Registration Nos. 33-81800
811-8644
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 29, 1999
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Post-Effective Amendment No. 8 /X/
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 10 /X/
(Check appropriate box or boxes)
VARIABLE INSURANCE FUNDS
(Exact name of Registrant as specified in charter)
3435 Stelzer Road
Columbus, Ohio 43219
(Address of Principal Executive Offices)
Registrant's Telephone Number, including Area Code: 1-800-257-5872
Keith T. Robinson
Dechert Price & Rhoads
1775 Eye Street, N.W.
Washington, D.C. 20006
(Name and address of agent for service)
Please send copies of all communications to:
Walter Grimm
BISYS Fund Services
3435 Stelzer Road
Columbus, Ohio 43219-3035
It is proposed that this filing will become effective (check appropriate box):
[ ] Immediately upon filing pursuant to paragraph (b)
[X] on September 30, 1999 pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
[X] This post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
<PAGE>
EXPLANATORY NOTE
This post-effective amendment no. 8 to the Registrant's registration
statement on Form N-1A (File Nos. 33-81800 and 811-8644) (the "Registration
Statement") incorporates by reference: (i) the prospectuses for the BB&T Growth
and Income Fund, AmSouth Select Equity Fund, and AmSouth Equity Income Fund,
each dated May 1, 1999, as filed with the Securities and Exchange Commission
(the "SEC") pursuant to Rule 497 under the Securities Act of 1933 on May 5,
1999; (ii) the prospectuses for BB&T Capital Manager Fund and AmSouth Regional
Equity Fund, each dated May 1, 1999, as filed with the SEC pursuant to Rule
485(b) under the Securities Act of 1933 on April 1, 1999; and (iii) the
statement of additional information describing the BB&T Growth and Income Fund,
BB&T Capital Manager Fund, AmSouth Regional Equity Fund, AmSouth Select Equity
Fund, and AmSouth Equity Income Fund, dated May 1, 1999, as filed with the SEC
pursuant to Rule 497 under the Securities Act of 1933 on May 13, 1999.
<PAGE>
Kent Variable Growth and Income Fund
Variable Insurance Funds
3435 Stelzer Road
Columbus, Ohio 43219-3035
1-800-__________
The Kent Variable Growth and Income Fund seeks long-term capital growth, with
current income as a secondary objective, by investing primarily in equity
securities of U.S. companies. The Fund's goals and investment program are
described in more detail inside. Lyon Street Asset Management Company ("Lyon
Street") serves as the Fund's investment adviser.
The Fund sells its shares to insurance company separate accounts, so that the
Fund may serve as an investment option under variable life insurance policies
and variable annuity contracts issued by insurance companies. The Fund also may
sell its shares to certain other investors, such as qualified pension and
retirement plans, insurance companies, and Lyon Street.
This prospectus should be read in conjunction with the separate account's
prospectus describing the variable insurance contract. Please read both
prospectuses and retain them for future reference.
The Securities and Exchange Commission has not approved the Fund's shares or
determined whether this prospectus is accurate or complete. Anyone who tells you
otherwise is committing a crime.
The date of this prospectus is October 1, 1999.
TABLE OF CONTENTS
RISK/RETURN SUMMARY AND FUND EXPENSES
Investment Objectives
Principal Investment Strategies
Principal Investment Risks
Fund Performance
Fund Expenses
INVESTMENT OBJECTIVES, STRATEGIES AND RISKS
VALUATION OF SHARES
PURCHASING AND REDEEMING SHARES
MANAGEMENT OF THE FUND
Investment Adviser
Administrator and Distributor
Servicing Agents
Year 2000
TAXATION
GENERAL INFORMATION
Description of the Trust and Its Shares
Similar Fund Performance Information
Miscellaneous
<PAGE>
RISK/RETURN SUMMARY AND FUND EXPENSES
Investment Objectives
The Fund seeks long-term capital growth, with current income as a secondary
objective.
Principal Investment Strategies
Under normal market conditions, the Fund will invest primarily in equity
securities of U.S. companies each having $100 million or more in market
capitalization, that are traded on the New York Stock Exchange, American Stock
Exchange or over-the-counter. The Fund intends to primarily invest its assets in
equity securities that Lyon Street believes have potential for capital growth,
and secondarily for income. A portion of the Fund's assets may be invested in
preferred stock or bonds convertible into common stock. The Fund expects to earn
current income mainly from stock dividends and from interest on convertible
bonds.
Principal Investment Risks
An investment in the Fund entails investment risk, including possible loss of
the principal amount invested. The Fund is subject to market risk, which is the
risk that the market value of a portfolio security may move up and down,
sometimes rapidly and unpredictably. This risk may be particularly acute for the
Fund's investments in equity securities. The Fund also is subject to interest
rate risk, which is the risk that changes in interest rates will affect the
value of the Fund's investments. In particular, the Fund's investments in fixed
income securities, such as convertible bonds and preferred stocks, generally
will change in value inversely with changes in interest rates. Also, the Fund's
investments, and particularly its investments in fixed income securities, may
expose it to credit risk, which is the risk that the issuer of a security will
default or not be able to meet its financial obligations.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
Fund Performance
Because the Fund has no investment track record, it has no performance
information to compare against other mutual funds or a broad measure of
securities market performance, such as an index.
Fund Expenses
The following expense table indicates the estimated expenses that an investor
will incur as a shareholder of the Fund during the current fiscal year. These
expenses are reflected in the share price of the Fund.
<PAGE>
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets)
Management Fees..........................................0.70%
Other Expenses...........................................0.83%
Total Annual Fund Operating Expenses.....................1.53%
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Expense Example
Use the following table to compare fees and expenses of the Fund to other
investment companies. It illustrates the amount of fees and expenses an investor
would pay, assuming (1) a $10,000 investment, (2) 5% annual return, (3)
redemption at the end of each time period, and (4) no changes in the Fund's
total operating expenses. It does not reflect separate account or insurance
contract fees and charges. An investor's actual costs may be different.
1 Year 3 Years
$156 $483
<PAGE>
INVESTMENT OBJECTIVES, STRATEGIES AND RISKS
Investors should be aware that the investments made by the Fund and the results
achieved by the Fund at any given time are not expected to be the same as those
made by other mutual funds for which Lyon Street acts as investment adviser,
including mutual funds with names, investment objectives and policies similar to
the Fund. Investors should carefully consider their investment goals and
willingness to tolerate investment risk before allocating their investment to
the Fund.
The Fund's investment objective is to seek long-term capital growth, with
current income as a secondary objective. While some equity securities may be
purchased primarily to achieve the Fund's investment objective for current
income, most equities will be purchased by the Fund primarily in pursuit of its
investment objective for long-term capital growth.
Lyon Street uses a flexible investment approach that allows investment in both
"growth" stocks and "value" stocks. Growth stocks typically offer strong revenue
and earnings potential and accompanying capital growth, with less dividend
income than value stocks. Value stocks are those that appear to be underpriced
based upon valuation measures. In evaluating prospective investments, Lyon
Street may consider broad economic, industry or market trends, company-specific
factors such as the market price of a company's securities relative to its
evaluation of the company's long-term earnings, asset value and cash flow
potential, and historical value measures such as price-earnings ratios, profit
margins and liquidation values. The Fund may invest in companies of any size,
although most stocks purchased will be issued by companies whose market
capitalizations are large relative to the entirety of the U.S. securities
markets and similar in size to the stocks represented in such broad market
indexes as the S&P 500(R) Index.
The Fund also utilizes convertible securities and preferred stocks, which
typically offer higher yields and good potential for capital appreciation. The
portion of the Fund's total assets invested in common stock, preferred stock,
and convertible securities varies according to Lyon Street's assessment of
market and economic conditions and outlook.
The Fund has the flexibility to make portfolio investments and engage in other
investment techniques that are different than its principal strategies mentioned
here. More information on the Fund's investment strategies may be found in the
Statement of Additional Information (see back cover).
The Fund's investment strategies may subject it to a number of risks, including
the following.
Market Risk. Although equities historically have outperformed other asset
classes over the long term, their prices tend to fluctuate more dramatically
over the shorter term. These movements may result from factors affecting
individual companies, or from broader influences like changes in interest rates,
market conditions, investor confidence or announcements of economic, political
or financial information. While potentially offering greater opportunities for
capital growth than larger, more established companies, the stocks of smaller
companies may be particularly volatile, especially during periods of economic
uncertainty. These companies may face less certain growth prospects, or depend
heavily on a limited line of products and services or the efforts of a small
number of key management personnel.
<PAGE>
The Fund may invest in securities issued by foreign companies. The securities of
foreign companies may pose risks in addition to, or to a greater degree than,
the risks described above. Foreign companies may be subject to disclosure,
accounting, auditing and financial reporting standards and practices that are
different from those to which U.S. issuers are subject. Accordingly, the Fund
may not have access to adequate or reliable company information. In addition,
political, economic and social developments in foreign countries and
fluctuations in currency exchange rates may affect the operations of foreign
companies or the value of their stocks.
To the extent the Fund concentrates its investments in growth stocks or value
stocks, it will be subject to the risks particular to each type of stock, as
well as the risk that the chosen stocks may underperform other types of stocks.
Growth stocks may be particularly susceptible to rapid price swings during
periods of economic uncertainty or in the event of earnings disappointments, and
they typically have less dividend income to cushion the effect of adverse market
conditions. Value stocks in theory limit downside risk because they are
underpriced. Of course, Lyon Street's success in moderating market risk cannot
be assured. There is no guarantee that a value stock is, in fact, undervalued,
or that the market will ever recognize its true value. In addition, to the
extent the Fund concentrates its investments in value stocks, the Fund may
produce more modest gains than stock funds with more aggressive investment
profiles.
Interest Rate Risk. Although the Fund's primary investment focus is stocks, it
may invest in fixed income securities, such as convertible bonds and preferred
stocks. Generally, the value of these securities will change inversely with
changes in interest rates. In addition, changes in interest rates may affect the
operations of the issuers of stocks in which the Fund invests. Rising interest
rates, which may be expected to lower the value of fixed income instruments and
negatively impact the operations of many issuers, generally exist during periods
of inflation or strong economic growth.
Credit Risk. The Fund's investments, and particularly investments in fixed
income securities, may be affected by the creditworthiness of issuers in which
the Fund invests. Changes in the financial strength, or perceived financial
strength, of a company may affect the value of its securities and, therefore,
impact the value of the Fund's shares.
The Fund may invest in lower rated convertible bonds. To a greater extent than
more highly rated securities, lower rated securities tend to reflect short-term
corporate, economic and market developments, as well as investor perceptions of
the issuer's credit quality. Lower rated securities may be especially
susceptible to real or perceived adverse economic and competitive industry
conditions. In addition, lower rated securities may be less liquid than higher
quality investments. Reduced liquidity may prevent the Fund from selling a
security at the time and price that would be most beneficial to the Fund.
<PAGE>
Temporary Investments. Lyon Street may temporarily invest up to 100% of the
Fund's assets in high quality, short-term money market instruments if it
believes adverse economic or market conditions, such as excessive volatility or
sharp market declines, justify taking a defensive investment posture. If the
Fund attempts to limit investment risk by temporarily taking a defensive
investment position, it may be unable to pursue its investment objectives during
that time, and it may miss out on some or all of an upswing in the securities
markets.
Please see the Statement of Additional Information for more detailed information
about the Fund, its investment strategies, and its risks.
VALUATION OF SHARES
The Fund prices its shares on the basis of the net asset value of the Fund,
which is determined as of the close of the New York Stock Exchange ("NYSE")
(generally 4:00 p.m. Eastern Time) on each Business Day (other than a day on
which there are insufficient changes in the value of the Fund's portfolio
securities to materially affect the Fund's net asset value or a day on which no
shares are tendered for redemption and no order to purchase any shares is
received). A Business Day is a day on which the NYSE is open for trading.
