File Nos. 33-79166, 811-8522
Filed under Rule 497 (c)
EQUI-SELECT SERIES TRUST
699 WALNUT STREET
DES MOINES, IOWA 50309
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Equi-Select Series Trust (the "Trust") is an open-end, series management
investment company which currently offers shares of beneficial interest of
nine series (the "Portfolios"), each of which has a different investment
objective and represents the entire interest in a separate portfolio of
investments. These Portfolios are currently available to the public only
through certain variable annuity contracts and variable life insurance
policies ("Variable Contracts") issued by Equitable Life Insurance Company of
Iowa and/or its affiliated life insurance companies (collectively, the "Life
Companies"). This Prospectus contains information pertaining to the Research
Portfolio, Total Return Portfolio and OTC Portfolio which are the only
Portfolios of the Trust offered under the Variable Contracts described in the
accompanying Variable Contract Prospectus.
This Prospectus sets forth concisely the information about the Trust that a
prospective investor should know before investing. Please read it carefully
and retain it for future reference. A Statement of Additional Information
("SAI") dated May 1, 1997, as amended, is available without charge upon
request and may be obtained by calling Equitable Life Insurance Company of
Iowa at (800) 648-6810 or by writing to Equitable Life Insurance Company of
Iowa, P.O. Box 9271, Des Moines, Iowa 50306-9271. Some of the discussions
contained in this Prospectus refer to the more detailed descriptions contained
in the SAI, which is incorporated by reference into this Prospectus and has
been filed with the Securities and Exchange Commission. The Securities and
Exchange Commission maintains a Web site (http:\\www.sec.gov) that contains
the SAI, material incorporated by reference, and other information regarding
the Trust.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
PROSPECTUS DATED MAY 1, 1997
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TABLE OF CONTENTS
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PAGE
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<S> <C>
SUMMARY.................................................................... 1
The Trust................................................................ 1
Investment Adviser and Sub-Adviser....................................... 1
The Portfolios........................................................... 1
Investment Risks......................................................... 2
Sales and Redemptions.................................................... 2
FINANCIAL HIGHLIGHTS....................................................... 3
INVESTMENT OBJECTIVES AND POLICIES OF THE PORTFOLIOS....................... 5
OTC Portfolio............................................................ 5
Research Portfolio....................................................... 7
Total Return Portfolio................................................... 9
MANAGEMENT OF THE TRUST.................................................... 11
Investment Adviser....................................................... 11
Advisory Fee Waiver and Expense Cap...................................... 12
Expenses of the Trust.................................................... 12
Sub-Adviser.............................................................. 12
SALES AND REDEMPTIONS...................................................... 13
NET ASSET VALUE............................................................ 14
TAX STATUS, DIVIDENDS, AND DISTRIBUTIONS................................... 14
ADDITIONAL INFORMATION..................................................... 15
APPENDIX................................................................... A-1
</TABLE>
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<PAGE>
SUMMARY
THE TRUST
The Trust is an open-end management investment company established as a
Massachusetts business trust under a Declaration of Trust dated May 11, 1994.
Each Portfolio issues a separate class of shares. The Declaration of Trust
permits the Trustees to issue an unlimited number of full or fractional shares
of each class of stock.
Each Portfolio has distinct investment objectives and policies. (See
"Investment Objectives and Policies of the Portfolios.") Additional Portfolios
may be added to the Trust in the future. Only shares of the Research, Total
Return and OTC Portfolios are offered herein. (The Research, Total Return and
OTC Portfolios may be referred to herein as "the Portfolios".)
INVESTMENT ADVISER AND SUB-ADVISER
Subject to the authority of the Board of Trustees of the Trust, Equitable
Investment Services, Inc. (the "Adviser") serves as the Trust's investment
adviser and has responsibility for the overall management of the investment
strategies and policies of the Portfolios. The Adviser has engaged
Massachusetts Financial Services Company as a Sub-Adviser to make investment
decisions and place orders for the Portfolios. For additional information
concerning the Adviser and the Sub-Adviser, including a description of
advisory and sub-advisory fees, see "Management of the Trust."
THE PORTFOLIOS
OTC PORTFOLIO. The primary investment objective of the OTC Portfolio is to
seek to obtain long-term growth of capital. The Portfolio seeks to achieve
this objective by investing at least 65% of its total assets, under normal
circumstances, in securities principally traded on the over-the-counter (OTC)
securities market. The Portfolio is intended for investors who understand and
are willing to accept the risks entailed in seeking long-term growth of
capital. The Portfolio may invest 20% or more of its net assets in foreign
securities (not including American Depositary Receipts ("ADRs")); however,
under normal market conditions, the Portfolio expects to invest less than 35%
of its net assets in foreign securities. The Portfolio may invest up to 10% of
its net assets in emerging markets or countries with limited or developing
capital markets. (See "Appendix--Foreign Investments" and the SAI for a
discussion of the risks involved in foreign investing.) The Portfolio may
invest a portion of its assets in lower-grade corporate debt securities
commonly known as "junk bonds." Investors should be aware that such
investments involve a significant degree of risk. (See "Appendix--Lower-Rated
Securities" and the SAI for a discussion of the risks involved in investing in
lower-rated securities.)
RESEARCH PORTFOLIO. The Research Portfolio seeks to provide long-term growth
of capital and future income by investing a substantial portion of its assets
in common stocks or securities convertible into common stocks of companies
believed to possess better than average prospects for long-term growth. A
smaller proportion of the assets may be invested in bonds, short-term
obligations, preferred stocks or common stocks whose principal characteristic
is income production rather than growth. The Portfolio may invest up to 20%
(and generally expects to invest between 0% and 20%) of its net assets in
foreign securities (not including ADRs). (See "Appendix--Foreign Investments"
and the SAI for a discussion of the risks involved in foreign investing.) The
Portfolio may invest up to 10% of its net assets in lower-grade corporate debt
securities commonly known as "junk bonds." Investors should be aware that such
investments involve a significant degree of risk. (See "Appendix--Lower-Rated
Securities" and the SAI for a discussion of the risks involved in investing in
lower-rated securities.)
TOTAL RETURN PORTFOLIO. The Total Return Portfolio primarily seeks to obtain
above-average income (compared to a portfolio entirely invested in equity
securities) consistent with the prudent employment of capital. The Portfolio's
secondary objective is to take advantage of opportunities for growth of
capital and income. Under normal market conditions, at least 25% of the
Portfolio's assets will be invested in fixed income securities and at
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<PAGE>
least 40% and no more than 75% of the Portfolio's assets will be invested in
equity securities, which include: common and preferred stocks; securities such
as bonds, warrants or rights that are convertible into stock; and depository
receipts for those securities. The Portfolio may invest up to 20% (and
generally expects to invest between 5% and 20%) of its net assets in foreign
securities (not including ADRs). (See "Appendix--Foreign Investments" and the
SAI for a discussion of the risks involved in foreign investing.) The
Portfolio may invest a portion of its assets in lower-grade corporate debt
securities commonly known as "junk bonds." Investors should be aware that such
investments involve a significant degree of risk. (See "Appendix--Lower-Rated
Securities" and the SAI for a discussion of the risks involved in investing in
lower-rated securities.)
The investment objectives of the Portfolios are not fundamental and may be
changed without the approval of a majority of the outstanding shares of a
Portfolio. Investment policies and restrictions specifically cited as
fundamental may not be changed without the approval of a majority of the
outstanding shares of that Portfolio. Other investment policies and practices
described in this Prospectus and the SAI are not fundamental, and the Board of
Trustees may change them without shareholder approval. A complete list of
investment restrictions, including those restrictions which cannot be changed
without shareholder approval, is contained in the SAI. There is no assurance
that a Portfolio will meet its stated objective.
INVESTMENT RISKS
The value of a Portfolio's shares will fluctuate with the value of the
underlying securities in its portfolio, and in the case of debt securities,
with the general level of interest rates. When interest rates decline, the
value of an investment portfolio invested in fixed-income securities can be
expected to rise. Conversely, when interest rates rise, the value of an
investment portfolio invested in fixed-income securities can be expected to
decline. In the case of foreign currency denominated securities, these trends
may be offset or amplified by fluctuations in foreign currencies. Investments
by a Portfolio in foreign securities may be affected by adverse political,
diplomatic, and economic developments, changes in foreign currency exchange
rates, taxes or other assessments imposed on distributions with respect to
those investments, and other factors affecting foreign investments generally.
High-yielding fixed-income securities, which are commonly known as "junk
bonds", are subject to greater market fluctuations and risk of loss of income
and principal than investments in lower yielding fixed-income securities.
Certain of the Portfolios intend to employ, from time to time, certain
investment techniques which are designed to enhance income or total return or
hedge against market or currency risks but which themselves involve additional
risks. These techniques include options on securities, futures, options on
futures, options on indexes, options on foreign currencies, foreign currency
exchange transactions, lending of securities and when-issued securities and
delayed-delivery transactions. The Portfolios may have higher-than-average
portfolio turnover which may result in higher-than-average brokerage
commissions and transaction costs.
SALES AND REDEMPTIONS
The Trust sells shares only to the separate accounts of the Life Companies
as a funding vehicle for the Variable Contracts offered by the Life Companies.
No fee is charged upon the sale or redemption of the Trust's shares. Expenses
of the Trust are passed through to the separate accounts of the Life
Companies, and therefore, are ultimately borne by Variable Contract owners. In
addition, other fees and expenses are assessed by the Life Companies at the
separate account level. (See the Prospectus for the Variable Contract for a
description of all fees and charges relating to the Variable Contract.)
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FINANCIAL HIGHLIGHTS
EQUI-SELECT SERIES TRUST
The following tables which have been audited by Ernst & Young LLP,
independent auditors, include selected data, derived from the Financial
Statements, for a share outstanding throughout the period shown for each of
the Research, Total Return and OTC Portfolios at December 31, 1996. The tables
should be read in conjunction with the Financial Statements and notes thereto
included in the Trust's Annual Report to Contractholders which is incorporated
by reference in the Statement of Additional Information. The Financial
Statements of the Trust at December 31, 1996 are incorporated herein by
reference in reliance upon the report of Ernst & Young LLP such report given
upon the authority of such firm as experts in accounting and auditing.
Further information about the performance of the Trust is contained in the
Trust's December 31, 1996 Annual Report which may be obtained without charge
by calling Equitable Life Insurance Company of Iowa at (800) 648-6810.
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EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO AND TOTAL RETURN PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Net
Realized
and
Unrealized
Net Asset Net Gain (Loss)
Value at Investment on
Beginning Income Invest-
of Period (Loss) (1) ments
_____________ _____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 12.08 (0.03) 2.52
Year ended December 31, 1995 10.36 (0.02) 3.07
Period ended December 31, 1994* 10.00 0.00 0.36
RESEARCH PORTFOLIO
Year ended December 31, 1996 12.88 0.00 3.00
Year ended December 31, 1995 9.59 0.03 3.48
Period ended December 31, 1994* 10.00 0.09 (0.41)
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 11.90 0.26 1.37
Year ended December 31, 1995 9.76 0.21 2.19
Period ended December 31, 1994* 10.00 0.09 (0.24)
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO AND TOTAL RETURN PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Total Distributions Net
from from Net Capital
Investment Investment Gains
Operations Income Distributions
____________ ____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 2.49 0.00 (0.75)
Year ended December 31, 1995 3.05 0.00 (1.33)
Period ended December 31, 1994* 0.36 0.00 0.00
RESEARCH PORTFOLIO
Year ended December 31, 1996 3.00 0.00 (6) (0.45)
Year ended December 31, 1995 3.51 (0.03) (0.19)
Period ended December 31, 1994* (0.32) (0.09) 0.00
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 1.63 (0.26) (0.12)
Year ended December 31, 1995 2.40 (0.21) (0.05)
Period ended December 31, 1994* (0.15) (0.09) 0.00
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO AND TOTAL RETURN PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Net Asset
Value at
Total End Total
Distribution of Period Return (2)
_____________ _____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 (0.75) 13.82 20.68
Year ended December 31, 1995 (1.33) 12.08 29.23
Period ended December 31, 1994* 0.00 10.36 3.59
RESEARCH PORTFOLIO
Year ended December 31, 1996 (0.45) 15.43 23.37
Year ended December 31, 1995 (0.22) 12.88 36.58
Period ended December 31, 1994* (0.09) 9.59 (3.22)
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 (0.38) 13.15 13.70
Year ended December 31, 1995 (0.26) 11.90 24.51
Period ended December 31, 1994* (0.09) 9.76 (1.47)
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO AND TOTAL RETURN PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Ratio Ratio of Net
of Operating Investment
Net Assets Expenses to Income (Loss)
End Average Net to Average
of Period Assets (1)(3) Net Assets (3)
_____________ _____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 43,321,580 1.35 (0.63)
Year ended December 31, 1995 9,054,622 1.07 (0.22)
Period ended December 31, 1994* 1,695,685 0.75 0.16
RESEARCH PORTFOLIO
Year ended December 31, 1996 75,178,842 1.31 0.05
Year ended December 31, 1995 16,185,802 1.12 0.58
Period ended December 31, 1994* 1,626,521 0.75 4.65
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 57,301,963 1.25 3.29
Year ended December 31, 1995 15,502,907 1.11 3.88
Period ended December 31, 1994* 1,298,365 0.75 4.58
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO AND TOTAL RETURN PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Portfolio Average
Turnover Commission
Rate (4) Rate (5)
_____________ _____________
<S> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 122 $.0402
Year ended December 31, 1995 111 --
Period ended December 31, 1994* 6 --
RESEARCH PORTFOLIO
Year ended December 31, 1996 68 .0281
Year ended December 31, 1995 83 --
Period ended December 31, 1994* 85 --
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 131 .0510
Year ended December 31, 1995 89 --
Period ended December 31, 1994* 45 --
</TABLE>
[FN]
(1) Net investment income is after reimbursement of certain fees and expenses
by Equitable Investment Services, Inc. ("EISI"). Had EISI not undertaken
to reimburse expenses related to the Portfolios, net investment income
(loss) per share and ratio of operating expenses to average net assets
would have been as follows for the year ended December 31, 1996, for the
year ended December 31, 1995 and for the period ended December 31, 1994,
respectively: OTC Portfolio, $(0.03) and 1.35%, $(0.10) and 2.52%, $(0.12)
and 7.10%; Research Portfolio, $0.00 and 1.31%, $(0.04) and 2.48%, $(0.04)
and 7.48%; and Total Return Portfolio, $0.26 and 1.25%, $0.14 and 2.36%,
$(0.06) and 8.31%.
(2) Total return figures are not annualized for periods less than one year.
Total return does not reflect expenses that apply to the separate account
or related variable insurance contracts and inclusion of these charges
would result in reducing the total return figures for the period shown.
(3) Annualized for periods less than one year.
(4) Portfolio turnover rates are not annualized.
(5) The average commission rate paid is applicable for Portfolios that invest
greater than 10% of average net assets in equity security transactions for
which commissions are charged. This disclosure is required for fiscal
periods beginning on or after September 1, 1995.
(6) Amount is less than $0.003 per share.
* For the period October 4, 1994 (commencement of investment operations)
through December 31, 1994.
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INVESTMENT OBJECTIVES AND POLICIES OF THE PORTFOLIOS
Each Portfolio of the Trust has a different investment objective or
objectives which it pursues through separate investment policies as described
below. The differences in objectives and policies among the Portfolios can be
expected to affect the return of each Portfolio and the degree of market and
financial risk to which each Portfolio is subject. An investment in a single
Portfolio should not be considered a complete investment program. The
investment objective(s) and policies of each Portfolio, unless otherwise
specifically stated, are non-fundamental and may be changed by the Trustees of
the Trust without a vote of the shareholders. Such changes may result in a
Portfolio having an investment objective(s) which differs from that which an
investor may have considered at the time of investment. There is no assurance
that any Portfolio will achieve its objective(s). United States Treasury
Regulations applicable to portfolios that serve as the funding vehicles for
variable annuity and variable life insurance contracts generally require that
such portfolios invest no more than 55% of the value of their assets in one
investment, 70% in two investments, 80% in three investments, and 90% in four
investments. The Portfolios intend to comply with the requirements of these
Regulations.
In order to comply with regulations which may be issued by the U.S.
Treasury, the Trust may be required to limit the availability or change the
investment policies of one or more Portfolios or to take steps to liquidate
one or more Portfolios. The Trust will not change any fundamental investment
policy of a Portfolio without a vote of shareholders of that Portfolio.
Except as otherwise noted herein, if the securities rating of a debt
security held by a Portfolio declines below the minimum rating for securities
in which the Portfolio may invest, the Portfolio will not be required to
dispose of the security, but the Portfolio's Sub-Adviser will consider whether
continued investment in the security is consistent with the Portfolio's
investment objective.
In implementing its investment objectives and policies, each Portfolio uses
a variety of instruments, strategies and techniques which are described in
more detail in the Appendix and the SAI. With respect to each Portfolio's
investment policies, use of the term "primarily" means that under normal
circumstances, at least 65% of such Portfolio's assets will be invested as
indicated. A description of the ratings systems used by the following
nationally recognized statistical rating organizations ("NRSROs") is also
contained in the SAI: Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Corporation ("S&P"), Duff & Phelps, Inc. ("Duff"), Fitch Investors
Service, Inc. ("Fitch"), Thomson Bankwatch, Inc., IBCA Limited and IBCA Inc.
New instruments, strategies and techniques, however, are evolving continually
and the Trust reserves authority to invest in or implement them to the extent
consistent with its investment objectives and policies. If new instruments,
strategies or techniques would involve a material change to the information
contained herein, they will not be purchased or implemented until this
Prospectus is appropriately supplemented.
OTC PORTFOLIO
The investment objective of the OTC Portfolio is to seek to obtain long-term
growth of capital.
INVESTMENT POLICIES AND RISKS--OTC PORTFOLIO
The Portfolio seeks to achieve its objective by investing at least 65% of
its total assets, under normal circumstances, in securities principally traded
on the over-the-counter (OTC) securities market. OTC securities tend to be
securities of companies which are smaller or newer than those listed on the
New York or American Stock Exchanges. Issuers of the securities of companies
which are traded on the OTC market include, among others, industrial
corporations, financial service institutions, public utilities, and
transportation companies. OTC securities include both equity and debt
securities (including obligations of the U.S. government). The Portfolio may
also invest in securities of companies that are not traded on the OTC
securities market that represent opportunities for capital appreciation. The
Portfolio will seek to invest in companies that are undervalued relative to
present or future earnings, cash flow or book value. While the Portfolio
intends to invest primarily in equity securities, the Portfolio may also
invest in fixed income securities as described below. Equity securities
include: common stocks and preferred stocks; securities such as bonds,
warrants or rights that are convertible into stock; and depositary receipts
for those securities.
5
<PAGE>
The Portfolio will not purchase a security, under normal circumstances, if
it would result in less than 65% of its total assets being invested in OTC
securities (the "65% limitation"). Securities that were principally traded on
the OTC securities market when purchased but which have since been listed on
the New York or American Stock Exchange or a foreign exchange will be
considered to fall within the Portfolio's 65% limitation for 12 months after
the date the security was listed on an exchange.
Debt securities of issuers in which the Portfolio may invest include all
types of long- or short-term debt obligations, such as bonds, debentures,
notes and commercial paper. Fixed income securities in which the Portfolio may
invest include securities in the lower rating categories of recognized rating
agencies (and comparable unrated securities). Fixed income securities in which
the Portfolio may invest also include zero coupon bonds, deferred interest
bonds and bonds on which the interest is payable in kind. Such investments
involve certain risks. See "Appendix--Lower-Rated Securities" and the SAI for
a discussion of the risks involved in investing in lower-rated securities.
Investing in securities traded on the OTC securities market can involve
greater risk than is customarily associated with investing in securities
traded on the New York or American Stock Exchanges since OTC securities are
generally securities of companies which are smaller or newer than those listed
on the New York or American Stock Exchange. For example, these companies often
have limited product lines, markets, or financial resources, may be dependent
for management on one or a few key persons, and can be more susceptible to
losses. Also, their securities may be thinly traded (and therefore have to be
sold at a discount from current prices or sold in small lots over an extended
period of time), may be followed by fewer investment research analysts and may
be subject to wider price swings and thus may create a greater risk of loss
than securities of larger capitalization or established companies. Shares of
the Portfolio, therefore, are subject to greater fluctuation in value than
shares of a conservative equity fund or of a growth fund which invests
entirely in proven growth stocks. Therefore, the Portfolio is intended for
long-term investors who understand and can accept the risks entailed in
seeking long-term growth of capital. The Portfolio is not meant to provide a
vehicle for those who wish to play short-term swings in the stock market.
Accordingly, an investment in shares of the Portfolio should not be considered
a complete investment program. Each prospective purchaser should take into
account his investment objectives as well as his other investments when
considering the purchase of shares of the Portfolio.
When the Sub-Adviser believes that investing for temporary defensive
purposes is appropriate, such as during periods of unusual market conditions,
part or all of the Portfolio's assets may be temporarily invested in cash
(including foreign currency) or cash equivalent short-term obligations
including, but not limited to, certificates of deposit, commercial paper,
short-term notes, obligations issued or guaranteed by the U.S. government or
any of its agencies or instrumentalities and repurchase agreements.
The Portfolio may invest 20% or more of its net assets in foreign securities
(not including ADRs); however, under normal market conditions, the Portfolio
expects to invest less than 35% of its net assets in foreign securities. The
Portfolio may invest up to 10% of its net assets in emerging markets or
countries with limited or developing capital markets. Investing in securities
of foreign issuers generally involves risks not ordinarily associated with
investing in securities of domestic issuers. (See "Appendix--Foreign
Investments" and the SAI for a discussion of the risks involved in foreign
investing.)
The Portfolio may invest in ADRs which are certificates issued by a U.S.
depository (usually a bank) and represent a specified quantity of shares of an
underlying non-U.S. stock on deposit with a custodian bank as collateral.
Although ADRs are issued by a U.S. depository, they are subject to many of the
risks of foreign securities such as changes in exchange rates and more limited
information about foreign issuers.
The Portfolio may also purchase securities that are not registered under the
Securities Act of 1933 ("1933 Act") ("restricted securities"), including those
that can be offered and sold to "qualified institutional buyers" under Rule
144A under the 1933 Act ("Rule 144A securities"). The Trust's Board of
Trustees confirms based upon information and recommendations provided by the
Sub-Adviser that a specific Rule 144A security is liquid and thus not subject
to the Portfolio's limitation on investing not more than 15% of its net assets
in illiquid investments. The Board of Trustees has adopted guidelines and
delegated to the Sub-Adviser the daily function of determining and monitoring
the liquidity of Rule 144A securities. The Board, however, will retain
sufficient
6
<PAGE>
oversight and be ultimately responsible for the determinations. This
investment practice could have the effect of decreasing the level of liquidity
in a Portfolio to the extent that qualified institutional buyers become for a
time uninterested in purchasing Rule 144A securities held in the investment
portfolio.
The Portfolio is classified as a "non-diversified" investment company. As a
result, the Portfolio is limited as to the percentage of its assets which may
be invested in the securities of any one issuer only by its own investment
restrictions and the diversification requirements imposed by the Internal
Revenue Code of 1986, as amended. U.S. Government securities which are
generally considered free of credit risk and are assured as to payment of
principal and interest if held to maturity are not subject to any investment
limitation. Since the Portfolio may invest a relatively high percentage of its
assets in a limited number of issuers, the Portfolio may be more susceptible
to any single economic, political or regulatory occurrence and to the
financial conditions of the issuers in which it invests. For these reasons, an
investment in shares of the Portfolio should not be considered to constitute a
complete investment program.
While it is not generally the Portfolio's policy to invest or trade for
short-term profits, the Portfolio may dispose of a portfolio security whenever
the Sub-Adviser is of the opinion that such security no longer has an
appropriate appreciation potential or when another security appears to offer
relatively greater appreciation potential. Portfolio changes are made without
regard to the length of time a security has been held, or whether a sale would
result in a profit or loss. Therefore, the rate of portfolio turnover is not a
limiting factor when a change in the portfolio is otherwise appropriate.
Because the Portfolio is expected to have a portfolio turnover rate of over
100%, transaction costs incurred by the Portfolio and the realized capital
gains and losses of the Portfolio may be greater than that of a portfolio with
a lesser turnover rate. The portfolio turnover rates of the Portfolio for the
periods ended December 31, 1996, 1995 and 1994 are set forth herein under
"Financial Highlights." (See also "Portfolio Turnover" in the SAI.)
ADDITIONAL PORTFOLIO INVESTMENTS AND TRANSACTIONS. The Portfolio may enter
into repurchase agreements to earn income on available cash or as a temporary
defensive measure. The Portfolio may seek to increase its income by lending
portfolio securities. The Portfolio may purchase securities on a "when issued"
or on a "forward delivery" basis, which means that the securities will be
delivered to the Portfolio at a future date usually beyond customary
settlement time.
The Portfolio may invest in indexed securities whose value is linked to
foreign currencies, commodities, indices, or other financial indicators. The
Portfolio may enter into mortgage "dollar roll" transactions with selected
banks and broker-dealers.
The Portfolio also may purchase restricted securities, corporate asset-
backed securities, options on securities, options on stock indices, options on
foreign currencies, futures contracts, options on futures contracts and
forward foreign currency exchange contracts.
All of the Portfolio investments and transactions described in this section
are described in greater detail in the Appendix and the SAI.
RESEARCH PORTFOLIO
The investment objective of the Research Portfolio is to provide long-term
growth of capital and future income.
The portfolio securities of the Research Portfolio are selected by a
committee of investment research analysts. This committee includes investment
analysts employed not only by MFS but also by MFS International (U.K.)
Limited, a wholly-owned subsidiary of MFS. The Portfolio's assets are
allocated among industries by the analysts acting together as a group.
Individual analysts are then responsible for selecting what they view as the
securities best suited to meet the Portfolio's investment objective within
their assigned industry responsibility.
INVESTMENT POLICIES AND RISKS--RESEARCH PORTFOLIO
The Portfolio's policy is to invest a substantial proportion of its assets
in the common stocks or securities convertible into common stocks of companies
believed to possess better than average prospects for long-term
7
<PAGE>
growth. A smaller proportion of the assets may be invested in bonds, short-
term obligations, preferred stocks or common stocks whose principal
characteristic is income production rather than growth. Such securities may
also offer opportunities for growth of capital as well as income. In the case
of both growth stocks and income issues, emphasis is placed on the selection
of progressive, well-managed companies. The Portfolio's debt investments, if
any, may consist of "investment grade" securities (e.g., rated Baa or better
by Moody's or BBB or better by S&P or Fitch), and, with respect to no more
than 10% of its net assets, securities in the lower rated categories (e.g.,
rated Ba or lower by Moody's or BB or lower by S&P or Fitch), or securities
which the Sub-Adviser believes to be of similar quality to these lower rated
securities (commonly known as "junk bonds"). For a description of bond
ratings, see the SAI. It is not the Portfolio's policy to rely exclusively on
ratings issued by established credit rating agencies but rather to supplement
such ratings with the Sub-Adviser's own independent and ongoing review of
credit quality. The Portfolio's achievement of its investment objective may be
more dependent on the Sub-Adviser's own credit analysis than in the case of a
fund investing in primarily higher quality bonds. From time to time, the
Portfolio's management will exercise its judgment with respect to the
proportions invested in growth stocks, income-producing securities or cash
(including foreign currency) and cash equivalents depending on its view of
their relative attractiveness.
The Portfolio may enter into repurchase agreements in order to earn income
on available cash or as a temporary defensive measure. The Portfolio may make
loans of its fixed income portfolio securities. (See "Appendix" for a further
description of these investments.)
The Portfolio may invest in ADRs which are certificates issued by a U.S.
depository (usually a bank) and represent a specified quantity of shares of an
underlying non-U.S. stock on deposit with a custodian bank as collateral.
Although ADRs are issued by a U.S. depository, they are subject to many of the
risks of foreign securities such as changes in exchange rates and more limited
information about foreign issuers.
The Portfolio may invest up to 20% (and generally expects to invest between
0% and 20%) of its net assets in foreign securities (not including ADRs). The
Portfolio may invest in emerging markets or countries with limited or
developing capital markets. Investing in securities of foreign issuers
generally involves risks not ordinarily associated with investing in
securities of domestic issuers. (See "Appendix--Foreign Investments" and the
SAI for a discussion of the risks involved in foreign investing.)
As described above, the Portfolio may invest in fixed income (i.e., debt)
securities rated Baa by Moody's or BBB by S&P or Fitch and comparable unrated
securities. These securities, while normally exhibiting adequate protection
parameters, have speculative characteristics and changes in economic
conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than in the case of higher
grade fixed income securities. (See "Appendix--Lower-Rated Securities" and the
SAI for a discussion of the risks involved in investing in lower-rated
securities.)
