell Trustee Retired; Director of Excelsior Funds,
333 East 69th Street Inc. and Excelsior Tax-Exempt
Apt. 10-H Funds, Inc. (Since 1984); Director of
New York, NY 10021 UST Master Variable Series, Inc.
Age: 71 (from 1994 to June 1997); Trustee of
the Trust (since 1995); and Director,
Royal Life Insurance Co. of New
York (since 1991).
</TABLE>
* This trustee is considered to be an "interested person" of the Trust as
defined in the 1940 Act.
-44-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with the During Past 5 Years and
Name and Address Trust Other Affiliations
- ---------------- ------- ----------------------
<S> <C> <C>
Rodman L. Drake Trustee Trustee, Excelsior Funds and the
485 Park Avenue Trust (since 1994); Director of
New York, NY 10022 Excelsior Funds, Inc. and Excelsior
Age: 54 Tax-Exempt Funds, Inc. (since
December 1996); Director, Parsons
Brinkerhoff Energy Services Inc.
(since 1996); Director, Parsons
Brinkerhoff, Inc. (engineering firm)
(since 1995); President, Mandrake
Group (investment and consulting
firm) (since 1994); Director,
Hyperion Total Return Fund, Inc.
and four other funds for which
Hyperion Capital Management, Inc.
serves as investment adviser (since
1991); Co-Chairman, KMR Power
Corporation (power plants) (from
1993 to 1996); Director, The Latin
American Growth Fund (since 1993);
Member of Advisory Board,
Argentina Private Equity Fund L.P.
(from 1992 to 1996) and Garantia
L.P (Brazil) (from 1993 to 1996);
and Director, Mueller Industries, Inc
(from 1992 to 1994).
Joseph H. Dugan Trustee Retired; Director of Excelsior Funds,
913 Franklin Lakes Road Inc. and Excelsior Tax-Exempt
Franklin Lakes, NJ 07417 Funds, Inc. (since 1984); Director of
Age: 72 UST Master Variable Series, Inc.
(from 1994 to June 1997); and
Trustee of the Trust (since 1995).
</TABLE>
-45-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with the During Past 5 Years and
Name and Address Trust Other Affiliations
- ---------------- ------- ----------------------
<S> <C> <C>
Wolfe J. Frankl Trustee Retired; Director of Excelsior Funds,
2320 Cumberland Road Inc. and Excelsior Tax-Exempt
Charlottesville, VA 22901 Funds, Inc. (since 1986); Director of
Age: 76 UST Master Variable Series, Inc.
(from 1994 to June 1997); Trustee of
the Trust (since 1995); Director,
Deutsche Bank Financial, Inc. (since
1989); Director, The Harbus
Corporation (since 1951); and
Trustee, HSBC Funds Trust and
HSBC Mutual Funds Trust (since
1988).
W. Wallace McDowell, Jr. Trustee Director of Excelsior Funds, Inc.
c/o Prospect Capital and Excelsior Tax-Exempt Funds,
Corp. Inc. (since 1996); Trustee of
43 Arch Street Excelsior Funds and the Trust (since
Greenwich, CT 06830 1994); Private Investor (since
Age: 60 1994); Managing Director, Morgan
Lewis Githens & Ahn (from 1991 to
1994); and Director, U.S. Homecare
Corporation (since 1992),
Grossmans, Inc. (from 1993 to
1996), Children's Discovery Centers
(since 1984), ITI Technologies, Inc.
(since 1992) and Jack Morton
Productions (since 1987).
</TABLE>
-46-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with the During Past 5 Years and
Name and Address Trust Other Affiliations
- ---------------- ------- ----------------------
<S> <C> <C>
Jonathan Piel Trustee Director of Excelsior Funds, Inc.
558 E. 87th Street and Excelsior Tax-Exempt Funds,
New York, NY 10128 Inc. (since 1996); Trustee of
Age: 58 Excelsior Funds and the Trust (since
1994); Vice President and Editor,
Scientific American, Inc. (from 1986
to 1994); Director, Group for The
South Fork, Bridgehampton, New
York (since 1993); and Member,
Advisory Committee, Knight
Journalism Fellowships,
Massachusetts Institute of
Technology (since 1984).
Robert A. Robinson Trustee Director of Excelsior Funds, Inc.