Currently, the NYSE is closed on the following holidays: New Year's Day, Martin
Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving and Christmas.
Net asset value per share for purposes of pricing sales and redemptions is
calculated by dividing the value of all securities and other assets belonging to
the Fund, less the liabilities charged to the Fund and any liabilities allocable
to the Fund, by the number of the Fund's outstanding shares. The net asset value
per share of the Fund will fluctuate as the value of the investment portfolio of
the Fund changes.
The securities in the Fund will be valued at market value. If market quotations
are not available, the securities will be valued by a method which the Board of
Trustees of Variable Insurance Funds (the "Trust") believes accurately reflects
fair value. For further information about valuation of investments, see the
Statement of Additional Information.
PURCHASING AND REDEEMING SHARES
Shares of the Fund are available for purchase by insurance company separate
accounts to serve as an investment medium for variable insurance contracts, and
by qualified pension and retirement plans, certain insurance companies, and Lyon
Street. Shares of the Fund are purchased or redeemed at the net asset value per
share next determined after receipt by the Fund's distributor of a purchase
order or redemption request. Transactions in shares of the Fund will be effected
only on a Business Day of the Fund.
<PAGE>
Payment for shares redeemed normally will be made within seven days. The Fund
intends to pay cash for all shares redeemed, but under conditions which make
payment in cash unwise, payment may be made wholly or partly in portfolio
securities at their then market value equal to the redemption price. A
shareholder may incur brokerage costs in converting such securities to cash.
Payment for shares may be delayed under extraordinary circumstances or as
permitted by the Securities and Exchange Commission in order to protect
remaining investors.
Investors do not deal directly with the Fund to purchase or redeem shares.
Please refer to the prospectus for the separate account for information on the
allocation of premiums and on transfers of accumulated value among sub-accounts
of the separate account that invests in the Fund.
The Fund currently does not foresee any disadvantages to investors if the Fund
served as an investment medium for both variable annuity contracts and variable
life insurance policies. However, it is theoretically possible that the interest
of owners of annuity contracts and insurance policies for which the Fund served
as an investment medium might at some time be in conflict due to differences in
tax treatment or other considerations. The Board of Trustees and each
participating insurance company would be required to monitor events to identify
any material conflicts between variable annuity contract owners and variable
life insurance policy owners, and would have to determine what action, if any,
should be taken in the event of such a conflict. If such a conflict occurred, an
insurance company participating in the Fund might be required to redeem the
investment of one or more of its separate accounts from the Fund, which might
force the Fund to sell securities at disadvantageous prices.
The Fund reserves the right to discontinue offering shares at any time. In the
event that the Fund ceases offering its shares, any investments allocated to the
Fund will, subject to any necessary regulatory approvals, be invested in another
portfolio of the Trust deemed appropriate by the Board of Trustees.
MANAGEMENT OF THE FUND
Investment Adviser
Lyon Street is the investment adviser of the Fund. Through its portfolio
management team, Lyon Street makes the day-to-day investment decisions for the
Fund and continuously reviews, supervises and administers the Fund's investment
program.
Lyon Street, a wholly owned subsidiary of Old Kent Bank, maintains offices at
111 Lyon Street, NW, Grand Rapids, Michigan 49503. Old Kent Bank is a wholly
owned subsidiary of Old Kent Financial Corporation, which is a financial
services company with total assets as of December 31, 1998 of approximately
$16.6 billion. Prior to 1998, the Investment Management Group ("IMG") at Lyon
Street managed assets as a division of Old Kent Bank. Old Kent Bank has managed
the assets of individual and institutional investors for over 100 years. Lyon
Street employs an experienced staff of professional investment analysts,
portfolio managers and traders, and uses several proprietary computer-based
systems in conjunction with fundamental analysis to identify investment
opportunities.
<PAGE>
Under an investment advisory agreement between the Trust and Lyon Street, the
Trust pays Lyon Street an investment advisory fee, computed daily and payable
monthly, at an annual rate equal to the lesser of: (a) 0.70% of the Fund's
average daily net assets; or (b) such amount as may from time to time be agreed
upon in writing by the Trust and Lyon Street.
Allan J. Meyers, CFA, the Chief Equity Officer at Lyon Street, is the person who
is primarily responsible for the management of the Fund. Mr. Meyers has over
twenty years of portfolio management experience, including fourteen years with
IMG.
Joseph T. Keating, President and Chief Investment Officer at Lyon Street, is
responsible for developing and implementing the Fund's investment policies. Mr.
Keating has over twenty-two years of portfolio management experience, including
eleven years with IMG.
Administrator and Distributor
BISYS Fund Services Ohio, Inc. is the administrator for the Fund, and BISYS Fund
Services acts as the Fund's principal underwriter and distributor. The address
of each is 3435 Stelzer Road, Columbus, Ohio 43219-3035.
See the Statement of Additional Information for further information about the
Fund's service providers.
Servicing Agents
The Trust has adopted a plan under which up to 0.25% of the Fund's average daily
net assets may be expended for support services to investors, such as
establishing and maintaining accounts and records, providing account
information, arranging for bank wires, responding to routine inquiries,
forwarding investor communications, assisting in the processing of purchase,
exchange and redemption requests, and assisting investors in changing account
designations and addresses. For expenses incurred and services provided, a
financial institution (or its affiliate) providing these services ("Servicing
Agent") may receive a fee from the Fund, computed daily and paid monthly, at an
annual rate of up to 0.25% of the average daily net assets of the Fund allocable
to variable insurance contracts owned by customers of the Servicing Agent. A
Servicing Agent may periodically waive all or a portion of its servicing fees
with respect to the Fund to increase the net income of the Fund available for
distribution as dividends.
<PAGE>
Year 2000
The services provided to the Fund by Lyon Street and the Fund's other service
providers (collectively, the "Service Providers") are dependent on those Service
Providers' computer systems. Many computer software and hardware systems in use
today cannot distinguish between the year 2000 and the year 1900 because of the
way dates are encoded and calculated (the "Year 2000 Issue"). The failure to
make this distinction could have a negative impact on the Service Providers'
ability to handle securities trades, price securities, and conduct general
account services on behalf of the Fund. The Trust is working with the Service
Providers to take steps that are reasonably designed to address the Year 2000
Issue with respect to computer systems relied on by the Fund. The Trust believes
that these steps will be sufficient to avoid any material adverse impact on the
Fund, although there can be no assurances. The costs or consequences of an
incomplete or an untimely resolution of the Year 2000 Issue are unknown to the
Trust and the Service Providers at this time, but could have a material adverse
impact on the operations of the Fund and the Service Providers. In addition, if
the value of a Fund investment is adversely affected by a Year 2000 problem, the
net asset value of the Fund may be affected as well.
TAXATION
To comply with regulations under the Internal Revenue Code, the Fund is required
to diversify its investments. Generally, the Fund will be required to diversify
its investments so that on the last day of each quarter of a calendar year no
more than 55% of the value of its total assets is represented by any one
investment, no more than 70% is represented by any two investments, no more than
80% is represented by any three investments, and no more than 90% is represented
by any four investments. For this purpose, securities of a given issuer
generally are treated as one investment, but each U.S. Government agency and
instrumentality is treated as a separate issuer. Any security issued,
guaranteed, or insured (to the extent so guaranteed or insured) by the U.S. or
an agency or instrumentality of the U.S. is treated as a security issued by the
U.S. Government or its agency or instrumentality, whichever is applicable.
If the Fund fails to meet this diversification requirement, income with respect
to variable insurance contracts invested in the Fund at any time during the
calendar quarter in which the failure occurred could become currently taxable to
the owners of the contracts. Similarly, income for prior periods with respect to
such contracts also could be taxable, most likely in the year of the failure to
achieve the required diversification. Other adverse tax consequences could also
ensue.
Reference is made to the prospectus for the separate account and variable
insurance contract for information regarding the federal income tax treatment of
distributions to the separate account. See the Statement of Additional
Information for more information on taxes.
GENERAL INFORMATION
Description of the Trust and Its Shares
Variable Insurance Funds was organized as a Massachusetts business trust in 1994
and currently consists of nine portfolios. The Board of Trustees of the Trust
may establish additional portfolios in the future. Under Massachusetts law,
shareholders could be held personally liable for the obligations of the Trust
under certain circumstances. However, the Trust's declaration of trust disclaims
liability of its shareholders and provides for indemnification out of Trust
property for all loss and expense of any shareholder held personally liable for
the obligations of the Trust. Accordingly, the risk of a shareholder incurring
financial loss on account of shareholder liability should be considered remote.
<PAGE>
Similar Fund Performance Information
The following table provides information concerning the historical total return
performance of the Institutional Class shares of the Kent Growth and Income Fund
(the "Similar Fund"), a series of the Kent Funds. The Similar Fund's investment
objectives, policies and strategies are substantially similar to those of the
Fund, and it is currently managed by the same portfolio manager. However, the
portfolio manager has not managed the Similar Fund for the entire period shown.
While the investment objectives, policies and risks of the Similar Fund and the
Fund are similar, they are not identical, and the performance of the Similar
Fund and the Fund will vary. The data is provided to illustrate the past
performance of Lyon Street in managing a substantially similar investment
portfolio and does not represent the past performance of the Fund or the future
performance of the Fund or its portfolio manager. Consequently, potential
investors should not consider this performance data as an indication of the
future performance of the Fund or of its portfolio manager.
The performance data shown below reflects the net operating expenses of the
Similar Fund, which are lower than the estimated operating expenses of the Fund.
Performance would have been lower for the Similar Fund if the Fund's expenses
were used. In addition, the Similar Fund, unlike the Fund, is not sold to
insurance company separate accounts to fund variable insurance contracts. As a
result, the performance results presented below do not take into account charges
or deductions against a separate account or variable insurance contract for cost
of insurance charges, premium loads, administrative fees, maintenance fees,
premium taxes, mortality and expense risk charges, or other charges that may be
incurred under a variable insurance contract for which the Fund serves as an
underlying investment vehicle. By contrast, investors with contract value
allocated to the Fund will be subject to charges and expenses relating to
variable insurance contracts and separate accounts.
The Similar Fund's performance data shown below is calculated in accordance with
standards prescribed by the Securities and Exchange Commission for the
calculation of average annual total return information. The investment results
of the Similar Fund presented below are unaudited and are not intended to
predict or suggest results that might be experienced by the Similar Fund or the
Fund. Share prices and investment returns will fluctuate reflecting market
conditions, as well as changes in company-specific fundamentals of portfolio
securities. The performance data for the benchmark index identified below does
not reflect the fees or expenses of the Similar Fund or the Fund.
<PAGE>
Average Annual Total Return for the Similar Fund and for Its Benchmark Index for
Periods Ended December 31, 1998
<TABLE>
<S> <C> <C> <C> <C> <C>
Similar Fund/Benchmark 1 Year 3 Years 5 Years Since Inception Inception Date
- ---------------------- ------ ------- ------- --------------- --------------
Kent Growth and Income Fund 28.07% 23.84% 20.83% 19.46% 11/2/92
S&P 500(R) Index* 28.60% 28.23% 24.06% 21.86% 10/31/92
- -----------------
* The Standard & Poor's 500 Composite Stock Price Index is an unmanaged
index containing common stocks of 500 industrial, transportation,
utility and financial companies, regarded as generally representative
of the U.S. stock market. The Index reflects income and distributions,
if any, but does not reflect fees, brokerage commissions, or other
expenses of investing.
# The Similar Fund performance information set forth above reflects fee
waivers and/or expense reimbursements. Absent such waivers and/or
reimbursements, Similar Fund performance would have been lower.