The Portfolio may also purchase securities that are not registered under the
Securities Act of 1933 ("1933 Act") ("restricted securities"), including those
that can be offered and sold to "qualified institutional buyers" under Rule
144A under the 1933 Act ("Rule 144A securities"). The Trust's Board of
Trustees confirms based upon information and recommendations provided by the
Sub-Adviser that a specific Rule 144A security is liquid and thus not subject
to the Portfolio's limitation on investing not more than 10% of its net assets
in illiquid investments. The Board of Trustees has adopted guidelines and has
delegated to the Sub-Adviser the daily function of determining and monitoring
the liquidity of Rule 144A securities. The Board, however, will retain
sufficient oversight and be ultimately responsible for the determinations.
This investment practice could have the effect of decreasing the level of
liquidity in the Portfolio to the extent that qualified institutional buyers
become for a time uninterested in purchasing Rule 144A securities held in the
investment portfolio. Subject to the Portfolio's 10% limitation on investments
in illiquid investments and subject to the diversification requirements of the
Internal Revenue Code of 1986, as amended (the "Code"), the Portfolio may also
invest in restricted securities that may not be sold under Rule 144A, which
presents certain risks. As a result, the Portfolio might not be able to sell
these securities when the Sub-Adviser wishes to do so, or might have to sell
them at less than fair value. In addition, market quotations are less readily
available. Therefore, judgment may at times play a greater role in valuing
these securities than in the case of unrestricted securities.
8
<PAGE>
While it is not generally the Portfolio's policy to invest or trade for
short-term profits, the Portfolio may dispose of a portfolio security whenever
the Sub-Adviser is of the opinion that such security no longer has an
appropriate appreciation potential or when another security appears to offer
relatively greater appreciation potential. Portfolio changes are made without
regard to the length of time a security has been held, or whether a sale would
result in a profit or loss. Therefore, the rate of portfolio turnover is not a
limiting factor when a change in the portfolio is otherwise appropriate. The
portfolio turnover rate of the Portfolio for the periods ended December 31,
1996, 1995 and 1994 are set forth herein under "Financial Highlights." (See
"Portfolio Turnover" in the SAI.)
TOTAL RETURN PORTFOLIO
The primary investment objective of the Total Return Portfolio is to obtain
above-average income (compared to a portfolio entirely invested in equity
securities) consistent with the prudent employment of capital. While current
income is the primary objective, the Portfolio believes that there should also
be a reasonable opportunity for growth of capital and income, since many
securities offering a better than average yield may also possess growth
potential. Thus, in selecting securities for its portfolio, the Portfolio
considers each of these objectives. Under normal market conditions, at least
25% of the Portfolio's assets will be invested in fixed income securities and
at least 40% and no more than 75% of the Portfolio's assets will be invested
in equity securities.
INVESTMENT POLICIES AND RISKS--TOTAL RETURN PORTFOLIO
The Portfolio's policy is to invest in a broad list of securities, including
short-term obligations. The list may be diversified not only by companies and
industries, but also by type of security. Fixed income securities and equity
securities (which include: common stocks and preferred stocks; securities such
as bonds, warrants or rights that are convertible into stock; and depository
receipts for those securities) may be held by the Portfolio. Some fixed income
securities may also have a call on common stock by means of a conversion
privilege or attached warrants. The Portfolio may vary the percentage of
assets invested in any one type of security in accordance with the Sub-
Adviser's interpretation of economic and money market conditions, fiscal and
monetary policy and underlying security values. The Portfolio's debt
investments may consist of both "investment grade" securities (rated Baa or
better by Moody's or BBB or better by S&P, Fitch or Duff & Phelps Credit
Rating Co. ("Duff")) and securities that are unrated or are in the lower
rating categories (rated Ba or lower by Moody's or BB or lower by S&P, Fitch
or Duff) (commonly known as "junk bonds") including up to 20% of its assets in
nonconvertible fixed income securities that are in these lower rating
categories and comparable unrated securities. Generally, most of the
Portfolio's long-term debt investments will consist of "investment grade"
securities. See the SAI for a description of these ratings. It is not the
Portfolio's policy to rely exclusively on ratings issued by established credit
rating agencies but rather to supplement such ratings with the Sub-Adviser's
own independent and ongoing review of credit quality.
U.S. GOVERNMENT SECURITIES. The Portfolio may also invest in U.S. government
securities, including: (1) U.S. Treasury obligations, which differ only in
their interest rates, maturities and times of issuance; U.S. Treasury bills
(maturities of one year or less); U.S. Treasury notes (maturities of one to
ten years); and U.S. Treasury bonds (generally maturities of greater than ten
years), all of which are backed by the full faith and credit of the U.S.
Government; and (2) obligations issued or guaranteed by U.S. Government
agencies or instrumentalities, some of which are backed by the full faith and
credit of the U.S. Treasury, e.g., direct pass-through certificates of GNMA;
some of which are supported by the right of the issuer to borrow from the U.S.
Government, e.g., obligations of Federal Home Loan Banks; and some of which
are backed only by the credit of the issuer itself, e.g., obligations of the
Student Loan Marketing Association.
MORTGAGE PASS-THROUGH SECURITIES. The Portfolio may invest in mortgage pass-
through securities. Mortgage pass-through securities are securities
representing interests in "pools" of mortgage loans. Monthly payments of
interest and principal by the individual borrowers on mortgages are passed
through to the holders of the securities (net of fees paid to the issuer or
guarantor of the securities) as the mortgages in the underlying mortgage pools
are paid off. Payment of principal and interest on some mortgage pass-through
securities (but not the market value of the securities themselves) may be
guaranteed by the full faith and credit of the U.S.
9
<PAGE>
government (in the case of securities guaranteed by GNMA); or guaranteed by
U.S. government-sponsored corporations (such as FNMA or FHLMC, which are
supported only by the discretionary authority of the U.S. government to
purchase the agency's obligations). Mortgage pass-through securities may also
be issued by non-governmental issuers (such as commercial banks, savings and
loan institutions, private mortgage insurance companies, mortgage bankers and
other secondary market issuers). See the Appendix for a further discussion of
these securities.
ZERO COUPON BONDS, DEFERRED INTEREST BONDS AND PIK BONDS. Fixed income
securities that the Portfolio may invest in also include zero coupon bonds,
deferred interest bonds and bonds on which the interest is payable in kind
("PIK bonds"). Zero coupon and deferred interest bonds are debt obligations
which are issued or purchased at a significant discount from face value. The
discount approximates the total amount of interest the bonds will accrue and
compound over the period until maturity or the first interest payment date at
a rate of interest reflecting the market rate of the security at the time of
issuance. While zero coupon bonds do not require the periodic payment of
interest, deferred interest bonds provide that the issuer thereof may, at its
option, pay interest on such bonds in cash or in the form of additional debt
obligations. Such investments benefit the issuer by mitigating its need for
cash to meet debt service, but also require a higher rate of return to attract
investors who are willing to defer receipt of such cash. Such investments may
experience greater volatility in market value due to changes in interest rates
than debt obligations which make regular payments of interest. The Portfolio
will accrue income on such investments for tax and accounting purposes, as
required, which is distributable to shareholders and which, because no cash is
received at the time of accrual, may require the liquidation of other
portfolio securities to satisfy the Portfolio's distribution obligations.
AMERICAN DEPOSITARY RECEIPTS. The Portfolio may invest in ADRs which are
certificates issued by a U.S. depository (usually a bank), that represent a
specified quantity of shares of an underlying non-U.S. stock on deposit with a
custodian bank as collateral. Although ADRs are issued by a U.S. depository,
they are subject to many of the risks of foreign securities such as changes in
exchange rates and more limited information about foreign issuers.
The Portfolio may invest up to 20% (and generally expects to invest between
5% and 20%) of its net assets in foreign securities (including investments in
emerging markets or countries with limited or developing capital markets) (not
including ADRs). Investing in securities of foreign issuers generally involves
risks not ordinarily associated with investing in securities of domestic
issuers. (See "Appendix--Foreign Investments" and the SAI for a discussion of
the risks involved in foreign investing.)
In order to protect the value of the Portfolio's investments from interest
rate fluctuations, the Portfolio may enter into various hedging transactions,
such as interest rate swaps, and the purchase or sale of interest rate caps,
floors and collars. (See the SAI for information relating to these
transactions including related risks.)
The Portfolio may also purchase securities that are not registered under the
1933 Act ("restricted securities"), including those that can be offered and
sold to "qualified institutional buyers" under Rule 144A under the 1933 Act
("Rule 144A securities"). The Trust's Board of Trustees confirms based upon
information and recommendations provided by the Sub-Adviser that a specific
Rule 144A security is liquid and thus not subject to the Portfolio's
limitation on investing not more than 15% of its net assets in illiquid
investments. The Board of Trustees has adopted guidelines and delegated to the
Sub-Adviser the daily function of determining and monitoring the liquidity of
Rule 144A securities. The Board, however, will retain sufficient oversight and
be ultimately responsible for the determinations. This investment practice
could have the effect of decreasing the level of liquidity in a Portfolio to
the extent that qualified institutional buyers become for a time uninterested
in purchasing Rule 144A securities held in the investment portfolio. Subject
to the Portfolio's 15% limitation on investments in illiquid investments and
subject to the diversification requirements of the Code, the Portfolio may
also invest in restricted securities that may not be sold under Rule 144A,
which presents certain risks. As a result, the Portfolio might not be able to
sell these securities when the Sub-Adviser wishes to do so, or might have to
sell them at less than fair value. In addition, market quotations are less
readily available. Therefore, judgment may at times play a greater role in
valuing these securities than in the case of unrestricted securities.
10
<PAGE>
While it is not generally the Portfolio's policy to invest or trade for
short-term profits, the Portfolio may dispose of a portfolio security whenever
the Sub-Adviser is of the opinion that such security no longer has an
appropriate appreciation potential or when another security appears to offer
relatively greater appreciation potential. Portfolio changes are made without
regard to the length of time a security has been held, or whether a sale would
result in a profit or loss. Therefore, the rate of portfolio turnover is not a
limiting factor when a change in the portfolio is otherwise appropriate.
Because the Portfolio is expected to have a portfolio turnover rate of over
100%, transaction costs incurred by the Portfolio and the realized capital
gains and losses of the Portfolio may be greater than that of a portfolio with
a lesser turnover rate. The portfolio turnover rates of the Portfolio for the
periods ended December 31, 1996, 1995 and 1994 are set forth herein under
"Financial Highlights." (See also "Portfolio Turnover" in the SAI.)
ADDITIONAL PORTFOLIO INVESTMENTS AND TRANSACTIONS. The Portfolio may enter
into repurchase agreements to earn income on available cash or as a temporary
defensive measure. The Portfolio may seek to increase its income by lending
portfolio securities. The Portfolio may purchase securities on a "when issued"
or on a "delayed delivery" basis, which means that the securities will be
delivered to the Portfolio at a future date usually beyond customary
settlement time.
The Portfolio may invest in indexed securities whose value is linked to
foreign currencies, indices, or other financial indicators. The Portfolio may
enter into mortgage "dollar roll" transactions with selected banks and broker-
dealers. The Portfolio may invest a portion of its assets in loan
participations and other direct indebtedness.
The Portfolio also may purchase restricted securities, corporate asset-
backed securities, options on securities, options on stock indices, options on
foreign currencies, futures contracts, options on futures contracts and
forward foreign currency exchange contracts.
All of the Portfolio investments and transactions described in this section
are described in greater detail in the Appendix and the SAI.
MANAGEMENT OF THE TRUST
INVESTMENT ADVISER
Under an Investment Advisory Agreement dated October 1, 1994, Equitable
Investment Services, Inc., 699 Walnut Street, Des Moines, Iowa 50309 (the
"Adviser"), manages the business and affairs of the Portfolios and the Trust,
subject to the control of the Trustees.
The Adviser is an Iowa corporation which was incorporated in 1969. The
Adviser is engaged in the business of providing investment advice to
affiliated insurance companies.
Under the Investment Advisory Agreement, the Adviser is obligated to
formulate a continuing program for the investment of the assets of each
Portfolio of the Trust in a manner consistent with each Portfolio's investment
objectives, policies and restrictions and to determine from time to time
securities to be purchased, sold, retained or lent by the Trust and implement
those decisions. The Investment Advisory Agreement also provides that the
Adviser shall manage the Trust's business and affairs and shall provide such
services required for effective administration of the Trust as are now
provided by employees or other agents engaged by the Trust. The Investment
Advisory Agreement further provides that the Adviser shall furnish the Trust
with office space and necessary personnel, pay ordinary office expenses, pay
all executive salaries of the Trust and furnish, without expense to the Trust,
the services of such members of its organization as may be duly elected
officers or Trustees of the Trust. The Investment Advisory Agreement provides
that Adviser may retain sub-advisers, at the Adviser's own cost and expense,
for the purpose of making investment recommendations and research information
available to the Trust.
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<PAGE>
As full compensation for its services under the Investment Advisory
Agreement, the Trust pays the Adviser a monthly fee at the following annual
rates shown in the table below based on the average daily net assets of each
Portfolio.
<TABLE>
<CAPTION>
ADVISORY FEE
(ANNUAL RATE BASED ON AVERAGE DAILY NET ASSETS
PORTFOLIO OF EACH PORTFOLIO)
------------ -------------------------------------------------------
<S> <C>
OTC .80% of first $300 million
.55% of average net assets over and above $300 million
Research .80% of first $300 million
.55% of average net assets over and above $300 million
Total Return .80% of first $300 million
.55% of average net assets over and above $300 million
</TABLE>
ADVISORY FEE WAIVER AND EXPENSE CAP
The Adviser has undertaken to reimburse each Portfolio for all operating
expenses, excluding management fees, that exceed .40% of each Portfolio's
average daily net assets. This undertaking is subject to termination at any
time without notice to shareholders. With respect to the OTC, Research and
Total Return Portfolios, the Adviser had agreed to reimburse the Trust for
expenses in excess of the voluntary expense limitations. For the year ended
December 31, 1996, no reimbursements were due the Portfolios for expenses in
excess of the voluntary expense limitations.
EXPENSES OF THE TRUST
The organizational expenses of the Trust are being amortized on a straight-
line basis over a period of five years (beginning with the commencement of
operations). If any of the initial shares (purchased by Equitable Life
Insurance Company of Iowa through its contribution of the initial "seed money"
to the Trust totaling $10,000 per Portfolio) are redeemed during the
amortization period by the holder thereof, the redemption proceeds will be
reduced by any unamortized organizational expenses in the same proportion as
the number of initial shares being redeemed bears to the number of initial
shares outstanding at the time of the redemption.
SUB-ADVISER
In accordance with each Portfolio's investment objective and policies and
under the supervision of Adviser and the Trust's Board of Trustees, the Sub-
Adviser is responsible for the day to day investment management of the
Portfolio, makes investment decisions for the Portfolio and places orders on
behalf of the Portfolio to effect the investment decisions made as provided in
a Sub-Advisory Agreement among the Sub-Adviser, the Adviser and the Trust.
MASSACHUSETTS FINANCIAL SERVICES COMPANY ("MFS"), 500 Boylston Street,
Boston, Massachusetts 02116, is the Sub-Adviser for the OTC Portfolio, the
Research Portfolio and the Total Return Portfolio of the Trust.
MFS is America's oldest mutual fund organization. MFS and its predecessor
organizations have a history of money management dating from 1924 and the
founding of the first mutual fund in the United States, Massachusetts
Investors Trust. Net assets under the management of the MFS organization were
approximately $43.9 billion on behalf of approximately 1.9 million investor
accounts as of February 28, 1997. As of such date, the MFS organization
managed approximately $28.9 billion of assets in equity securities and $19.9
billion of assets in fixed income securities. Approximately $4.0 billion of
assets managed by MFS are invested in securities of foreign issuers and non-
U.S. dollar denominated securities of U.S. issuers. MFS is a subsidiary of Sun
Life Assurance Company of Canada (U.S.) which in turn is a wholly-owned
subsidiary of Sun Life Assurance Company of Canada ("Sun Life"). The Directors
of MFS are A. Keith Brodkin, Jeffrey L. Shames, Arnold D. Scott, John D.
McNeil and Donald R. Stewart. Mr. Brodkin is the Chairman, Mr. Shames is the
President and
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<PAGE>
Mr. Scott is the Secretary and a Senior Executive Vice President of MFS.
Messrs. McNeil and Stewart are the Chairman and the President, respectively,
of Sun Life. Sun Life, a mutual life insurance company, is one of the largest
international life insurance companies and has been operating in the U.S.
since 1895, establishing a headquarters office in the U.S. in 1973. The
executive officers of MFS report to the Chairman of Sun Life.
Kevin R. Parke is the portfolio manager for the Research Portfolio. Mr.
Parke oversees the selection of portfolio securities made by various equity
research analysts employed by MFS. Mr. Parke is a Senior Vice President--
Investments of MFS and has been employed as a portfolio manager by MFS since
1985.
David M. Calabro heads a team of portfolio managers of MFS for the Total
Return Portfolio. Mr. Calabro is a Vice President--Investments of MFS and
manages the equity portion of the portfolio along with Judith N. Lamb, a Vice
President--Investments of MFS, Lisa B. Nurme, a Vice President--Investments of
MFS and Maura Shaughnessy, a Vice President--Investments of MFS. Geoffrey L.
Kurinsky, a Senior Vice President--Investment manages the fixed income portion
of the portfolio and has been employed as a portfolio manager by MFS since
1987. Mr. Calabro has been employed as a portfolio manager by MFS since 1992.
Ms. Lamb has been employed as a portfolio manager by MFS since 1992. Ms. Nurme
has been employed as a portfolio manager by MFS since 1987. Ms. Shaughnessy
has been employed as a portfolio manager by MFS since 1991.
John W. Ballen and Mark Regan are the portfolio managers for the OTC
Portfolio. Mr. Ballen is a Senior Vice President--Investments and the Chief
Equity Officer at MFS and has been employed by MFS since 1984. Mr. Regan is a
Vice President--Investments at MFS and has been employed as a portfolio
manager by MFS since 1989.
Under the terms of the Sub-Advisory Agreement, the Adviser shall pay to MFS,
as full compensation for services rendered under the Sub-Advisory Agreement
with respect to the OTC, Research and Total Return Portfolios, the following
annual fees:
<TABLE>
<CAPTION>
<S> <C>
OTC Portfolio .40% of first $300 million
.25% of average net assets over and above $300
million
Research Portfolio .40% of first $300 million
.25% of average net assets over and above $300
million
Total Return Portfolio .40% of first $300 million
.25% of average net assets over and above $300
million
</TABLE>
SALES AND REDEMPTIONS
The separate accounts of the Life Companies place orders to purchase and
redeem shares of each Portfolio based on, among other things, the amount of
premium payments to be invested and surrender and transfer requests to be
effected on that day pursuant to the Variable Contracts issued by the Life
Companies. Orders received by the Trust are effected on days on which the New
York Stock Exchange is open for trading, at the net asset value per share next
determined after receipt of the order. For orders received before 4:00 p.m.
New York time, such purchases and redemptions of shares of each Portfolio are
effected at the respective net asset values per share determined as of 4:00
p.m. New York time on that day. See "Net Asset Value," below and
"Determination of Net Asset Value" in the Trust's SAI. Payment for redemptions
will be made within seven days after receipt of a redemption request in good
order. No fee is charged the separate accounts of the Life Companies when they
redeem Portfolio shares. The Trust may suspend the sale of shares at any time
and may refuse any order to purchase shares.
The Trust may suspend the right of redemption of shares of any Portfolio and
may postpone payment for any period: (i) during which the New York Stock
Exchange is closed other than for customary weekend and holiday closings or
during which trading on the New York Stock Exchange is restricted; (ii) when
the Securities and Exchange Commission determines that a state of emergency
exists which makes the sale of portfolio
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<PAGE>
securities or the determination of net asset value not reasonably practicable;
(iii) as the Securities and Exchange Commission may by order permit for the
protection of the security holders of the Trust; or (iv) at any time when the
Trust may, under applicable laws and regulations, suspend payment on the
redemption of its shares.
NET ASSET VALUE
Each Portfolio calculates the net asset value of a share by dividing the
total value of its assets, less liabilities, by the number of shares
outstanding. Shares are valued as of 4:00 p.m. New York time on each day the
New York Stock Exchange is open.
Because foreign securities are quoted in foreign currencies which will be
translated into U.S. dollars at the New York cable transfer rates or at such
other rates as the Trustees may determine in computing net asset value,
fluctuations in the value of such currencies in relation to the U.S. dollar
will affect the net asset value of shares of a Portfolio investing in foreign
securities even though there has not been any change in the local currency
values of such securities.
Performance information for the Portfolios may also be presented from time
to time in advertisements and sales literature. The Portfolios may advertise
several types of performance information. These are the "yield," "average
annual total return" and "aggregate total return". Each of these figures is
based upon historical results and is not necessarily representative of the
future performance of any Portfolio.
The yield of a Portfolio's shares is determined by annualizing net
investment income earned per share for a stated period (normally one month or
thirty days) and dividing the result by the net asset value per share at the
end of the valuation period. The average annual total return and aggregate
total return figures measure both the net investment income generated by, and
the effect of any realized or unrealized appreciation or depreciation of the
underlying investments in, the Portfolio's portfolio for the period in
question, assuming the reinvestment of all dividends. Thus, these figures
reflect the change in the value of an investment in a Portfolio's shares
during a specified period. Average annual total return will be quoted for at
least the one, five and ten year periods ending on a recent calendar quarter
(or if such periods have not yet elapsed, at the end of a shorter period
corresponding to the life of the Portfolio). Average annual total return
figures are annualized and, therefore, represent the average annual percentage
change over the period in question. Total return figures are not annualized
and represent the aggregate percentage or dollar value change over the period
in question. For more information regarding the computation of yield, average
annual total return and aggregate total return, see "Performance Information"
in the SAI.
Any Portfolio performance information presented will also include
performance information for the separate accounts of the Life Companies
investing in the Trust which will take into account insurance-related charges
and expenses under such insurance policies and contracts.
Advertisements concerning the Trust may from time to time compare the
performance of one or more Portfolios to various indices. Advertisements may
also contain the performance rankings assigned certain Portfolios or their
advisers by various publications and statistical services, including, for
example, SEI, Lipper Analytical Services Mutual Funds Survey, Lipper Variable
Insurance Products Performance Analysis Service, Morningstar, Intersec
Research Survey of Non-U.S. Equity Fund Returns, Frank Russell International
Universe and Financial Services Week. Any such comparisons or rankings are
based on past performance and the statistical computation performed by
publications and services, and are not necessarily indications of future
performance. Because the Portfolios are managed investment vehicles investing
in a wide variety of securities, the securities owned by a Portfolio will not
match those making up an index.
TAX STATUS, DIVIDENDS, AND DISTRIBUTIONS
Each Portfolio of the Trust intends to qualify and elect to be treated as a
regulated investment company that is taxed under the rules of Subchapter M of
the Internal Revenue Code. As such an electing regulated investment
14
<PAGE>
company, a Portfolio will not be subject to federal income tax on its net
ordinary income and net realized capital gains to the extent such income and
gains are distributed to the separate accounts of the Life Company which hold
its shares. For further information concerning federal income tax consequences
for the holders of the Variable Contracts of the Life Company, investors
should consult the prospectus used in connection with the issuance of their
Variable Contracts.
The Portfolios will declare and distribute dividends from net ordinary
income at least annually and will distribute its net realized capital gains,
if any, at least annually. Distributions of ordinary income and capital gains
will be made in shares of such Portfolios unless an election is made on behalf
of a separate account to receive distributions in cash. The Life Companies
will be informed at least annually about the amount and character of
distributions from the Trust for federal income tax purposes.
ADDITIONAL INFORMATION
The Trust was established as a Massachusetts business trust under the laws
of Massachusetts by a Declaration of Trust dated May 11, 1994 (the
"Declaration of Trust"). Under Massachusetts law, shareholders of such a trust
may, under certain circumstances, be held personally liable as partners for
the obligations of the trust. The Declaration of Trust contains an express
disclaimer of shareholder liability in connection with Trust property or the
acts, obligations, or affairs of the Trust. The Declaration of Trust also
provides for indemnification out of a Portfolio's property of any shareholder
of that Portfolio held personally liable for the claims and liabilities to
which a shareholder may become subject by reason of being or having been a
shareholder. Thus, the risk of a shareholder's incurring financial loss on
account of shareholder liability is limited to circumstances in which the
Portfolio itself would be unable to meet its obligations. A copy of the
Declaration of Trust is on file with the Secretary of State of The
Commonwealth of Massachusetts.
The Trust has an unlimited authorized number of shares of beneficial
interest. Shares of the Trust are entitled to one vote per share (with
proportional voting for fractional shares) and are freely transferable, and,
in liquidation of a Portfolio, shareholders of the Portfolio are entitled to
receive pro rata the net assets of the Portfolio. Although no Portfolio is
required to hold annual meetings of its shareholders, shareholders have the
right to call a meeting to elect or remove Trustees or to take other actions
as provided in the Declaration of Trust. Shareholders have no preemptive
rights. The Trust's custodian, transfer and dividend-paying agent is State
Street Bank and Trust Company.
To mitigate the possibility that a Portfolio will be adversely affected by
personal trading of employees, the Trust, the Adviser and the Sub-Adviser have
adopted policies that restrict securities trading in personal accounts of the
portfolio managers and others who normally come into possession of information
on portfolio transactions. These policies comply, in all material respects,
with the recommendations of the Investment Company Institute.
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APPENDIX
SECURITIES AND INVESTMENT PRACTICES
In attempting to achieve its investment objective or policies each Portfolio
employs a variety of instruments, strategies and techniques, which are
described in greater detail below. Risks and restrictions associated with these
practices are also described. Policies and limitations are considered at the
time a security or instrument is purchased or a practice initiated. Generally,
securities need not be sold if subsequent changes in market value result in
applicable limitations not being met.
A Portfolio might not buy all of these securities or use all of these
techniques to the full extent permitted unless the Sub-Adviser, subject to
oversight by Adviser, believes that doing so will help the Portfolio achieve
its goal. As a shareholder, you will receive Portfolio reports every six months
detailing the Trust's holdings and describing recent investment practices.
The investment guidelines set forth below may be changed at any time without
shareholder consent by vote of the Board of Trustees of the Trust. A complete
list of investment restrictions that identifies additional restrictions that
cannot be changed without the approval of a majority of an affected Portfolio's
outstanding shares is contained in the SAI.
AMERICAN DEPOSITARY RECEIPTS AND EUROPEAN DEPOSITARY RECEIPTS
Certain of the Portfolios may invest in securities of foreign issuers
directly or in the form of American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other similar securities representing
securities of foreign issuers. These securities may not necessarily be
denominated in the same currency as the securities they represent. ADRs are
receipts typically issued by a United States bank or trust company evidencing
beneficial ownership of the underlying foreign securities. EDRs are receipts
issued by a European financial institution evidencing a similar arrangement.
Generally, ADRs, in registered form, are designed for use in the United States
securities markets, and EDRs, in bearer form, are designed for use in European
securities markets.
ASSET-BACKED SECURITIES
Certain of the Portfolios may purchase asset-backed securities, which
represent a participation in, or are secured by and payable from, a stream of
payments generated by particular assets, most often a pool of assets similar to
one another. Assets generating such payments may include motor vehicle
installment purchase obligations, credit card receivables and home equity
loans.
BANK OBLIGATIONS
All of the Portfolios may invest in Bank Obligations, which include
certificates of deposit, time deposits and bankers' acceptances of U.S.
commercial banks or savings and loan institutions which are determined by the
Sub-Adviser to present minimal credit risks. Certain of the Portfolios may
invest in foreign-currency denominated Bank Obligations, including Euro-
currency instruments and securities of U.S. and foreign banks and thrifts.
BORROWING
Each of the Portfolios may borrow money (up to 33 1/3% of its assets) for
temporary or emergency purposes. If a Portfolio borrows money, its share price
may be subject to greater fluctuation until the borrowing is paid off. If the
Portfolio makes additional investments while borrowings are outstanding, this
may be construed as a form of leverage.
Borrowing, including reverse repurchase agreements and, in certain
circumstances, dollar rolls, creates leverage which increases a Portfolio's
investment risk. If the income and gains on the securities purchased with
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the proceeds of borrowings exceed the cost of the arrangements, the
Portfolio's earnings or net asset value will increase faster than would be the
case otherwise. Conversely, if the income and gains fail to exceed the costs,
earnings or net asset value will decline faster than would otherwise be the
case.