Church Pension Fund and Excelsior Tax-Exempt Funds,
800 Second Avenue Inc. (since 1987); Director of UST
New York, NY 10017 Master Variable Series, Inc. (from
Age: 71 1994 to June 1997); Trustee of the
Trust (since 1995); President
Emeritus, The Church Pension Fund
and its affiliated companies (since
1966); Trustee, H.B. and F.H.
Bugher Foundation and Director of
its wholly owned subsidiaries --
Rosiclear Lead and Flourspar Mining
Co. and The Pigmy Corporation
(since 1984); Director, Morehouse
Publishing Co. (since 1974);
Trustee, HSBC Funds Trust and
HSBC Mutual Funds Trust (since
1982); and Director, Infinity Funds,
Inc. (since 1995).
W. Bruce McConnel, III Secretary Partner of the law firm of Drinker
Philadelphia National Biddle & Reath LLP.
Bank Building
1345 Chestnut Street
Philadelphia, PA 19107
Age: 54
</TABLE>
-47-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with the During Past 5 Years and
Name and Address Trust Other Affiliations
- ---------------- ------- ----------------------
<S> <C> <C>
Gregory Sackos Assistant Second Vice President, Senior
Chase Global Funds Secretary Manager of Blue Sky Compliance
Services Company and Financial Reporting, Chase
73 Tremont Street Global Funds Services Company
Boston, MA 02108-3913 (March 1997 to present); Second
Age: 32 Vice President, Senior Manager of
Financial Reporting, Chase Global
Funds Services Company (September
1996 to March 1997); and Assistant
Vice President, Assistant Manager of
Financial Reporting, Scudder,
Stevens & Clark Inc. (October 1992
to September 1996).
John M. Corcoran Assistant Vice President, Director of
Chase Global Funds Treasurer Administration Client Group, Chase
Services Company Global Funds Services Company
73 Tremont Street (since July 1996); Second Vice
Boston, MA 02108-3913 President, Manager of
Age: 32 Administration, Chase Global Funds
Services Company (from October
1993 to July 1996); and Audit
Manager, Ernst & Young LLP (from
August 1987 to September 1993).
</TABLE>
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 period ended
March 31, 1997 is set forth below. The Trustees may hold various other
directorships unrelated to these Funds.
-48-
<PAGE>
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT FROM THE
BENEFITS ESTIMATED TRUST AND
AGGREGATE ACCRUED AS ANNUAL FUND
COMPENSATION PART OF TRUST BENEFITS UPON COMPLEX* PAID
FROM THE TRUST EXPENSES RETIREMENT TO TRUSTEES
<S> <C> <C> <C> <C>
Frederick S. Wonham*** $5,000 None None (4)**$35,000
Rodman L. Drake**** $4,750 None None (4)**$12,250
W. Wallace McDowell**** $4,750 None None (4)**$ 9,250
Jonathan Piel**** $5,000 None None (4)**$12,500
Alfred Tannachion*** $5,000 None None (4)**$45,000
Donald L. Campbell $4,750 None None (4)**$31,750
Joseph C. Dugan $5,000 None None (4)**$35,000
Wolfe J. Frankl $5,000 None None (4)**$35,000
Robert A. Robinson $5,000 None None (4)**$35,000
</TABLE>
- -----------------------------
* The "Fund Complex" consists of the Trust, Excelsior Funds, Excelsior Funds,
Inc., Excelsior Tax-Exempt Funds, Inc. and UST Master Variable Series, Inc. The
Trust has no pension plan.
** Number of investment companies in the Fund Complex for which trustee served
as director or trustee.
*** Mr. Tannachion served as the Trust's Chairman of the Board, President and
Treasurer until February 13, 1997. On that date, Mr. Wonham was elected to
serve as the Trust's Chairman of the Board, President and Treasurer.
**** Messrs. Drake, McDowell and Piel were elected to the Board of Excelsior
Funds, Inc. and Excelsior Tax-Exempt Funds, Inc. on December 9, 1996.
* * * * *
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
-49-
<PAGE>
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.