Miscellaneous
No person has been authorized to give any information or to make any
representations not contained in this prospectus in connection with the offering
made by this prospectus. If given or made, such information or representations
must not be relied upon as having been authorized by the Fund or its
distributor. This prospectus does not constitute an offering by the Fund or its
distributor in any jurisdiction in which such offering may not be lawfully made.
<PAGE>
For more information about the Fund, the following document is available free
upon request:
Statement of Additional Information (SAI): The SAI provides more detailed
information about the Fund, including its operations and investment policies. It
is incorporated by reference and is legally considered a part of this
prospectus.
- --------------------------------------------------------------------------------
An investor can get free copies of the SAI, or request other information and
discuss any questions about the Fund, by contacting a broker or bank that sells
an insurance contract that offers the Fund as an investment option. Or contact
the Fund at:
Variable Insurance Funds
3435 Stelzer Road
Columbus, Ohio 43219-3035
Telephone: 1-800-__________
- --------------------------------------------------------------------------------
Investors can review the SAI at the Public Reference Room of the Securities and
Exchange Commission. Investors can get text-only copies:
. For a fee, by writing the Public Reference Section of the Commission,
Washington, D.C. 20549-6009 or calling 1-800-SEC-0330.
. Free from the Commission's Website at http://www.sec.gov
Investment Company Act file no. 811-8644.
<PAGE>
HSBC Variable Growth and Income Fund
HSBC Variable Fixed Income Fund
HSBC Variable Cash Management Fund
Variable Insurance Funds
3435 Stelzer Road
Columbus, Ohio 43219-3035
1-888-467-8167
This prospectus describes three mutual funds offered by Variable Insurance Funds
(the "Trust"):
. HSBC Variable Growth and Income Fund, which seeks long-term growth of
capital and current income by investing primarily in common stocks,
preferred stocks, and convertible securities.
. HSBC Variable Fixed Income Fund, which seeks high current income
consistent with appreciation of capital by investing primarily in fixed
income securities.
. HSBC Variable Cash Management Fund, which seeks as high a level of
current income as is consistent with preservation of capital and
liquidity by investing in short-term, high quality money market
instruments.
The Funds' goals and investment programs are described in more detail inside.
HSBC Asset Management (Americas) Inc. ("HSBC") serves as the Funds' investment
adviser.
The Funds sell their shares to insurance company separate accounts, so that the
Funds may serve as an investment option under variable life insurance policies
and variable annuity contracts issued by insurance companies. The Funds also may
sell their shares to certain other investors, such as qualified pension and
retirement plans, insurance companies, and HSBC.
This prospectus should be read in conjunction with the separate account's
prospectus describing the variable insurance contract. Please read both
prospectuses and retain them for future reference.
The Securities and Exchange Commission has not approved the Funds' shares or
determined whether this prospectus is accurate or complete. Anyone who tells you
otherwise is committing a crime.
The date of this prospectus is October 1, 1999.
<PAGE>
TABLE OF CONTENTS
RISK/RETURN SUMMARIES AND FUND EXPENSES
HSBC VARIABLE GROWTH AND INCOME FUND
HSBC VARIABLE FIXED INCOME FUND
HSBC VARIABLE CASH MANAGEMENT FUND
INVESTMENT OBJECTIVES AND STRATEGIES
HSBC VARIABLE GROWTH AND INCOME FUND
HSBC VARIABLE FIXED INCOME FUND
HSBC VARIABLE CASH MANAGEMENT FUND
RISK CONSIDERATIONS
VALUATION OF SHARES
PURCHASING AND REDEEMING SHARES
MANAGEMENT OF THE FUNDS
INVESTMENT ADVISER
PORTFOLIO MANAGERS
ADMINISTRATOR AND DISTRIBUTOR
SERVICING AGENTS
YEAR 2000
TAXATION
GENERAL INFORMATION
DESCRIPTION OF THE TRUST AND ITS SHARES
SIMILAR FUND PERFORMANCE INFORMATION
MISCELLANEOUS
<PAGE>
RISK/RETURN SUMMARIES AND FUND EXPENSES
HSBC Variable Growth and Income Fund
Investment Objective
The Variable Growth and Income Fund seeks long-term growth of capital and
current income.
Principal Investment Strategies
Under normal market conditions, the Variable Growth and Income Fund will invest
primarily in common stocks, preferred stocks, and convertible securities. The
Fund may invest the balance of its assets in various types of fixed income
securities and in money market instruments.
HSBC selects securities for the portfolio that appear to be undervalued, some of
which will be income-producing. In selecting securities, HSBC uses quantitative
and fundamental research to identify stocks meeting either or both growth and
income criteria. Investments will be sold if they no longer meet the Fund's
criteria for income-oriented or growth-oriented instruments.
Principal Investment Risks
An investment in the Variable Growth and Income Fund entails risk, including
possible loss of the principal amount invested. The principal risks of investing
in the Fund include:
. Market Risk. The value of the Fund's investments will fluctuate as the
stock market fluctuates, sometimes rapidly and unpredictably, and
securities prices overall may decline over short or longer-term
periods. This risk may be particularly acute for the Fund's investments
in common stocks. Because the value of the Fund's investments will
fluctuate with market conditions, so will the value of an investment in
the Fund. Additionally, there is the risk that stocks selected because
they represent value will remain undervalued or out of favor.
. Interest Rate Risk. Changes in interest rates will affect the value of
the Fund's investments. In particular, the Fund's investments in
income-producing, fixed income or debt securities, such as preferred
stocks or convertible securities, generally will change in value
inversely with changes in interest rates.
. Credit Risk. The issuer of a security may default or not be able to
meet its financial obligations. This risk may be particularly acute for
the Fund's investments in income-producing, fixed income or debt
securities. The degree of risk for a particular security may be
reflected in its credit rating.
. Prepayment Risk. Risk that the principal amount of the mortgage or
other asset underlying an asset-backed security in which the Fund
invests (if any) may be repaid prior to the bond's maturity date, which
is particularly likely to occur if interest rates decline. When such
repayment occurs, no additional interest will be paid on the
investment, and the Fund may be exposed to potentially lower returns
upon subsequent reinvestment of the principal.
. Security-Specific Risk. An issuer of a portfolio investment may be
unable to achieve its earnings or growth expectations.
<PAGE>
An investment in the Variable Growth and Income Fund is not a bank deposit and
is not insured or guaranteed by the Federal Deposit Insurance Corporation or any
other government agency.
Fund Performance
Because the Variable Growth and Income Fund has no investment track record, it
has no performance information to compare against other mutual funds or a broad
measure of securities market performance, such as an index. However, HSBC's
track record in managing a similar mutual fund is discussed under "General
Information."
Fund Expenses
The following expense table indicates the estimated expenses that an investor
will incur as a shareholder of the Variable Growth and Income Fund during the
current fiscal year. These expenses are reflected in the share price of the
Fund.
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets)
Management Fees*........................................0.55%
Other Expenses*.........................................0.93%
Total Annual Fund Operating Expenses*...................1.48%
- ---------------------
*HSBC currently limits its management fees to 0.33%, and other expenses
currently are being limited to 0.82%. Total expenses after fee waivers and
expense reimbursements are 1.15%. Investors will be notified of any material
revision or cancellation of a fee waiver or expense reimbursement, which may be
terminated at any time at the option of the Fund.
Expense Example
Use the following table to compare fees and expenses of the Variable Growth and
Income Fund to other investment companies. The table illustrates the amount of
fees and expenses an investor would pay assuming (1) a $10,000 investment, (2)
5% annual return, (3) redemption at the end of each time period, and (4) no
changes in the Fund's total operating expenses. It does not reflect separate
account or insurance contract fees and charges. An investor's actual costs may
be different.
1 Year 3 Years
$151 $468
<PAGE>
HSBC Variable Fixed Income Fund
Investment Objective
The Variable Fixed Income Fund seeks high current income consistent with
appreciation of capital.
Principal Investment Strategies
Under normal market conditions, the Variable Fixed Income Fund will invest
primarily in investment grade fixed income securities, which includes securities
rated at least Baa by Moody's Investors Service ("Moody's") or BBB by Standard
and Poor's Ratings Services ("S&P"), or securities of comparable quality.
HSBC selects securities based on various factors, including outlook for the
economy and anticipated changes in interest rates and inflation. HSBC will
consider selling those securities that no longer meet the Fund's criteria for
investment.
Principal Investment Risks
An investment in the Variable Fixed Income Fund entails risk, including possible
loss of the principal amount invested. The principal risks of investing in the
Fund include:
. Market Risk. The value of the Fund's investments will fluctuate as the
securities market fluctuates, sometimes rapidly and unpredictably, and
securities prices overall may decline over short or longer-term
periods. Because the value of the Fund's investments will fluctuate
with market conditions, so will the value of an investment in the Fund.
. Interest Rate Risk. Changes in interest rates will affect the value of
the Fund's investments. In particular, the Fund's investments in fixed
income and debt securities generally will change in value inversely
with changes in interest rates. Interest rate risk may be greater for
the Fund's investments in mortgage-related securities because when
interest rates rise, the duratio of these types of securities tend
to lengthen, and the value of the securities decreases more
significantly.
. Credit Risk. The issuer of a security may default or not be able to
meet its financial obligations. The degree of risk for a particular
security may be reflected in its credit rating. Credit risk includes
the possibility that the Fund's investments will have their credit
ratings downgraded.
. Prepayment Risk. The principal amount of the mortgage or other asset
underlying as asset-backed security may be repaid prior to the bond's
maturity date, which is particularly likely to occur if interest rates
decline. When such repayment occurs, no additional interest will be
paid on the investment, and the Fund may be exposed to potentially
lower returns upon subsequent reinvestment of the principal.
An investment in the Variable Fixed Income Fund is not a bank deposit and is not
insured or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
<PAGE>
Fund Performance
Because the Variable Fixed Income Fund has no investment track record, it has no
performance information to compare against other mutual funds or a broad measure
of securities market performance, such as an index. However, HSBC's track record
in managing a similar mutual fund is discussed under "General Information."
Fund Expenses
The following expense table indicates the estimated expenses that an investor
will incur as a shareholder of the Variable Fixed Income Fund during the current
fiscal year. These expenses are reflected in the share price of the Fund.
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets)
Management Fees*.............................................0.55%
Other Expenses*..............................................2.16%
Total Annual Fund Operating Expenses*........................2.71%
- ----------------------
*HSBC currently waives its entire management fee, and other expenses currently
are being limited to 1.15%. Total expenses after fee waivers and expense
reimbursements are 1.15%. Investors will be notified of any material revision or
cancellation of a fee waiver or expense reimbursement, which may be terminated
at any time at the option of the Fund.
Expense Example
Use the following table to compare fees and expenses of the Variable Fixed
Income Fund to other investment companies. It illustrates the amount of fees and
expenses an investor would pay, assuming (1) a $10,000 investment, (2) 5% annual
return, (3) redemption at the end of each time period, and (4) no changes in the
Fund's total operating expenses. It does not reflect separate account or
insurance contract fees and charges. An investor's actual costs may be
different.
1 Year 3 Years
$274 $841
<PAGE>
HSBC Variable Cash Management Fund
Investment Objective
The Variable Cash Management Fund seeks as high a level of current income as is
consistent with preservation of capital and liquidity.
Principal Investment Strategies
The Variable Cash Management Fund is a "money market fund" that seeks to
maintain a stable net asset value of $1.00 per share. The Fund pursues its
investment objective by investing in short-term, high quality money market
instruments. Under normal market conditions, the Variable Cash Management Fund
invests primarily in high quality obligations of banks, the U.S. Government, and
corporations. The Fund may concentrate its investments in bank obligations.