COMMON STOCK AND OTHER EQUITY SECURITIES
Common Stocks represent an equity (ownership) interest in a corporation.
This ownership interest generally gives a Portfolio the right to vote on
measures affecting the company's organization and operations.
Certain of the Portfolios may also buy securities such as convertible debt,
preferred stock, warrants or other securities exchangeable for shares of
Common Stock. In selecting equity investments for a Portfolio, the Sub-Adviser
will generally invest the Portfolio's assets in industries and companies that
it believes are experiencing favorable demand for their products and services
and which operate in a favorable competitive and regulatory climate.
CONVERTIBLE SECURITIES
A convertible security is a security that may be converted either at a
stated price or rate within a specified period of time into a specified number
of shares of Common Stock. By investing in Convertible Securities, a Portfolio
seeks the opportunity, through the conversion feature, to participate in the
capital appreciation of the Common Stock into which the securities are
convertible, while earning a higher fixed rate of return than is available in
Common Stocks.
CURRENCY MANAGEMENT
A Portfolio's flexibility to participate in higher yielding debt markets
outside of the United States may allow the Portfolio to achieve higher yields
than those generally obtained by domestic money market funds and short-term
bond investments. When a Portfolio invests significantly in securities
denominated in foreign currencies, however, movements in foreign currency
exchange rates versus the U.S. dollar are likely to impact the Portfolio's
share price stability relative to domestic short-term income funds.
Fluctuations in foreign currencies can have a positive or negative impact on
returns. Normally, to the extent that the Portfolio is invested in foreign
securities, a weakening in the U.S. dollar relative to the foreign currencies
underlying a Portfolio's investments should help increase the net asset value
of the Portfolio. Conversely, a strengthening in the U.S. dollar versus the
foreign currencies in which a Portfolio's securities are denominated will
generally lower the net asset value of the Portfolio. The Portfolio's Sub-
Adviser attempts to minimize exchange rate risk through active portfolio
management, including hedging currency exposure through the use of futures,
options and forward currency transactions and attempting to identify bond
markets with strong or stable currencies. There can be no assurance that such
hedging will be successful and such transactions, if unsuccessful, could
result in additional losses or expenses to a Portfolio.
DOLLAR ROLL TRANSACTIONS
Certain Portfolios seeking a high level of current income may enter into
dollar rolls or "covered rolls" in which the Portfolio sells securities
(usually Mortgage-Backed Securities) and simultaneously contracts to purchase,
typically in 30 to 60 days, substantially similar, but not identical
securities, on a specified future date. The proceeds of the initial sale of
securities in the Dollar Roll Transactions may be used to purchase long-term
securities which will be held during the roll period. During the roll period,
the Portfolio forgoes principal and interest paid on the securities sold at
the beginning of the roll period. The Portfolio is compensated by the
difference between the current sales price and the forward price for the
future purchase (often referred to as the "drop") as well as by the interest
earned on the cash proceeds of the initial sale. A "covered roll" is a
specific type of dollar roll for which there is an offsetting cash position or
cash equivalent securities position that matures on or before the forward
settlement date of the dollar roll transaction. As used herein the term
"dollar roll" refers to dollar rolls that are not "covered rolls." At the end
of the roll commitment period, the Portfolio may or may not take delivery of
the securities the Portfolio has contracted to purchase.
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The Portfolio will establish a segregated account with its custodian in
which it will maintain cash, U.S. Government Securities or other liquid high-
grade debt obligations equal in value at all times to its obligations in
respect of dollar rolls, and, accordingly, the Portfolio will not treat such
obligations as senior securities for purposes of the 1940 Act. "Covered rolls"
are not subject to these segregation requirements. Dollar Roll Transactions
may be considered borrowings and are, therefore, subject to the borrowing
limitations applicable to the Portfolios.
EQUITY AND DEBT SECURITIES ISSUED OR GUARANTEED BY SUPRANATIONAL ORGANIZATIONS
Portfolios authorized to invest in securities of foreign issuers may invest
assets in equity and debt securities issued or guaranteed by Supranational
Organizations, such as obligations issued or guaranteed by the Asian
Development Bank, Inter-American Development Bank, International Bank for
Reconstruction and Development (World Bank), African Development Bank,
European Coal and Steel Community, European Economic Community, European
Investment Bank and the Nordic Investment Bank.
EXCHANGE RATE-RELATED SECURITIES
Certain of the Portfolios may invest in securities which are indexed to
certain specific foreign currency exchange rates. The terms of such security
would provide that the principal amount or interest payments are adjusted
upwards or downwards (but not below zero) at payment to reflect fluctuations
in the exchange rate between two currencies while the obligation is
outstanding, depending on the terms of the specific security. A Portfolio will
purchase such security with the currency in which it is denominated and will
receive interest and principal payments thereon in the currency, but the
amount of principal or interest payable by the issuer will vary in proportion
to the change (if any) in the exchange rate between the two specific
currencies between the date the instrument is issued and the date the
principal or interest payment is due. The staff of the SEC is currently
considering whether a mutual fund's purchase of this type of security would
result in the issuance of a "senior security" within the meaning of the 1940
Act. The Trust believes that such investments do not involve the creation of
such a senior security, but nevertheless undertakes, pending the resolution of
this issue by the staff, to establish a segregated account with respect to
such investments and to maintain in such account cash not available for
investment or U.S. Government Securities or other liquid high quality debt
securities having a value equal to the aggregate principal amount of
outstanding securities of this type.
Investment in Exchange Rate-Related Securities entails certain risks. There
is the possibility of significant changes in rates of exchange between the
U.S. dollar and any foreign currency to which an Exchange Rate-Related
Security is linked. In addition, there is no assurance that sufficient trading
interest to create a liquid secondary market will exist for a particular
Exchange Rate-Related Security due to conditions in the debt and foreign
currency markets. Illiquidity in the forward foreign exchange market and the
high volatility of the foreign exchange market may from time to time combine
to make it difficult to sell an Exchange Rate-Related Security prior to
maturity without incurring a significant price loss.
FIXED-INCOME SECURITIES
The market value of fixed-income obligations held by the Portfolios and,
consequently, the net asset value per share of the Portfolios can be expected
to vary inversely to changes in prevailing interest rates. Investors should
also recognize that, in periods of declining interest rates, to the extent the
Portfolios are invested in fixed income obligations, the yields of the
Portfolios will tend to be somewhat higher than prevailing market rates and,
in periods of rising interest rates, the Portfolios' yields will tend to be
somewhat lower. Also, when interest rates are falling, the inflow of net new
money to the Portfolios from the continuous sales of their shares will, to the
extent that their assets are to be invested in fixed income obligations,
likely be invested in instruments producing lower yields than the balance of
their assets, thereby reducing current yields. In periods of rising interest
rates, the opposite can be expected to occur. Prices of longer term securities
generally increase or decrease more sharply than those of shorter term
securities in response to interest rate changes. In addition, obligations
purchased by the Portfolios that are rated in the lower categories are
considered to have speculative characteristics and changes in economic
conditions or other circumstances are more likely to lead to a weakened
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capacity to make principal and interest payments than is the case with higher
grade securities. (See "Lower Rated Securities" in this Appendix.)
FOREIGN CURRENCY EXCHANGE TRANSACTIONS
Certain of the Portfolios may engage in foreign currency exchange
transactions. Portfolios that 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, 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. A
Portfolio can 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 Portfolio
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 a commission. When a
Portfolio engages in forward contracts for the sale or purchase of currencies,
the Portfolio will either cover its position or establish a segregated
account. The Portfolio will consider its position covered if it has securities
in the currency subject to the forward contract, or otherwise has the right to
obtain that currency at no additional cost. In the alternative, the Trust, on
behalf of the Portfolio, will place cash which is not available for
investment, liquid, high-grade debt securities or other securities
(denominated in the foreign currency subject to the forward contract) in a
separate account. The amounts in such separate account will equal the value of
the Portfolio's total assets which are committed to the consummation of
foreign currency exchange contracts. If the value of the securities placed in
the separate account declines, the Trust, on behalf of the Portfolio, will
place additional cash or securities in the account on a daily basis so that
the value of the account will equal the amount of the Portfolio's commitments
with respect to such contracts. Neither spot transactions nor forward foreign
currency exchange contracts eliminate fluctuations in the prices of the
Portfolio's portfolio securities or in foreign exchange rates, or prevent loss
if the prices of these securities should decline.
A Portfolio may enter into foreign currency exchange transactions for
hedging purposes as well as for non-hedging purposes. Transactions are entered
into 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 portfolio
position. 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 these securities in foreign currencies will change as a
consequence of market movements in the value of those 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. In addition,
when the Sub-Adviser believes that the currency of a specific country may
deteriorate against another currency, it may enter into a forward contract to
sell the less attractive currency and buy the more attractive one. The amount
in question could be less than or equal to the value of the Portfolio's
securities denominated in the less attractive currency. The Portfolio may also
enter into a forward contract to sell a currency which is linked to a currency
or currencies in which some or all of the Portfolio's portfolio securities are
or could be denominated, and to buy U.S. dollars. These practices are referred
to as "cross hedging" and "proxy hedging."
A Portfolio may enter into foreign currency exchange transactions for other
than hedging purposes which presents greater profit potential but also
involves increased risk. For example, if the Sub-Adviser believes that the
value of a particular foreign currency will increase or decrease relative to
the value of the U.S. dollar, the Portfolio may purchase or sell such
currency, respectively, through a forward foreign currency exchange contract.
If the expected changes in the value of the currency occur, the Portfolio will
realize profits which will increase
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its gross income. Where exchange rates do not move in the direction or to the
extent anticipated, however, the Portfolio may sustain losses which will
reduce its gross income. Such transactions, therefore, could be considered
speculative.
Forward currency exchange contracts are agreements to exchange one currency
for another--for example, to exchange a certain amount of U.S. dollars for a
certain amount of Japanese Yen--at a future date and specified price.
Typically, the other party to a currency exchange contract will be a
commercial bank or other financial institution. Because there is a risk of
loss to the Portfolio if the other party does not complete the transaction,
the Portfolio's Sub-Adviser will enter into foreign currency exchange
contracts only with parties approved by the Trust's Board of Trustees.
A Portfolio may maintain "short" positions in forward currency exchange
transactions in which the Portfolio agrees to exchange currency that it
currently does not own for another currency--for example, to exchange an
amount of Japanese Yen that it does not own for a certain amount of U.S.
dollars--at a future date and specified price in anticipation of a decline in
the value of the currency sold short relative to the currency that the
Portfolio has contracted to receive in the exchange.
While such actions are intended to protect the Portfolio from adverse
currency movements, there is a risk that currency movements involved will not
be properly anticipated. Use of this technique may also be limited by
management's need to protect the status of the Portfolio as a regulated
investment company under the Internal Revenue Code of 1986, as amended. The
projection of currency market movements is extremely difficult, and the
successful execution of currency strategies is highly uncertain.
FOREIGN INVESTMENTS
Certain Portfolios may invest in securities of foreign issuers. There are
certain risks involved in investing in foreign securities, including those
resulting from fluctuations in currency exchange rates, devaluation of
currencies, future political or economic developments and the possible
imposition of currency exchange blockages or other foreign governmental laws
or restrictions, reduced availability of public information concerning
issuers, and the fact that foreign companies are not generally subject to
uniform accounting, auditing and financial reporting standards or to other
regulatory practices and requirements comparable to those applicable to
domestic companies. Moreover, securities of many foreign companies may be less
liquid and the prices more volatile than those of securities of comparable
domestic companies. With respect to certain foreign countries, there is the
possibility of expropriation, nationalization, confiscatory taxation and
limitations on the use or removal of funds or other assets of the Portfolios,
including the withholding of dividends.
Because foreign securities generally are denominated and pay dividends or
interest in foreign currencies, and the Portfolios hold various foreign
currencies from time to time, the value of the net assets of the Portfolios as
measured in U.S. dollars will be affected favorably or unfavorably by changes
in exchange rates. The cost of the Portfolio's currency exchange transactions
will generally be the difference between the bid and offer spot rate of the
currency being purchased or sold. In order to protect against uncertainty in
the level of future foreign currency exchange rates, the Portfolios are
authorized to enter into certain foreign currency exchange transactions.
Investors should be aware that exchange rate movements can be significant and
can endure for long periods of time. Extensive research of the economic,
political and social factors that influence global markets is conducted by the
Sub-Adviser. Particular attention is given to country-specific analysis,
reviewing the strength or weakness of a country's overall economy, the
government policies influencing business conditions and the outlook for the
country's currency. Certain Portfolios are authorized to engage in foreign
currency options, futures, options on futures and forward currency contract
transactions for hedging and/or other permissible purposes.
In addition, while the volume of transactions effected on foreign stock
exchanges has increased in recent years, in most cases it remains appreciably
below that of the NYSE. Accordingly, the Portfolios' foreign investments may
be less liquid and their prices may be more volatile than comparable
investments in securities of United States companies. Moreover, the settlement
periods for foreign securities, which are often longer than
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those for securities of United States issuers, may affect portfolio liquidity.
In buying and selling securities on foreign exchanges, the Portfolio normally
pays fixed commissions that are generally higher than the negotiated
commissions charged in the United States. In addition, there is generally less
governmental supervision and regulation of securities exchanges, brokers and
issuers in foreign countries than in the United States.
Certain of the Portfolios may invest, as described below, in countries or
regions with relatively low gross national product per capita compared to the
world's major economies, and in countries or regions with the potential for
rapid economic growth (emerging markets). Emerging markets will include any
country: (i) having an "emerging stock market" as defined by the International
Finance Corporation; (ii) with lowto middle-income economies according to the
International Bank for Reconstruction and Development (the World Bank); (iii)
listed in World Bank publications as developing; or (iv) determined by the
Sub-Adviser to be an emerging market as defined above. The Portfolio may
invest in securities of: (i) companies the principal securities trading market
for which is an emerging market country; (ii) companies organized under the
laws of, and with a principal office in, an emerging market country; (iii)
companies whose principal activities are located in emerging market countries;
(iv) companies traded in any market that derive 50% or more of their total
revenue from either goods or services produced in an emerging market or sold
in an emerging market; (v) companies that have 50% or more of their assets in
an emerging market country; or (vi) the security is issued or guaranteed by
the government of an emerging market country or any of its agencies,
authorities or instrumentalities.
The risks of investing in foreign securities may be intensified in the case
of investments in emerging markets. Securities prices in emerging markets can
be significantly more volatile than in the more developed nations of the
world, reflecting the greater uncertainties of investing in less established
markets and economies. In particular, countries with emerging markets may have
relatively unstable governments, present the risk of nationalization of
businesses, restrictions on foreign ownership, or prohibitions of repatriation
of assets, and may have less protection of property rights than more developed
countries. The economies of countries with emerging markets may be
predominantly based on only a few industries, may be highly vulnerable to
changes in local or global trade conditions, and may suffer from extreme and
volatile debt burdens or inflation rates. Local securities markets may trade a
small number of securities and may be unable to respond effectively to
increases in trading volume, potentially making prompt liquidation of
substantial holdings difficult or impossible at times. Securities of issuers
located in countries with emerging markets may have limited marketability and
may be subject to more abrupt or erratic price movements.
FUTURES AND OPTIONS ON FUTURES
When deemed appropriate by its Sub-Adviser, certain Portfolios may enter
into financial or currency futures and related options that are traded on a
U.S. exchange or board of trade or, to the extent permitted by applicable law,
on exchanges located outside the U.S., for hedging purposes or for non-hedging
purposes to the extent permitted by applicable law. A Portfolio may not enter
into futures and options contracts for which aggregate initial margin deposits
and premiums paid for unexpired futures options entered into for purposes
other than "bona fide hedging" positioning as defined in regulations adopted
by the Commodity Futures Trading Commission exceed 5% of the fair market value
of the Portfolio's net assets, after taking into account unrealized profits
and unrealized losses on futures contracts into which it has entered. With
respect to each long position in a futures contract or option thereon, the
underlying commodity value of such contract will always be covered by cash and
cash equivalents set aside plus accrued profits held at the futures commission
merchant.
A financial or currency futures contract provides for the future sale by one
party and the purchase by the other party of a specified amount of a
particular financial instrument or currency (e.g., debt security or currency)
at a specified price, date, time and place. An index futures contract is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. An option on a futures contract generally
gives the purchaser the right, in return for the premium paid, to assume a
position in a futures contract at a specified exercise price at any time prior
to the expiration date of the option.
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The purpose of entering into a futures contract by a Portfolio is to either
enhance return or to protect the Portfolio from fluctuations in the value of
its securities caused by anticipated changes in interest rates, currency or
market conditions without necessarily buying or selling the securities. The
use of futures contracts and options on futures contracts involves several
risks. There can be no assurance that there will be a correlation between
price movements in the underlying securities, currencies or index, on the one
hand, and price movements in the securities which are the subject of the
futures contract or option on futures contract, on the other hand. Positions
in futures contracts and options on futures contracts may be closed out only
on the exchange or board of trade on which they were entered into, and there
can be no assurance that an active market will exist for a particular contract
or option at any particular time. If a Portfolio has hedged against the
possibility of an increase in interest rates or bond prices adversely
affecting the value of securities held in its portfolio and rates or prices
decrease instead, a Portfolio will lose part or all of the benefit of the
increased value of securities that it has hedged because it will have
offsetting losses in its futures positions. In addition, in such situations,
if a Portfolio had insufficient cash, it may have to sell securities to meet
daily variation margin requirements at a time when it may be disadvantageous
to do so. These sales of securities may, but will not necessarily, be at
increased prices that reflect the decline in interest rates or bond prices, as
the case may be. In addition, the Portfolio would pay commissions and other
costs in connection with such investments, which may increase the Portfolio's
expenses and reduce its return. While utilization of options, futures
contracts and similar instruments may be advantageous to the Portfolio, if the
Portfolio's Sub-Adviser is not successful in employing such instruments in
managing the Portfolio's investments, the Portfolio's performance will be
worse than if the Portfolio did not make such investments.
Losses incurred in futures contracts and options on futures contracts and
the costs of these transactions will adversely affect a Portfolio's
performance.
GEOGRAPHICAL AND INDUSTRY CONCENTRATION
Where a Portfolio invests at least 25% of its assets in Bank Obligations,
the Portfolio's investments may be subject to greater risk than a Portfolio
that does not concentrate in the banking industry. In particular, Bank
Obligations may be subject to the risks associated with interest rate
volatility, changes in federal and state laws and regulations governing
banking and the inability of borrowers to pay principal and interest when due.
In addition, foreign banks present the risks of investing in foreign
securities generally and are not subject to reserve requirements and other
regulations comparable to those of U.S. Banks.
GOVERNMENT STRIPPED MORTGAGE-BACKED SECURITIES
Certain Portfolios may invest in Government Stripped Mortgage-Backed
Securities issued or guaranteed by the Government National Mortgage
Association ("GNMA"), Federal National Mortgage Association ("FNMA") and
Federal Home Loan Mortgage Corporation ("FHLMC"). These securities represent
beneficial ownership interests in either periodic principal distributions
("principal-only") or interest distributions ("interest-only") on mortgage-
backed certificates issued by GNMA, FNMA or FHLMC, as the case may be. The
certificates underlying the Government Stripped Mortgage-Backed Securities
represent all or part of the beneficial interest in pools of mortgage loans.
The Portfolios will invest in interest-only Government Stripped Mortgage-
Backed Securities in order to enhance yield or to benefit from anticipated
appreciation in value of the securities at times when the appropriate Sub-
Adviser believes that interest rates will remain stable or increase. In
periods of rising interest rates, the value of interest-only Government
Stripped Mortgage-Backed Securities may be expected to increase because of the
diminished expectation that the underlying mortgages will be prepaid. In this
situation the expected increase in the value of interest-only Government
Stripped Mortgage-Backed Securities may offset all or a portion of any decline
in value of the portfolio securities of the Portfolios. Investing in
Government Stripped Mortgage-Backed Securities involves the risks normally
associated with investing in mortgage-backed securities issued by government
or government-related entities. See "Mortgage-Backed Securities" below. In
addition, the yields on interest-only and principal-only Government Stripped
Mortgage-Backed Securities are extremely sensitive to the prepayment
experience on the mortgage loans underlying the certificates collateralizing
the securities. If a decline in the level of prevailing interest rates results
in a rate of principal prepayments higher than anticipated, distributions of
principal will be accelerated, thereby reducing the
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yield to maturity on interest-only Government Stripped Mortgage-Backed
Securities and increasing the yield to maturity on principal-only Government
Stripped Mortgage-Backed Securities. Conversely, if an increase in the level
of prevailing interest rates results in a rate of principal prepayments lower
than anticipated, distributions of principal will be deferred, thereby
increasing the yield to maturity on interest-only Government Stripped
Mortgage-Backed Securities and decreasing the yield to maturity on principal-
only Government Stripped Mortgage-Backed Securities. Sufficiently high
prepayment rates could result in the Portfolio not fully recovering its
initial investment in an interest-only Government Stripped Mortgage-Backed
Security. Government Stripped Mortgage-Backed Securities are currently traded
in an over-the-counter market maintained by several large investment banking
firms. There can be no assurance that the Portfolio will be able to effect a
trade of a Government Stripped Mortgage-Backed Security at a time when it
wishes to do so. The Portfolios will acquire Government Stripped Mortgage-
Backed Securities only if a liquid secondary market for the securities exists
at the time of acquisition.
INTEREST RATE TRANSACTIONS
Certain Portfolios may engage in certain Interest Rate Transactions, such as
swaps, caps, floors and collars. Interest rate swaps involve the exchange with
another party of commitments to pay or receive interest (e.g., an exchange of
floating rate payments for fixed rate payments). The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds
a predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase
of an interest rate floor entitles the purchaser, to the extent that a
specified index falls below a predetermined interest rate, to receive payments
of interest on a notional principal amount from the party selling such
interest rate floor. An interest rate collar combines the elements of
purchasing a cap and selling a floor. The collar protects against an interest
rate rise above the maximum amount but gives up the benefits of an interest
rate decline below the minimum amount. The net amount of the excess, if any,
of a Portfolio's obligations over its entitlements with respect to each
interest rate swap will be accrued on a daily basis and an amount of cash or
liquid securities having an aggregate net asset value at least equal to the
accrued excess will be maintained in a segregated account with the Trust's
custodian. If there is a default by the other party to the transaction, the
Portfolio will have contractual remedies pursuant to the agreements related to
the transactions.
ILLIQUID SECURITIES
Up to 10% (15% for the OTC Portfolio and Total Return Portfolio) of the net
assets of a Portfolio may be invested in securities that are not readily
marketable, including, where applicable: (1) Repurchase Agreements with
maturities greater than seven calendar days; (2) time deposits maturing in
more than seven calendar days; (3) to the extent a liquid secondary market
does not exist for the instruments, futures contracts and options thereon; (4)
certain over-the-counter options, as described in the SAI; (5) certain
variable rate demand notes having a demand period of more than seven days; and
(6) securities the disposition of which is restricted under Federal securities
laws (excluding Rule 144A Securities, described below). The Portfolios will
not include for purposes of the restrictions on illiquid investments,
securities sold pursuant to Rule 144A under the Securities Act of 1933, as
amended, so long as such securities meet liquidity guidelines established by
the Trust's Board of Trustees. Under Rule 144A, securities which would
otherwise be restricted may be sold by persons other than issuers or dealers
to qualified institutional buyers.
INVESTMENT COMPANIES
When a Portfolio's Sub-Adviser believes that it would be beneficial for the
Portfolio and appropriate under the circumstances, the Sub-Adviser may invest
up to 10% of the Portfolio's assets in securities of mutual funds. As a
shareholder in any such mutual fund, the Portfolio will bear its ratable share
of the mutual fund's expenses, including management fees, and will remain
subject to the Portfolio's advisory and administration fees with respect to
the assets so invested.
LEASE OBLIGATION BONDS
Lease Obligation Bonds are mortgages on a facility that is secured by the
facility and are paid by a lessee over a long term. The rental stream to
service the debt as well as the mortgage are held by a collateral trustee on
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behalf of the public bondholders. The primary risk of such instrument is the
risk of default. Under the lease indenture, the failure to pay rent is an
event of default. The remedy to cure default is to rescind the lease and sell
the assets. If the lease obligation is not readily marketable or market
quotations are not readily available, such lease obligations will be subject
to a Portfolio's limit on Illiquid Securities.
LENDING OF SECURITIES
All of the Portfolios have the ability to lend portfolio securities to
brokers and other financial organizations. By lending its securities, a
Portfolio can increase its income by continuing to receive interest on the
loaned securities as well as by either investing the cash collateral in short-
term instruments or obtaining yield in the form of interest paid by the
borrower when U.S. Government Securities are used as collateral. These loans,
if and when made, may not exceed 20% of a Portfolio's total assets taken at
value. Loans of portfolio securities by a Portfolio will be collateralized by
cash, irrevocable letters of credit or U.S. Government Securities that are
maintained at all times in an amount at least equal to the current market
value of the loaned securities. Any gain or loss in the market price of the
securities loaned that might occur during the term of the loan would be for
the account of the Portfolio involved. The Sub-Adviser will monitor on an
ongoing basis the credit worthiness of the institutions to which the Portfolio
lends securities.
LOWER-RATED SECURITIES
Certain Portfolios may invest in debt securities rated in the lower NRSRO
categories (e.g., BBB- by S&P or Baa3 by Moody's), or of equivalent quality as
determined by the Sub-Adviser. Securities rated BB+, Ba1 or lower are commonly
referred to as high yield securities or "junk bonds."
Securities rated below investment grade as well as unrated securities are
often considered to be speculative and usually entail greater risk (including
the possibility of default or bankruptcy of the issuers). Such securities
generally involve greater price volatility and risk of principal and income,
and may be less liquid, than securities in higher rated categories. Both price
volatility and illiquidity may make it difficult for the Portfolio to value
certain of these securities at certain times and these securities may be
difficult to sell under certain market conditions. Prices for securities rated
below investment grade may be affected by legislative and regulatory
developments. (See SAI for additional information pertaining to lower-rated
securities including risks.)
MORTGAGE-BACKED SECURITIES
Certain of the Portfolios may invest in Mortgage-Backed Securities, which
represent an interest in a pool of mortgage loans. The primary government
issuers or guarantors of Mortgage-Backed Securities are GNMA, FHMA and FHLMC.
Mortgage-Backed Securities provide a monthly payment consisting of interest
and principal payments. Additional payments may be made out of unscheduled
repayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs that may be
incurred. Prepayments of principal on Mortgage-Backed Securities may tend to
increase due to refinancing of mortgages as interest rates decline. Prompt
payment of principal and interest on GNMA mortgage pass-through certificates
is backed by the full faith and credit of the U.S. government. FNMA guaranteed
mortgage pass-through certificates and FHLMC participation certificates are
solely the obligations of those entities but are supported by the
discretionary authority of the U.S. Government to purchase the agencies'
obligations. Collateralized Mortgage Obligations are a type of bond secured by
an underlying pool of mortgages or mortgage pass-through certificates that are
structured to direct payments on underlying collateral to different series or
classes of the obligations.
To the extent that a Portfolio purchases mortgage-related or mortgage-backed
securities at a premium, prepayments may result in some loss of the
Portfolio's principal investment to the extent of the premium paid. The yield
of the Portfolio may be affected by reinvestment of prepayments at higher or
lower rates than the original investment. In addition, like other debt
securities, the value of mortgage-related securities, including government and
government-related mortgage pools, will generally fluctuate in response to
market interest rates.
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NEW ISSUERS
A Portfolio may invest up to 5% (except for the OTC Portfolio which may
invest without limitation) of its assets in the securities of issuers which
have been in continuous operation for less than three years.
OPTIONS ON SECURITIES
OPTION PURCHASE. Certain Portfolios may purchase put and call options on
portfolio securities in which they may invest that are traded on a U.S. or
foreign securities exchange or in the over-the-counter market. A Portfolio may
utilize up to 10% of its assets to purchase put options on portfolio
securities and may do so at or about the same time that it purchases the
underlying security or at a later time and may also utilize up to 10% of its
assets to purchase call options on securities in which it is authorized to
invest. By buying a put, the Portfolios limit their risk of loss from a
decline in the market value of the security until the put expires. Any
appreciation in the value of the underlying security, however, will be
partially offset by the amount of the premium paid for the put option and any
related transaction costs. Call options may be purchased by the Portfolio in
order to acquire the underlying securities for the Portfolio at a price that
avoids any additional cost that would result from a substantial increase in
the market value of a security. The Portfolios may also purchase call options
to increase their return to investors at a time when the call is expected to
increase in value due to anticipated appreciation of the underlying security.