As of July 14, 1997, the Trustees and officers of the Trust as a group owned
beneficially less than 1% of the outstanding shares of each fund of the Trust,
and less than 1% of the outstanding shares of all funds of the Trust in the
aggregate. 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
United States Trust Company of the Pacific Northwest ("U.S. Trust Pacific") is
responsible for the management of the assets of the Balanced 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. United States Trust Company of New York ("U.S.
Trust New York") and U.S. Trust Company of Connecticut ("U.S. Trust Connecticut"
and, collectively with U.S. Trust New York, "U.S. Trust") are responsible for
the management of the assets of the Equity, Income, Total Return Bond, Optimum
Growth and Value 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. 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 as
long as such continuance is specifically approved at least annually by the Board
of Trustees of the Trust or by a majority vote of the shareholders in the
applicable Fund and, in either case, by a majority of the Trustees of the Trust
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 investment adviser and administrator has agreed to waive certain fees.
Each Advisory Agreement provides that the investment adviser may render
services to others, and each Advisory Agreement is terminable by the Trust
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 by a vote of a majority
of the Board of Trustees of the Trust, 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
-50-
<PAGE>
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, except that U.S. Trust Pacific shall be liable, and U.S. Trust shall
be jointly, but not severally, liable for willful misfeasance, bad faith, gross
negligence or reckless disregard of its or their obligations and duties under
the Advisory Agreement.
The Prospectuses contain descriptions of the fees payable to the investment
advisers under the Advisory Agreements.
Prior to May 16, 1997, U.S. Trust New York served as investment adviser to the
Equity, Income, Total Return Bond, Value Equity and Optimum Growth Funds
pursuant to advisory agreements substantially similar to the Investment Advisory
Agreements currently in effect for the Funds.
For the fiscal period ended March 31, 1997, U.S. Trust New York received
advisory fees of $438,147, $41,543, $48,831, $71,647, and $252,506 with respect
to the Equity, Value Equity, Optimum Growth, Income and Total Return Bond Funds,
respectively. For the same period, U.S. Trust New York waived advisory fees of
$223,185, $76,512, $82,357, $173,417 and $457,871 with respect to the Equity,
Value Equity, Optimum Growth, Income and Total Return Bond Funds, respectively.
For the fiscal year ended May 31, 1996, U.S. Trust New York received advisory
fees of $28,097, $14,373 and $31,440 with respect to the Equity, Income and
Total Return Bond Funds, respectively. For the same period, U.S. Trust New York
waived advisory fees of $109,889, $189,870 and $223,015 and reimbursed expenses
totalling $68,274, $64,906 and $67,299 with respect to the Equity, Income and
Total Return Bond Funds, respectively.
For the fiscal year ended May 31, 1995, U.S. Trust New York waived its entire
advisory fee totalling $23,905, $67,732 and $43,478 and reimbursed expenses
totalling $52,689, $57,377 and $52,905 with respect to the Equity, Income and
Total Return Bond Funds, respectively.
For the fiscal period ended March 31, 1997, U.S. Trust Pacific received
advisory fees of $332,346 and $119,788 with respect to the Balanced and
International Equity Funds, respectively. For the same period, U.S. Trust
Pacific waived advisory fees of $180,419 and $173,028 with respect to the
Balanced and International Equity Funds, respectively.
For the fiscal year ended May 31, 1996, U.S. Trust Pacific received advisory
fees of $167,588 and $38,181 with respect to the Balanced and International
Equity Funds, respectively. For the same period, U.S. Trust Pacific waived
advisory fees of $395,766 and $143,820 and U.S. Trust reimbursed expenses
totalling $97,439 and $66,499 with respect to the Balanced and International
Equity Funds, respectively.
-51-
<PAGE>
For the fiscal year ended May 31, 1995, U.S. Trust Pacific waived its entire
advisory fee totalling $365,664 and $26,276 and U.S. Trust reimbursed expenses
totalling $153,882 and $40,377 with respect to the Balanced and International
Equity Funds, respectively.
With respect to the Balanced and International Equity Funds, U.S. Trust
Pacific has entered into an investment sub-advisory agreement (each a "Sub-
Advisory Agreement") with each of the sub-advisers listed below opposite the
name of the Fund. For their services under the Sub-Advisory Agreements, the
sub-advisers 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.