Principal Investment Risks
An investment in the Variable Cash Management Fund entails investment risk. The
principal risks of investing in the Fund include:
. Interest Rate Risk. Changes in interest rates will affect the value of
the Fund's investments. In particular, the Fund's investments generally
will change in value inversely with changes in interest rates.
. Credit Risk. The issuer of a security may default or not be able to
meet its financial obligations. The degree of risk for a particular
security may be reflected in its credit rating. Credit risk includes
the possibility that any of the Fund's investments will have their
credit ratings downgraded.
Although the Variable Cash Management Fund seeks to preserve the value of your
investment at $1.00 per share, it is possible to lose money by investing in the
Fund. An investment in the Variable Cash Management Fund is not a bank deposit
and is not insured or guaranteed by the Federal Deposit Insurance Corporation or
any other government agency.
Fund Performance
Because the Variable Cash Management Fund has no investment track record, it has
no performance information to compare against other mutual funds or a broad
measure of securities market performance. However, HSBC's track record in
managing a similar mutual fund is discussed under "General Information."
Fund Expenses
The following expense table indicates the estimated expenses that an investor
will incur as a shareholder of the Variable Cash Management Fund during the
current fiscal year. These expenses are reflected in the share price of the
Fund.
<PAGE>
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets)
Management Fees*...............................................0.35%
Other Expenses*................................................1.51%
Total Annual Fund Operating Expenses*..........................1.86%
- --------------------
*HSBC currently waives its entire management fee, and other expenses currently
are being limited to 0.93%. Total expenses after fee waivers and expense
reimbursements are 0.93%. Investors will be notified of any material revision or
cancellation of a fee waiver or expense reimbursement, which may be terminated
at any time at the option of the Fund.
Expense Example
Use the following table to compare fees and expenses of the Variable Cash
Management Fund to other investment companies. It illustrates the amount of fees
and expenses an investor would pay, assuming (1) a $10,000 investment, (2) 5%
annual return, (3) redemption at the end of each time period, and (4) no changes
in the Fund's total operating expenses. It does not reflect separate account or
insurance contract fees and charges. An investor's actual costs may be
different.
1 Year 3 Years
$189 $585
<PAGE>
INVESTMENT OBJECTIVES AND STRATEGIES
Investors should be aware that the investments made by a Fund and the results
achieved by a Fund at any given time are not expected to be the same as those
made by other mutual funds for which HSBC acts as investment adviser, including
mutual funds with names, investment objectives and policies similar to the Fund.
Investors should carefully consider their investment goals and willingness to
tolerate investment risk before allocating their investment to a Fund.
Each Fund has the flexibility to make portfolio investments and engage in other
investment techniques that are different than its principal strategies mentioned
here. More information on each Fund's investment strategies may be found in the
Statement of Additional Information (see back cover).
HSBC Variable Growth and Income Fund
The Variable Growth and Income Fund's investment objective is long-term growth
of capital and current income. The Fund seeks to achieve this objective by
investing primarily in common stocks, preferred stocks, and convertible
securities. The Fund may invest the balance of its assets in fixed income
securities and money market instruments, including U.S. Government securities,
corporate bonds, asset-backed and mortgage-backed securities, obligations of
savings and loans and U.S. and foreign banks, commercial paper, and related
repurchase agreements.
The Fund's criteria for selecting equity securities are the issuer's managerial
strength, competitive position, price to earnings ratio, profitability,
prospects for growth, underlying asset value and relative market value. HSBC
uses quantitative and fundamental research to identify stocks meeting either or
both growth and income criteria and selects securities for the portfolio that
appear to be undervalued. The Fund may invest in securities that appear to be
undervalued because the value or potential for growth has been overlooked by
many investors or because recent changes in the economy, industry or the company
have not yet been reflected in the price of the securities. In order to increase
the Fund's portfolio income, the Fund may invest in securities that provide
current dividends or, in the opinion of HSBC, have a potential for dividend
growth in the future. Investments will be sold if they no longer meet the Fund's
criteria for income-oriented or growth-oriented instruments.
The Variable Growth and Income Fund will place greater emphasis on capital
appreciation as compared to income, although changes in market conditions and
interest rates will cause the Fund to vary emphasis of these two elements of its
investment program in order to meet its investment objective.
HSBC Variable Fixed Income Fund
The Variable Fixed Income Fund's investment objective is high current income
consistent with appreciation of capital. The Fund normally invests primarily in
fixed income securities. The Fund expects to maintain an average quality rating
of its investment portfolio of Aa (Moody's) or AA (S&P), or equivalent quality.
The Fund currently has no policy with respect to its average portfolio maturity.
<PAGE>
The Variable Fixed Income Fund invests primarily in U.S. Government securities,
corporate bonds, asset-backed and mortgage-backed securities, obligations of
savings and loans and U.S. and foreign banks, commercial paper, and related
repurchase agreements. The Fund also may invest in mortgage-related securities
that are issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, as well as variable and floating rate debt securities meeting
its quality standards.
The Variable Fixed Income Fund selects its investments based upon an analysis of
various factors, including the outlook for the economy and anticipated changes
in interest rates and inflation. If a security held by the Fund has its rating
revoked or reduced below the Fund's quality standards, the Fund may continue to
hold the security. In these circumstances, however, HSBC will consider whether
the Fund should continue to hold the security. Lower rated and unrated
securities may be subject to greater credit risk and have greater price
volatility than securities in the higher rating categories.
HSBC Variable Cash Management Fund
The Variable Cash Management Fund seeks as high a level of current income as is
consistent with preservation of capital and liquidity. The Fund invests in a
broad range of short-term money market instruments including: (i) obligations
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities; (ii) variable rate demand and master demand notes; (iii)
certain repurchase agreements; (iv) negotiable certificates of deposit, bankers'
acceptances, time deposits, and other obligations issued or supported by U.S.
banks (including foreign branches) that have more than $1 billion in total
assets at the time of investment; (v) U.S. dollar-denominated obligations of
foreign banks (including U.S. branches) which at the time of investment have
more than $10 billion (or the equivalent in other currencies) in total assets
and branches or agencies in the United States, and which in the opinion of the
HSBC are of an investment quality comparable to obligations of U.S. banks which
may be purchased by the Fund and present minimal credit risk; (vi) domestic and
foreign commercial paper rated in the highest category by one or more nationally
recognized statistical rating organizations or rating agencies, or if unrated,
determined to be of comparable quality by HSBC; and (vii) investment grade
corporate debt securities.
The Variable Cash Management Fund may invest more than 25% of the current value
of its total assets in domestic bank obligations (including bank obligations
subject to repurchase agreements).
As a money market fund, the Variable Cash Management Fund must meet strict
requirements on the investment quality, maturity, and diversification of the
Fund's investments. Under applicable law, the Variable Cash Management Fund's
investments must have a remaining maturity of no more than 397 days, and its
investments must maintain on average weighted maturity that does not exceed 90
days.
<PAGE>
RISK CONSIDERATIONS
Each Fund's investment strategies may subject it to a number of risks, including
the following.
Market Risk (All Funds).
All of the Funds are subject, to some degree, to the risk that fluctuations in
the markets in which a Fund invests may affect the value of its investments.
This risk is most significant for the Variable Growth and Income Fund, which
invests primarily in stocks and other equity securities. Although equities
historically have outperformed other asset classes over the long term, their
prices tend to fluctuate more dramatically over the shorter term. These
movements may result from factors affecting individual companies, or from
broader influences like changes in interest rates, market conditions, investor
confidence or announcements of economic, political or financial information.
While potentially offering greater opportunities for capital growth than larger,
more established companies, the equities of smaller companies may be
particularly volatile, especially during periods of economic uncertainty. These
companies may face less certain growth prospects, or depend heavily on a limited
line of products and services or the efforts of a small number of key management
personnel.
The Variable Growth and Income Fund and the Variable Fixed Income Fund may
invest in securities issued by foreign companies. In addition, the Variable Cash
Management Fund may invest in U.S. dollar-denominated obligations (or credit and
liquidity enhancements) of foreign banks, foreign branches of U.S. banks, U.S.
branches of foreign banks, and commercial paper of foreign companies. The
securities of foreign companies may pose risks in addition to, or to a greater
degree than, the risks described above. Foreign companies may be subject to
disclosure, accounting, auditing and financial reporting standards and practices
that are different from those to which U.S. issuers are subject. Accordingly,
the Funds may not have access to adequate or reliable company information. In
addition, political, economic and social developments in foreign countries and
fluctuations in currency exchange rates may affect the operations of foreign
companies or the value of their securities.
Interest Rate Risk (All Funds).
Each Fund may invest in debt securities and fixed income securities. Generally,
the value of these securities will change inversely with changes in interest
rates. In addition, changes in interest rates may affect the operations of the
issuers of stocks in which the Variable Growth and Income Fund invests. Rising
interest rates, which may be expected to lower the value of fixed income
instruments and negatively impact the operations of many issuers, generally
exist during periods of inflation or strong economic growth.
The Variable Cash Management Fund invests only in short-term instruments, whose
value is less affected by changes in interest rates than securities with longer
maturities. However, it is possible that an increase in interest rates could
change the Fund's share price.
<PAGE>
Credit Risk (All Funds).
The Funds' investments, and particularly investments in fixed income securities,
may be affected by the creditworthiness of issuers in which the Funds invest.
Changes in the financial strength, or perceived financial strength, of a company
may affect the value of its securities and, therefore, impact the value of the
Funds' shares.
The Variable Growth and Income and Variable Fixed Income Fund may invest in
lower rated debt obligations, and the Variable Growth and Income Fund can invest
in comparably rated convertible securities. To a greater extent than more highly
rated securities, lower rated securities tend to reflect short-term corporate,
economic and market developments, as well as investor perceptions of the
issuer's credit quality. Lower rated securities may be especially susceptible to
real or perceived adverse economic and competitive industry conditions. In
addition, lower rated securities may be less liquid than higher quality
investments. Reduced liquidity may prevent a Fund from selling a security at the
time and price that would be most beneficial to the Fund.
The Variable Cash Management Fund invests in highly-rated securities to minimize
credit risk. Under applicable law, 95% of the Fund's holdings must be rated in
the highest credit category for money market instruments, and the remaining 5%
must be rated no lower than the second highest credit category.
Active Trading (Variable Growth and Income Fund and Variable Fixed Income Fund).
The Variable Growth and Income Fund and Variable Fixed Income Fund are actively
managed and, in some cases in response to market conditions, a Fund's portfolio
turnover may exceed 100%, which generally is considered to be a high rate of
portfolio turnover. A higher rate of portfolio turnover increases brokerage and
other expenses, which must be borne by a Fund and its shareholders, and may
negatively affect a Fund's performance.
Temporary Investments (Variable Growth and Income Fund and Variable Fixed Income
Fund).
HSBC may temporarily invest up to 100% of a Fund's assets in high quality,
short-term money market instruments if it believes adverse economic or market
conditions, such as excessive volatility or sharp market declines, justify
taking a defensive investment posture. If the Fund attempts to limit investment
risk by temporarily taking a defensive investment position, it may be unable to
pursue its investment objectives during that time, and it may miss out on some
or all of an upswing in the securities markets.
Concentration of Investments (Variable Cash Management Fund).
To the extent that the Variable Cash Management Fund concentrates its
investments in the domestic banking industry, it may be impacted by economic and
other factors affecting that industry, unlike other mutual funds that do not
concentrate in bank obligations.
<PAGE>
Please see the Statement of Additional Information for more detailed information
about the Funds, their investment strategies, and their risks.
VALUATION OF SHARES
Each Fund prices its shares on the basis of the net asset value of the Fund,
which is determined on each Business Day (other than a day on which there are
insufficient changes in the value of a Fund's portfolio securities to materially
affect the Fund's net asset value or a day on which no shares are tendered for
redemption and no order to purchase any shares is received). A Business Day is a
day on which the New York Stock Exchange ("NYSE") is open for trading.