Prior to their expirations, put and call options may be sold in closing sale
transactions (sales by the Portfolio, prior to the exercise of options that it
has purchased, of options of the same series), and profit or loss from the
sale will depend on whether the amount received is more or less than the
premium paid for the option plus the related transaction costs.
COVERED OPTION WRITING. Certain Portfolios may write put and call options on
securities for hedging purposes. The Portfolios realize fees (referred to as
"premiums") for granting the rights evidenced by the options. A put option
embodies the right of its purchaser to compel the writer of the option to
purchase from the option holder an underlying security at a specified price at
any time during the option period. In contrast, a call option embodies the
right of its purchaser to compel the writer of the option to sell to the
option holder an underlying security at a specified price at anytime during
the option period.
Upon the exercise of a put option written by a Portfolio, the Portfolio may
suffer a loss equal to the difference between the price at which the Portfolio
is required to purchase the underlying security and its market value at the
time of the option exercise, less the premium received for writing the option.
Upon the exercise of a call option written by the Portfolio, the Portfolio may
suffer a loss equal to the excess of the security's market value at the time
of the option exercise over the Portfolio's acquisition cost of the security,
less the premium received for writing the option.
Each Portfolio will comply with regulatory requirements of the SEC and the
Commodity Futures Trading Commission with respect to coverage of options and
futures positions by registered investment companies and, if the guidelines so
require, will set aside cash and/or appropriate liquid assets in a segregated
custodial account in the amount prescribed. Securities held in a segregated
account cannot be sold while the futures or options position is outstanding,
unless replaced with other permissible assets. As a result, there is a
possibility that the segregation of a large percentage of a Portfolio's assets
may force the Portfolio to close out futures and options positions and/or
liquidate other portfolio securities, any of which may occur at
disadvantageous prices, in order for the Portfolio to meet redemption requests
or other current obligations.
The principal reason for writing covered call and put options on a
securities portfolio is to attempt to realize, through the receipt of
premiums, a greater return than would be realized on the securities alone. In
return for a premium, the writer of a covered call option forfeits the rights
to any appreciation in the value of the underlying security above the strike
price for the life of the option (or until a closing purchase transaction can
be effected). Nevertheless, the call writer retains the risk of a decline in
the price of the underlying security. Similarly, the principal reason for
writing covered put options is to realize income in the form of premiums. The
writer of the covered put option accepts the risk of a decline in the price of
the underlying security. The size of the premiums that the Portfolios may
receive may be adversely affected as new or existing institutions, including
other investment companies, engage in or increase their option-writing
activities.
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The Portfolios may engage in closing purchase transactions to realize a
profit, to prevent an underlying security from being called or put or, in the
case of a call option, to unfreeze an underlying security (thereby permitting
its sale or the writing of a new option on the security prior to the
outstanding option's expiration). To effect a closing purchase transaction,
the Portfolios would purchase, prior to the holder's exercise of an option
that the Portfolio has written, an option of the same series as that on which
the Portfolio desires to terminate its obligation. The obligation of the
Portfolio under an option that it has written would be terminated by a closing
purchase transaction, but the Portfolio would not be deemed to own an option
as the result of the transaction. There can be no assurance that the Portfolio
will be able to effect closing purchase transactions at a time when it wishes
to do so. The ability of the Portfolio to engage in closing transactions with
respect to options depends on the existence of a liquid secondary market.
While the Portfolio will generally purchase or write options only if there
appears to be a liquid secondary market for the options purchased or sold, for
some options no such secondary market may exist or the market may cease to
exist. To facilitate closing purchase transactions, however, the Portfolio
will ordinarily write options only if a secondary market for the options
exists on a U.S. securities exchange or in the over-the-counter market.
Option writing for the Portfolios may be limited by position and exercise
limits established by U.S. securities exchanges and the National Association
of Securities Dealers, Inc. and by requirements of the Code for qualification
as a regulated investment company. In addition to writing covered put and call
options to generate current income, the Portfolios may enter into options
transactions as hedges to reduce investment risk, generally by making an
investment expected to move in the opposite direction of a portfolio position.
A hedge is designed to offset a loss on a portfolio position with a gain on
the hedge position; at the same time, however, a properly correlated hedge
will result in a gain on the portfolio position's being offset by a loss on
the hedge position. The Portfolios bear the risk that the prices of the
securities being hedged will not move in the same amount as the hedge. A
Portfolio will engage in hedging transactions only when deemed advisable by
its Sub-Adviser. Successful use by the Portfolio of options will depend on its
Sub-Adviser's ability to correctly predict movements in the direction of the
stock underlying the option used as a hedge. Losses incurred in hedging
transactions and the costs of these transactions will adversely affect the
Portfolio's performance.
OPTIONS ON FOREIGN CURRENCIES
A Portfolio may purchase and write put and call options on foreign
currencies for the purpose of hedging against declines in the U.S. dollar
value of foreign currency-denominated portfolio securities and against
increases in the U.S. dollar cost of such securities to be acquired.
Generally, transactions relating to Options on Foreign Currencies occur in the
over-the-counter market. As in the case of other kinds of options, however,
the writing of an option on a foreign currency constitutes only a partial
hedge, up to the amount of the premium received, and the Portfolio could be
required to purchase or sell foreign currencies at disadvantageous exchange
rates, thereby incurring losses. The purchase of an option on a foreign
currency may constitute an effective hedge against fluctuations in exchange
rates, although, in the event of rate movements adverse to the Portfolio's
position, it may forfeit the entire amount of the premium plus related
transaction costs. There is no specific percentage limitation on the
Portfolio's investments in Options on Foreign Currencies. See the SAI for
further discussion of the use, risks and costs of Options on Foreign
Currencies and Over the Counter Options.
OPTIONS ON INDEXES
A Portfolio may, subject to applicable securities regulations, purchase and
write put and call options on stock and fixed-income indexes listed on foreign
and domestic stock exchanges. A stock index fluctuates with changes in the
market values of the stocks included in the index. An example of a domestic
stock index is the Standard and Poor's 500 Stock Index. Examples of foreign
stock indexes are the Canadian Market Portfolio Index (Montreal Stock
Exchange), The Financial Times--Stock Exchange 100 (London Stock Exchange) and
the Toronto Stock Exchange Composite 300 (Toronto Stock Exchange). Examples of
fixed-income indexes include the Lehman Government/Corporate Bond Index and
the Lehman Treasury Bond Index.
Options on Indexes are generally similar to options on securities except
that the delivery requirements are different. Instead of giving the right to
take or make delivery of a security at a specified price, an option on an
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index gives the holder the right to receive a cash "exercise settlement
amount" equal to (a) the amount, if any, by which the fixed exercise price of
the option exceeds (in the case of a put) or is less than (in the case of a
call) the closing value of the underlying index on the date of exercise,
multiplied by (b) a fixed "index multiplier." Receipt of this cash amount will
depend upon the closing level of the index upon which the option is based
being greater than, in the case of a call, or less than, in the case of a put,
the exercise price of the option. The amount of cash received will be equal to
such difference between the closing price of the index and the exercise price
of the option expressed in dollars or a foreign currency, as the case may be,
times a specified multiple. The writer of the option is obligated, in return
for the premium received, to make a delivery of this amount. The writer may
offset its position in index options prior to expiration by entering into a
closing transaction on an exchange or the option may expire unexercised.
The effectiveness of purchasing or writing options as a hedging technique
will depend upon the extent to which price movements in the portion of the
securities portfolio of a Portfolio correlate with price movements of the
stock index selected. Because the value of an index option depends upon
movements in the level of the index rather than the price of a particular
stock, whether a Portfolio will realize a gain or loss from the purchase or
writing of options on an index depends upon movements in the level of stock
prices in the stock market generally or, in the case of certain indexes, in an
industry or market segment, rather than movements in the price of a particular
stock. Accordingly, successful use of Options on Indexes by a Portfolio will
be subject to its Sub-Adviser's ability to predict correctly movements in the
direction of the market generally or of a particular industry. This requires
different skills and techniques than predicting changes in the price of
individual stocks.
Options on securities indexes entail risks in addition to the risks of
options on securities. Because exchange trading of options on securities
indexes is relatively new, the absence of a liquid secondary market to close
out an option position is more likely to occur, although a Portfolio generally
will only purchase or write such an option if the Sub-Adviser believes the
option can be closed out. Because options on securities indexes require
settlement in cash, a Portfolio may be forced to liquidate portfolio
securities to meet settlement obligations. A Portfolio will engage in stock
index options transactions only when determined by its Sub-Adviser to be
consistent with its efforts to control risk. There can be no assurance that
such judgement will be accurate or that the use of these portfolio strategies
will be successful.
OVER-THE-COUNTER OPTIONS
Certain Portfolios may write or purchase options in privately negotiated
domestic or foreign transactions ("OTC Options"), as well as exchange-traded
or "listed" options. OTC Options can be closed out only by agreement with the
other party to the transaction, and thus any OTC Options purchased by a
Portfolio will be considered an Illiquid Security. In addition, certain OTC
Options on foreign currencies are traded through financial institutions acting
as market-makers in such options and the underlying currencies.
The staff of the SEC has taken the position that purchased over-the-counter
options and assets used to cover written over-the-counter options are illiquid
and, therefore, together with other illiquid securities, cannot exceed a
certain percentage of a Portfolio's assets (the "SEC illiquidity ceiling").
Except as provided below, the Portfolios intend to write over-the-counter
options only with primary U.S. Government securities dealers recognized by the
Federal Reserve Bank of New York. Also, the contracts which such Portfolios
have in place with such primary dealers will provide that each Portfolio has
the absolute right to repurchase any option it writes at any time at a price
which represents the fair market value, as determined in good faith through
negotiation between the parties, but which in no event will exceed a price
determined pursuant to a formula in the contract. Although the specific
formula may vary between contracts with different primary dealers, the formula
will generally be based on a multiple of the premium received by the Portfolio
for writing the option, plus the amount, if any, of the option's intrinsic
value (i.e., the amount that the option is in-the-money). The formula may also
include a factor to account for the difference between the price of the
security and the strike price of the option if the option is written out-of-
money. A Portfolio will treat all or a part of the formula price as illiquid
for purposes of the SEC illiquidity ceiling. Certain Portfolios may also write
over-the-counter options with non-primary dealers, including foreign dealers,
and will treat the assets used to cover these options as illiquid for purposes
of such SEC illiquidity ceiling.
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OTC Options entail risks in addition to the risks of exchange-traded
options. Exchange-traded options are in effect guaranteed by the Options
Clearing Corporation, while a Portfolio relies on the party from whom it
purchases an OTC Option to perform if the Portfolio exercises the option. With
OTC Options, if the transacting dealer fails to make or take delivery of the
securities or amount of foreign currency underlying an option it has written,
in accordance with the terms of that option, the Portfolio will lose the
premium paid for the option as well as any anticipated benefit of the
transaction. Furthermore, OTC Options are less liquid than exchange-traded
options.
REPURCHASE AGREEMENTS
Repurchase Agreements are agreements to purchase underlying debt obligations
from financial institutions, such as banks and broker-dealers, subject to the
seller's agreement to repurchase the obligations at an established time and
price. The collateral for such Repurchase Agreements will be held by the
Portfolio's custodian or a duly appointed sub-custodian. The Portfolio will
enter into Repurchase Agreements only with banks and broker-dealers that have
been determined to be creditworthy by the Trust's Board of Trustees under
criteria established in consultation with the Adviser and the Sub-Adviser. The
seller under a Repurchase Agreement would be required to maintain the value of
the obligations subject to the Repurchase Agreement at not less than the
repurchase price. Default by the seller would, however, expose the Portfolio
to possible loss because of adverse market action or delay in connection with
the disposition of the underlying obligations. In addition, if bankruptcy
proceedings are commenced with respect to the seller of the obligations, the
Portfolio may be delayed or limited in its ability to sell the collateral.
REVERSE REPURCHASE AGREEMENTS
Reverse Repurchase Agreements are the same as repurchase agreements except
that, in this instance, the Portfolios would assume the role of
seller/borrower in the transaction. The Portfolios will maintain segregated
accounts with the Custodian consisting of U.S. Government Securities, cash or
money market instruments that at all times are in an amount equal to their
obligations under Reverse Repurchase Agreements. Reverse Repurchase Agreements
involve the risk that the market value of the securities sold by a Portfolio
may decline below the repurchase price of the securities and, if the proceeds
from the reverse repurchase agreement are invested in securities, that the
market value of the securities sold may decline below the repurchase price of
the securities sold. Each Portfolio's Sub-Adviser, acting under the
supervision of the Board of Trustees, reviews on an on-going basis the
creditworthiness of the parties with which it enters into Reverse Repurchase
Agreements. Under the 1940 Act, Reverse Repurchase Agreements may be
considered borrowings by the seller. Whenever borrowings by a fund, including
Reverse Repurchase Agreements, exceed 5% of the value of a Portfolio's total
assets, the Portfolio will not purchase any securities.
SMALL COMPANIES
Certain of the Portfolios may invest in small companies, some of which may
be unseasoned. While smaller companies generally have potential for rapid
growth, investments in such companies often involve higher risks because the
companies may lack the management experience, financial resources, product
diversification and competitive strengths of larger corporations. Moreover,
the markets for the shares of such companies typically are less liquid than
those for the shares of larger companies.
STRATEGIC TRANSACTIONS
Subject to the investment limitations and restrictions for each of the
Portfolios as stated elsewhere in the Prospectus and SAI of the Trust, each of
the Portfolios may, but is not required to, utilize various investment
strategies as described in this Appendix to hedge various market risks, to
manage the effective maturity or duration of Fixed-Income Securities, or to
seek potentially higher returns. Utilizing these investment strategies, the
Portfolio may purchase and sell, to the extent not otherwise limited or
restricted for such Portfolio, exchange-listed and over-the-counter put and
call options on securities, equity and fixed-income indexes and other
financial
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instruments, purchase and sell financial futures contracts and options
thereon, enter into various Interest Rate Transactions such as swaps, caps,
floors or collars, and enter into various currency transactions such as
currency forward contracts, currency futures contracts, currency swaps or
options on currencies or currency futures (collectively, all the above are
called "Strategic Transactions").
Strategic Transactions may be used to attempt to protect against possible
changes in the market value of securities held in or to be purchased for the
Portfolio's portfolio resulting from securities markets or currency exchange
rate fluctuations, to protect the Portfolio's unrealized gains in the value of
its portfolio securities, to facilitate the sale of such securities for
investment purposes, to manage the effective maturity or duration of the
Portfolio's portfolio, or to establish a position in the derivatives markets
as a temporary substitute for purchasing or selling particular securities.
Some Strategic Transactions may also be used to seek potentially higher
returns, although no more than 5% of the Portfolio's assets will be used as
the initial margin or purchase price of options for Strategic Transactions
entered into for purposes other than "bona fide hedging" positions as defined
in the regulations adopted by the Commodity Futures Trading Commission. Any or
all of these investment techniques may be used at any time, as use of any
Strategic Transaction is a function of numerous variables including market
conditions. The ability of the Portfolio to utilize these Strategic
Transactions successfully will depend on the Sub-Adviser's ability to predict,
which cannot be assured, pertinent market movements. The Portfolio will comply
with applicable regulatory requirements when utilizing Strategic Transactions.
Strategic Transactions involving financial futures and options thereon will be
purchased, sold or entered into only for bona fide hedging, risk management or
portfolio management purposes.
U.S. GOVERNMENT SECURITIES
U.S. Government Securities include direct obligations of the U.S. Treasury
(such as U.S. Treasury bills, notes and bonds) and obligations directly issued
or guaranteed by U.S. Government agencies or instrumentalities. Some
obligations issued or guaranteed by agencies or instrumentalities of the U.S.
Government are backed by the full faith and credit of the U.S. Government
(such as GNMA certificates), others are backed only by the right of the issuer
to borrow from the U.S. Treasury (such as securities of Federal Home Loan
Banks) and still others are backed only by the credit of the instrumentality
(such as FNMA and FHLMC certificates).
WHEN ISSUED SECURITIES AND DELAYED-DELIVERY TRANSACTIONS
In order to secure yields or prices deemed advantageous at the time, certain
Portfolios may purchase or sell securities on a when-issued or a delayed-
delivery basis. The Portfolios will enter into a when-issued transaction for
the purpose of acquiring portfolio securities and not for the purpose of
leverage. In such transactions, delivery of the securities occurs beyond the
normal settlement periods, but no payment or delivery is made by, and no
interest accrues to, the Portfolios prior to the actual delivery or payment by
the other party to the transaction. Due to fluctuations in the value of
securities purchased on a when-issued or a delayed-delivery basis, the yields
obtained on such securities may be higher or lower than the yields available
in the market on the dates when the investments are actually delivered to the
buyers. Similarly, the sale of securities for delayed-delivery can involve the
risk that the prices available in the market when delivery is made may
actually be higher than those obtained in the transaction itself. A Portfolio
will establish a segregated account with the Custodian consisting of cash,
U.S. Government-securities or other high grade debt obligations in an amount
equal to the amount of its when-issued and delayed-delivery commitments.
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EQUI-SELECT SERIES TRUST
699 WALNUT STREET
DES MOINES, IOWA 50309
---------------
Equi-Select Series Trust (the "Trust") is an open-end, series management
investment company which currently offers shares of beneficial interest of
nine series (the "Portfolios"), each of which has a different investment
objective and represents the entire interest in a separate portfolio of
investments. These Portfolios are currently available to the public only
through certain variable annuity contracts and variable life insurance
policies ("Variable Contracts") issued by Equitable Life Insurance Company of
Iowa and/or its affiliated life insurance companies (collectively, the "Life
Companies"). This Prospectus contains information pertaining to the Research
Portfolio, Total Return Portfolio, OTC Portfolio, Growth & Income Portfolio
and the Value + Growth Portfolio which are the only Portfolios of the Trust
offered under the Variable Contracts described in the accompanying Variable
Contract prospectus.
This Prospectus sets forth concisely the information about the Trust that a
prospective investor should know before investing. Please read it carefully
and retain it for future reference. A Statement of Additional Information
("SAI") dated May 1, 1997, as amended, is available without charge upon
request and may be obtained by calling Equitable Life Insurance Company of
Iowa at (800) 344-6864 or by writing to Equitable Life Insurance Company of
Iowa, P.O. Box 9271, Des Moines, Iowa 50306-9271. Some of the discussions
contained in this Prospectus refer to the more detailed descriptions contained
in the SAI, which is incorporated by reference into this Prospectus and has
been filed with the Securities and Exchange Commission. The Securities and
Exchange Commission maintains a Web site (http:\\www.sec.gov) that contains
the SAI, material incorporated by reference, and other information regarding
the Trust.
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
PROSPECTUS DATED MAY 1, 1997
<PAGE>
TABLE OF CONTENTS
<TABLE>
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PAGE
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<S> <C>
SUMMARY.................................................................... 1
The Trust................................................................. 1
Investment Adviser and Sub-Advisers....................................... 1
The Portfolios............................................................ 1
Investment Risks.......................................................... 2
Sales and Redemptions..................................................... 2
FINANCIAL HIGHLIGHTS....................................................... 3
INVESTMENT OBJECTIVES AND POLICIES OF THE PORTFOLIOS....................... 5
Portfolios Seeking Capital Growth......................................... 5
OTC Portfolio............................................................ 5
Research Portfolio....................................................... 7
Value + Growth Portfolio................................................. 8
Portfolios Seeking Total Return........................................... 10
Total Return Portfolio................................................... 10
Growth & Income Portfolio................................................ 12
MANAGEMENT OF THE TRUST.................................................... 14
Investment Adviser........................................................ 14
Advisory Fee Waiver and Expense Cap....................................... 14
Expenses of the Trust..................................................... 15
Sub-Advisers.............................................................. 15
SALES AND REDEMPTIONS...................................................... 16
NET ASSET VALUE............................................................ 16
PERFORMANCE INFORMATION.................................................... 17
TAX STATUS, DIVIDENDS, AND DISTRIBUTIONS................................... 17
ADDITIONAL INFORMATION..................................................... 17
APPENDIX................................................................... A-1
</TABLE>
<PAGE>
SUMMARY
THE TRUST
The Trust is an open-end management investment company established as a
Massachusetts business trust under a Declaration of Trust dated May 11, 1994.
Each Portfolio issues a separate class of shares. The Declaration of Trust
permits the Trustees to issue an unlimited number of full or fractional shares
of each class of stock.
Each Portfolio has distinct investment objectives and policies. (See
"Investment Objectives and Policies of the Portfolios.") Additional Portfolios
may be added to the Trust in the future. This Prospectus will be supplemented
to reflect the addition of new Portfolios.
INVESTMENT ADVISER AND SUB-ADVISERS
Subject to the authority of the Board of Trustees of the Trust, Equitable
Investment Services, Inc. (the "Adviser") serves as the Trust's investment
adviser and has responsibility for the overall management of the investment
strategies and policies of the Portfolios. The Adviser has engaged Sub-
Advisers for certain of the Portfolios to make investment decisions and place
orders. The Sub-Advisers for these Portfolios are:
<TABLE>
<CAPTION>
SUB-ADVISER NAME OF PORTFOLIO
----------- -----------------
<S> <C>
Massachusetts Financial Services Company................. OTC
Research
Total Return
Robertson, Stephens & Company Investment Management, Growth & Income
L.P..................................................... Value + Growth
</TABLE>
For additional information concerning the Adviser and the Sub-Advisers,
including a description of advisory and sub-advisory fees, see "Management of
the Trust."
THE PORTFOLIOS
GROWTH & INCOME PORTFOLIO. The Growth & Income Portfolio seeks long-term
total return by investing in equity securities and debt securities, focusing
on small- and mid-cap companies that offer the potential for capital
appreciation, current income, or both.
OTC PORTFOLIO. The primary investment objective of the OTC Portfolio is to
seek to obtain long-term growth of capital. The Portfolio seeks to achieve
this objective by investing at least 65% of its total assets, under normal
circumstances, in securities principally traded on the over-the-counter (OTC)
securities market. The Portfolio is intended for investors who understand and
are willing to accept the risks entailed in seeking long-term growth of
capital. The Portfolio may invest 20% or more of its net assets in foreign
securities (not including American Depositary Receipts ("ADRs"); however,
under normal market conditions, the Portfolio expects to invest less than 35%
of its net assets in foreign securities. The Portfolio may invest up to 10% of
its net assets in emerging markets or countries with limited or developing
capital markets. (See "Appendix -- Foreign Investments" and the SAI for a
discussion of the risks involved in foreign investing.) The Portfolio may
invest a portion of its assets in lower-grade corporate debt securities
commonly known as "junk bonds." Investors should be aware that such
investments involve a significant degree of risk. (See "Appendix -- Lower-
Rated Securities" and the SAI for a discussion of the risks involved in
investing in lower-rated securities.)
RESEARCH PORTFOLIO. The Research Portfolio seeks to provide long-term growth
of capital and future income by investing a substantial portion of its assets
in common stocks or securities convertible into common stocks of companies
believed to possess better than average prospects for long-term growth. A
smaller proportion of the assets may be invested in bonds, short-term
obligations, preferred stocks or common stocks whose principal characteristic
is income production rather than growth. The Portfolio may invest up to 20%
(and generally expects to invest between 0% and 20%) of its net assets in
foreign securities (not including ADRs). (See "Appendix -- Foreign
Investments" and the SAI for a discussion of the risks involved in foreign
investing.) The Portfolio may invest up to 10% of its net assets in lower-
grade corporate debt securities commonly known as "junk bonds." Investors
should be aware that such investments involve a significant degree of risk.
(See "Appendix -- Lower-Rated Securities" and the SAI for a discussion of the
risks involved in investing in lower-rated securities.)
TOTAL RETURN PORTFOLIO. The Total Return Portfolio primarily seeks to obtain
above-average income (compared to a portfolio entirely invested in equity
securities) consistent with the prudent employment of capital. The Portfolio's
secondary objective is to take advantage of opportunities for growth of
capital and income. Under normal market conditions, at least
1
<PAGE>
25% of the Portfolio's assets will be invested in fixed income securities and
at least 40% and no more than 75% of the Portfolio's assets will be invested
in equity securities, which include: common and preferred stocks; securities
such as bonds, warrants or rights that are convertible into stock; and
depository receipts for those securities. The Portfolio may invest up to 20%
(and generally expects to invest between 5% and 20%) of its net assets in
foreign securities (not including ADRs). (See "Appendix -- Foreign
Investments" and the SAI for a discussion of the risks involved in foreign
investing.) The Portfolio may invest a portion of its assets in lower-grade
corporate debt securities commonly known as "junk bonds." Investors should be
aware that such investments involve a significant degree of risk. (See
"Appendix --Lower-Rated Securities" and the SAI for a discussion of the risks
involved in investing in lower-rated securities.)
VALUE + GROWTH PORTFOLIO. The Value + Growth Portfolio seeks capital
appreciation by investing primarily in growth companies with favorable
relationships between price/earnings ratios and growth rates, in sectors
offering the potential for above-average returns.
The investment objectives of a Portfolio and policies and restrictions
specifically cited as fundamental may not be changed without the approval of a
majority of the outstanding shares of that Portfolio. Other investment
policies and practices described in this Prospectus and the SAI are not
fundamental, and the Board of Trustees may change them without shareholder
approval. A complete list of investment restrictions, including those
restrictions which cannot be changed without shareholder approval, is
contained in the SAI. There is no assurance that a Portfolio will meet its
stated objective.
INVESTMENT RISKS
The value of a Portfolio's shares will fluctuate with the value of the
underlying securities in its portfolio, and in the case of debt securities,
with the general level of interest rates. When interest rates decline, the
value of an investment portfolio invested in fixed-income securities can be
expected to rise. Conversely, when interest rates rise, the value of an
investment portfolio invested in fixed-income securities can be expected to
decline. In the case of foreign currency denominated securities, these trends
may be offset or amplified by fluctuations in foreign currencies. Investments
by a Portfolio in foreign securities may be affected by adverse political,
diplomatic, and economic developments, changes in foreign currency exchange
rates, taxes or other assessments imposed on distributions with respect to
those investments, and other factors affecting foreign investments generally.
High-yielding fixed-income securities, which are commonly known as "junk
bonds", are subject to greater market fluctuations and risk of loss of income
and principal than investments in lower yielding fixed-income securities.
Certain of the Portfolios intend to employ, from time to time, certain
investment techniques which are designed to enhance income or total return or
hedge against market or currency risks but which themselves involve additional
risks. These techniques include options on securities, futures, options on
futures, options on indexes, options on foreign currencies, foreign currency
exchange transactions, lending of securities and when-issued securities and
delayed-delivery transactions. The Portfolios may have higher-than-average
portfolio turnover which may result in higher-than-average brokerage
commissions and transaction costs.
The investment strategies and portfolio investments of the Growth & Income
Portfolio and Value + Growth Portfolio will differ from those of most other
mutual funds. Robertson, Stephens & Company Investment Management, L.P., the
Sub-Adviser to each of these two Portfolios, seeks aggressively to identify
favorable securities, economic and market sectors, and investment
opportunities that other investors and investment advisers may not have
identified. When Robertson, Stephens & Company Investment Management, L.P.
identifies such an investment opportunity, it may devote more of a Portfolio's
assets to pursuing that opportunity, or at different times, than many other
mutual funds, and may select investments for a Portfolio that would be
inappropriate for less aggressive mutual funds.
SALES AND REDEMPTIONS
The Trust sells shares only to the separate accounts of the Life Companies
as a funding vehicle for the Variable Contracts offered by the Life Companies.
No fee is charged upon the sale or redemption of the Trust's shares. Expenses
of the Trust are passed through to the separate accounts of the Life
Companies, and therefore, are ultimately borne by Variable Contract owners. In
addition, other fees and expenses are assessed by the Life Companies at the
separate account level. (See the Prospectus for the Variable Contract for a
description of all fees and charges relating to the Variable Contract.)
2
<PAGE>
FINANCIAL HIGHLIGHTS
EQUI-SELECT SERIES TRUST
The following tables which have been audited by Ernst & Young LLP,
independent auditors, include selected data, derived from the Financial
Statements, for a share outstanding throughout the period shown for each of
the Portfolios at December 31, 1996. The tables should be read in conjunction
with the Financial Statements and notes thereto included in the Trust's Annual
Report to Contractholders which is incorporated by reference in the Statement
of Additional Information. The Financial Statements of the Trust at December
31 1996, are incorporated herein by reference in reliance upon the report of
Ernst & Young LLP such report given upon the authority of such firm as experts
in accounting and auditing.
Further information about the performance of the Trust is contained in the
Trust's December 31, 1996 Annual Report which may be obtained without charge
by calling Equitable Life Insurance Company of Iowa at (800) 344-6864.