<TABLE>
<CAPTION>
Compensation Rate for
Fund Name Sub-Adviser Sub-Adviser (%)
- --------------------------- ---------------------- ------------------
<S> <C> <C>
Balanced Fund Becker Capital .425%
Management, Inc.
("Becker")
International Equity Fund Harding, Loevner .50%
Management, Inc. L.P.
("Harding Loevner")
</TABLE>
It is the responsibility of each of the above sub-advisers 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 sub-adviser 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.
For the fiscal period ended March 31, 1997, Becker and Harding Loevner
received sub-advisory fees of $188,946 and $145,572 with respect to the Balanced
and International Equity Funds, respectively. For the same period, Becker
waived sub-advisory fees of $145,986 with respect to the Balanced Fund.
For the fiscal year ended May 31, 1996, Becker and Harding Loevner received
sub-advisory fees of $210,011 and $88,105 with respect to the Balanced and
International Equity Funds, respectively. For the same period, Becker and
Harding Loevner waived sub-advisory fees of $158,336 and $2,896 with respect to
the Balanced and International Equity Funds, respectively.
For the fiscal year ended May 31, 1995, Becker and Harding Loevner received
sub-advisory fees of $239,088 and $11,824 with respect to the Balanced and
International Equity Funds, respectively.
-52-
<PAGE>
ADMINISTRATORS
Chase Global Funds Services Company ("CGFSC"), Federated Administrative
Services ("FAS") and U.S. Trust Connecticut serve as the Funds' administrators
(the "Administrators") pursuant to an agreement between the Administrators and
the Trust (the "Administrative Agreement"). The Prospectuses contain
descriptions 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 values, net income and
realized capital gains or losses, if any, of the Funds. The Administrators
prepare semi-annual reports to the SEC, 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.
Prior to May 16, 1997, CGFSC, FAS and U.S. Trust New York served as the Funds'
administrators pursuant to an administration agreement substantially similar to
the administration agreement currently in effect for the Funds.
For the fiscal period ended March 31, 1997, CGFSC, FAS and U.S. Trust New York
received administration fees of $155,310, $27,893, $30,991, $121,293, $58,563,
$57,907 and $167,883 with respect to the Equity, Value Equity, Optimum Growth,
Balanced, International Equity, Income and Total Return Bond Funds,
respectively.
For the period from December 18, 1995 through May 31, 1996, CGFSC, Federated
Administrative Services and U.S. Trust New York received administration fees of
$15,122, $19,853, $33,627, $65,113 and $20,897 with respect to the Equity,
Income, Total Return Bond, Balanced and International Equity Funds,
respectively.
Prior to December 18, 1995, Signature Financial Services, Inc. ("SFSI") served
as servicing agent and fund accounting agent to each of the Funds. For its
services as servicing agent, SFSI was entitled to fees at the annual rate of up
to .07% of the average daily net assets of each Fund. For its fund accounting
services, SFSI was entitled to receive a per annum fee of $12,000 from each
Fund. For period from June 1, 1995 through December 18, 1995, SFSI received
fund accounting and servicing agent fees of $38,777, $44,400, $42,518, $54,933
and $41,496 with respect to the Equity, Income, Total Return Bond, Balanced and
International Equity Funds, respectively.
For the fiscal year ended May 31, 1995, SFSI received fund accounting and
servicing agent fees of $24,861, $28,302, $25,798, $82,822 and $23,227 with
respect to the Equity, Income, Total Return Bond, Balanced and International
Equity Funds, respectively.
-53-
<PAGE>
SHAREHOLDER ORGANIZATIONS
As stated in the Prospectuses, the Trust may enter into agreements with
certain Shareholder Organizations. Such agreements require the Shareholder
Organizations to provide shareholder administrative services to their Customers
who beneficially own Shares in consideration for a Fund's payment of not more
than the annual rate of .40% of the average daily net assets of the Fund's
Shares beneficially owned by Customers of the Shareholder Organization. Such
services may include: (a) acting as recordholder of Shares; (b) assisting in
processing purchase, exchange and redemption transactions; (c) providing
periodic statements showing a Customer's account balances and confirmations of
transactions by the Customer; (d) providing tax and dividend information to
shareholders as appropriate; (e) transmitting proxy statements, annual reports,
updated prospectuses and other communications from the Trust to Customers; and
(f) providing or arranging for the provision of other related services.