Currently, the NYSE is closed on the following holidays: New Year's Day, Martin
Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving and Christmas. The Variable Growth and Income Fund
and the Variable Fixed Income Fund determine their net asset values as of the
close of the NYSE (generally 4:00 p.m., Eastern Time), while the Variable Cash
Management Fund determines its net asset value as of noon, Eastern Time.
Net asset value per share for purposes of pricing sales and redemptions is
calculated by dividing the value of all securities and other assets belonging to
a Fund, less the liabilities charged to the Fund and any liabilities allocable
to the Fund, by the number of the Fund's outstanding shares. The net asset value
per share of the Growth and Income Fund and the Variable Fixed Income Fund will
fluctuate as the value of the investment portfolio of the Fund changes.
The Variable Growth and Income Fund and Variable Fixed Income Fund value their
securities at market value. If market quotations are not available, the
securities will be valued by a method that the Board of Trustees of the Trust
believes accurately reflects fair value. The Variable Cash Management Fund
values its securities at their amortized cost. This method involves valuing an
instrument at its cost and thereafter applying a constant amortization to
maturity of any discount or premium, regardless of the impact of fluctuating
interest rates on the market value of the instrument.
For further information about valuation of investments, see the Statement of
Additional Information.
PURCHASING AND REDEEMING SHARES
Shares of each Fund are available for purchase by insurance company separate
accounts to serve as an investment medium for variable insurance contracts, and
by qualified pension and retirement plans, certain insurance companies, and
HSBC. Shares of a Fund are purchased or redeemed at the net asset value per
share next determined after receipt by the Fund's distributor of a purchase
order or redemption request. Transactions in shares of a Fund will be effected
only on a Business Day of the Fund.
Payment for shares redeemed normally will be made within seven days. Each Fund
intends to pay cash for all shares redeemed, but under conditions that make
payment in cash unwise, payment may be made wholly or partly in portfolio
securities at their then market value equal to the redemption price. A
shareholder may incur brokerage costs in converting such securities to cash.
Payment for shares may be delayed under extraordinary circumstances or as
permitted by the Securities and Exchange Commission in order to protect
remaining investors.
<PAGE>
Investors do not deal directly with the Funds to purchase or redeem shares.
Please refer to the prospectus for the separate account for information on the
allocation of premiums and on transfers of accumulated value among sub-accounts
of the separate accounts that invest in the Funds.
The Trust currently does not foresee any disadvantages to investors if the Funds
serve as an investment medium for both variable annuity contracts and variable
life insurance policies. However, it is theoretically possible that the interest
of owners of annuity contracts and insurance policies for which the Funds serve
as an investment medium might at some time be in conflict due to differences in
tax treatment or other considerations. The Board of Trustees and each
participating insurance company would be required to monitor events to identify
any material conflicts between variable annuity contract owners and variable
life insurance policy owners, and would have to determine what action, if any,
should be taken in the event of such a conflict. If such a conflict occurred, an
insurance company participating in a Fund might be required to redeem the
investment of one or more of its separate accounts from the Fund, which might
force the Fund to sell securities at disadvantageous prices.
Each Fund reserves the right to discontinue offering shares at any time. In the
event that a Fund ceases offering its shares, any investments allocated to the
Fund will, subject to any necessary regulatory approvals, be invested in another
portfolio of the Trust deemed appropriate by the Board of Trustees.
MANAGEMENT OF THE FUNDS
Investment Adviser
HSBC Asset Management (Americas) Inc., 140 Broadway, New York, NY, 10005, is the
adviser for the Funds. HSBC manages more than $4.7 billion of assets (June 30,
1999) of individuals, pension plans, corporations and institutions. Through its
portfolio management team, HSBC makes the day-to-day investment decisions and
continuously reviews, supervises and administers the Funds' investment programs.
Under an investment advisory agreement between the Trust and HSBC, the Trust
pays HSBC an investment advisory fee, computed daily and payable monthly, at an
annual rate equal to the lesser of the rates indicated below, or such amount as
may from time to time be agreed upon in writing by the Trust and HSBC.
<PAGE>
Percentage of
average daily net assets
- ------------------------------------- --------------------------------
Variable Growth and Income Fund .55%
- ------------------------------------- --------------------------------
Variable Fixed Income Fund .55%
- ------------------------------------- --------------------------------
Variable Cash Management Fund .35%
- ------------------------------------- --------------------------------
Portfolio Managers
Variable Growth and Income Fund: Mr. Fredric Lutcher III, Managing Director,
U.S. Equities, is responsible for the day-to-day management of the Variable
Growth and Income Fund. Prior to joining HSBC in late 1997, Mr. Lutcher worked
as Vice President and Senior Mutual Fund Portfolio Manager at Merrill Lynch
Asset Management for nine years.
Variable Fixed Income Fund and Variable Cash Management Fund: Edward J. Merkle,
Managing Director, Fixed Income is responsible for the day-to-day management of
the Variable Fixed Income Fund and the Cash Management Fund. Prior to joining
HSBC in 1986, Mr. Merkle served as Vice President in the money management
division at Bradford Trust and was the Senior Repo Trader at Shearson-American
Express.
Administrator and Distributor
BISYS Fund Services Ohio, Inc. is the administrator for the Funds, and BISYS
Fund Services acts as the Funds' principal underwriter and distributor. The
address of each is 3435 Stelzer Road, Columbus, Ohio 43219-3035.
See the Statement of Additional Information for further information about the
Funds' service providers.
Servicing Agents
The Trust has adopted a plan under which up to 0.25% of each Fund's average
daily net assets may be expended for support services to investors, such as
establishing and maintaining accounts and records, providing account
information, arranging for bank wires, responding to routine inquiries,
forwarding investor communications, assisting in the processing of purchase,
exchange and redemption requests, and assisting investors in changing account
designations and addresses. For expenses incurred and services provided, a
financial institution (or its affiliate) providing these services ("Servicing
Agent") may receive a fee from a Fund, computed daily and paid monthly, at an
annual rate of up to 0.25% of the average daily net assets of the Fund allocable
to variable insurance contracts owned by customers of the Servicing Agent. A
Servicing Agent may periodically waive all or a portion of its servicing fees
with respect to the Fund to increase the net income of the Fund available for
distribution as dividends.
<PAGE>
Year 2000
The services provided to the Funds by HSBC and the Funds' other service
providers (collectively, the "Service Providers") are dependent on those Service
Providers' computer systems. Many computer software and hardware systems in use
today cannot distinguish between the year 2000 and the year 1900 because of the
way dates are encoded and calculated (the "Year 2000 Issue"). The failure to
make this distinction could have a negative impact on the Service Providers'
ability to handle securities trades, price securities, and conduct general
account services on behalf of the Funds. The Trust is working with the Service
Providers to take steps that are reasonably designed to address the Year 2000
Issue with respect to computer systems relied on by the Funds. The Trust
believes that these steps will be sufficient to avoid any material adverse
impact on the Funds, although there can be no assurances. The costs or
consequences of an incomplete or an untimely resolution of the Year 2000 Issue
are unknown to the Trust and the Service Providers at this time, but could have
a material adverse impact on the operations of the Funds and the Service
Providers. In addition, if the values of a Fund's investments are adversely
affected by a Year 2000 problem, the net asset value of the Fund may be affected
as well.
TAXATION
To comply with regulations under the Internal Revenue Code, each Fund is
required to diversify its investments. Generally, each Fund will be required to
diversify its investments so that on the last day of each quarter of a calendar
year no more than 55% of the value of its total assets is represented by any one
investment, no more than 70% is represented by any two investments, no more than
80% is represented by any three investments, and no more than 90% is represented
by any four investments. For this purpose, securities of a given issuer
generally are treated as one investment, but each U.S. Government agency and
instrumentality is treated as a separate issuer. Any security issued,
guaranteed, or insured (to the extent so guaranteed or insured) by the U.S. or
an agency or instrumentality of the U.S. is treated as a security issued by the
U.S. Government or its agency or instrumentality, whichever is applicable.
If a Fund fails to meet this diversification requirement, income with respect to
variable insurance contracts invested in the Fund at any time during the
calendar quarter in which the failure occurred could become currently taxable to
the owners of the contracts. Similarly, income for prior periods with respect to
such contracts also could be taxable, most likely in the year of the failure to
achieve the required diversification. Other adverse tax consequences could also
ensue.
Reference is made to the prospectus for the separate account and variable
insurance contract for information regarding the federal income tax treatment of
distributions to the separate account. See the Statement of Additional
Information for more information on taxes.
<PAGE>
GENERAL INFORMATION
Description of the Trust and Its Shares
Variable Insurance Funds was organized as a Massachusetts business trust in 1994
and currently consists of nine portfolios. The Board of Trustees of the Trust
may establish additional portfolios in the future. Under Massachusetts law,
shareholders could be held personally liable for the obligations of the Trust
under certain circumstances. However, the Trust's declaration of trust disclaims
liability of its shareholders and provides for indemnification out of Trust
property for all loss and expense of any shareholder held personally liable for
the obligations of the Trust. Accordingly, the risk of a shareholder incurring
financial loss on account of shareholder liability should be considered remote.
Similar Fund Performance Information
The following table provides information concerning the historical total return
performance of the Class A shares of the Growth and Income Fund and Fixed Income
Fund, each a series of the HSBC Mutual Funds Trust, and the Cash Management
Fund, a series of HSBC Funds Trust (collectively, the "Similar Funds"), which
are similar to the HSBC Variable Growth and Income Fund, the HSBC Variable Fixed
Income Fund, and HSBC Variable Cash Management Fund, respectively. Each Similar
Fund's investment objectives, policies and strategies are substantially similar
to those of its corresponding Fund, and each is currently managed by the same
portfolio manager as the corresponding Fund. However, the portfolio managers of
the Growth and Income Fund and Fixed Income Fund have not managed the
corresponding Similar Funds for the entire period shown. While the investment
objectives, policies and risks of the Similar Funds and the Funds are similar,
they are not identical, and the performance of a Similar Fund and its
corresponding Fund will vary. The data is provided to illustrate the past
performance of HSBC in managing substantially similar investment portfolios and
does not represent the past performance of the Funds or the future performance
of the Funds or their portfolio managers. Consequently, potential investors
should not consider this performance data as an indication of the future
performance of the Funds or of their portfolio managers.
The performance data shown below reflects the net operating expenses of the
Similar Funds, which are comparable to the estimated net operating expenses of
the Funds. The Similar Funds, unlike the Funds, are not sold to insurance
company separate accounts to fund variable insurance contracts. As a result, the
performance results presented below do not take into account charges or
deductions against a separate account or variable insurance contract for cost of
insurance charges, premium loads, administrative fees, maintenance fees, premium
taxes, mortality and expense risk charges, or other charges that may be incurred
under a variable insurance contract for which the Funds serve as an underlying
investment vehicles. By contrast, investors with contract value allocated to the
Funds will be subject to charges and expenses relating to variable insurance
contracts and separate accounts.
<PAGE>
The Similar Funds' performance data shown below is calculated in accordance with
standards prescribed by the Securities and Exchange Commission for the
calculation of average annual total return information. The investment results
of the Similar Funds presented below are unaudited and are not intended to
predict or suggest results that might be experienced by the Similar Funds or the
Funds. Share prices and investment returns will fluctuate reflecting market
conditions, as well as changes in company-specific fundamentals of portfolio
securities. The performance data for the benchmarks identified below do not
reflect the fees or expenses of the Similar Funds or the Funds.