3
<PAGE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO, TOTAL RETURN PORTFOLIO,VALUE + GROWTH
PORTFOLIO AND GROWTH & INCOME PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OF STOCK OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Net
Realized
and
Unrealized
Net Asset Net Gain (Loss)
Value at Investment on
Beginning Income Invest-
of Period (Loss) (1) ments
_____________ _____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 12.08 (0.03) 2.52
Year ended December 31, 1995 10.36 (0.02) 3.07
Period ended December 31, 1994* 10.00 0.00 0.36
RESEARCH PORTFOLIO
Year ended December 31, 1996 12.88 0.00 3.00
Year ended December 31, 1995 9.59 0.03 3.48
Period ended December 31, 1994* 10.00 0.09 (0.41)
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 11.90 0.26 1.37
Year ended December 31, 1995 9.76 0.21 2.19
Period ended December 31, 1994* 10.00 0.09 (0.24)
VALUE + GROWTH PORTFOLIO
Period ended December 31, 1996** 10.00 (0.04) 1.59
GROWTH & INCOME PORTFOLIO
Period ended December 31, 1996** 10.00 0.02 2.61
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO, TOTAL RETURN PORTFOLIO,VALUE + GROWTH
PORTFOLIO AND GROWTH & INCOME PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OF STOCK OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Total Distributions Net
from from Net Capital
Investment Investment Gains
Operations Income Distributions
____________ ____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 2.49 0.00 (0.75)
Year ended December 31, 1995 3.05 0.00 (1.33)
Period ended December 31, 1994* 0.36 0.00 0.00
RESEARCH PORTFOLIO
Year ended December 31, 1996 3.00 0.00 (6) (0.45)
Year ended December 31, 1995 3.51 (0.03) (0.19)
Period ended December 31, 1994* (0.32) (0.09) 0.00
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 1.63 (0.26) (0.12)
Year ended December 31, 1995 2.40 (0.21) (0.05)
Period ended December 31, 1994* (0.15) (0.09) 0.00
VALUE + GROWTH PORTFOLIO
Period ended December 31, 1996** 1.55 0.00 (0.12)
GROWTH & INCOME PORTFOLIO
Period ended December 31, 1996** 2.63 (0.02) (0.02)
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO, TOTAL RETURN PORTFOLIO,VALUE + GROWTH
PORTFOLIO AND GROWTH & INCOME PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OF STOCK OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Net Asset
Value at
Total End Total
Distribution of Period Return (2)
_____________ _____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 (0.75) 13.82 20.68
Year ended December 31, 1995 (1.33) 12.08 29.23
Period ended December 31, 1994* 0.00 10.36 3.59
RESEARCH PORTFOLIO
Year ended December 31, 1996 (0.45) 15.43 23.37
Year ended December 31, 1995 (0.22) 12.88 36.58
Period ended December 31, 1994* (0.09) 9.59 (3.22)
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 (0.38) 13.15 13.70
Year ended December 31, 1995 (0.26) 11.90 24.51
Period ended December 31, 1994* (0.09) 9.76 (1.47)
VALUE + GROWTH PORTFOLIO
Period ended December 31, 1996** (0.12) 11.43 15.49
GROWTH & INCOME PORTFOLIO
Period ended December 31, 1996** (0.04) 12.59 26.19
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO, TOTAL RETURN PORTFOLIO,VALUE + GROWTH
PORTFOLIO AND GROWTH & INCOME PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OF STOCK OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Ratio Ratio of Net
of Operating Investment
Net Assets Expenses to Income (Loss)
End Average Net to Average
of Period Assets (1)(3) Net Assets (3)
_____________ _____________ _____________
<S> <C> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 43,321,580 1.35 (0.63)
Year ended December 31, 1995 9,054,622 1.07 (0.22)
Period ended December 31, 1994* 1,695,685 0.75 0.16
RESEARCH PORTFOLIO
Year ended December 31, 1996 75,178,842 1.31 0.05
Year ended December 31, 1995 16,185,802 1.12 0.58
Period ended December 31, 1994* 1,626,521 0.75 4.65
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 57,301,963 1.25 3.29
Year ended December 31, 1995 15,502,907 1.11 3.88
Period ended December 31, 1994* 1,298,365 0.75 4.58
VALUE + GROWTH PORTFOLIO
Period ended December 31, 1996** 19,721,864 1.70 (0.90)
GROWTH & INCOME PORTFOLIO
Period ended December 31, 1996** 42,400,808 1.64 0.38
</TABLE>
EQUI-SELECT SERIES TRUST
OTC PORTFOLIO, RESEARCH PORTFOLIO, TOTAL RETURN PORTFOLIO,VALUE + GROWTH
PORTFOLIO AND GROWTH & INCOME PORTFOLIO
FINANCIAL HIGHLIGHTS
(FOR A SHARE OF STOCK OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
<TABLE>
<CAPTION>
Portfolio Average
Turnover Commission
Rate (4) Rate (5)
_____________ _____________
<S> <C> <C>
OTC PORTFOLIO
Year ended December 31, 1996 122 $.0402
Year ended December 31, 1995 111 --
Period ended December 31, 1994* 6 --
RESEARCH PORTFOLIO
Year ended December 31, 1996 68 .0281
Year ended December 31, 1995 83 --
Period ended December 31, 1994* 85 --
TOTAL RETURN PORTFOLIO
Year ended December 31, 1996 131 .0510
Year ended December 31, 1995 89 --
Period ended December 31, 1994* 45 --
VALUE + GROWTH PORTFOLIO
Period ended December 31, 1996** 143 .0523
GROWTH & INCOME PORTFOLIO
Period ended December 31, 1996** 115 .0551
</TABLE>
[FN]
(1) Net investment income is after reimbursement of certain fees and expenses by
Equitable Investment Services, Inc. ("EISI"). Had EISI not undertaken to
reimburse expenses related to the Portfolios, net investment income (loss)
per share and ratio of operating expenses to average net assets would have
been as follows for the years ended December 31, 1996 and 1995 and the
period ended December 31, 1994, respectively: OTC Portfolio, $(0.03) and
1.35%, $(0.10) and 2.52%, $(0.12) and 7.10%; Research Portfolio, $0.00 and
1.31%, $(0.04) and 2.48%, $(0.04) and 7.48%; and Total Return Portfolio,
$0.26 and 1.25%, $0.14 and 2.36%, $(0.06) and 8.31%.
(2) Total return figures are not annualized for periods less than one year.
Total return does not reflect expenses that apply to the separate account or
related variable insurance contracts and inclusion of these charges would
result in reducing the total return figures for the period shown.
(3) Annualized for periods less than one year.
(4) Portfolio turnover rates are not annualized.
(5) The average commission rate paid is applicable to Portfolios that invest
greater than 10% of average net assets in equity security transactions for
which commissions are charged. This disclosure is required for fiscal
periods beginning on or after September 1, 1995.
(6) Amount is less than $0.003 per share.
* For the period October 4, 1994 (commencement of investment operations)
through December 31, 1994.
** For the period April 1, 1996 (commencement of investment operations)
through December 31, 1996.
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES OF THE PORTFOLIOS
Each Portfolio of the Trust has a different investment objective or
objectives which it pursues through separate investment policies as described
below. The differences in objectives and policies among the Portfolios can be
expected to affect the return of each Portfolio and the degree of market and
financial risk to which each Portfolio is subject. An investment in a single
Portfolio should not be considered a complete investment program. The
investment objective(s) and policies of each Portfolio, unless otherwise
specifically stated, are non-fundamental and may be changed by the Trustees of
the Trust without a vote of the shareholders. Such changes may result in a
Portfolio having an investment objective(s) which differs from that which an
investor may have considered at the time of investment. There is no assurance
that any Portfolio will achieve its objective(s). United States Treasury
Regulations applicable to portfolios that serve as the funding vehicles for
variable annuity and variable life insurance contracts generally require that
such portfolios invest no more than 55% of the value of their assets in one
investment, 70% in two investments, 80% in three investments, and 90% in four
investments. The Portfolios intend to comply with the requirements of these
Regulations.
In order to comply with regulations which may be issued by the U.S.
Treasury, the Trust may be required to limit the availability or change the
investment policies of one or more Portfolios or to take steps to liquidate
one or more Portfolios. The Trust will not change any fundamental investment
policy of a Portfolio without a vote of shareholders of that Portfolio.
Except as otherwise noted herein, if the securities rating of a debt
security held by a Portfolio declines below the minimum rating for securities
in which the Portfolio may invest, the Portfolio will not be required to
dispose of the security, but the Portfolio's Adviser or Sub-Adviser will
consider whether continued investment in the security is consistent with the
Portfolio's investment objective.
In implementing its investment objectives and policies, each Portfolio uses
a variety of instruments, strategies and techniques which are described in
more detail in the Appendix and the SAI. With respect to each Portfolio's
investment policies, use of the term "primarily" means that under normal
circumstances, at least 65% of such Portfolio's assets will be invested as
indicated. A description of the ratings systems used by the following
nationally recognized statistical rating organizations ("NRSROs") is also
contained in the SAI: Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Corporation ("S&P"), Duff & Phelps, Inc. ("Duff"), Fitch Investors
Service, Inc. ("Fitch"), Thomson Bankwatch, Inc., IBCA Limited and IBCA Inc.
New instruments, strategies and techniques, however, are evolving continually
and the Trust reserves authority to invest in or implement them to the extent
consistent with its investment objectives and policies. If new instruments,
strategies or techniques would involve a material change to the information
contained herein, they will not be purchased or implemented until this
Prospectus is appropriately supplemented.
PORTFOLIOS SEEKING CAPITAL GROWTH
OTC PORTFOLIO
The investment objective of the OTC Portfolio is to seek to obtain long-term
growth of capital.
INVESTMENT POLICIES AND RISKS -- OTC PORTFOLIO
The Portfolio seeks to achieve its objective by investing at least 65% of
its total assets, under normal circumstances, in securities principally traded
on the over-the-counter (OTC) securities market. OTC securities tend to be
securities of companies which are smaller or newer than those listed on the
New York or American Stock Exchanges. Issuers of the securities of companies
which are traded on the OTC market include, among others, industrial
corporations, financial service institutions, public utilities, and
transportation companies. OTC securities include both equity and debt
securities (including obligations of the U.S. government). The Portfolio may
also invest in securities of companies that are not traded on the OTC
securities market that represent opportunities for capital appreciation. The
Portfolio will seek to invest in companies that are undervalued relative to
present or future earnings, cash flow or book value. While the Portfolio
intends to invest primarily in equity securities, the Portfolio may also
invest in fixed income securities as described below. Equity securities
include: common stocks and preferred stocks; securities such as bonds,
warrants or rights that are convertible into stock; and depositary receipts
for those securities.
The Portfolio will not purchase a security, under normal circumstances, if
it would result in less than 65% of its total assets being invested in OTC
securities (the "65% limitation"). Securities that were principally traded on
the OTC securities market when purchased but which have since been listed on
the New York or American Stock Exchange or a foreign exchange will be
considered to fall within the Portfolio's 65% limitation for 12 months after
the date the security was listed on an exchange.
5
<PAGE>
Debt securities of issuers in which the Portfolio may invest include all
types of long- or short-term debt obligations, such as bonds, debentures,
notes and commercial paper. Fixed income securities in which the Portfolio may
invest include securities in the lower rating categories of recognized rating
agencies (and comparable unrated securities). Fixed income securities in which
the Portfolio may invest also include zero coupon bonds, deferred interest
bonds and bonds on which the interest is payable in kind. Such investments
involve certain risks. See "Appendix--Lower-Rated Securities" and the SAI for
a discussion of the risks involved in investing in lower-rated securities.
Investing in securities traded on the OTC securities market can involve
greater risk than is customarily associated with investing in securities
traded on the New York or American Stock Exchanges since OTC securities are
generally securities of companies which are smaller or newer than those listed
on the New York or American Stock Exchange. For example, these companies often
have limited product lines, markets, or financial resources, may be dependent
for management on one or a few key persons, and can be more susceptible to
losses. Also, their securities may be thinly traded (and therefore have to be
sold at a discount from current prices or sold in small lots over an extended
period of time), may be followed by fewer investment research analysts and may
be subject to wider price swings and thus may create a greater risk of loss
than securities of larger capitalization or established companies. Shares of
the Portfolio, therefore, are subject to greater fluctuation in value than
shares of a conservative equity fund or of a growth fund which invests
entirely in proven growth stocks. Therefore, the Portfolio is intended for
long-term investors who understand and can accept the risks entailed in
seeking long-term growth of capital. The Portfolio is not meant to provide a
vehicle for those who wish to play short-term swings in the stock market.
Accordingly, an investment in shares of the Portfolio should not be considered
a complete investment program. Each prospective purchaser should take into
account his investment objectives as well as his other investments when
considering the purchase of shares of the Portfolio.
When the Sub-Adviser believes that investing for temporary defensive
purposes is appropriate, such as during periods of unusual market conditions,
part or all of the Portfolio's assets may be temporarily invested in cash
(including foreign currency) or cash equivalent short-term obligations
including, but not limited to, certificates of deposit, commercial paper,
short-term notes, obligations issued or guaranteed by the U.S. government or
any of its agencies or instrumentalities and repurchase agreements.
The Portfolio may invest 20% or more of its net assets in foreign securities
(not including ADRs); however, under normal market conditions, the Portfolio
expects to invest less than 35% of its net assets in foreign securities. The
Portfolio may invest up to 10% of its net assets in emerging markets or
countries with limited or developing capital markets. Investing in securities
of foreign issuers generally involves risks not ordinarily associated with
investing in securities of domestic issuers. (See "Appendix--Foreign
Investments" and the SAI for a discussion of the risks involved in foreign
investing.)
The Portfolio may invest in ADRs which are certificates issued by a U.S.
depository (usually a bank) and represent a specified quantity of shares of an
underlying non-U.S. stock on deposit with a custodian bank as collateral.
Although ADRs are issued by a U.S. depository, they are subject to many of the
risks of foreign securities such as changes in exchange rates and more limited
information about foreign issuers.
The Portfolio may also purchase securities that are not registered under the
Securities Act of 1933 ("1933 Act") ("restricted securities"), including those
that can be offered and sold to "qualified institutional buyers" under Rule
144A under the 1933 Act ("Rule 144A securities"). The Trust's Board of
Trustees confirms based upon information and recommendations provided by the
Sub-Adviser that a specific Rule 144A security is liquid and thus not subject
to the Portfolio's limitation on investing not more than 15% of its net assets
in illiquid investments. The Board of Trustees has adopted guidelines and
delegated to the Sub-Adviser the daily function of determining and monitoring
the liquidity of Rule 144A securities. The Board, however, will retain
sufficient oversight and be ultimately responsible for the determinations.
This investment practice could have the effect of decreasing the level of
liquidity in a Portfolio to the extent that qualified institutional buyers
become for a time uninterested in purchasing Rule 144A securities held in the
investment portfolio.
The Portfolio is classified as a "non-diversified" investment company. As a
result, the Portfolio is limited as to the percentage of its assets which may
be invested in the securities of any one issuer only by its own investment
restrictions and the diversification requirements imposed by the Internal
Revenue Code of 1986, as amended. U.S. Government securities which are
generally considered free of credit risk and are assured as to payment of
principal and interest if held to maturity are not subject to any investment
limitation. Since the Portfolio may invest a relatively high percentage of its
assets in a limited number of issuers, the Portfolio may be more susceptible
to any single economic, political or regulatory occurrence and to the
financial conditions of the issuers in which it invests. For these reasons, an
investment in shares of the Portfolio should not be considered to constitute a
complete investment program.
6
<PAGE>
While it is not generally the Portfolio's policy to invest or trade for
short-term profits, the Portfolio may dispose of a portfolio security whenever
the Sub-Adviser is of the opinion that such security no longer has an
appropriate appreciation potential or when another security appears to offer
relatively greater appreciation potential. Portfolio changes are made without
regard to the length of time a security has been held, or whether a sale would
result in a profit or loss. Therefore, the rate of portfolio turnover is not a
limiting factor when a change in the portfolio is otherwise appropriate.
Because the Portfolio is expected to have a portfolio turnover rate of over
100%, transaction costs incurred by the Portfolio and the realized capital
gains and losses of the Portfolio may be greater than that of a portfolio with
a lesser turnover rate. The portfolio turnover rates of the Portfolio for the
periods ended December 31, 1996, 1995 and 1994 are set forth herein under
"Financial Highlights." (See also "Portfolio Turnover" in the SAI.)
Additional Portfolio Investments and Transactions. The Portfolio may enter
into repurchase agreements to earn income on available cash or as a temporary
defensive measure. The Portfolio may seek to increase its income by lending
portfolio securities. The Portfolio may purchase securities on a "when issued"
or on a "forward delivery" basis, which means that the securities will be
delivered to the Portfolio at a future date usually beyond customary
settlement time.
The Portfolio may invest in indexed securities whose value is linked to
foreign currencies, commodities, indices, or other financial indicators. The
Portfolio may enter into mortgage "dollar roll" transactions with selected
banks and broker-dealers.
The Portfolio also may purchase restricted securities, corporate asset-
backed securities, options on securities, options on stock indices, options on
foreign currencies, futures contracts, options on futures contracts and
forward foreign currency exchange contracts.
All of the Portfolio investments and transactions described in this section
are described in greater detail in the Appendix and the SAI.
RESEARCH PORTFOLIO
The investment objective of the Research Portfolio is to provide long-term
growth of capital and future income.
The portfolio securities of the Research Portfolio are selected by a
committee of investment research analysts. This committee includes investment
analysts employed not only by the Sub-Adviser but also by a wholly-owned
international subsidiary of the Sub-Adviser. The Portfolio's assets are
allocated among industries by the analysts acting together as a group.
Individual analysts are then responsible for selecting what they view as the
securities best suited to meet the Portfolio's investment objective within
their assigned industry responsibility.
INVESTMENT POLICIES AND RISKS -- RESEARCH PORTFOLIO
The Portfolio's policy is to invest a substantial proportion of its assets
in the common stocks or securities convertible into common stocks of companies
believed to possess better than average prospects for long-term growth. A
smaller proportion of the assets may be invested in bonds, short-term
obligations, preferred stocks or common stocks whose principal characteristic
is income production rather than growth. Such securities may also offer
opportunities for growth of capital as well as income. In the case of both
growth stocks and income issues, emphasis is placed on the selection of
progressive, well-managed companies. The Portfolio's debt investments, if any,
may consist of "investment grade" securities (e.g., rated Baa or better by
Moody's or BBB or better by S&P or Fitch), and, with respect to no more than
10% of its net assets, securities in the lower rated categories (e.g., rated
Ba or lower by Moody's or BB or lower by S&P or Fitch), or securities which
the Sub-Adviser believes to be of similar quality to these lower rated
securities (commonly known as "junk bonds"). For a description of bond
ratings, see the SAI. It is not the Portfolio's policy to rely exclusively on
ratings issued by established credit rating agencies but rather to supplement
such ratings with the Sub-Adviser's own independent and ongoing review of
credit quality. The Portfolio's achievement of its investment objective may be
more dependent on the Sub-Adviser's own credit analysis than in the case of a
fund investing in primarily higher quality bonds. From time to time, the
Portfolio's management will exercise its judgment with respect to the
proportions invested in growth stocks, income-producing securities or cash
(including foreign currency) and cash equivalents depending on its view of
their relative attractiveness.
The Portfolio may enter into repurchase agreements in order to earn income
on available cash or as a temporary defensive measure. The Portfolio may make
loans of its fixed income portfolio securities. (See "Appendix" for a further
description of these investments.)
The Portfolio may invest in ADRs which are certificates issued by a U.S.
depository (usually a bank) and represent a specified quantity of shares of an
underlying non-U.S. stock on deposit with a custodian bank as collateral.
Although ADRs
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are issued by a U.S. depository, they are subject to many of the risks of
foreign securities such as changes in exchange rates and more limited
information about foreign issuers.
The Portfolio may invest up to 20% (and generally expects to invest between
0% and 20%) of its net assets in foreign securities (not including ADRs). The
Portfolio may invest in emerging markets or countries with limited or
developing capital markets. Investing in securities of foreign issuers
generally involves risks not ordinarily associated with investing in
securities of domestic issuers. (See "Appendix--Foreign Investments" and the
SAI for a discussion of the risks involved in foreign investing.)
As described above, the Portfolio may invest in fixed income (i.e., debt)
securities rated Baa by Moody's or BBB by S&P or Fitch and comparable unrated
securities. These securities, while normally exhibiting adequate protection
parameters, have speculative characteristics and changes in economic
conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than in the case of higher
grade fixed income securities. (See "Appendix--Lower-Rated Securities" and the
SAI for a discussion of the risks involved in investing in lower-rated
securities.)
The Portfolio may also purchase securities that are not registered under the
Securities Act of 1933 ("1933 Act") ("restricted securities"), including those
that can be offered and sold to "qualified institutional buyers" under Rule
144A under the 1933 Act ("Rule 144A securities"). The Trust's Board of
Trustees confirms based upon information and recommendations provided by the
Sub-Adviser that a specific Rule 144A security is liquid and thus not subject
to the Portfolio's limitation on investing not more than 10% of its net assets
in illiquid investments. The Board of Trustees has adopted guidelines and has
delegated to the Sub-Adviser the daily function of determining and monitoring
the liquidity of Rule 144A securities. The Board, however, will retain
sufficient oversight and be ultimately responsible for the determinations.
This investment practice could have the effect of decreasing the level of
liquidity in the Portfolio to the extent that qualified institutional buyers
become for a time uninterested in purchasing Rule 144A securities held in the
investment portfolio. Subject to the Portfolio's 10% limitation on investments
in illiquid investments and subject to the diversification requirements of the
Internal Revenue Code of 1986, as amended (the "Code"), the Portfolio may also
invest in restricted securities that may not be sold under Rule 144A, which
presents certain risks. As a result, the Portfolio might not be able to sell
these securities when the Sub-Adviser wishes to do so, or might have to sell
them at less than fair value. In addition, market quotations are less readily
available. Therefore, judgment may at times play a greater role in valuing
these securities than in the case of unrestricted securities.
While it is not generally the Portfolio's policy to invest or trade for
short-term profits, the Portfolio may dispose of a portfolio security whenever
the Sub-Adviser is of the opinion that such security no longer has an
appropriate appreciation potential or when another security appears to offer
relatively greater appreciation potential. Portfolio changes are made without
regard to the length of time a security has been held, or whether a sale would
result in a profit or loss. Therefore, the rate of portfolio turnover is not a
limiting factor when a change in the portfolio is otherwise appropriate. The
portfolio turnover rates of the Portfolio for the periods ended December 31,
1996, 1995 and 1994 are set forth herein under "Financial Highlights." (See
also "Portfolio Turnover" in the SAI.)
VALUE + GROWTH PORTFOLIO
The investment objective of the Value + Growth Portfolio is capital
appreciation. The Portfolio invests primarily in growth companies with
favorable relationships between price/earnings ratios and growth rates, in
sectors offering the potential for above-average returns.
INVESTMENT POLICIES AND RISKS -- VALUE + GROWTH PORTFOLIO
In selecting investments for the Portfolio, the primary emphasis of
Robertson, Stephens & Company Investment Management, L.P., the Portfolio's
Sub-Adviser, is typically on evaluating a company's management, growth
prospects, business operations, revenues, earnings, cash flows, and balance
sheet in relationship to its share price. Robertson, Stephens & Company
Investment Management, L.P. may select stocks which it believes are
undervalued relative to the current stock price. Undervaluation of a stock can
result from a variety of factors, such as a lack of investor recognition of
(1) the value of a business franchise and continuing growth potential, (2) a
new, improved or upgraded product, service or business operation, (3) a
positive change in either the economic or business condition for a company,
(4) expanding or changing markets that provide a company with either new
earnings direction or acceleration, or (5) a catalyst, such as an impending or
potential asset sale or change in management, that could draw increased
investor attention to a company. Robertson, Stephens &
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<PAGE>
Company Investment Management, L.P. also may use similar factors to identify
stocks which it believes to be overvalued and may engage in short sales of
such securities.
The Portfolio may invest a substantial portion of its assets in securities
issued by small companies. Such companies may offer greater opportunities for
capital appreciation than larger companies, but investments in such companies
may involve certain special risks. See "Appendix--Small Companies" for a
discussion of such risks.
The Portfolio may invest in securities principally traded in foreign markets
and may buy or sell foreign currencies and options and futures contracts on
foreign currencies for hedging purposes in connection with its foreign
investments. The Portfolio also may at times invest a substantial portion of
its assets in securities of issuers in developing countries. The Portfolio may
at times invest a substantial portion of its assets in securities traded in
the over-the-counter markets in such countries and not on any exchange, which
may affect the liquidity of the investment and expose the Portfolio to the
credit risk of its counterparties in trading those investments.
International investing in general may involve greater risks than U.S.
investments. These risks may be intensified in the case of investments in
emerging markets or countries with limited or developing capital markets. (See
"Appendix--Foreign Investments" and the SAI for a discussion of the risks
involved in foreign investing and see "Appendix--Strategic Transactions--
Futures and Options on Futures" and "Options on Foreign Currencies" for a
discussion of the risks involved in investing in foreign currencies, options
and futures contracts.)
The Portfolio may invest in debt securities from time to time if the Sub-
Adviser believes that it might help achieve the Portfolio's objective. The
Portfolio may invest in debt securities to the extent consistent with its
investment policies, although the Sub-Adviser expects that under normal
circumstances, the Portfolio would not likely invest a substantial portion of
its assets in debt securities.
The Portfolio will invest only in securities rated "investment grade" or
considered by the Sub-Adviser to be of comparable quality. Investment grade
securities are rated Baa or higher by Moody's or BBB or higher by S&P.
Securities rated Baa or BBB lack outstanding investment characteristics, have
speculative characteristics, and are subject to greater credit and market
risks than higher-rated securities. Descriptions of the securities ratings
assigned by Moody's and S&P are contained in the SAI.
The Portfolio may at times invest in so-called "zero-coupon" bonds and
"payment-in-kind" bonds. Zero-coupon bonds are issued at a significant
discount from face value and pay interest only at maturity rather than at
intervals during the life of the security. Payment-in-kind bonds allow the
issuer, at its option, to make current interest payments on the bonds either
in cash or in additional bonds. The values of zero-coupon bonds and payment-
in-kind bonds are subject to greater fluctuation in response to changes in
market interest rates than bonds which pay interest currently, and may involve
greater credit risk than such bonds. See "Zero Coupon Securities and Pay-in-
Kind Securities" in the SAI.
The Portfolio will not necessarily dispose of a security when its debt
rating is reduced below its rating at the time of purchase, although the Sub-
Adviser will monitor the investment to determine whether continued investment
in the security will assist in meeting the Portfolio's investment objective.
The Portfolio may buy and sell call and put options to hedge against changes
in net asset value or to attempt to realize a greater current return. In
addition, through the purchase and sale of futures contracts and related
options, a Portfolio may at times seek to hedge against fluctuations in net
asset value and to attempt to increase its investment return. Although the
Portfolio will only engage in options and futures transactions for limited
purposes, those transactions involve certain risks which are described in the
Appendix and SAI.
The Portfolio may buy and sell index futures contracts ("index futures") and
options on index futures and on indices for hedging purposes or to increase
its investment return (or may purchase warrants whose value is based on the
value from time to time of one or more foreign securities indices). See the
SAI for a further description of index futures and options including risks.
The Value + Growth Portfolio may purchase long-term exchange-traded equity
options called Long-Term Equity Anticipation Securities ("LEAPs") and Buy-
Write Options Unitary Derivatives ("BOUNDs"). LEAPs provide a holder the
opportunity to participate in the underlying securities' appreciation in
excess of a fixed dollar amount, and BOUNDs provide a holder the opportunity
to retain dividends on the underlying securities while potentially
participating in the underlying securities' capital appreciation up to a fixed
dollar amount. The Value + Growth Portfolio will not purchase these options
with respect to more than 25% of the value of its net assets.
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<PAGE>
The Portfolio may purchase and sell options in the over-the-counter markets
but only when appropriate exchange-traded transactions are unavailable and
when, in the opinion of the Sub-Adviser, the pricing mechanism and liquidity
of the over-the-counter markets are satisfactory and the participants are
responsible parties likely to meet their obligations. (See "Appendix -- Over-
the-Counter Options.")
The Portfolio will not purchase futures or options on futures or sell
futures if, as a result, the sum of the initial margin deposits on the
Portfolio's existing futures positions and premiums paid for outstanding
options on futures contracts would exceed 5% of the Portfolio's assets. (For
options that are "in-the-money" at the time of purchase, the amount by which
the option is "in-the-money" is excluded from this calculation.)