The Trust's agreements with Shareholder Organizations are governed by an
Administrative Services Plan (the "Plan") adopted by the Trust. Pursuant to the
Plan, the Trust's Board of Trustees will review, at least quarterly, a written
report of the amounts expended under the Trust's agreements with Shareholder
Organizations and the purposes for which the expenditures were made. In
addition, the arrangements with Shareholder Organizations will be approved
annually by a majority of the Trust's Trustees, including a majority of the
Trustees who are not "interested persons" of the Trust (as defined in the 1940
Act) and have no direct or indirect financial interest in such arrangements (the
"Disinterested Trustees").
Any material amendment to the Trust's arrangements with Shareholder
Organizations must be approved by a majority of the Trust's Board of Trustees
(including a majority of the Disinterested Trustees). So long as the Trust's
arrangements with Shareholder Organizations are in effect, the selection and
nomination of the members of the Trust's Board of Trustees who are not
"interested persons" of the Trust (as defined in the 1940 Act) will be committed
to the discretion of such Disinterested Trustees.
For the fiscal period ended March 31, 1997, the Funds did not make any
payments to Shareholder Organizations.
-54-
<PAGE>
TRANSFER AGENT AND CUSTODIAN
The Chase Manhattan Bank ("Chase") serves as custodian of the Funds' assets.
Under the Custodian Agreement, Chase has agreed to (i) maintain a separate
account or accounts in the name of the Funds; (ii) make receipts and
disbursements of money on behalf of the Funds; (iii) collect and receive all
income and other payments and distributions on account of the Funds' portfolio
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's Board of Trustees concerning the
Funds' operations. 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 for the performance of all its custodial duties
under the Custodian Agreement, notwithstanding any delegation.
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's Board of Trustees 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.
INDEPENDENT AUDITORS
Ernst & Young LLP ("E&Y"), independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of the Trust. The Funds' Financial Highlights
included in the Prospectuses and the financial statements for the period ended
March 31, 1997 incorporated by reference in this Statement of Additional
Information have been audited by Ernst & Young LLP for the periods included in
their reports thereon which appear therein.
-55-
<PAGE>
COUNSEL
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of the Trust, is
a partner), Philadelphia National Bank Building, 1345 Chestnut Street,
Philadelphia, Pennsylvania 19107, is counsel to the Trust and will pass upon the
legality of the Shares offered by the Trust's Prospectuses.
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 investment company taxable income, and the Fund's
distributions would generally be taxable as ordinary dividend income to
shareholders.
Any Fund distribution (or, in the case of the Income and Total Return Bond
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.
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.
-56-
<PAGE>
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 foreign
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 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. In the case of corporate shareholders,
distributions (other than capital gains dividends) will qualify for the amount
of "qualifying dividends" received by a Fund for the year. Generally, a
"qualifying dividend" is a dividend that has been received from a domestic
corporation. 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
-57-
<PAGE>
ordinary income and capital gains from previous years. For this and other
purposes, a Fund dividend declared by a Fund in October, November or December
with a record date before the end of the year will be deemed for tax purposes to
have been paid by the Fund and received by the shareholder during that year, so
long as the dividends are actually paid 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 income taxes paid by the Fund.
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. Fund shareholders may be subject to state and
local taxes on Fund distributions to them by a Fund.
* * *
As of the date of this Statement of Additional Information, new Federal tax
legislation -- the Taxpayer Relief Act of 1997 (the "TRA") -- has been passed by
the House of Representatives and the Senate, and is expected to be signed by the
President. The TRA, if enacted as expected, will repeal the Short-Short Test
(effective for each Fund's next fiscal year) and will change applicable rates
and holding period rules for capital gains.
The foregoing discussion is based on Federal tax laws and regulations which
are in effect on the date of this Statement of Additional Information; such laws
and regulations may be changed by legislative or administrative action.
Shareholders are
-58-
<PAGE>
advised to consult their tax advisers concerning their specific
situations, the application of state and local taxes and changes in Federal tax
rules under the TRA.
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 eight active series, although
additional series may be established from time to time. Each Share
(irrespective of class designation) of a Fund represents an interest in that
Fund that is proportionate with the interest represented by each other Share.