Average Annual Total Return for the Similar Funds and for Their Benchmarks for
Periods Ended December 31, 1998
<S>
Similar Fund/Benchmark 1 Year 3 Years 5 Years 10 Years
- ---------------------- ------ ------- ------- --------
Growth and Income Fund+ 20.63% 21.91% 18.54% 16.07%
Growth and Income Fund++ 26.97% 24.02% 19.76% 16.67%
S&P 500(R)Composite Index* 28.60% 28.23% 24.05% 17.19%
Since Inception
Similar Fund/Benchmark 1 Year 3 Years 5 Years (January 15, 1993)
- ---------------------- ------ ------- ------- ------------------
Fixed Income Fund+ 7.27% 4.61% 5.55% 6.10%
Fixed Income Fund++ 8.33% 6.31% 8.83% 6.97%
Lehman Brothers Aggregate Bond Index** 8.69% 7.29% 7.27% 8.49%
<PAGE>
Similar Fund/Benchmark 1 Year 3 Years 5 Years 10 Years
- ---------------------- ------ ------- ------- --------
Cash Management Fund 5.15% 5.11% 4.94% 5.45%
Lipper Money Market Fund Avg.*** 4.85% 4.87% 4.78% 5.22%
- -----------------
+ Assumes imposition of maximum front-end sales charge.
++ Absent imposition of maximum front-end sales charge.
* The Standard & Poor's 500 Composite Stock Price Index is an unmanaged
index containing common stocks of 500 industrial, transportation,
utility and financial companies, regarded as generally representative
of the U.S. stock market. The Index reflects income and distributions,
if any, but does not reflect fees, brokerage commissions, or other
expenses of investing.
** The Lehman Brothers Aggregate Bond Index is an unmanaged index
generally representative of the bond market as a whole. The Index
reflects income and distributions, if any, but does not reflect fees,
brokerage commissions, or other expenses of investing.
*** The Lipper Money Market Fund Average is a total return performance
average of funds tracked by Lipper Analytical Services, Inc. that
invest in high quality financial instruments (rated in the top two
grades) with dollar-weighted average maturities of less than 90 days.
It does not take into account sales charges.
# The Similar Fund performance information set forth above reflects fee
waivers and/or expense reimbursements. Absent such waivers and/or
reimbursements, Similar Fund performance would have been lower.
Miscellaneous
No person has been authorized to give any information or to make any
representations not contained in this prospectus in connection with the offering
made by this prospectus. If given or made, such information or representations
must not be relied upon as having been authorized by the Funds or its
distributor. This prospectus does not constitute an offering by the Funds or its
distributor in any jurisdiction in which such offering may not be lawfully made.
<PAGE>
For more information about the Funds, the following document is available free
upon request:
Statement of Additional Information (SAI): The SAI provides more detailed
information about each Fund, including its operations and investment policies.
It is incorporated by reference and is legally considered a part of this
prospectus.
- --------------------------------------------------------------------------------
An investor can get free copies of the SAI, or request other information and
discuss any questions about the Funds, by contacting a broker or bank that sells
an insurance contract that offers the Funds as an investment option. Or contact
the Funds at:
Variable Insurance Funds
3435 Stelzer Road
Columbus, Ohio 43219-3035
Telephone: 1-888-467-8167
- --------------------------------------------------------------------------------
Investors can review the SAI at the Public Reference Room of the Securities and
Exchange Commission. Investors can get text-only copies:
. For a fee, by writing the Public Reference Section of the Commission,
Washington, D.C. 20549-6009 or calling 1-800-SEC-0330.
. Free from the Commission's Website at http://www.sec.gov
Investment Company Act file no. 811-8644.
<PAGE>
Variable Insurance Funds
3435 Stelzer Road
Columbus, Ohio 43219-3035
(800) __________
STATEMENT OF ADDITIONAL INFORMATION
October 1, 1999
This Statement of Additional Information ("SAI") describes the Kent Variable
Growth and Income Fund (the "Fund"), a diversified investment portfolio of
Variable Insurance Funds (the "Trust").
The Trust offers an indefinite number of transferable units ("Shares") of the
Fund. Shares of the Fund may be sold to segregated asset accounts ("Separate
Accounts") of insurance companies to serve as the investment medium for variable
life insurance policies and variable annuity contracts ("Variable Contracts")
issued by the insurance companies. Shares of the Fund also may be sold to
qualified pension and retirement plans, certain insurance companies, and the
investment adviser of the Fund. The Separate Accounts invest in Shares of the
Fund in accordance with allocation instructions received from owners of the
Variable Contracts ("Variable Contract Owners").
This SAI is not a Prospectus and is authorized for distribution only when
preceded or accompanied by a Prospectus of the Fund, dated October 1, 1999, as
supplemented from time to time. This SAI contains more detailed information than
that set forth in a Prospectus and should be read in conjunction with the
Prospectus. This SAI is incorporated by reference in its entirety into each
Prospectus. Copies of a Prospectus may be obtained by writing the Trust at 3435
Stelzer Road, Columbus, Ohio 43219-3035, or by telephoning the toll free numbers
set forth above.
<PAGE>
TABLE OF CONTENTS
INVESTMENT OBJECTIVES AND POLICIES.......................................1
INVESTMENT RESTRICTIONS.................................................20
Portfolio Turnover.............................................21
NET ASSET VALUE.........................................................22
Valuation of the Fund..........................................22
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION..........................23
MANAGEMENT OF THE TRUST.................................................24
Trustees and Officers..........................................24
Investment Adviser.............................................26
Portfolio Transactions.........................................28
Glass-Steagall Act.............................................29
Administrator..................................................30
Expenses.......................................................31
Distributor....................................................31
Custodian, Transfer Agent and Fund Accounting Services.........32
Auditors.......................................................33
Legal Counsel..................................................33
ADDITIONAL INFORMATION..................................................33
Description of Shares..........................................33
Vote of a Majority of the Outstanding Shares...................34
Shareholder and Trustee Liability..............................35
Additional Tax Information.....................................35
Performance Information........................................37
Miscellaneous..................................................39
FINANCIAL STATEMENTS....................................................40
APPENDIX................................................................41
<PAGE>
The Trust is an open-end management investment company which currently offers
nine separate funds, each with different investment objectives. This SAI
contains information about the Kent Variable Growth and Income Fund, which is
advised by Lyon Street Asset Management Company ("Lyon Street").
Much of the information contained in this SAI expands upon subjects discussed in
the Prospectus of the Fund. Capitalized terms not defined herein are defined in
the Prospectus. No investment in the Fund should be made without first reading
the Fund's Prospectus.
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the investment objectives and policies of
the Fund as set forth in the Prospectus.
Bank Obligations. The Fund may invest in bank obligations consisting of bankers'
acceptances, certificates of deposit, and time deposits.
Bankers' acceptances are negotiable drafts or bills of exchange typically drawn
by an importer or exporter to pay for specific merchandise, which are "accepted"
by a bank, meaning, in effect, that the bank unconditionally agrees to pay the
face value of the instrument on maturity.
Certificates of deposit are negotiable certificates issued against funds
deposited in a commercial bank or a savings and loan association for a definite
period of time and earning a specified return.
Fixed time deposits are obligations of foreign branches of United States banks
or foreign banks which are payable on a stated maturity date and bear a fixed
rate of interest. Although fixed time deposits do not have a market, there are
no contractual restrictions on the right to transfer a beneficial interest in
the deposit to a third party.
The Fund may invest a portion of its assets in the obligations of foreign banks
and foreign branches of domestic banks. Such obligations include Eurodollar
Certificates of Deposit ("ECDs") which are U.S. dollar-denominated certificates
of deposit issued by offices of foreign and domestic banks located outside the
United States; Eurodollar Time Deposits ("ETDs") which are U.S.
dollar-denominated deposits in a foreign branch of a U.S. bank or a foreign
bank; Canadian Time Deposits ("CTDs") which are essentially the same as ETDs
except they are issued by Canadian offices of major Canadian banks; Schedule Bs,
which are obligations issued by Canadian branches of foreign or domestic banks;
Yankee Certificates of Deposit ("Yankee CDs") which are U.S. dollar-denominated
certificates of deposit issued by a U.S. branch of a foreign bank and held in
the United States; and Yankee Bankers' Acceptances ("Yankee BAs") which are U.S.
dollar-denominated bankers' acceptances issued by a U.S.
branch of a foreign bank and held in the United States.
<PAGE>
Although the Fund may invest in obligations of foreign banks or foreign branches
of U.S. banks only when the investment adviser deems the instrument to present
minimal credit risk, such investments nevertheless entail risks that are
different from those of investments in domestic obligations of U.S. banks. These
additional risks include future political and economic developments, the
possible imposition of withholding taxes on interest income, possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls, or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on such obligations. In
addition, foreign branches of U.S. banks and U.S. branches of foreign banks may
be subject to less stringent reserve requirements and to different accounting,
auditing, reporting and record keeping standards than those applicable to
domestic branches of U.S. banks.
Commercial Paper. Commercial paper consists of unsecured promissory notes issued
by corporations. Except as noted below with respect to variable amount master
demand notes, issues of commercial paper normally have maturities of less than
nine months and fixed rates of return.
The Fund may invest in short-term promissory notes (including variable amount
master demand notes) issued by corporations and other entities, such as
municipalities, rated at the time of purchase within the two highest categories
assigned by two nationally recognized statistical rating organization ("NRSRO")
(e.g., A-2 or better by Standard & Poor's Ratings Services ("S&P"), Prime-2 or
better by Moody's Investors Service, Inc. ("Moody's") or F-2 or better by Fitch
Investors Service ("Fitch")) or, if not rated, determined to be of comparable
quality to instruments that are so rated.
Commercial paper may include variable and floating rate instruments. Commercial
paper issues include securities issued by corporations without registration
under the Securities Act of 1933, as amended (the "1933 Act"), in reliance on
the exemption in Section 3(a)(3), and commercial paper issued in reliance on the
so-called "private placement" exemption in Section 4(2) ("Section 4(2) Paper").
Section 4(2) Paper is restricted as to disposition under the federal securities
laws in that any resale must similarly be made in an exempt transaction. Section
4(2) Paper is normally resold to other institutional investors through or with
the assistance of investment dealers which make a market in Section 4(2) Paper,
thus providing liquidity. For purposes of the Fund's limitation on purchases of
illiquid instruments, Section 4(2) Paper will not be considered illiquid if the
investment adviser has determined, in accordance with guidelines approved by the
Board of Trustees, that an adequate trading market exists for such securities.
<PAGE>
Variable Amount Master Demand Notes. The Fund may invest in variable amount
master demand notes, which are unsecured demand notes that permit the
indebtedness thereunder to vary and provide for periodic adjustments in the
interest rate according to the terms of the instrument. Because master demand
notes are direct lending arrangements between the Fund and the issuer, they are
not normally traded. Although there is no secondary market in the notes, the
Fund may demand payment of principal and accrued interest at any time. While the
notes are not typically rated by credit rating agencies, issuers of variable
amount master demand notes (which are normally manufacturing, retail, financial,
and other business concerns) must satisfy the same criteria as set forth above
for commercial paper. Lyon Street will consider the earning power, cash flow,
and other liquidity ratios of the issuers of such notes and will continuously
monitor their financial status and ability to meet payment on demand. In
determining dollar weighted average portfolio maturity, a variable amount master
demand note will be deemed to have a maturity equal to the longer of the period
of time remaining until the next interest rate adjustment or the period of time
remaining until the principal amount can be recovered from the issuer through
demand.