At times the Portfolio may invest more than 25% of its assets in securities
of issuers in one or more market sectors such as, for example, the technology
sector. A market sector may be made up of companies in a number of related
industries. The Portfolio would only concentrate its investments in a
particular market sector if the Portfolio's Sub-Adviser were to believe the
investment return available from concentration in that sector justifies any
additional risk associated with concentration in that sector. When the
Portfolio concentrates its investments in a market sector, financial,
economic, business, and other developments affecting issuers in that sector
will have a greater effect on the Portfolio than if it had not concentrated
its assets in that sector.
The Portfolio may lend portfolio securities to broker-dealers and may enter
into repurchase agreements. These transactions must be fully collateralized at
all times, but involve some risk to the Portfolio if the other party should
default on its obligations and the Portfolio is delayed or prevented from
recovering the collateral.
At times, the Portfolio's Sub-Adviser may judge that market conditions make
pursuing the Portfolio's basic investment strategy inconsistent with the best
interests of its shareholders. At such times, the Portfolio's Sub-Adviser may
temporarily use alternative strategies, primarily designed to reduce
fluctuations in the values of the Portfolio's assets. In implementing these
"defensive" strategies, the Portfolio may invest in U.S. Government
securities, other high-quality debt instruments, and other securities the
Portfolio's Sub-Adviser believes to be consistent with the Portfolio's best
interests.
The length of time a Portfolio has held a particular security is not
generally a consideration in investment decisions. The investment policies of
a Portfolio may lead to frequent changes in the Portfolio's investments,
particularly in periods of volatile market movements. A change in the
securities held by a Portfolio is known as "portfolio turnover." Portfolio
turnover generally involves some expense to a Portfolio, including brokerage
commissions or dealer markups and other transaction costs on the sale of
securities and reinvestment in other securities. Such sales may result in
realization of taxable capital gains. The Portfolio's turnover rate for the
period ended December 31, 1996 is set forth herein under "Financial
Highlights." (See also "Portfolio Turnover" in the SAI.)
PORTFOLIOS SEEKING TOTAL RETURN
TOTAL RETURN PORTFOLIO
The primary investment objective of the Total Return Portfolio is to obtain
above-average income (compared to a portfolio entirely invested in equity
securities) consistent with the prudent employment of capital. While current
income is the primary objective, the Portfolio believes that there should also
be a reasonable opportunity for growth of capital and income, since many
securities offering a better than average yield may also possess growth
potential. Thus, in selecting securities for its portfolio, the Portfolio
considers each of these objectives. Under normal market conditions, at least
25% of the Portfolio's assets will be invested in fixed income securities and
at least 40% and no more than 75% of the Portfolio's assets will be invested
in equity securities.
INVESTMENT POLICIES AND RISKS -- TOTAL RETURN PORTFOLIO
The Portfolio's policy is to invest in a broad list of securities, including
short-term obligations. The list may be diversified not only by companies and
industries, but also by type of security. Fixed income securities and equity
securities (which include: common stocks and preferred stocks; securities such
as bonds, warrants or rights that are convertible into stock; and depository
receipts for those securities) may be held by the Portfolio. Some fixed income
securities may also have a call on common stock by means of a conversion
privilege or attached warrants. The Portfolio may vary the percentage of
assets invested in any one type of security in accordance with the Sub-
Adviser's interpretation of economic and money market conditions, fiscal and
monetary policy and underlying security values. The Portfolio's debt,
investments may consist of both "investment grade" securities (rated Baa or
better by Moody's or BBB or better by S&P, Fitch or Duff & Phelps Credit
Rating Co. ("Duff")) and securities that are unrated or are in the lower
rating categories (rated Ba or lower by
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Moody's or BB or lower by S&P, Fitch or Duff) (commonly known as "junk bonds")
including up to 20% of its assets in nonconvertible fixed income securities
that are in these lower rating categories and comparable unrated securities.
Generally, most of the Portfolio's long-term debt investments will consist of
"investment grade" securities. See the SAI for a description of these ratings.
It is not the Portfolio's policy to rely exclusively on ratings issued by
established credit rating agencies but rather to supplement such ratings with
the Sub-Adviser's own independent and ongoing review of credit quality.
U.S. Government Securities. The Portfolio may also invest in U.S. government
securities, including: (1) U.S. Treasury obligations, which differ only in
their interest rates, maturities and times of issuance; U.S. Treasury bills
(maturities of one year or less); U.S. Treasury notes (maturities of one to
ten years); and U.S. Treasury bonds (generally maturities of greater than ten
years), all of which are backed by the full faith and credit of the U.S.
Government; and (2) obligations issued or guaranteed by U.S. Government
agencies or instrumentalities, some of which are backed by the full faith and
credit of the U.S. Treasury, e.g., direct pass-through certificates of GNMA;
some of which are supported by the right of the issuer to borrow from the U.S.
Government, e.g., obligations of Federal Home Loan Banks; and some of which
are backed only by the credit of the issuer itself, e.g., obligations of the
Student Loan Marketing Association.
MORTGAGE PASS-THROUGH SECURITIES. The Portfolio may invest in mortgage pass-
through securities. Mortgage pass-through securities are securities
representing interests in "pools" of mortgage loans. Monthly payments of
interest and principal by the individual borrowers on mortgages are passed
through to the holders of the securities (net of fees paid to the issuer or
guarantor of the securities) as the mortgages in the underlying mortgage pools
are paid off. Payment of principal and interest on some mortgage pass-through
securities (but not the market value of the securities themselves) may be
guaranteed by the full faith and credit of the U.S. government (in the case of
securities guaranteed by GNMA); or guaranteed by U.S. government-sponsored
corporations (such as FNMA or FHLMC, which are supported only by the
discretionary authority of the U.S. government to purchase the agency's
obligations). Mortgage pass-through securities may also be issued by non-
governmental issuers (such as commercial banks, savings and loan institutions,
private mortgage insurance companies, mortgage bankers and other secondary
market issuers). See the Appendix for a further discussion of these
securities.
ZERO COUPON BONDS, DEFERRED INTEREST BONDS AND PIK BONDS. Fixed income
securities that the Portfolio may invest in also include zero coupon bonds,
deferred interest bonds and bonds on which the interest is payable in kind
("PIK bonds"). Zero coupon and deferred interest bonds are debt obligations
which are issued or purchased at a significant discount from face value. The
discount approximates the total amount of interest the bonds will accrue and
compound over the period until maturity or the first interest payment date at
a rate of interest reflecting the market rate of the security at the time of
issuance. While zero coupon bonds do not require the periodic payment of
interest, deferred interest bonds provide that the issuer thereof may, at its
option, pay interest on such bonds in cash or in the form of additional debt
obligations. Such investments benefit the issuer by mitigating its need for
cash to meet debt service, but also require a higher rate of return to attract
investors who are willing to defer receipt of such cash. Such investments may
experience greater volatility in market value due to changes in interest rates
than debt obligations which make regular payments of interest. The Portfolio
will accrue income on such investments for tax and accounting purposes, as
required, which is distributable to shareholders and which, because no cash is
received at the time of accrual, may require the liquidation of other
portfolio securities to satisfy the Portfolio's distribution obligations.
AMERICAN DEPOSITARY RECEIPTS. The Portfolio may invest in ADRs which are
certificates issued by a U.S. depository (usually a bank), that represent a
specified quantity of shares of an underlying non-U.S. stock on deposit with a
custodian bank as collateral. Although ADRs are issued by a U.S. depository,
they are subject to many of the risks of foreign securities such as changes in
exchange rates and more limited information about foreign issuers.
The Portfolio may invest up to 20% (and generally expects to invest between
5% and 20%) of its net assets in foreign securities (including investments in
emerging markets or countries with limited or developing capital markets) (not
including ADRs). Investing in securities of foreign issuers generally involves
risks not ordinarily associated with investing in securities of domestic
issuers. (See "Appendix--Foreign Investments" and the SAI for a discussion of
the risks involved in foreign investing.)
In order to protect the value of the Portfolio's investments from interest
rate fluctuations, the Portfolio may enter into various hedging transactions,
such as interest rate swaps, and the purchase or sale of interest rate caps,
floors and collars. (See the SAI for information relating to these
transactions including related risks.)
The Portfolio may also purchase securities that are not registered under the
1933 Act ("restricted securities"), including those that can be offered and
sold to "qualified institutional buyers" under Rule 144A under the 1933 Act
("Rule 144A securities"). The Trust's Board of Trustees confirms based upon
information and recommendations provided by the Sub-
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<PAGE>
Adviser that a specific Rule 144A security is liquid and thus not subject to
the Portfolio's limitation on investing not more than 15% of its net assets in
illiquid investments. The Board of Trustees has adopted guidelines and
delegated to the Sub-Adviser the daily function of determining and monitoring
the liquidity of Rule 144A securities. The Board, however, will retain
sufficient oversight and be ultimately responsible for the determinations.
This investment practice could have the effect of decreasing the level of
liquidity in a Portfolio to the extent that qualified institutional buyers
become for a time uninterested in purchasing Rule 144A securities held in the
investment portfolio. Subject to the Portfolio's 15% limitation on investments
in illiquid investments and subject to the diversification requirements of the
Code, the Portfolio may also invest in restricted securities that may not be
sold under Rule 144A, which presents certain risks. As a result, the Portfolio
might not be able to sell these securities when the Sub-Adviser wishes to do
so, or might have to sell them at less than fair value. In addition, market
quotations are less readily available. Therefore, judgment may at times play a
greater role in valuing these securities than in the case of unrestricted
securities.
While it is not generally the Portfolio's policy to invest or trade for
short-term profits, the Portfolio may dispose of a portfolio security whenever
the Sub-Adviser is of the opinion that such security no longer has an
appropriate appreciation potential or when another security appears to offer
relatively greater appreciation potential. Portfolio changes are made without
regard to the length of time a security has been held, or whether a sale would
result in a profit or loss. Therefore, the rate of portfolio turnover is not a
limiting factor when a change in the portfolio is otherwise appropriate.
Because the Portfolio is expected to have a Portfolio turnover rate of over
100%, transactions costs incurred by the Portfolio and the realized capital
gains and losses of the Portfolio may be greater than that of a portfolio with
a lesser turnover rate. The portfolio turnover rates of the Portfolio for the
periods ended December 31, 1996, 1995 and 1994 are set forth herein under
"Financial Highlights." (See also "Portfolio Turnover" in the SAI.)
ADDITIONAL PORTFOLIO INVESTMENTS AND TRANSACTIONS. The Portfolio may enter
into repurchase agreements to earn additional income on available cash or as a
temporary defensive measure. The Portfolio may seek to increase its income by
lending portfolio securities. The Portfolio may purchase securities on a "when
issued" or on a "delayed delivery" basis, which means that the securities will
be delivered to the Portfolio at a future date usually beyond customary
settlement time.
The Portfolio may invest in indexed securities whose value is linked to
foreign currencies, indices, or other financial indicators. The Portfolio may
enter into mortgage "dollar roll" transactions with selected banks and broker-
dealers. The Portfolio may invest a portion of its assets in loan
participations and other direct indebtedness.
The Portfolio also may purchase restricted securities, corporate asset-
backed securities, options on securities, options on stock indices, options on
foreign currencies, futures contracts, options on futures contracts and
forward foreign currency exchange contracts.
All of the Portfolio investments and transactions described in this section
are described in greater detail in the Appendix and the SAI.
GROWTH & INCOME PORTFOLIO
The investment objective of the Growth & Income Portfolio is long-term total
return. The Portfolio will pursue this objective primarily by investing in
equity and debt securities, focusing on small- and mid-cap companies that
offer the potential for capital appreciation, current income, or both.
The Portfolio will normally invest the majority of its assets in common and
preferred stocks, convertible securities, bonds, and notes. Although the
Portfolio will focus on companies with market capitalizations of up to $3
billion, the Portfolio intends to remain flexible and may invest in securities
of larger companies. The Portfolio may also engage in short sales of
securities it expects to decline in price.
INVESTMENT POLICIES AND RISKS -- GROWTH & INCOME PORTFOLIO
Small- and mid-cap companies may present greater opportunities for
investment return, but may also involve greater risks. They may have limited
product lines, markets, or financial resources, or may depend on a limited
management group. Their securities may trade less frequently and in limited
volume. As a result, the prices of these securities may fluctuate more than
prices of securities of larger, widely traded companies. See "Appendix --
Small Companies."
The Portfolio may invest a substantial portion of its assets in securities
issued by small companies. Such companies may offer greater opportunities for
capital appreciation than larger companies, but investments in such companies
may involve certain special risks. See "Appendix -- Small Companies" for a
discussion of such risks.
The Portfolio may invest in securities principally traded in foreign markets
and may buy or sell foreign currencies and options and futures contracts on
foreign currencies for hedging purposes in connection with its foreign
investments. The
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Portfolio also may at times invest a substantial portion of its assets in
securities of issuers in developing countries. The Portfolio may at times
invest a substantial portion of its assets in securities traded in the over-
the-counter markets in such countries and not on any exchange, which may
affect the liquidity of the investment and expose the Portfolio to the credit
risk of its counterparties in trading those investments.
International investing in general may involve greater risks than U.S.
investments. These risks may be intensified in the case of investments in
emerging markets or countries with limited or developing capital markets. (See
"Appendix -- Foreign Investments" and the SAI for a discussion of the risks
involved in foreign investing and see "Appendix -- Strategic Transactions --
Futures and Options on Futures" and "Options on Foreign Currencies" for a
discussion of the risks involved in investing in foreign currencies, options
and futures contracts.)
The Portfolio may invest without limit in debt securities and other fixed-
income securities. The Portfolio may invest in lower-quality, high yielding
debt securities. Lower-rated debt securities (commonly called "junk bonds")
are considered to be of poor standing and predominantly speculative. Such
investments involve certain risks. See "Appendix -- Lower Rated Securities"
and the SAI for a discussion of the risks involved in investing in lower-rated
securities.
The Portfolio may at times invest in so-called "zero-coupon" bonds and
"payment-in-kind" bonds. Zero-coupon bonds are issued at a significant
discount from face value and pay interest only at maturity rather than at
intervals during the life of the security. Payment-in-kind bonds allow the
issuer, at its option, to make current interest payments on the bonds either
in cash or in additional bonds. The values of zero-coupon bonds and payment-
in-kind bonds are subject to greater fluctuation in response to changes in
market interest rates than bonds which pay interest currently, and may involve
greater credit risk than such bonds. See "Zero Coupon Securities and Pay-in-
Kind Securities" in the SAI.
The Portfolio will not necessarily dispose of a security when its debt
rating is reduced below its rating at the time of purchase, although the Sub-
Adviser will monitor the investment to determine whether continued investment
in the security will assist in meeting the Portfolio's investment objective.
The Portfolio may buy and sell call and put options to hedge against changes
in net asset value or to attempt to realize a greater current return. In
addition, through the purchase and sale of futures contracts and related
options, a Portfolio may at times seek to hedge against fluctuations in net
asset value and to attempt to increase its investment return. Although the
Portfolio will only engage in options and futures transactions for limited
purposes, those transactions involve certain risks which are described in the
Appendix and SAI.
The Portfolio may buy and sell index futures contracts ("index futures") and
options on index futures and on indices for hedging purposes or to increase
its investment return (or may purchase warrants whose value is based on the
value from time to time of one or more foreign securities indices). See the
SAI for a further description of index futures and options including risks.
The Portfolio may purchase and sell options in the over-the-counter markets
but only when appropriate exchange-traded transactions are unavailable and
when, in the opinion of the Sub-Adviser, the pricing mechanism and liquidity
of the over-the-counter markets are satisfactory and the participants are
responsible parties likely to meet their obligations (See "Appendix -- Over-
the-Counter Options.")
The Portfolio will not purchase futures or options on futures or sell
futures if, as a result, the sum of the initial margin deposits on the
Portfolio's existing futures positions and premiums paid for outstanding
options on futures contracts would exceed 5% of the Portfolio's assets. (For
options that are "in-the-money" at the time of purchase, the amount by which
the option is "in-the-money" is excluded from this calculation.)
At times the Portfolio may invest more than 25% of its assets in securities
of issuers in one or more market sectors such as, for example, the technology
sector. A market sector may be made up of companies in a number of related
industries. The Portfolio would only concentrate its investments in a
particular market sector if the Portfolio's Sub-Adviser were to believe the
investment return available from concentration in that sector justifies any
additional risk associated with concentration in that sector. When the
Portfolio concentrates its investments in a market sector, financial,
economic, business, and other developments affecting issuers in that sector
will have a greater effect on the Portfolio than if it had not concentrated
its assets in that sector.
The Portfolio may lend portfolio securities to broker-dealers and may enter
into repurchase agreements. These transactions must be fully collateralized at
all times, but involve some risk to the Portfolio if the other party should
default on its obligations and the Portfolio is delayed or prevented from
recovering the collateral.
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<PAGE>
At times, the Portfolio's Sub-Adviser may judge that market conditions make
pursuing the Portfolio's basic investment strategy inconsistent with the best
interests of its shareholders. At such times, the Portfolio's Sub-Adviser may
temporarily use alternative strategies, primarily designed to reduce
fluctuations in the values of the Portfolio's assets. In implementing these
"defensive" strategies, the Portfolio may invest in U.S. Government
securities, other high-quality debt instruments, and other securities the
Portfolio's Sub-Adviser believes to be consistent with the Portfolio's best
interests.
The length of time a Portfolio has held a particular security is not
generally a consideration in investment decisions. The investment policies of
a Portfolio may lead to frequent changes in the Portfolio's investments,
particularly in periods of volatile market movements. A change in the
securities held by a Portfolio is known as "portfolio turnover." Portfolio
turnover generally involves some expense to a Portfolio, including brokerage
commissions or dealer markups and other transaction costs on the sale of
securities and reinvestment in other securities. Such sales may result in
realization of taxable capital gains. The Portfolio's turnover rate for the
period ended December 31, 1996 is set forth herein under "Financial
Highlights." (See also "Portfolio Turnover" in the SAI.)
MANAGEMENT OF THE TRUST
INVESTMENT ADVISER
Under an Investment Advisory Agreement dated October 1, 1994, Equitable
Investment Services, Inc., 699 Walnut Street, Des Moines, Iowa 50309 (the
"Adviser"), manages the business and affairs of the Portfolios and the Trust,
subject to the control of the Trustees.
The Adviser is an Iowa corporation which was incorporated in 1969. The
Adviser is engaged in the business of providing investment advice to
affiliated insurance companies.
Under the Investment Advisory Agreement, the Adviser is obligated to
formulate a continuing program for the investment of the assets of each
Portfolio of the Trust in a manner consistent with each Portfolio's investment
objectives, policies and restrictions and to determine from time to time
securities to be purchased, sold, retained or lent by the Trust and implement
those decisions. The Investment Advisory Agreement also provides that the
Adviser shall manage the Trust's business and affairs and shall provide such
services required for effective administration of the Trust as are now
provided by employees or other agents engaged by the Trust. The Investment
Advisory Agreement further provides that the Adviser shall furnish the Trust
with office space and necessary personnel, pay ordinary office expenses, pay
all executive salaries of the Trust and furnish, without expense to the Trust,
the services of such members of its organization as may be duly elected
officers or Trustees of the Trust. The Investment Advisory Agreement provides
that Adviser may retain sub-advisers, at the Adviser's own cost and expense,
for the purpose of making investment recommendations and research information
available to the Trust.
The Adviser retains sub-advisers for each of the Portfolios.
As full compensation for its services under the Investment Advisory
Agreement, the Trust pays the Adviser a monthly fee at the following annual
rates shown in the table below based on the average daily net assets of each
Portfolio.
<TABLE>
<CAPTION>
ADVISORY FEE
(ANNUAL RATE BASED ON AVERAGE DAILY NET ASSETS
PORTFOLIO OF EACH PORTFOLIO)
--------- ------------------------------------------------------
<S> <C>
Growth & Income .95% of first $200 million
.75% of average net assets over and above $200 million
OTC .80% of first $300 million
.55% of average net assets over and above $300 million
Research .80% of first $300 million
.55% of average net assets over and above $300 million
Total Return .80% of first $300 million
.55% of average net assets over and above $300 million
Value + Growth .95% of first $500 million
.75% of average net assets over and above $500 million
</TABLE>
ADVISORY FEE WAIVER AND EXPENSE CAP
The Adviser has undertaken to reimburse each Portfolio for all operating
expenses, excluding management fees, that exceed .40% of the average daily net
assets of each Portfolio. This undertaking is subject to termination at any
time without notice to shareholders. For the year ended December 31, 1996,
with respect to the Value + Growth Portfolio, the Adviser
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<PAGE>
had agreed to reimburse the Trust for $16,963 for expenses in excess of the
voluntary expense limitations, all of which was owed to the Trust as of
December 31, 1996.
EXPENSES OF THE TRUST
The organizational expenses of the Trust are being amortized on a straight-
line basis over a period of five years (beginning with the commencement of
operations). If any of the initial shares (purchased by Equitable Life
Insurance Company of Iowa through its contribution of the initial "seed money"
to the Trust totaling $10,000 per Portfolio) are redeemed during the
amortization period by the holder thereof, the redemption proceeds will be
reduced by any unamortized organizational expenses in the same proportion as
the number of initial shares being redeemed bears to the number of initial
shares outstanding at the time of the redemption.
SUB-ADVISERS
In accordance with a Portfolio's investment objective and policies and under
the supervision of Adviser and the Trust's Board of Trustees, a Portfolio's
Sub-Adviser is responsible for the day to day investment management of the
Portfolio, makes investment decisions for the Portfolio and places orders on
behalf of the Portfolio to effect the investment decisions made as provided in
separate Sub-Advisory Agreements among each Sub-Adviser, the Adviser and the
Trust. The following organizations act as Sub-Advisers to the Portfolios:
MASSACHUSETTS FINANCIAL SERVICES COMPANY ("MFS"), 500 Boylston Street,
Boston, Massachusetts 02116, is the Sub-Adviser for the OTC Portfolio, the
Research Portfolio and the Total Return Portfolio of the Trust.
MFS is America's oldest mutual fund organization. MFS and its predecessor
organizations have a history of money management dating from 1924 and the
founding of the first mutual fund in the United States, Massachusetts
Investors Trust. Net assets under the management of the MFS organization were
approximately $43.9 billion on behalf of approximately 1.9 million investor
accounts as of February 28, 1997. As of such date, the MFS organization
managed approximately $28.9 billion of assets in equity securities and $19.9
billion of assets in fixed income securities. Approximately $4.0 billion of
assets managed by MFS are invested in securities of foreign issuers and non-
U.S. dollar denominated securities of U.S. issuers. MFS is a subsidiary of Sun
Life Assurance Company of Canada (U.S.) which in turn is a wholly-owned
subsidiary of Sun Life Assurance Company of Canada ("Sun Life"). The Directors
of MFS are A. Keith Brodkin, Jeffrey L. Shames, Arnold D. Scott, John D.
McNeil and Donald R. Stewart. Mr. Brodkin is the Chairman, Mr. Shames is the
President and Mr. Scott is the Secretary and a Senior Executive Vice President
of MFS. Messrs. McNeil and Stewart are the Chairman and the President,
respectively, of Sun Life. Sun Life, a mutual life insurance company, is one
of the largest international life insurance companies and has been operating
in the U.S. since 1895, establishing a headquarters office in the U.S. in
1973. The executive officers of MFS report to the Chairman of Sun Life.
Kevin R. Parke is the portfolio manager for the Research Portfolio. Mr.
Parke oversees the selection of portfolio securities made by various equity
research analysts employed by MFS. Mr. Parke is a Senior Vice President--
Investments of MFS and has been employed as a portfolio manager by MFS since
1985.
David M. Calabro heads a team of portfolio managers of MFS for the Total
Return Portfolio. Mr. Calabro is a Vice President--Investments of MFS and
manages the equity portion of the portfolio along with Judith N. Lamb, a Vice
President--Investments of MFS, Lisa B. Nurme, a Vice President--Investments of
MFS and Maura Shaughnessy, a Vice President--Investments of MFS. Geoffrey L.
Kurinsky, a Senior Vice President--Investment manages the fixed income portion
of the portfolio and has been employed as a portfolio manager by MFS since
1987. Mr. Calabro has been employed as a portfolio manager by MFS since 1992.
Ms. Lamb has been employed as a portfolio manager by MFS since 1992. Ms. Nurme
has been employed as a portfolio manager by MFS since 1987. Ms. Shaughnessy
has been employed as a portfolio manager by MFS since 1991.
John W. Ballen and Mark Regan are the portfolio managers for the OTC
Portfolio. Mr. Ballen is a Senior Vice President--Investments and the Chief
Equity Officer of MFS and has been employed by MFS since 1984. Mr. Regan is a
Vice President--Investments at MFS and has been employed as a portfolio
manager by MFS since 1989.
Under the terms of the Sub-Advisory Agreement, the Adviser shall pay to MFS,
as full compensation for services rendered under the Sub-Advisory Agreement
with respect to the OTC, Research and Total Return Portfolios, the following
annual fees:
<TABLE>
<S> <C>
OTC Portfolio .40% of first $300 million
.25% of average net assets over and above $300
million
Research Portfolio .40% of first $300 million
.25% of average net assets over and above $300
million
Total Return Portfolio .40% of first $300 million
.25% of average net assets over and above $300
million
</TABLE>
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<PAGE>
ROBERTSON, STEPHENS & COMPANY INVESTMENT MANAGEMENT, L.P., 555 California
Street, San Francisco, CA 94104, is the Sub-Adviser for the Growth & Income
and Value + Growth Portfolios of the Trust. Robertson, Stephens & Company
Investment Management, L.P., a California limited partnership, was formed in
1993 and is registered as an investment adviser with the Securities and
Exchange Commission. The general partner of Robertson, Stephens & Company
Investment Management, L.P. is Robertson, Stephens & Company, Inc. Robertson,
Stephens; Company Investment Management, L.P. is affiliated with Robertson,
Stephens & Company, LLC, a major investment banking firm specializing in
emerging growth companies that has developed substantial investment research,
underwriting, and venture capital expertise. Since 1978, Robertson, Stephens &
Company, LLC has managed underwritten public offerings for over $15 billion of
securities of emerging growth companies. Robertson, Stephens & Company
Investment Management, L.P., and its affiliates have in excess of $3.5 billion
under management in public and private investment funds. Robertson, Stephens &
Company, L.P., its general partner, Robertson, Stephens & Company, Inc. and
Sanford R. Robertson may be deemed to be control persons of Robertson,
Stephens & Company Investment Management, L.P.
Ronald E. Elijah joined Robertson, Stephens & Company Investment Management,
L.P. in 1992 and is the portfolio manager for the Value + Growth Portfolio.
From August 1985 to January, 1990, Mr. Elijah was a securities analyst for
Robertson, Stephens & Company, L.P. From January 1990 to January 1992, Mr.
Elijah was an analyst and portfolio manager for Water Street Capital, which
managed short selling investment funds.
John L. Wallace is the portfolio manager for the Growth & Income Portfolio.
Prior to joining Robertson, Stephens & Company Investment Management, L.P.,
Mr. Wallace was Vice President of Oppenheimer Management Corp., where he was
portfolio manager of the Oppenheimer Main Street Income and Growth Fund.
Under the terms of the Sub-Advisory Agreement, the Adviser shall pay to
Robertson, Stephens & Company Investment Management, L.P., as full
compensation for services rendered under the Agreement with respect to the
Growth & Income and Value + Growth Portfolios the following annual fees:
<TABLE>
<S> <C>
Growth & Income Portfolio .55% of first $200 million
.45% of average net assets over and above $200
million
Value + Growth Portfolio .55% of first $500 million
.45% of average net assets over and above $500
million
</TABLE>
SALES AND REDEMPTIONS
The separate accounts of the Life Companies place orders to purchase and
redeem shares of each Portfolio based on, among other things, the amount of
premium payments to be invested and surrender and transfer requests to be
effected on that day pursuant to the Variable Contracts issued by the Life
Companies. Orders received by the Trust are effected on days on which the New
York Stock Exchange is open for trading, at the net asset value per share next
determined after receipt of the order. For orders received before 4:00 p.m.
New York time, such purchases and redemptions of shares of each Portfolio are
effected at the respective net asset values per share determined as of 4:00
p.m. New York time on that day. See "Net Asset Value," below and
"Determination of Net Asset Value" in the Trust's SAI. Payment for redemptions
will be made within seven days after receipt of a redemption request in good
order. No fee is charged the separate accounts of the Life Companies when they
redeem Portfolio shares. The Trust may suspend the sale of shares at any time
and may refuse any order to purchase shares.