The Shares of the Value Equity, Optimum Growth, International Equity and
Balanced Funds are classified into two separate classes of Shares representing
Trust Shares and Institutional Shares. Trust Shares have different expenses than
Institutional Shares which may affect performance.
The assets of the Trust received for the issue or sale of the Shares of each
class of each series and all income, earnings, profits and proceeds thereof,
subject only to the rights of creditors, are specifically allocated to such
class and series and constitute the underlying assets of such class and 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 class or 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
-59-
<PAGE>
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 and shareholders
will vote in the aggregate and not by class or series, except as otherwise
expressly required by law. Separate votes, however, are taken by each class or
series on matters affecting an individual class or 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.
MISCELLANEOUS
As of July 14, 1997, U.S. Trust and its affiliates held of record
substantially all of the Trust's outstanding shares as agent or custodian for
their customers, but did not
-60-
<PAGE>
own such shares beneficially because they did not have voting or investment
discretion with respect to such shares.
As of July 14, 1997, the name, address and percentage ownership of each person
that beneficially owned 5% or more of the outstanding Shares of a Fund were as
follows: (i) Equity Fund: PJM Intrctn D B Plan, c/o United States Trust Company
-----------
of New York, 114 West 47th Street, New York, NY 10036, 10.32%; (ii) Balanced
--------
Fund: Columbia Helicopters, c/o United States Trust Company of New York, 114
- ----
West 47th Street, New York, NY 10036, 8.08%; Red Lion Employee Retirement
Savings Plan, c/o United States Trust Company of New York, 114 West 47th Street,
New York, NY 10036, 14.75%; and Copper Mountain Trust WWP, c/o United States
Trust Company of New York, 114 West 47th Street, New York, NY 10036, 17.33%;
(iii) International Fund: Stevedoring, c/o United States Trust Company of New
------------------
York, 114 West 47th Street, New York, NY 10036, 12.43%; (iv) Income Fund: UW
-----------
Eugene Higgins, c/o United States Trust Company of New York, 114 West 47th
Street, New York, NY 10036, 81.75%; and UWMS Paine Foundation, c/o United States
Trust Company of New York, 114 West 47th Street, New York, NY 10036, 11.92%; (v)
Total Return Bond Fund: PJM INTRCTN DB Plan, c/o United States Trust Company of
- ----------------------
New York, 114 West 47th Street, New York, NY 10036, 5.06%; and The Liberty Fund,
c/o United States Trust Company of New York, 114 West 47th Street, New York, NY
10036, 16.48%; (vi) Optimum Growth Fund: U.S. Trust Retirement Plan, c/o United
-------------------
States Trust Company of New York, 114 West 47th Street, New York, NY 10036,
64.54%; and Willamette Dental 401K, c/o United States Trust Company of New York,
114 West 47th Street, New York, NY 10036, 5.85%; and (vii) Value Equity Fund:
-----------------
U.S. Trust Retirement Plan, c/o United States Trust Company of New York, 114
West 47th Street, New York, NY 10036, 92.82%.
FINANCIAL STATEMENTS
The audited financial statements and notes thereto in the Trust's Annual
Report to Shareholders for the fiscal period ended March 31, 1997 (the "1997
Annual Report") are incorporated into this Statement of Additional Information
by reference. No other parts of the 1997 Annual Report are incorporated by
reference herein. The financial statements included in the 1997 Annual Report
have been audited by Ernst & Young LLP, whose reports thereon are incorporated
herein by reference. Such financial statements have been incorporated herein in
reliance upon such reports given upon their authority as experts in accounting
and auditing. Additional copies of the 1997 Annual Report may be obtained at no
charge by telephoning CGFSC at (800) 909-1989.
Prior to December 18, 1995 the Equity, Balanced, International Equity, Income
and Total Return Bond Funds invested substantially all of their investable
assets in the corresponding portfolio of the St. James Portfolios as follows:
-61-
<PAGE>
<TABLE>
<CAPTION>
Portfolio of
Fund St. James Portfolios
---- --------------------
<S> <C>
Excelsior Institutional Equity Fund Equity Portfolio
Excelsior Institutional Balanced Fund Balanced Portfolio
Excelsior Institutional International Equity Fund International Equity Portfolio
Excelsior Institutional Income Fund Income Portfolio
Excelsior Institutional Total Return Bond Fund Total Return Bond Portfolio
</TABLE>
Effective December 18, 1995, each of the above 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.