Variable And Floating Rate Demand Notes. The Fund may, from time to time, buy
variable or floating rate demand notes issued by corporations, bank holding
companies and financial institutions and similar taxable and tax-exempt
instruments issued by government agencies and instrumentalities. These
securities will typically have a maturity over one year but carry with them the
right of the holder to put the securities to a remarketing agent or other entity
at designated time intervals and on specified notice. The obligation of the
issuer of the put to repurchase the securities may be backed by a letter of
credit or other obligation issued by a financial institution. The purchase price
is ordinarily par plus accrued and unpaid interest. Generally, the remarketing
agent will adjust the interest rate every seven days (or at other specified
intervals) in order to maintain the interest rate at the prevailing rate for
securities with a seven-day or other designated maturity.
Short-Term Obligations. The Fund may invest in high quality short-term
obligations (with maturities of 12 months or less) such as domestic and foreign
commercial paper (including variable amount master demand notes), bankers'
acceptances, certificates of deposit, demand and time deposits of domestic and
foreign branches of U.S. banks and foreign banks, and repurchase agreements, in
order to acquire interest income combined with liquidity. Pending investment or
to meet anticipated redemption requests, the Fund may invest without limitation
in short-term obligations. For temporary defensive purposes, these investments
may constitute 100% of a Fund's portfolio and, in such circumstances, will
constitute a temporary suspension of its attempts to achieve its investment
objective.
Corporate Debt Securities. The Fund may invest in U.S. dollar-denominated debt
obligations issued or guaranteed by U.S. corporations or U.S. commercial banks,
U.S. dollar-denominated obligations of foreign issuers and debt obligations of
foreign issuers denominated in foreign currencies. Such debt obligations
include, among others, bonds, notes, debentures and variable rate demand notes.
In choosing corporate debt securities on behalf of a Fund, its investment
adviser may consider (i) general economic and financial conditions; (ii) the
specific issuer's (a) business and management, (b) cash flow, (c) earnings
coverage of interest and dividends, (d) ability to operate under adverse
economic conditions, (e) fair market value of assets, and (f) in the case of
foreign issuers, unique political, economic or social conditions applicable to
such issuer's country; and, (iii) other considerations deemed appropriate.
<PAGE>
The Fund will not purchase corporate debt securities rated below Baa by Moody's
or BBB by S&P or to the extent certain U.S. or foreign debt obligations are
unrated or rated by other rating agencies, are determined to be of comparable
quality ("Medium-Grade Securities"). While "Baa"/"BBB" and comparable unrated
securities may produce a higher return than higher rated securities, they are
subject to a greater degree of market fluctuation and credit risk than the
higher quality securities in which the Fund may invest and may be regarded as
having speculative characteristics as well.
As with other fixed-income securities, Medium-Grade Securities are subject to
credit risk and market risk. Market risk relates to changes in a security's
value as a result of changes in interest rates. Credit risk relates to the
ability of the issuer to make payments of principal and interest.
Medium-Grade Securities are generally subject to greater credit risk than
comparable higher-rated securities because issuers are more vulnerable to
economic downturns, higher interest rates or adverse issuer-specific
developments. In addition, the prices of Medium-Grade Securities are generally
subject to greater market risk and therefore react more sharply to changes in
interest rates. The value and liquidity of Medium-Grade Securities may be
diminished by adverse publicity and investor perceptions.
Because certain Medium-Grade Securities are traded only in markets where the
number of potential purchasers and sellers, if any, is limited, the ability of
the Fund to sell such securities at their fair market value either to meet
redemption requests or to respond to changes in the financial markets may be
limited.
Particular types of Medium-Grade Securities may present special concerns. The
prices of payment-in-kind or zero-coupon securities may react more strongly to
changes in interest rates than the prices of other Medium-Grade Securities. Some
Medium-Grade Securities in which the Fund may invest may be subject to
redemption or call provisions that may limit increases in market value that
might otherwise result from lower interest rates while increasing the risk that
the Fund may be required to reinvest redemption or call proceeds during a period
of relatively low interest rates.
The credit ratings issued by nationally recognized statistical rating
organization ("NRSROs") are subject to various limitations. For example, while
such ratings evaluate credit risk, they ordinarily do not evaluate the market
risk of Medium-Grade Securities. In certain circumstances, the ratings may not
reflect in a timely fashion adverse developments affecting an issuer. For these
reasons, an investment adviser will conduct their own independent credit
analysis of Medium-Grade Securities.
<PAGE>
After purchase, a security may cease to be rated or its rating may be reduced
below the minimum required for purchase by the Fund. Neither event will require
a sale of such security. However, Lyon Street will consider such event in its
determination of whether a Fund should continue to hold the security. A security
which has had its rating downgraded or revoked may be subject to greater risk to
principal and income, and often involve greater volatility of price, than
securities in the higher rating categories. Such securities are also subject to
greater credit risks (including, without limitation, the possibility of default
by or bankruptcy of the issuers of such securities) than securities in higher
rating categories.
Foreign Investments. The Fund may invest in foreign securities. Investment in
foreign securities is subject to special investment risks that differ in some
respects from those related to investments in securities of U.S. domestic
issuers. Such risks include political, social or economic instability in the
country of the issuer, the difficulty of predicting international trade
patterns, the possibility of the imposition of exchange controls, expropriation,
limits on removal of currency or other assets, nationalization of assets,
foreign withholding and income taxation, and foreign trading practices
(including higher trading commissions, custodial charges and delayed
settlements). Such securities may be subject to greater fluctuations in price
than securities issued by U.S. corporations or issued or guaranteed by the U.S.
Government, its agencies or instrumentalities. The markets on which such
securities trade may have less volume and liquidity, and may be more volatile
than securities markets in the U.S. In addition, there may be less publicly
available information about a foreign company than about a U.S. domiciled
company. Foreign companies generally are not subject to uniform accounting,
auditing and financial reporting standards comparable to those applicable to
U.S. domestic companies. There is generally less government regulation of
securities exchanges, brokers and listed companies abroad than in the U.S.
Confiscatory taxation or diplomatic developments could also affect investment in
those countries. In addition, foreign branches of U.S. banks, foreign banks and
foreign issuers may be subject to less stringent reserve requirements and to
different accounting, auditing, reporting, and recordkeeping standards than
those applicable to domestic branches of U.S. banks and U.S. domestic issuers.
Because foreign companies are not subject to uniform accounting, auditing and
financial reporting standards, practices and requirements comparable to those
applicable to U.S. companies, there may be less publicly available information
about a foreign company than about a U.S. company. Volume and liquidity in most
foreign bond markets are less than in the U.S., and securities of many foreign
companies are less liquid and more volatile than securities of comparable U.S.
companies. Fixed commissions on foreign securities exchanges are generally
higher than negotiated commissions on U.S. exchanges, although the Fund will
endeavor to achieve the most favorable net results on portfolio transactions.
There is generally less government supervision and regulation of securities
exchanges, brokers, dealers and listed companies than in the U.S., thus
increasing the risk of delayed settlements of portfolio transactions or loss of
certificates for portfolio securities.
<PAGE>
Foreign markets also have different clearance and settlement procedures, and in
certain markets, there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Such delays in settlement could result in temporary periods
when a portion of the assets of the Fund is uninvested and no return is earned
thereon. The inability of the Fund to make intended security purchases due to
settlement problems could cause the Fund to miss attractive investment
opportunities. Losses to a Fund due to subsequent declines in the value of
portfolio securities, or losses arising out of an inability to fulfill a
contract to sell such securities, could result in potential liability to the
Fund. In addition, with respect to certain foreign countries, there is the
possibility of expropriation or confiscatory taxation, political or social
instability, or diplomatic developments which could affect the investments in
those countries. Moreover, individual foreign economies may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross national
product, rate of inflation, capital reinvestment, resource self-sufficiency and
balance of payments position.
Additionally, the Fund may invest in countries with emerging economies or
securities markets. Political and economic structures in many of these countries
may be undergoing significant evolution and rapid development, and these
countries may lack the social, political and economic stability characteristics
of more developed countries. Some of these countries may have in the past failed
to recognize private property rights and have at time nationalized or
expropriated the assets of private companies. As a result, the risks described
above, including the risks of nationalization or expropriation of assets, may be
heightened. In addition, unanticipated political or social developments may
affect the value of investments in these countries and the availability to the
Fund of additional investments in emerging market countries. The small size and
inexperience of the securities markets in certain of these countries and the
limited volume of trading in securities in these countries may make investments
in the countries illiquid and more volatile than investments in more developed
countries. There may be little financial or accounting information available
with respect to issuers located in certain emerging market countries, and it may
be difficult as a result to assess the value or prospects of an investment in
such issuers.
In many instances, foreign debt securities may provide higher yields than
securities of domestic issuers which have similar maturities and quality. Under
certain market conditions these investments may be less liquid than the
securities of U.S. corporations and are certainly less liquid than securities
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities. Finally, in the event of a default of any such foreign debt
obligations, it may be more difficult to obtain or to enforce a judgment against
the issuers of such securities.
If a security is denominated in foreign currency, the value of the security to
the Fund will be affected by changes in currency exchange rates and in exchange
control regulations, and costs will be incurred in connection with conversions
between currencies. Currency risks generally increase in lesser developed
markets. Exchange rate movements can be large and can endure for extended
periods of time, affecting either favorably or unfavorably the value of the
Fund's assets. The value of the assets of the Fund as measured in U.S. dollars
may be affected favorably or unfavorably by changes in foreign currency exchange
rates and exchange control regulations.
A change in the value of any foreign currency against the U.S. dollar will
result in a corresponding change in the U.S. dollar value of securities
denominated in that currency. Such changes will also affect the income and
distributions to Shareholders of the Fund investing in securities that are not
U.S. dollar-denominated. In addition, although the Fund will receive income on
foreign securities in such currencies, the Fund will be required to compute and
distribute income in U.S. dollars. Therefore, if the exchange rate for any such
currency declines materially after income has been accrued and translated into
U.S. dollars, the Fund could be required to liquidate portfolio securities to
make required distributions. Similarly, if an exchange rate declines between the
time the Fund incurs expenses in U.S. dollars and the time such expenses are
paid, the amount of such currency required to be converted into U.S. dollars in
order to pay such expenses in U.S. dollars will be greater.
<PAGE>
For many foreign securities, U.S. dollar denominated American Depositary
Receipts ("ADRs"), which are traded in the United States on exchanges or
over-the-counter, are issued by domestic banks. ADRs represent the right to
receive securities of foreign issuers deposited in a domestic bank or a
correspondent bank. ADRs do not eliminate all the risk inherent in investing in
the securities of foreign issuers' stock. However, by investing in ADRs rather
than directly in foreign issuers' stock, the Fund can avoid currency risks
during the settlement period for either purchase or sales.
In general, there is a large, liquid market in the United States for many ADRs.
The information available for ADRs is subject to the accounting, auditing and
financial reporting standards of the domestic market or exchange on which they
are traded, which standards are more uniform and more exacting than those to
which many foreign issuers may be subject. Certain ADRs, typically those
denominated as unsponsored, require the holders thereof to bear most of the
costs of such facilities, while issuers of sponsored facilities normally pay
more of the costs thereof. The depository of an unsponsored facility frequently
is under no obligation to distribute shareholder communications received from
the issuer of the deposited securities or to pass through the voting rights to
facility holders with respect to the deposited securities, whereas the
depository of a sponsored facility typically distributes shareholder
communications and passes through the voting rights.
The Fund may invest in both sponsored and unsponsored ADRs and European
Depositary Receipts ("EDRs"), Global Depositary Receipts ("GDRs") and other
similar global instruments. EDRs, which are sometimes referred to as Continental
Depositary Receipts, are receipts issued in Europe, typically by foreign banks
and trust companies, that evidence ownership of either foreign or domestic
underlying securities. GDRs are depositary receipts structured like global debt
issues to facilitate trading on an international basis. Unsponsored ADR, EDR and
GDR programs are organized independently and without the cooperation of the
issuer of the underlying securities. As a result, available information
concerning the issuers may not be as current as for sponsored ADRs, EDRs, and
GDRs, and the prices of unsponsored depositary receipts may be more volatile
than if such instruments were sponsored by the issuer.