The Trust may suspend the right of redemption of shares of any Portfolio and
may postpone payment for any period: (i) during which the New York Stock
Exchange is closed other than for customary weekend and holiday closings or
during which trading on the New York Stock Exchange is restricted; (ii) when
the Securities and Exchange Commission determines that a state of emergency
exists which makes the sale of portfolio securities or the determination of
net asset value not reasonably practicable; (iii) as the Securities and
Exchange Commission may by order permit for the protection of the security
holders of the Trust; or (iv) at any time when the Trust may, under applicable
laws and regulations, suspend payment on the redemption of its shares.
NET ASSET VALUE
Each Portfolio calculates the net asset value of a share by dividing the
total value of its assets, less liabilities, by the number of shares
outstanding. Shares are valued as of 4:00 p.m. New York time on each day the
New York Stock Exchange is open.
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<PAGE>
Because foreign securities are quoted in foreign currencies which will be
translated into U.S. dollars at the New York cable transfer rates or at such
other rates as the Trustees may determine in computing net asset value,
fluctuations in the value of such currencies in relation to the U.S. dollar
will affect the net asset value of shares of a Portfolio investing in foreign
securities even though there has not been any change in the local currency
values of such securities.
PERFORMANCE INFORMATION
Performance information for each of the Portfolios may be presented from
time to time in advertisements and sales literature. The Portfolios may
advertise several types of performance information. These are the "yield,"
"average annual total return" and "aggregate total return". Each of these
figures is based upon historical results and is not necessarily representative
of the future performance of any Portfolio.
The yield of a Portfolio's shares is determined by annualizing net
investment income earned per share for a stated period (normally one month or
thirty days) and dividing the result by the net asset value per share at the
end of the valuation period. The average annual total return and aggregate
total return figures measure both the net investment income generated by, and
the effect of any realized or unrealized appreciation or depreciation of the
underlying investments in, the Portfolio's portfolio for the period in
question, assuming the reinvestment of all dividends. Thus, these figures
reflect the change in the value of an investment in a Portfolio's shares
during a specified period. Average annual total return will be quoted for at
least the one, five and ten year periods ending on a recent calendar quarter
(or if such periods have not yet elapsed, at the end of a shorter period
corresponding to the life of the Portfolio). Average annual total return
figures are annualized and, therefore, represent the average annual percentage
change over the period in question. Total return figures are not annualized
and represent the aggregate percentage or dollar value change over the period
in question. For more information regarding the computation of yield, average
annual total return and aggregate total return, see "Performance Information"
in the SAI.
Any Portfolio performance information presented will also include
performance information for the separate accounts of the Life Companies
investing in the Trust which will take into account insurance-related charges
and expenses under such insurance policies and contracts.
Advertisements concerning the Trust may from time to time compare the
performance of one or more Portfolios to various indices. Advertisements may
also contain the performance rankings assigned certain Portfolios or their
advisers by various publications and statistical services, including, for
example, SEI, Lipper Analytical Services Mutual Funds Survey, Lipper Variable
Insurance Products Performance Analysis Service, Morningstar, Intersec
Research Survey of Non-U.S. Equity Fund Returns, Frank Russell International
Universe, and Financial Services Week. Any such comparisons or rankings are
based on past performance and the statistical computation performed by
publications and services, and are not necessarily indications of future
performance. Because the Portfolios are managed investment vehicles investing
in a wide variety of securities, the securities owned by a Portfolio will not
match those making up an index.
TAX STATUS, DIVIDENDS, AND DISTRIBUTIONS
Each Portfolio of the Trust intends to qualify and elect to be treated as a
regulated investment company that is taxed under the rules of Subchapter M of
the Internal Revenue Code. As such an electing regulated investment company, a
Portfolio will not be subject to federal income tax on its net ordinary income
and net realized capital gains to the extent such income and gains are
distributed to the separate accounts of the Life Companies which hold its
shares. For further information concerning federal income tax consequences for
the holders of the Variable Contracts of the Life Companies, investors should
consult the prospectus used in connection with the issuance of their Variable
Contracts.
Each of the Portfolios will declare and distribute dividends from net
ordinary income at least annually and will distribute its net realized capital
gains, if any, at least annually. Distributions of ordinary income and capital
gains will be made in shares of such Portfolios unless an election is made on
behalf of a separate account to receive distributions in cash. The Life
Companies will be informed at least annually about the amount and character of
distributions from the Trust for federal income tax purposes.
ADDITIONAL INFORMATION
The Trust was established as a Massachusetts business trust under the laws
of Massachusetts by a Declaration of Trust dated May 11, 1994 (the
"Declaration of Trust"). Under Massachusetts law, shareholders of such a trust
may, under certain
17
<PAGE>
circumstances, be held personally liable as partners for the obligations of
the trust. The Declaration of Trust contains an express disclaimer of
shareholder liability in connection with Trust property or the acts,
obligations, or affairs of the Trust. The Declaration of Trust also provides
for indemnification out of a Portfolio's property of any shareholder of that
Portfolio held personally liable for the claims and liabilities to which a
shareholder may become subject by reason of being or having been a
shareholder. Thus, the risk of a shareholder's incurring financial loss on
account of shareholder liability is limited to circumstances in which the
Portfolio itself would be unable to meet its obligations. A copy of the
Declaration of Trust is on file with the Secretary of State of The
Commonwealth of Massachusetts.
The Trust has an unlimited authorized number of shares of beneficial
interest. Shares of the Trust are entitled to one vote per share (with
proportional voting for fractional shares) and are freely transferable, and,
in liquidation of a Portfolio, shareholders of the Portfolio are entitled to
receive pro rata the net assets of the Portfolio. Although no Portfolio is
required to hold annual meetings of its shareholders, shareholders have the
right to call a meeting to elect or remove Trustees or to take other actions
as provided in the Declaration of Trust. Shareholders have no preemptive
rights. The Trust's custodian, transfer and dividend-paying agent is State
Street Bank and Trust Company.
To mitigate the possibility that a Portfolio will be adversely affected by
personal trading of employees, the Trust, the Adviser and the Sub-Advisers
have adopted policies that restrict securities trading in personal accounts of
the portfolio managers and others who normally come into possession of
information on portfolio transactions. These policies comply, in all material
respects, with the recommendations of the Investment Company Institute.
18
<PAGE>
APPENDIX
SECURITIES AND INVESTMENT PRACTICES
In attempting to achieve its investment objective or policies each Portfolio
employs a variety of instruments, strategies and techniques, which are
described in greater detail below. Risks and restrictions associated with
these practices are also described. Policies and limitations are considered at
the time a security or instrument is purchased or a practice initiated.
Generally, securities need not be sold if subsequent changes in market value
result in applicable limitations not being met.
A Portfolio might not buy all of these securities or use all of these
techniques to the full extent permitted unless the Adviser or the Sub-Adviser,
subject to oversight by Adviser, believes that doing so will help the
Portfolio achieve its goal. As a shareholder, you will receive Portfolio
reports every six months detailing the Trust's holdings and describing recent
investment practices.
The investment guidelines set forth below may be changed at any time without
shareholder consent by vote of the Board of Trustees of the Trust. A complete
list of investment restrictions that identifies additional restrictions that
cannot be changed without the approval of a majority of an affected
Portfolio's outstanding shares is contained in the SAI.
AMERICAN DEPOSITARY RECEIPTS AND EUROPEAN DEPOSITARY RECEIPTS
Certain of the Portfolios may invest in securities of foreign issuers
directly or in the form of American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other similar securities representing
securities of foreign issuers. These securities may not necessarily be
denominated in the same currency as the securities they represent. ADRs are
receipts typically issued by a United States bank or trust company evidencing
beneficial ownership of the underlying foreign securities. EDRs are receipts
issued by a European financial institution evidencing a similar arrangement.
Generally, ADRs, in registered form, are designed for use in the United States
securities markets, and EDRs, in bearer form, are designed for use in European
securities markets.
ASSET-BACKED SECURITIES
Certain of the Portfolios may purchase asset-backed securities, which
represent a participation in, or are secured by and payable from, a stream of
payments generated by particular assets, most often a pool of assets similar
to one another. Assets generating such payments may include motor vehicle
installment purchase obligations, credit card receivables and home equity
loans.
BANK OBLIGATIONS
All of the Portfolios may invest in Bank Obligations, which include
certificates of deposit, time deposits and bankers' acceptances of U.S.
commercial banks or savings and loan institutions which are determined by the
Adviser or the Sub-Advisers to present minimal credit risks. Certain of the
Portfolios may invest in foreign-currency denominated Bank Obligations,
including Euro-currency instruments and securities of U.S. and foreign banks
and thrifts.
BORROWING
Each of the Portfolios may borrow money (up to 33 1/3% of its assets) for
temporary or emergency purposes. If a Portfolio borrows money, its share price
may be subject to greater fluctuation until the borrowing is paid off. If the
Portfolio makes additional investments while borrowings are outstanding, this
may be construed as a form of leverage.
Borrowing, including reverse repurchase agreements and, in certain
circumstances, dollar rolls, creates leverage which increases a Portfolio's
investment risk. If the income and gains on the securities purchased with the
proceeds of borrowings exceed the cost of the arrangements, the Portfolio's
earnings or net asset value will increase faster than would be the case
otherwise. Conversely, if the income and gains fail to exceed the costs,
earnings or net asset value will decline faster than would otherwise be the
case.
BRADY BONDS
Certain Portfolios of the Trust may invest in Brady Bonds, which are
securities created through the exchange of existing commercial bank loans to
public and private entities in certain emerging markets for new bonds in
connection with debt restructurings under a debt restructuring plan introduced
by former U.S. Secretary of the Treasury, Nicholas F. Brady (the "Brady
Plan"). Brady Plan debt restructurings have been implemented to date in
Argentina, Brazil, Bulgaria, Costa Rica, Ecuador, Mexico, Nigeria, the
Philippines, Poland, Uruguay, and Venezuela. Brady Bonds have been issued only
recently, and for that reason do not have a long payment history. Brady Bonds
may be collateralized or uncollateralized, are issued in
A-1
<PAGE>
various currencies (but primarily the U.S. dollar) and are actively traded in
over-the-counter secondary markets. U.S. dollar denominated, collateralized
Brady Bonds, which may be fixed rate bonds or floating-rate bonds, are
generally collateralized in full as to principal by U.S. Treasury zero coupon
bonds having the same maturity as the bonds. Brady Bonds are often viewed as
having three or four valuation components: the collateralized repayment of
principal at final maturity; the collateralized interest payments; the
uncollateralized interest payments; and any uncollateralized repayment of
principal at maturity (these uncollateralized amounts constituting the
"residual risk"). In light of the residual risk of Brady Bonds and the history
of defaults of countries issuing Brady Bonds with respect to commercial bank
loans by public and private entities, investments in Brady Bonds may be viewed
as speculative.
COMMON STOCK AND OTHER EQUITY SECURITIES
Common Stocks represent an equity (ownership) interest in a corporation.
This ownership interest generally gives a Portfolio the right to vote on
measures affecting the company's organization and operations.
Certain of the Portfolios may also buy securities such as convertible debt,
preferred stock, warrants or other securities exchangeable for shares of
Common Stock. In selecting equity investments for a Portfolio, the Adviser or
Sub-Adviser will generally invest the Portfolio's assets in industries and
companies that it believes are experiencing favorable demand for their
products and services and which operate in a favorable competitive and
regulatory climate.
CONVERTIBLE SECURITIES
A convertible security is a security that may be converted either at a
stated price or rate within a specified period of time into a specified number
of shares of Common Stock. By investing in Convertible Securities, a Portfolio
seeks the opportunity, through the conversion feature, to participate in the
capital appreciation of the Common Stock into which the securities are
convertible, while earning a higher fixed rate of return than is available in
Common Stocks.
CURRENCY MANAGEMENT
A Portfolio's flexibility to participate in higher yielding debt markets
outside of the United States may allow the Portfolio to achieve higher yields
than those generally obtained by domestic money market funds and short-term
bond investments. When a Portfolio invests significantly in securities
denominated in foreign currencies, however, movements in foreign currency
exchange rates versus the U.S. dollar are likely to impact the Portfolio's
share price stability relative to domestic short-term income funds.
Fluctuations in foreign currencies can have a positive or negative impact on
returns. Normally, to the extent that the Portfolio is invested in foreign
securities, a weakening in the U.S. dollar relative to the foreign currencies
underlying a Portfolio's investments should help increase the net asset value
of the Portfolio. Conversely, a strengthening in the U.S. dollar versus the
foreign currencies in which a Portfolio's securities are denominated will
generally lower the net asset value of the Portfolio. Each Portfolio's Adviser
or Sub-Adviser attempts to minimize exchange rate risk through active
portfolio management, including hedging currency exposure through the use of
futures, options and forward currency transactions and attempting to identify
bond markets with strong or stable currencies. There can be no assurance that
such hedging will be successful and such transactions, if unsuccessful, could
result in additional losses or expenses to a Portfolio.
DOLLAR ROLL TRANSACTIONS
Certain Portfolios seeking a high level of current income may enter into
dollar rolls or "covered rolls" in which the Portfolio sells securities
(usually Mortgage-Backed Securities) and simultaneously contracts to purchase,
typically in 30 to 60 days, substantially similar, but not identical
securities, on a specified future date. The proceeds of the initial sale of
securities in the Dollar Roll Transactions may be used to purchase long-term
securities which will be held during the roll period. During the roll period,
the Portfolio forgoes principal and interest paid on the securities sold at
the beginning of the roll period. The Portfolio is compensated by the
difference between the current sales price and the forward price for the
future purchase (often referred to as the "drop") as well as by the interest
earned on the cash proceeds of the initial sale. A "covered roll" is a
specific type of dollar roll for which there is an offsetting cash position or
cash equivalent securities position that matures on or before the forward
settlement date of the dollar roll transaction. As used herein the term
"dollar roll" refers to dollar rolls that are not "covered rolls." At the end
of the roll commitment period, the Portfolio may or may not take delivery of
the securities the Portfolio has contracted to purchase.
The Portfolio will establish a segregated account with its custodian in
which it will maintain cash, U.S. Government Securities or other liquid high-
grade debt obligations equal in value at all times to its obligations in
respect of dollar rolls, and, accordingly, the Portfolio will not treat such
obligations as senior securities for purposes of the 1940 Act. "Covered rolls"
are not subject to these segregation requirements. Dollar Roll Transactions
may be considered borrowings and are, therefore, subject to the borrowing
limitations applicable to the Portfolios.
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EQUITY AND DEBT SECURITIES ISSUED OR GUARANTEED BY SUPRANATIONAL ORGANIZATIONS
Portfolios authorized to invest in securities of foreign issuers may invest
assets in equity and debt securities issued or guaranteed by Supranational
Organizations, such as obligations issued or guaranteed by the Asian
Development Bank, Inter-American Development Bank, International Bank for
Reconstruction and Development (World Bank), African Development Bank,
European Coal and Steel Community, European Economic Community, European
Investment Bank and the Nordic Investment Bank.
EXCHANGE RATE-RELATED SECURITIES
Certain of the Portfolios may invest in securities which are indexed to
certain specific foreign currency exchange rates. The terms of such security
would provide that the principal amount or interest payments are adjusted
upwards or downwards (but not below zero) at payment to reflect fluctuations
in the exchange rate between two currencies while the obligation is
outstanding, depending on the terms of the specific security. A Portfolio will
purchase such security with the currency in which it is denominated and will
receive interest and principal payments thereon in the currency, but the
amount of principal or interest payable by the issuer will vary in proportion
to the change (if any) in the exchange rate between the two specific
currencies between the date the instrument is issued and the date the
principal or interest payment is due. The staff of the SEC is currently
considering whether a mutual fund's purchase of this type of security would
result in the issuance of a "senior security" within the meaning of the 1940
Act. The Trust believes that such investments do not involve the creation of
such a senior security, but nevertheless undertakes, pending the resolution of
this issue by the staff, to establish a segregated account with respect to
such investments and to maintain in such account cash not available for
investment or U.S. Government Securities or other liquid high quality debt
securities having a value equal to the aggregate principal amount of
outstanding securities of this type.
Investment in Exchange Rate-Related Securities entails certain risks. There
is the possibility of significant changes in rates of exchange between the
U.S. dollar and any foreign currency to which an Exchange Rate-Related
Security is linked. In addition, there is no assurance that sufficient trading
interest to create a liquid secondary market will exist for a particular
Exchange Rate-Related Security due to conditions in the debt and foreign
currency markets. Illiquidity in the forward foreign exchange market and the
high volatility of the foreign exchange market may from time to time combine
to make it difficult to sell an Exchange Rate-Related Security prior to
maturity without incurring a significant price loss.
FIXED-INCOME SECURITIES
The market value of fixed-income obligations held by the Portfolios and,
consequently, the net asset value per share of the Portfolios can be expected
to vary inversely to changes in prevailing interest rates. Investors should
also recognize that, in periods of declining interest rates, the yields of the
Portfolios investing in fixed income obligations will tend to be somewhat
higher than prevailing market rates and, in periods of rising interest rates,
these Portfolios' yields will tend to be somewhat lower. Also, when interest
rates are falling, the inflow of net new money to the Portfolios investing in
fixed income obligations from the continuous sales of their shares will likely
be invested in instruments producing lower yields than the balance of their
assets, thereby reducing current yields. In periods of rising interest rates,
the opposite can be expected to occur. Prices of longer term securities
generally increase or decrease more sharply than those of shorter term
securities in response to interest rate changes. In addition, obligations
purchased by certain of these Portfolios that are rated in the lower
categories are considered to have speculative characteristics and changes in
economic conditions or other circumstances are more likely to lead to a
weakened capacity to make principal and interest payments than is the case
with higher grade securities. (See "Lower Rated Securities" in this Appendix.)
FOREIGN CURRENCY EXCHANGE TRANSACTIONS
Certain of the Portfolios may engage in foreign currency exchange
transactions. Portfolios that 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, 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. A
Portfolio can 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 Portfolio
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 a commission. When a
Portfolio engages in forward contracts for the sale or purchase of currencies,
the Portfolio will either cover its position or establish a
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segregated account. The Portfolio will consider its position covered if it has
securities in the currency subject to the forward contract, or otherwise has
the right to obtain that currency at no additional cost. In the alternative,
the Trust, on behalf of the Portfolio, will place cash which is not available
for investment, liquid, high-grade debt securities or other securities
(denominated in the foreign currency subject to the forward contract) in a
separate account. The amounts in such separate account will equal the value of
the Portfolio's total assets which are committed to the consummation of
foreign currency exchange contracts. If the value of the securities placed in
the separate account declines, the Trust, on behalf of the Portfolio, will
place additional cash or securities in the account on a daily basis so that
the value of the account will equal the amount of the Portfolio's commitments
with respect to such contracts. Neither spot transactions nor forward foreign
currency exchange contracts eliminate fluctuations in the prices of the
Portfolio's portfolio securities or in foreign exchange rates, or prevent loss
if the prices of these securities should decline.
A Portfolio may enter into foreign currency exchange transactions for
hedging purposes as well as for non-hedging purposes. Transactions are entered
into 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 portfolio
position. 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 these securities in foreign currencies will change as a
consequence of market movements in the value of those 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. In addition,
when the Adviser or Sub-Adviser believes that the currency of a specific
country may deteriorate against another currency, it may enter into a forward
contract to sell the less attractive currency and buy the more attractive one.
The amount in question could be less than or equal to the value of the
Portfolio's securities denominated in the less attractive currency. The
Portfolio may also enter into a forward contract to sell a currency which is
linked to a currency or currencies in which some or all of the Portfolio's
portfolio securities are or could be denominated, and to buy U.S. dollars.
These practices are referred to as "cross hedging" and "proxy hedging."
A Portfolio may enter into foreign currency exchange transactions for other
than hedging purposes which presents greater profit potential but also
involves increased risk. For example, if the Adviser or Sub-Adviser believes
that the value of a particular foreign currency will increase or decrease
relative to the value of the U.S. dollar, the Portfolio may purchase or sell
such currency, respectively, through a forward foreign currency exchange
contract. If the expected changes in the value of the currency occur, the
Portfolio will realize profits which will increase its gross income. Where
exchange rates do not move in the direction or to the extent anticipated,
however, the Portfolio may sustain losses which will reduce its gross income.
Such transactions, therefore, could be considered speculative.
Forward currency exchange contracts are agreements to exchange one currency
for another -- for example, to exchange a certain amount of U.S. dollars for a
certain amount of Japanese Yen -- at a future date and specified price.
Typically, the other party to a currency exchange contract will be a
commercial bank or other financial institution. Because there is a risk of
loss to the Portfolio if the other party does not complete the transaction,
the Portfolio's Adviser or Sub-Adviser will enter into foreign currency
exchange contracts only with parties approved by the Trust's Board of
Trustees.
A Portfolio may maintain "short" positions in forward currency exchange
transactions in which the Portfolio agrees to exchange currency that it
currently does not own for another currency -- for example, to exchange an
amount of Japanese Yen that it does not own for a certain amount of U.S.
dollars -- at a future date and specified price in anticipation of a decline
in the value of the currency sold short relative to the currency that the
Portfolio has contracted to receive in the exchange.
While such actions are intended to protect the Portfolio from adverse
currency movements, there is a risk that currency movements involved will not
be properly anticipated. Use of this technique may also be limited by
management's need to protect the status of the Portfolio as a regulated
investment company under the Internal Revenue Code of 1986, as amended. The
projection of currency market movements is extremely difficult, and the
successful execution of currency strategies is highly uncertain.
FOREIGN INVESTMENTS
Certain Portfolios may invest in securities of foreign issuers. There are
certain risks involved in investing in foreign securities, including those
resulting from fluctuations in currency exchange rates, devaluation of
currencies, future political or economic developments and the possible
imposition of currency exchange blockages or other foreign governmental laws
or restrictions, reduced availability of public information concerning
issuers, and the fact that foreign companies are not generally subject to
uniform accounting, auditing and financial reporting standards or to other
regulatory practices and
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requirements comparable to those applicable to domestic companies. Moreover,
securities of many foreign companies may be less liquid and the prices more
volatile than those of securities of comparable domestic companies. With
respect to certain foreign countries, there is the possibility of
expropriation, nationalization, confiscatory taxation and limitations on the
use or removal of funds or other assets of the Portfolios, including the
withholding of dividends.
Because foreign securities generally are denominated and pay dividends or
interest in foreign currencies, and the Portfolios hold various foreign
currencies from time to time, the value of the net assets of the Portfolios as
measured in U.S. dollars will be affected favorably or unfavorably by changes
in exchange rates. The cost of the Portfolio's currency exchange transactions
will generally be the difference between the bid and offer spot rate of the
currency being purchased or sold. In order to protect against uncertainty in
the level of future foreign currency exchange rates, the Portfolios are
authorized to enter into certain foreign currency exchange transactions.
Investors should be aware that exchange rate movements can be significant and
can endure for long periods of time. Extensive research of the economic,
political and social factors that influence global markets is conducted by the
Adviser or Sub-Advisers. Particular attention is given to country-specific
analysis, reviewing the strength or weakness of a country's overall economy,
the government policies influencing business conditions and the outlook for
the country's currency. Certain Portfolios are authorized to engage in foreign
currency options, futures, options on futures and forward currency contract
transactions for hedging and/or other permissible purposes.
In addition, while the volume of transactions effected on foreign stock
exchanges has increased in recent years, in most cases it remains appreciably
below that of the NYSE. Accordingly, the Portfolios' foreign investments may
be less liquid and their prices may be more volatile than comparable
investments in securities of United States companies. Moreover, the settlement
periods for foreign securities, which are often longer than those for
securities of United States issuers, may affect portfolio liquidity. In buying
and selling securities on foreign exchanges, the Portfolio normally pays fixed
commissions that are generally higher than the negotiated commissions charged
in the United States. In addition, there is generally less governmental
supervision and regulation of securities exchanges, brokers and issuers in
foreign countries than in the United States.
Certain of the Portfolios may invest, as described below, in countries or
regions with relatively low gross national product per capita compared to the
world's major economies, and in countries or regions with the potential for
rapid economic growth (emerging markets). Emerging markets will include any
country: (i) having an "emerging stock market" as defined by the International
Finance Corporation; (ii) with low- to middle-income economies according to
the International Bank for Reconstruction and Development (the World Bank);
(iii) listed in World Bank publications as developing; or (iv) determined by
the Adviser or a Sub-Adviser to be an emerging market as defined above. The
Portfolio may invest in securities of: (i) companies the principal securities
trading market for which is an emerging market country; (ii) companies
organized under the laws of, and with a principal office in, an emerging
market country; (iii) companies whose principal activities are located in
emerging market countries; (iv) companies traded in any market that derive 50%
or more of their total revenue from either goods or services produced in an
emerging market or sold in an emerging market; (v) companies that have 50% or
more of their assets in an emerging market country; or (vi) the security is
issued or guaranteed by the government of an emerging market country or any of
its agencies, authorities or instrumentalities.
The risks of investing in foreign securities may be intensified in the case
of investments in emerging markets. Securities prices in emerging markets can
be significantly more volatile than in the more developed nations of the
world, reflecting the greater uncertainties of investing in less established
markets and economies. In particular, countries with emerging markets may have
relatively unstable governments, present the risk of nationalization of
businesses, restrictions on foreign ownership, or prohibitions of repatriation
of assets, and may have less protection of property rights than more developed
countries. The economies of countries with emerging markets may be
predominantly based on only a few industries, may be highly vulnerable to
changes in local or global trade conditions, and may suffer from extreme and
volatile debt burdens or inflation rates. Local securities markets may trade a
small number of securities and may be unable to respond effectively to
increases in trading volume, potentially making prompt liquidation of
substantial holdings difficult or impossible at times. Securities of issuers
located in countries with emerging markets may have limited marketability and
may be subject to more abrupt or erratic price movements.
FUTURES AND OPTIONS ON FUTURES
When deemed appropriate by its Adviser or Sub-Adviser, certain Portfolios
may enter into financial or currency futures and related options that are
traded on a U.S. exchange or board of trade or, to the extent permitted by
applicable law, on exchanges located outside the U.S., for hedging purposes or
for non-hedging purposes to the extent permitted by applicable law. A
Portfolio may not enter into futures and options contracts for which aggregate
initial margin deposits and premiums paid for unexpired futures options
entered into for purposes other than "bona fide hedging" positioning as
defined in regulations adopted by the Commodity Futures Trading Commission
exceed 5% of the fair market value of the Portfolio's net assets, after taking
into account unrealized profits and unrealized losses on futures contracts
into which it has entered.
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With respect to each long position in a futures contract or option thereon,
the underlying commodity value of such contract will always be covered by cash
and cash equivalents set aside plus accrued profits held at the futures
commission merchant.
A financial or currency futures contract provides for the future sale by one
party and the purchase by the other party of a specified amount of a
particular financial instrument or currency (e.g., debt security or currency)
at a specified price, date, time and place. An index futures contract is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. An option on a futures contract generally
gives the purchaser the right, in return for the premium paid, to assume a
position in a futures contract at a specified exercise price at any time prior
to the expiration date of the option.
The purpose of entering into a futures contract by a Portfolio is to either
enhance return or to protect the Portfolio from fluctuations in the value of
its securities caused by anticipated changes in interest rates, currency or
market conditions without necessarily buying or selling the securities. The
use of futures contracts and options on futures contracts involves several
risks. There can be no assurance that there will be a correlation between
price movements in the underlying securities, currencies or index, on the one
hand, and price movements in the securities which are the subject of the
futures contract or option on futures contract, on the other hand. Positions
in futures contracts and options on futures contracts may be closed out only
on the exchange or board of trade on which they were entered into, and there
can be no assurance that an active market will exist for a particular contract
or option at any particular time. If a Portfolio has hedged against the
possibility of an increase in interest rates or bond prices adversely
affecting the value of securities held in its portfolio and rates or prices
decrease instead, a Portfolio will lose part or all of the benefit of the
increased value of securities that it has hedged because it will have
offsetting losses in its futures positions. In addition, in such situations,
if a Portfolio had insufficient cash, it may have to sell securities to meet
daily variation margin requirements at a time when it may be disadvantageous
to do so. These sales of securities may, but will not necessarily, be at
increased prices that reflect the decline in interest rates or bond prices, as
the case may be. In addition, the Portfolio would pay commissions and other
costs in connection with such investments, which may increase the Portfolio's
expenses and reduce its return. While utilization of options, futures
contracts and similar instruments may be advantageous to the Portfolio, if the
Portfolio's Adviser or Sub-Adviser is not successful in employing such
instruments in managing the Portfolio's investments, the Portfolio's
performance will be worse than if the Portfolio did not make such investments.