-62-
<PAGE>
APPENDIX A
----------
COMMERCIAL PAPER RATINGS
- ------------------------
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - The 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 sign (+) 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.
"B" - Issues are regarded as having only a speculative capacity for timely
payment.
"C" - This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
"D" - Issues are in payment default.
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of 9 months. The following summarizes the rating categories used by
Moody's for commercial paper:
"Prime-1" - Issuers or related supporting institutions have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuers or related supporting institutions have a strong capacity
for repayment of short-term promissory obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternative liquidity is maintained.
"Prime-3" - Issuers or related supporting institutions have an acceptable
capacity for repayment of short-term promissory obligations. The effects 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 the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime rating categories.
The three rating categories of Duff & Phelps for investment grade commercial
paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps employs
three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses 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.
"D-1" - Debt possesses very high certainty of timely payment. Liquidity
factors are excellent and supported by good fundamental protection factors.
Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity factors
are strong and supported by good fundamental protection factors. Risk factors
are very small.
"D-2" - Debt possesses 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.
"D-3" - Debt possesses satisfactory liquidity and other protection factors
qualify issue as investment grade. Risk factors are larger and subject to more
variation. Nevertheless, timely payment is expected.
A-2
<PAGE>
"D-4" - Debt possesses speculative investment characteristics. Liquidity is
not sufficient to ensure against disruption in debt service. Operating factors
and market access may be subject to a high degree of variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
"F-1" - Securities possess very strong credit quality. Issues assigned this
rating reflect an assurance of timely payment only slightly less in degree than
issues rated "F-1+."
"F-2" - Securities possess 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 the "F-1+" and "F-1" ratings.
"F-3" - Securities possess 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.
"F-S" - Securities possess weak credit quality. Issues assigned this rating
have characteristics suggesting a minimal degree of assurance for timely payment
and are vulnerable to near-term adverse changes in financial and economic
conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to indicate
that the rating is based upon a letter of credit issued by a commercial bank.
Thomson BankWatch short-term ratings assess the likelihood of an untimely or
incomplete payment of principal or interest of unsubordinated instruments having
a maturity of one year or less which are issued by United States commercial
banks, thrifts and non-bank banks; non-United States banks; and broker-dealers.
The following summarizes the ratings used by Thomson BankWatch:
A-3
<PAGE>
"TBW-1" - This designation represents Thomson BankWatch's highest rating
category and indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety regarding
timely payment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade category and
indicates that while the debt is more susceptible to adverse developments (both
internal and external) than obligations with higher ratings, capacity to service
principal and interest in a timely fashion is considered adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an original
maturity of less than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for short-term debt ratings:
"A1+" - Obligations which posses a particularly strong credit feature are
supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by the highest capacity for timely repayment.
"A2" - Obligations are supported by a good capacity for timely repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity to
ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which are
currently in default.
A-4
<PAGE>
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
- ----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for corporate
and municipal debt:
"AAA" - This designation represents the highest rating assigned by Standard &
Poor's to a debt obligation and indicates an extremely strong capacity to pay
interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay interest and
repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and repay
principal although such issues are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in higher-
rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay interest and
repay principal. Whereas such issues normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt 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.
"B" - Debt has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The "B" rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied "BB" or "BB-"
rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default, and is
dependent upon favorable business, financial and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior debt
that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior debt
which is assigned an actual or implied "CCC-" debt rating. The "C" rating may
be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest is being
paid.
"D" - Debt is in payment default. This rating is used when interest payments
or principal payments are not made on the date due, even if the applicable grace
period has not expired, unless S & P believes that such payments will be made
during such grace period. "D" rating is also used upon the filing of a
bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and certain
other obligations that S & P believes may experience high volatility or high
variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds 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
A-6
<PAGE>
as can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards. Together with
the "Aaa" group they comprise what are generally known as high-grade bonds. They
are rated lower than the best bonds because margins of protection may not be as
large as in "Aaa" securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which make the long-
term risks appear somewhat larger than in "Aaa" securities.
"A" - Bonds 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 considered 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," "B," "Caa," "Ca," and "C" - Bonds that possess one of these ratings
provide questionable protection of interest and principal ("Ba" indicates some
speculative elements; "B" indicates a general lack of characteristics of
desirable investment; "Caa" represents a poor standing; "Ca" represents
obligations which are speculative in a high degree; and "C" represents the
lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in default.
Con. (---) - Bonds for which the security depends upon the completion of some
act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
(P)... - When applied to forward delivery bonds, indicates that the rating is
provisional pending delivery of the bonds. The rating may be revised prior to
delivery if changes occur in the legal documents or the underlying credit
quality of the bonds.
A-7
<PAGE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols, Aa1,
A1, Baa1, Ba1 and B1.
The following summarizes the long-term debt ratings used by Duff & Phelps for
corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The risk
factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors are
strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but adequate.
However, risk factors are more variable and greater in periods of economic
stress.
"BBB" - Debt possesses below average protection factors but such protection
factors are still considered sufficient for prudent investment. Considerable
variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these ratings is
considered to be below investment grade. Although below investment grade, debt
rated "BB" is deemed likely to meet obligations when due. Debt rated "B"
possesses the risk that obligations will not be met when due. Debt rated "CCC"
is well below investment grade and has considerable uncertainty as to timely
payment of principal, interest or preferred dividends. Debt rated "DD" is a
defaulted debt obligation, and the rating "DP" represents preferred stock with
dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A," "BBB,"
"BB" and "B" ratings may be modified by the addition of a plus (+) or minus (-)
sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for corporate
and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the
A-8
<PAGE>
"AAA" and "AA" categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated "F-1+."
"A" - Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an 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.
To provide more detailed indications of credit quality, the Fitch ratings from
and including "AA" to "BBB" may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major rating categories.
IBCA assesses the investment quality of unsecured debt with an original
maturity of more than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions are
unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions may
increase investment risk, albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
other categories.
A-9
<PAGE>
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of these
ratings where it is considered that speculative characteristics are present.
"BB" represents the lowest degree of speculation and indicates a possibility of
investment risk developing. "C" represents the highest degree of speculation and
indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating below "AAA" to
denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by Thomson
BankWatch to long-term debt and indicates that the ability to repay principal
and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to repay principal and
interest on a timely basis with limited incremental risk compared to issues
rated in the highest category.
"A" - This designation indicates that the ability to repay principal and
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest investment
grade category and indicates an acceptable capacity to repay principal and
interest. Issues rated "BBB" are, however, more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by Thomson
BankWatch to non-investment grade long-term debt. Such issues are regarded as
having speculative characteristics regarding the likelihood of timely payment of
principal and interest. "BB" indicates the lowest degree of speculation and
"CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may include a plus
or minus sign designation which indicates where within the respective category
the issue is placed.
A-10
<PAGE>
MUNICIPAL NOTE RATINGS
- ----------------------
A Standard and Poor's rating reflects the liquidity concerns and market access
risks unique to notes due in three years or less. The following summarizes the
ratings used by Standard & Poor's Ratings Group for municipal notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or strong
capacity to pay principal and interest. Those issues determined to possess
overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory capacity to
pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative capacity to
pay principal and interest.
Moody's ratings for state and municipal notes and other short-term loans are
designated Moody's Investment Grade ("MIG") and variable rate demand obligations
are designated Variable Moody's Investment Grade ("VMIG"). Such ratings
recognize the differences between short-term credit risk and long-term risk.
The following summarizes the ratings by Moody's Investors Service, Inc. for
short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best quality,
enjoying strong protection by established cash flows, superior liquidity support
or demonstrated broad-based access to the market for refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality, with
margins of protection ample although not so large as in the preceding group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable quality,
with all security elements accounted for but lacking the undeniable strength of
the preceding grades. Liquidity and cash flow protection may be narrow and
market access for refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate quality,
carrying specific risk but having protection commonly regarded as required of an
investment security and not distinctly or predominantly speculative.
"SG" - Loans bearing this designation are of speculative quality and lack
margins of protection.
A-11
<PAGE>
Fitch and Duff & Phelps use the short-term ratings described under Commercial
Paper Ratings for municipal notes.
A-12