Losses incurred in futures contracts and options on futures contracts and
the costs of these transactions will adversely affect a Portfolio's
performance.
GEOGRAPHICAL AND INDUSTRY CONCENTRATION
Where a Portfolio invests at least 25% of its assets in Bank Obligations,
the Portfolio's investments may be subject to greater risk than a Portfolio
that does not concentrate in the banking industry. In particular, Bank
Obligations may be subject to the risks associated with interest rate
volatility, changes in federal and state laws and regulations governing
banking and the inability of borrowers to pay principal and interest when due.
In addition, foreign banks present the risks of investing in foreign
securities generally and are not subject to reserve requirements and other
regulations comparable to those of U.S. Banks.
GOVERNMENT STRIPPED MORTGAGE-BACKED SECURITIES
Certain Portfolios may invest in Government Stripped Mortgage-Backed
Securities issued or guaranteed by the Government National Mortgage
Association ("GNMA"), Federal National Mortgage Association ("FNMA") and
Federal Home Loan Mortgage Corporation ("FHLMC"). These securities represent
beneficial ownership interests in either periodic principal distributions
("principal-only") or interest distributions ("interest-only") on mortgage-
backed certificates issued by GNMA, FNMA or FHLMC, as the case may be. The
certificates underlying the Government Stripped Mortgage-Backed Securities
represent all or part of the beneficial interest in pools of mortgage loans.
The Portfolios will invest in interest-only Government Stripped Mortgage-
Backed Securities in order to enhance yield or to benefit from anticipated
appreciation in value of the securities at times when the Adviser or
appropriate Sub-Adviser believes that interest rates will remain stable or
increase. In periods of rising interest rates, the value of interest-only
Government Stripped Mortgage-Backed Securities may be expected to increase
because of the diminished expectation that the underlying mortgages will be
prepaid. In this situation the expected increase in the value of interest-only
Government Stripped Mortgage-Backed Securities may offset all or a portion of
any decline in value of the portfolio securities of the Portfolios. Investing
in Government Stripped Mortgage-Backed Securities involves the risks normally
associated with investing in mortgage-backed securities issued by government
or government-related entities. See "Mortgage-Backed Securities" below. In
addition, the yields on interest-only and principal-only Government Stripped
Mortgage-Backed Securities are extremely sensitive to the prepayment
experience on the mortgage loans underlying the certificates collateralizing
the securities. If a decline in the level of prevailing interest
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rates results in a rate of principal prepayments higher than anticipated,
distributions of principal will be accelerated, thereby reducing the yield to
maturity on interest-only Government Stripped Mortgage-Backed Securities and
increasing the yield to maturity on principal-only Government Stripped
Mortgage-Backed Securities. Conversely, if an increase in the level of
prevailing interest rates results in a rate of principal prepayments lower
than anticipated, distributions of principal will be deferred, thereby
increasing the yield to maturity on interest-only Government Stripped
Mortgage-Backed Securities and decreasing the yield to maturity on principal-
only Government Stripped Mortgage-Backed Securities. Sufficiently high
prepayment rates could result in the Portfolio not fully recovering its
initial investment in an interest-only Government Stripped Mortgage-Backed
Security. Government Stripped Mortgage-Backed Securities are currently traded
in an over-the-counter market maintained by several large investment banking
firms. There can be no assurance that the Portfolio will be able to effect a
trade of a Government Stripped Mortgage-Backed Security at a time when it
wishes to do so. The Portfolios will acquire Government Stripped Mortgage-
Backed Securities only if a liquid secondary market for the securities exists
at the time of acquisition.
INTEREST RATE TRANSACTIONS
Certain Portfolios may engage in certain Interest Rate Transactions, such as
swaps, caps, floors and collars. Interest rate swaps involve the exchange with
another party of commitments to pay or receive interest (e.g., an exchange of
floating rate payments for fixed rate payments). The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds
a predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase
of an interest rate floor entitles the purchaser, to the extent that a
specified index falls below a predetermined interest rate, to receive payments
of interest on a notional principal amount from the party selling such
interest rate floor. An interest rate collar combines the elements of
purchasing a cap and selling a floor. The collar protects against an interest
rate rise above the maximum amount but gives up the benefits of an interest
rate decline below the minimum amount. The net amount of the excess, if any,
of a Portfolio's obligations over its entitlements with respect to each
interest rate swap will be accrued on a daily basis and an amount of cash or
liquid securities having an aggregate net asset value at least equal to the
accrued excess will be maintained in a segregated account with the Trust's
custodian. If there is a default by the other party to the transaction, the
Portfolio will have contractual remedies pursuant to the agreements related to
the transactions.
ILLIQUID SECURITIES
Up to 10% (15% for the OTC Portfolio and Total Return Portfolio) of the net
assets of a Portfolio may be invested in securities that are not readily
marketable, including, where applicable: (1) Repurchase Agreements with
maturities greater than seven calendar days; (2) time deposits maturing in
more than seven calendar days; (3) to the extent a liquid secondary market
does not exist for the instruments, futures contracts and options thereon; (4)
certain over-the-counter options, as described in the SAI; (5) certain
variable rate demand notes having a demand period of more than seven days; and
(6) securities the disposition of which is restricted under Federal securities
laws (excluding Rule 144A Securities, described below). The Portfolios will
not include for purposes of the restrictions on illiquid investments,
securities sold pursuant to Rule 144A under the Securities Act of 1933, as
amended, so long as such securities meet liquidity guidelines established by
the Trust's Board of Trustees. Under Rule 144A, securities which would
otherwise be restricted may be sold by persons other than issuers or dealers
to qualified institutional buyers.
INVESTMENT COMPANIES
When a Portfolio's Adviser or Sub-Adviser believes that it would be
beneficial for the Portfolio and appropriate under the circumstances, up to
10% of the Portfolio's assets may be invested in securities of mutual funds.
As a shareholder in any such mutual fund, the Portfolio will bear its ratable
share of the mutual fund's expenses, including management fees, and will
remain subject to the Portfolio's advisory and administration fees with
respect to the assets so invested.
LEASE OBLIGATION BONDS
Lease Obligation Bonds are mortgages on a facility that is secured by the
facility and are paid by a lessee over a long term. The rental stream to
service the debt as well as the mortgage are held by a collateral trustee on
behalf of the public bondholders. The primary risk of such instrument is the
risk of default. Under the lease indenture, the failure to pay rent is an
event of default. The remedy to cure default is to rescind the lease and sell
the assets. If the lease obligation is not readily marketable or market
quotations are not readily available, such lease obligations will be subject
to a Portfolio's limit on Illiquid Securities.
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LENDING OF SECURITIES
All of the Portfolios have the ability to lend portfolio securities to
brokers and other financial organizations. By lending its securities, a
Portfolio can increase its income by continuing to receive interest on the
loaned securities as well as by either investing the cash collateral in short-
term instruments or obtaining yield in the form of interest paid by the
borrower when U.S. Government Securities are used as collateral. These loans,
if and when made, may not exceed 20% of a Portfolio's total assets taken at
value. Loans of portfolio securities by a Portfolio will be collateralized by
cash, irrevocable letters of credit or U.S. Government Securities that are
maintained at all times in an amount at least equal to the current market
value of the loaned securities. Any gain or loss in the market price of the
securities loaned that might occur during the term of the loan would be for
the account of the Portfolio involved. Each Portfolio's Adviser or Sub-Adviser
will monitor on an ongoing basis the credit worthiness of the institutions to
which the Portfolio lends securities.
LOWER-RATED SECURITIES
Certain Portfolios may invest in debt securities rated in the lower NRSRO
categories (e.g., BBB- by S&P or Baa3 by Moody's), or of equivalent quality as
determined by the Adviser or Sub-Adviser. Securities rated BB+, Ba1 or lower
are commonly referred to as high yield securities or "junk bonds."
Securities rated below investment grade as well as unrated securities are
often considered to be speculative and usually entail greater risk (including
the possibility of default or bankruptcy of the issuers). Such securities
generally involve greater price volatility and risk of principal and income,
and may be less liquid, than securities in higher rated categories. Both price
volatility and illiquidity may make it difficult for the Portfolio to value
certain of these securities at certain times and these securities may be
difficult to sell under certain market conditions. Prices for securities rated
below investment grade may be affected by legislative and regulatory
developments. (See SAI for additional information pertaining to lower-rated
securities including risks.)
MORTGAGE-BACKED SECURITIES
Certain of the Portfolios may invest in Mortgage-Backed Securities, which
represent an interest in a pool of mortgage loans. The primary government
issuers or guarantors of Mortgage-Backed Securities are GNMA, FHMA and FHLMC.
Mortgage-Backed Securities provide a monthly payment consisting of interest
and principal payments. Additional payments may be made out of unscheduled
repayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs that may be
incurred. Prepayments of principal on Mortgage-Backed Securities may tend to
increase due to refinancing of mortgages as interest rates decline. Prompt
payment of principal and interest on GNMA mortgage pass-through certificates
is backed by the full faith and credit of the U.S. government. FNMA guaranteed
mortgage pass-through certificates and FHLMC participation certificates are
solely the obligations of those entities but are supported by the
discretionary authority of the U.S. Government to purchase the agencies'
obligations. Collateralized Mortgage Obligations are a type of bond secured by
an underlying pool of mortgages or mortgage pass-through certificates that are
structured to direct payments on underlying collateral to different series or
classes of the obligations.
To the extent that a Portfolio purchases mortgage-related or mortgage-backed
securities at a premium, prepayments may result in some loss of the
Portfolio's principal investment to the extent of the premium paid. The yield
of the Portfolio may be affected by reinvestment of prepayments at higher or
lower rates than the original investment. In addition, like other debt
securities, the value of mortgage-related securities, including government and
government-related mortgage pools, will generally fluctuate in response to
market interest rates.
NEW ISSUERS
A Portfolio may invest up to 5% (except for the OTC Portfolio which may
invest without limitation) of its assets in the securities of issuers which
have been in continuous operation for less than three years.
OPTIONS ON SECURITIES
Option Purchase. Certain Portfolios may purchase put and call options on
portfolio securities in which they may invest that are traded on a U.S. or
foreign securities exchange or in the over-the-counter market. A Portfolio may
utilize up to 10% of its assets to purchase put options on portfolio
securities and may do so at or about the same time that it purchases the
underlying security or at a later time and may also utilize up to 10% of its
assets to purchase call options on securities in which it is authorized to
invest. By buying a put, the Portfolios limit their risk of loss from a
decline in the market value of the security until the put expires. Any
appreciation in the value of the underlying security, however, will be
partially offset by the amount of the premium paid for the put option and any
related transaction costs. Call options may be purchased by the Portfolio in
order to acquire the underlying securities for the Portfolio at a price that
avoids any additional cost that
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would result from a substantial increase in the market value of a security.
The Portfolios may also purchase call options to increase their return to
investors at a time when the call is expected to increase in value due to
anticipated appreciation of the underlying security. Prior to their
expirations, put and call options may be sold in closing sale transactions
(sales by the Portfolio, prior to the exercise of options that it has
purchased, of options of the same series), and profit or loss from the sale
will depend on whether the amount received is more or less than the premium
paid for the option plus the related transaction costs.
Covered Option Writing. Certain Portfolios may write put and call options on
securities for hedging purposes. The Portfolios realize fees (referred to as
"premiums") for granting the rights evidenced by the options. A put option
embodies the right of its purchaser to compel the writer of the option to
purchase from the option holder an underlying security at a specified price at
any time during the option period. In contrast, a call option embodies the
right of its purchaser to compel the writer of the option to sell to the
option holder an underlying security at a specified price at anytime during
the option period.
Upon the exercise of a put option written by a Portfolio, the Portfolio may
suffer a loss equal to the difference between the price at which the Portfolio
is required to purchase the underlying security and its market value at the
time of the option exercise, less the premium received for writing the option.
Upon the exercise of a call option written by the Portfolio, the Portfolio may
suffer a loss equal to the excess of the security's market value at the time
of the option exercise over the Portfolio's acquisition cost of the security,
less the premium received for writing the option.
Each Portfolio will comply with regulatory requirements of the SEC and the
Commodity Futures Trading Commission with respect to coverage of options and
futures positions by registered investment companies and, if the guidelines so
require, will set aside cash and/or appropriate liquid assets in a segregated
custodial account in the amount prescribed. Securities held in a segregated
account cannot be sold while the futures or options position is outstanding,
unless replaced with other permissible assets. As a result, there is a
possibility that the segregation of a large percentage of a Portfolio's assets
may force the Portfolio to close out futures and options positions and/or
liquidate other portfolio securities, any of which may occur at
disadvantageous prices, in order for the Portfolio to meet redemption requests
or other current obligations.
The principal reason for writing covered call and put options on a
securities portfolio is to attempt to realize, through the receipt of
premiums, a greater return than would be realized on the securities alone. In
return for a premium, the writer of a covered call option forfeits the rights
to any appreciation in the value of the underlying security above the strike
price for the life of the option (or until a closing purchase transaction can
be effected). Nevertheless, the call writer retains the risk of a decline in
the price of the underlying security. Similarly, the principal reason for
writing covered put options is to realize income in the form of premiums. The
writer of the covered put option accepts the risk of a decline in the price of
the underlying security. The size of the premiums that the Portfolios may
receive may be adversely affected as new or existing institutions, including
other investment companies, engage in or increase their option-writing
activities.
The Portfolios may engage in closing purchase transactions to realize a
profit, to prevent an underlying security from being called or put or, in the
case of a call option, to unfreeze an underlying security (thereby permitting
its sale or the writing of a new option on the security prior to the
outstanding option's expiration). To effect a closing purchase transaction,
the Portfolios would purchase, prior to the holder's exercise of an option
that the Portfolio has written, an option of the same series as that on which
the Portfolio desires to terminate its obligation. The obligation of the
Portfolio under an option that it has written would be terminated by a closing
purchase transaction, but the Portfolio would not be deemed to own an option
as the result of the transaction. There can be no assurance that the Portfolio
will be able to effect closing purchase transactions at a time when it wishes
to do so. The ability of the Portfolio to engage in closing transactions with
respect to options depends on the existence of a liquid secondary market.
While the Portfolio will generally purchase or write options only if there
appears to be a liquid secondary market for the options purchased or sold, for
some options no such secondary market may exist or the market may cease to
exist. To facilitate closing purchase transactions, however, the Portfolio
will ordinarily write options only if a secondary market for the options
exists on a U.S. securities exchange or in the over-the-counter market.
Option writing for the Portfolios may be limited by position and exercise
limits established by U.S. securities exchanges and the National Association
of Securities Dealers, Inc. and by requirements of the Code for qualification
as a regulated investment company. In addition to writing covered put and call
options to generate current income, the Portfolios may enter into options
transactions as hedges to reduce investment risk, generally by making an
investment expected to move in the opposite direction of a portfolio position.
A hedge is designed to offset a loss on a portfolio position with a gain on
the hedge position; at the same time, however, a properly correlated hedge
will result in a gain on the portfolio position's being offset by a loss on
the hedge position. The Portfolios bear the risk that the prices of the
securities being hedged will not move in the same amount as the hedge. A
Portfolio will engage in hedging transactions only when deemed advisable by
its Adviser or Sub-Adviser. Successful use by the Portfolio of options will
depend on its Adviser's or Sub-Adviser's ability to
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correctly predict movements in the direction of the stock underlying the
option used as a hedge. Losses incurred in hedging transactions and the costs
of these transactions will adversely affect the Portfolio's performance.
OPTIONS ON FOREIGN CURRENCIES
A Portfolio may purchase and write put and call options on foreign
currencies for the purpose of hedging against declines in the U.S. dollar
value of foreign currency-denominated portfolio securities and against
increases in the U.S. dollar cost of such securities to be acquired.
Generally, transactions relating to Options on Foreign Currencies occur in the
over-the-counter market. As in the case of other kinds of options, however,
the writing of an option on a foreign currency constitutes only a partial
hedge, up to the amount of the premium received, and the Portfolio could be
required to purchase or sell foreign currencies at disadvantageous exchange
rates, thereby incurring losses. The purchase of an option on a foreign
currency may constitute an effective hedge against fluctuations in exchange
rates, although, in the event of rate movements adverse to the Portfolio's
position, it may forfeit the entire amount of the premium plus related
transaction costs. There is no specific percentage limitation on the
Portfolio's investments in Options on Foreign Currencies. See the SAI for
further discussion of the use, risks and costs of Options on Foreign
Currencies and Over the Counter Options.
OPTIONS ON INDEXES
A Portfolio may, subject to applicable securities regulations, purchase and
write put and call options on stock and fixed-income indexes listed on foreign
and domestic stock exchanges. A stock index fluctuates with changes in the
market values of the stocks included in the index. An example of a domestic
stock index is the Standard and Poor's 500 Stock Index. Examples of foreign
stock indexes are the Canadian Market Portfolio Index (Montreal Stock
Exchange), The Financial Times--Stock Exchange 100 (London Stock Exchange) and
the Toronto Stock Exchange Composite 300 (Toronto Stock Exchange). Examples of
fixed-income indexes include the Lehman Government/Corporate Bond Index and
the Lehman Treasury Bond Index.
Options on Indexes are generally similar to options on securities except
that the delivery requirements are different. Instead of giving the right to
take or make delivery of a security at a specified price, an option on an
index gives the holder the right to receive a cash "exercise settlement
amount" equal to (a) the amount, if any, by which the fixed exercise price of
the option exceeds (in the case of a put) or is less than (in the case of a
call) the closing value of the underlying index on the date of exercise,
multiplied by (b) a fixed "index multiplier." Receipt of this cash amount will
depend upon the closing level of the index upon which the option is based
being greater than, in the case of a call, or less than, in the case of a put,
the exercise price of the option. The amount of cash received will be equal to
such difference between the closing price of the index and the exercise price
of the option expressed in dollars or a foreign currency, as the case may be,
times a specified multiple. The writer of the option is obligated, in return
for the premium received, to make a delivery of this amount. The writer may
offset its position in index options prior to expiration by entering into a
closing transaction on an exchange or the option may expire unexercised.
The effectiveness of purchasing or writing options as a hedging technique
will depend upon the extent to which price movements in the portion of the
securities portfolio of a Portfolio correlate with price movements of the
stock index selected. Because the value of an index option depends upon
movements in the level of the index rather than the price of a particular
stock, whether a Portfolio will realize a gain or loss from the purchase or
writing of options on an index depends upon movements in the level of stock
prices in the stock market generally or, in the case of certain indexes, in an
industry or market segment, rather than movements in the price of a particular
stock. Accordingly, successful use of Options on Indexes by a Portfolio will
be subject to its Adviser's or Sub-Adviser's ability to predict correctly
movements in the direction of the market generally or of a particular
industry. This requires different skills and techniques than predicting
changes in the price of individual stocks.
Options on securities indexes entail risks in addition to the risks of
options on securities. Because exchange trading of options on securities
indexes is relatively new, the absence of a liquid secondary market to close
out an option position is more likely to occur, although a Portfolio generally
will only purchase or write such an option if the Adviser or Sub-Adviser
believes the option can be closed out. Because options on securities indexes
require settlement in cash, a Portfolio may be forced to liquidate portfolio
securities to meet settlement obligations. A Portfolio will engage in stock
index options transactions only when determined by its Adviser or Sub-Adviser
to be consistent with its efforts to control risk. There can be no assurance
that such judgement will be accurate or that the use of these portfolio
strategies will be successful.
OVER-THE-COUNTER OPTIONS
Certain Portfolios may write or purchase options in privately negotiated
domestic or foreign transactions ("OTC Options"), as well as exchange-traded
or "listed" options. OTC Options can be closed out only by agreement with the
other party to the transaction, and thus any OTC Options purchased by a
Portfolio will be considered an Illiquid Security. In
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addition, certain OTC Options on foreign currencies are traded through
financial institutions acting as market-makers in such options and the
underlying currencies.
The staff of the SEC has taken the position that purchased over-the-counter
options and assets used to cover written over-the-counter options are illiquid
and, therefore, together with other illiquid securities, cannot exceed a
certain percentage of a Portfolio's assets (the "SEC illiquidity ceiling").
Except as provided below, the Portfolios intend to write over-the-counter
options only with primary U.S. Government securities dealers recognized by the
Federal Reserve Bank of New York. Also, the contracts which such Portfolios
have in place with such primary dealers will provide that each Portfolio has
the absolute right to repurchase any option it writes at any time at a price
which represents the fair market value, as determined in good faith through
negotiation between the parties, but which in no event will exceed a price
determined pursuant to a formula in the contract. Although the specific
formula may vary between contracts with different primary dealers, the formula
will generally be based on a multiple of the premium received by the Portfolio
for writing the option, plus the amount, if any, of the option's intrinsic
value (i.e., the amount that the option is in-the-money). The formula may also
include a factor to account for the difference between the price of the
security and the strike price of the option if the option is written out-of-
money. A Portfolio will treat all or a part of the formula price as illiquid
for purposes of the SEC illiquidity ceiling. Certain Portfolios may also write
over-the-counter options with non-primary dealers, including foreign dealers,
and will treat the assets used to cover these options as illiquid for purposes
of such SEC illiquidity ceiling.
OTC Options entail risks in addition to the risks of exchange-traded
options. Exchange-traded options are in effect guaranteed by the Options
Clearing Corporation, while a Portfolio relies on the party from whom it
purchases an OTC Option to perform if the Portfolio exercises the option. With
OTC Options, if the transacting dealer fails to make or take delivery of the
securities or amount of foreign currency underlying an option it has written,
in accordance with the terms of that option, the Portfolio will lose the
premium paid for the option as well as any anticipated benefit of the
transaction. Furthermore, OTC Options are less liquid than exchange-traded
options.
REPURCHASE AGREEMENTS
Repurchase Agreements are agreements to purchase underlying debt obligations
from financial institutions, such as banks and broker-dealers, subject to the
seller's agreement to repurchase the obligations at an established time and
price. The collateral for such Repurchase Agreements will be held by the
Portfolio's custodian or a duly appointed sub-custodian. The Portfolio will
enter into Repurchase Agreements only with banks and broker-dealers that have
been determined to be creditworthy by the Trust's Board of Trustees under
criteria established in consultation with the Adviser and the Sub-Adviser. The
seller under a Repurchase Agreement would be required to maintain the value of
the obligations subject to the Repurchase Agreement at not less than the
repurchase price. Default by the seller would, however, expose the Portfolio
to possible loss because of adverse market action or delay in connection with
the disposition of the underlying obligations. In addition, if bankruptcy
proceedings are commenced with respect to the seller of the obligations, the
Portfolio may be delayed or limited in its ability to sell the collateral.
REVERSE REPURCHASE AGREEMENTS
Reverse Repurchase Agreements are the same as repurchase agreements except
that, in this instance, the Portfolios would assume the role of
seller/borrower in the transaction. The Portfolios will maintain segregated
accounts with the Custodian consisting of U.S. Government Securities, cash or
money market instruments that at all times are in an amount equal to their
obligations under Reverse Repurchase Agreements. Reverse Repurchase Agreements
involve the risk that the market value of the securities sold by a Portfolio
may decline below the repurchase price of the securities and, if the proceeds
from the reverse repurchase agreement are invested in securities, that the
market value of the securities sold may decline below the repurchase price of
the securities sold. Each Portfolio's Adviser or Sub-Adviser, acting under the
supervision of the Board of Trustees, reviews on an on-going basis the
creditworthiness of the parties with which it enters into Reverse Repurchase
Agreements. Under the 1940 Act, Reverse Repurchase Agreements may be
considered borrowings by the seller. Whenever borrowings by a fund, including
Reverse Repurchase Agreements, exceed 5% of the value of a Portfolio's total
assets, the Portfolio will not purchase any securities.
SMALL COMPANIES
Certain of the Portfolios may invest in small companies, some of which may
be unseasoned. Such companies may have limited product lines, markets, or
financial resources and may be dependent on a limited management group. While
the markets in securities of such companies have grown rapidly in recent
years, such securities may trade less frequently and in smaller volume than
more widely held securities. The values of these securities may fluctuate more
sharply than those of other securities, and a Portfolio may experience some
difficulty in establishing or closing out positions in these securities at
prevailing market prices. There may be less publicly available information
about the issuers of these securities or less market
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interest in such securities than in the case of larger companies, and it may
take a longer period of time for the prices of such securities to reflect the
full value of their issuers' underlying earnings potential or assets.
Some securities of smaller issuers may be restricted as to resale or may
otherwise be highly illiquid. The ability of a Portfolio to dispose of such
securities may be greatly limited, and a Portfolio may have to continue to
hold such securities during periods when the Adviser or a Sub-Adviser would
otherwise have sold the security. It is possible that the Adviser or a Sub-
Adviser or its affiliates or clients may hold securities issued by the same
issuers, and may in some cases have acquired the securities at different
times, on more favorable terms, or at more favorable prices, than a Portfolio
which it manages.
STRATEGIC TRANSACTIONS
Subject to the investment limitations and restrictions for each of the
Portfolios as stated elsewhere in the Prospectus and SAI of the Trust, certain
of the Portfolios may, but are not required to, utilize various investment
strategies as described in this Appendix to hedge various market risks, to
manage the effective maturity or duration of Fixed-Income Securities, or to
seek potentially higher returns. Utilizing these investment strategies, the
Portfolio may purchase and sell, to the extent not otherwise limited or
restricted for such Portfolio, exchange-listed and over-the-counter put and
call options on securities, equity and fixed-income indexes and other
financial instruments, purchase and sell financial futures contracts and
options thereon, enter into various Interest Rate Transactions such as swaps,
caps, floors or collars, and enter into various currency transactions such as
currency forward contracts, currency futures contracts, currency swaps or
options on currencies or currency futures (collectively, all the above are
called "Strategic Transactions").
Strategic Transactions may be used to attempt to protect against possible
changes in the market value of securities held in or to be purchased for the
Portfolio's portfolio resulting from securities markets or currency exchange
rate fluctuations, to protect the Portfolio's unrealized gains in the value of
its portfolio securities, to facilitate the sale of such securities for
investment purposes, to manage the effective maturity or duration of the
Portfolio's portfolio, or to establish a position in the derivatives markets
as a temporary substitute for purchasing or selling particular securities.
Some Strategic Transactions may also be used to seek potentially higher
returns, although no more than 5% of the Portfolio's assets will be used as
the initial margin or purchase price of options for Strategic Transactions
entered into for purposes other than "bona fide hedging" positions as defined
in the regulations adopted by the Commodity Futures Trading Commission. Any or
all of these investment techniques may be used at any time, as use of any
Strategic Transaction is a function of numerous variables including market
conditions. The ability of the Portfolio to utilize these Strategic
Transactions successfully will depend on the Adviser's or Sub-Adviser's
ability to predict, which cannot be assured, pertinent market movements. The
Portfolio will comply with applicable regulatory requirements when utilizing
Strategic Transactions. Strategic Transactions involving financial futures and
options thereon will be purchased, sold or entered into only for bona fide
hedging, risk management or portfolio management purposes.
U.S. GOVERNMENT SECURITIES
U.S. Government Securities include direct obligations of the U.S. Treasury
(such as U.S. Treasury bills, notes and bonds) and obligations directly issued
or guaranteed by U.S. Government agencies or instrumentalities. Some
obligations issued or guaranteed by agencies or instrumentalities of the U.S.
Government are backed by the full faith and credit of the U.S. Government
(such as GNMA certificates), others are backed only by the right of the issuer
to borrow from the U.S. Treasury (such as securities of Federal Home Loan
Banks) and still others are backed only by the credit of the instrumentality
(such as FNMA and FHLMC certificates).
WHEN ISSUED SECURITIES AND DELAYED-DELIVERY TRANSACTIONS
In order to secure yields or prices deemed advantageous at the time, certain
Portfolios may purchase or sell securities on a when-issued or a delayed-
delivery basis. The Portfolios will enter into a when-issued transaction for
the purpose of acquiring portfolio securities and not for the purpose of
leverage. In such transactions, delivery of the securities occurs beyond the
normal settlement periods, but no payment or delivery is made by, and no
interest accrues to, the Portfolios prior to the actual delivery or payment by
the other party to the transaction. Due to fluctuations in the value of
securities purchased on a when-issued or a delayed-delivery basis, the yields
obtained on such securities may be higher or lower than the yields available
in the market on the dates when the investments are actually delivered to the
buyers. Similarly, the sale of securities for delayed-delivery can involve the
risk that the prices available in the market when delivery is made may
actually be higher than those obtained in the transaction itself. A Portfolio
will establish a segregated account with the Custodian consisting of cash,
U.S. Government-securities or other high grade debt obligations in an amount
equal to the amount of its when-issued and delayed-delivery commitments.
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