Securities Of Foreign Governments And Supranational Organizations. The Fund may
invest in U.S. dollar denominated debt securities issued by foreign governments,
their political subdivisions, governmental authorities, agencies and
instrumentalities and supranational organizations. A supranational organization
is an entity designated or supported by the national government of one or more
countries to promote economic reconstruction or development. Examples of
supranational organizations include, among others, the International Bank for
Reconstruction and Development (World Bank), the European Economic Community,
the European Coal and Steel Community, the European Investment Bank, the Inter-
American Development Bank, the Asian Development Bank, and the African
Development Bank. The Fund may also invest in "quasi-government securities"
which are debt obligations issued by entities owned by either a national, state
or equivalent government or are obligations of such a government jurisdiction
which are not backed by its full faith and credit and general taxing powers.
<PAGE>
Investing in foreign government and quasi-government securities involves
considerations and possible risks not typically associated with investing in
obligations issued by the U.S. Government. The values of foreign investments are
affected by changes in governmental administration or economic or monetary
policy (in the U.S. or other countries) or changed circumstances in dealings
between countries. In addition, investments in foreign countries could be
affected by other factors not present in the United States, including
expropriation, confiscatory taxation and lack of uniform accounting and auditing
standards.
Foreign Currency Transactions. The value of the assets of the Fund as measured
in U.S. dollars may be affected favorably or unfavorably by changes in foreign
currency exchange rates and exchange control regulations, and the Fund may incur
costs in connection with conversions between various currencies. The Fund will
conduct foreign currency exchange transactions either on a spot (i.e., cash)
basis at the spot rate prevailing in the foreign currency exchange market, or
through forward contracts to purchase or sell foreign currencies. A forward
foreign currency exchange contract ("forward currency contract") involves an
obligation 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 agreed upon by the
parties, at a price set at the time of the contract. These forward currency
contracts are traded directly between currency traders (usually large commercial
banks) and their customers. The Fund may enter into forward currency contracts
in order to hedge against adverse movements in exchange rates between
currencies.
By entering into a forward currency contract in U.S. dollars for the purchase or
sale of the amount of foreign currency involved in an underlying security
transaction, the Fund is able to protect itself against a possible loss between
trade and settlement dates resulting from an adverse change in the relationship
between the U.S. dollar and such foreign currency. However, this tends to limit
potential gains which might result from a positive change in such currency
relationships. The Fund also may hedge foreign currency exchange rate risk by
engaging in a currency financial futures and options transactions, which are
described below. The forecasting of short-term currency market movements is
extremely difficult and whether such a short-term heading strategy will be
successful is highly uncertain.
<PAGE>
It is impossible to forecast with precision the market value of portfolio
securities at the expiration of a forward currency contract. Accordingly, it may
be necessary for the Fund to purchase additional currency on the spot market if
the market value of the security is less than the amount of foreign currency the
Fund is obligated to deliver when a decision is made to sell the security and
make delivery of the foreign currency in settlement of a forward contract.
Conversely, it may be necessary to sell on the spot market some of the foreign
currency received upon the sale of the portfolio security if its market value
exceeds the amount of foreign currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an offsetting
transaction, it will incur a gain or a loss to the extent that there has been
movement in forward currency contract prices. If a Fund engages in an offsetting
transaction, it may subsequently enter into a new forward currency contract to
sell the foreign currency. Although such contracts tend to minimize the risk of
loss due to a decline in the value of the hedged currency, they also tend to
limit any potential gain which might result should the value of such currency
increase. The Fund will have to convert its holdings of foreign currencies into
U.S. dollars from time to time. Although foreign exchange dealers do not charge
a fee for conversion, they do realize a profit based on the difference (the
"spread") between the prices at which they are buying and selling various
currencies.
Standard & Poor's Depository Receipts. The Fund may invest in Standard & Poor's
Depository Receipts ("SPDRs"). SPDRs represent interests in trusts sponsored by
a subsidiary of the American Stock Exchange, Inc. and are structured to provide
investors proportionate undivided interests in a securities portfolio
constituting substantially all the common stocks (in substantially the same
weighting) as the component common stocks of a particular Standard & Poor's
Index ("S&P Index"), such as the S&P 500. SPDRs are not redeemable, but are
exchange traded. SPDRs represent interests in an investment company that is not
actively managed, and instead holds securities in an effort to track the
performance of the pertinent S&P Index and not for the purpose of selecting
securities that are considered superior investments. The results of SPDRs will
not replicate exactly the performance of the pertinent S&P Index due to
reductions in the SPDRs' performance attributable to transaction and other
expenses, including fees to service providers, borne by the SPDRs. SPDRs
distribute dividends on a quarterly basis. The Fund must limit investments in an
SPDR to 5% of its total assets and 3% of the outstanding voting securities of
the SPDR issuer. Moreover, the Fund's investments in SPDRs, when aggregated with
all other investments in investment companies, may not exceed 10% of the total
assets of the Fund.
U.S. Government Obligations. The Fund may invest in obligations issued or
guaranteed by the U.S. Government, its agencies and instrumentalities, including
bills, notes and bonds issued by the U.S. Treasury, as well as "stripped" U.S.
Treasury obligations such as Treasury Receipts issued by the U.S. Treasury
representing either future interest or principal payments. Stripped securities
are issued at a discount to their "face value," and may exhibit greater price
volatility than ordinary debt securities because of the manner in which their
principal and interest are returned to investors. The stripped Treasury
obligations in which the Fund may invest do not include Certificates of Accrual
on Treasury Securities ("CATS") or Treasury Income Growth Receipts ("TIGRs").
<PAGE>
Obligations of certain agencies and instrumentalities of the U.S. Government,
such as the Government National Mortgage Association ("GNMA"), are supported by
the full faith and credit of the U.S. Treasury; others, such as those of the
Federal National Mortgage Association ("FNMA"), are supported by the right of
the issuer to borrow from the Treasury; others, such as those of the Student
Loan Marketing Association ("SLMA"), are supported by the discretionary
authority of the U.S. Government to purchase the agency's obligations; still
others, such as those of the Federal Farm Credit Bureau or the Federal Home Loan
Mortgage Corporation ("FHLMC"), are supported only by the credit of the
instrumentality. No assurance can be given that the U.S. Government would
provide financial support to U.S. Government-sponsored agencies or
instrumentalities if it is not obligated to do so by law. The Fund will invest
in the obligations of such agencies or instrumentalities only when Lyon Street
believes that the credit risk with respect thereto is minimal.
The Fund may also invest in "zero coupon" U.S. Government securities. These
securities tend to be more volatile than other types of U.S. Government
securities. Zero coupon securities are debt instruments that do not pay current
interest and are typically sold at prices greatly discounted from par value. The
return on a zero coupon obligation, when held to maturity, equals the difference
between the par value and the original purchase price.
Options. The Fund may purchase put and call options on securities, securities
indices and foreign currencies and may write (sell) covered put and call
options.
A call option gives the purchaser the right to buy, and a writer has the
obligation to sell, the underlying security or foreign currency at the stated
exercise price at any time prior to the expiration of the option, regardless of
the market price or exchange rate of the security or foreign currency, as the
case may be. The premium paid to the writer is consideration for undertaking the
obligations under the option contract. A put option gives the purchaser the
right to sell the underlying security or foreign currency at the stated exercise
price at any time prior to the expiration date of the option, regardless of the
market price or exchange rate of the security or foreign currency, as the case
may be. A call option is covered if the Fund owns the underlying security
covered by the call or has an absolute and immediate right to acquire that
security without additional cash consideration (or for additional cash
consideration if the underlying security is held in a segregated account by its
custodian) upon conversion or exchange of other securities held in its
portfolio. A put option is covered if the Fund maintains cash, or other liquid
assets with a value equal to the exercise price in a segregated account with its
custodian. Put and call options will be valued at the last sale price, or in the
absence of such a price, at the mean between bid and asked price.
<PAGE>
When a portfolio security or currency subject to a call option is sold, the Fund
will effect a "closing purchase transaction"--the purchase of a call option on
the same security or currency with the same exercise price and expiration date
as the call option which the Fund previously has written. If a Fund is unable to
effect a closing purchase transaction, it will not be able to sell the
underlying security or currency until the option expires or the Fund delivers
the underlying security or currency upon exercise. In addition, upon the
exercise of a call option by the holder thereof, the Fund will forego the
potential benefit represented by market appreciation over the exercise price.
When the Fund writes an option, an amount equal to the net premium (the premium
less the commission) received by the Fund is included in the liability section
of its statement of assets and liabilities as a deferred credit. The amount of
the deferred credit will be subsequently marked-to-market to reflect the current
value of the option written. The current value of the traded option is the last
sale price or, in the absence of a sale, the average of the closing bid and
asked prices. If an option expires on the stipulated expiration date, or if the
Fund enters into a closing purchase transaction, it will realize a gain (or a
loss if the cost of a closing purchase transaction exceeds the net premium
received when the option is sold) and the deferred credit related to such option
will be eliminated. If an option is exercised, the Fund may deliver the
underlying security in the open market. In either event, the proceeds of the
sale will be increased by the net premium originally received and the Fund will
realize a gain or loss.
Covered call options must be listed on a national securities exchange and issued
by the Options Clearing Corporation. The purpose of writing covered call options
is to generate additional premium income for the Fund. This premium income will
serve to enhance the Fund's total return and will reduce the effect of any price
decline of the security involved in the option. Covered call options will
generally be written on securities which are not expected to make any major
price moves in the near future but which, over the long term, are deemed to be
attractive investments for the Fund.
Once the decision to write a call option has been made, Lyon Street, in
determining whether a particular call option should be written on a particular
security, will consider the reasonableness of the anticipated premium and the
likelihood that a liquid secondary market will exist for those options. Closing
transactions will be effected in order to realize a profit on an outstanding
call option, to prevent an underlying security from being called, or to permit
the sale of the underlying security. Furthermore, effecting a closing
transaction will permit the Fund to write another call option on the underlying
security with either a different exercise price or expiration date or both. If
the Fund desires to sell a particular security from its portfolio on which it
has written a call option, it will seek to effect a closing transaction prior
to, or concurrently with, the sale of the security. There is, of course, no
assurance that the Fund will be able to effect such closing transactions at a
favorable price. If the Fund cannot enter into such a transaction, it may be
required to hold a security that it might otherwise have sold, in which case it
would continue to be at market risk on the security. This could result in higher
transaction costs. The Fund will pay transaction costs in connection with the
writing of options to close out previously written options. Such transaction
costs are normally higher than those applicable to purchases and sales of
portfolio securities.
<PAGE>
Exercise prices of options may be below, equal to, or above the current market
values of the underlying securities at the time the options are written. From
time to time, the Fund may purchase an underlying security for delivery in
accordance with an exercise notice of a call option assigned to it, rather than
delivering such security from its portfolio. In such cases, additional costs
will be incurred. The Fund will realize a profit or loss from a closing purchase
transaction if the cost of the transaction is less or more than the premium
received from the writing of the option. Because increases in the market price
of a call option will generally reflect increases in the market price of the
underlying security, any loss resulting from the repurchase of a call option is
likely to be offset in whole or in part by appreciation of the underlying
security owned by the Fund.
Where the Fund may purchase put options, the Fund is purchasing the right to
sell a specified security (or securities) within a specified period of time at a
specified exercise price. Puts may be acquired to facilitate the liquidity of
the portfolio assets. Puts may also be used to facilitate the reinvestment of
assets at a rate of return more favorable than that of the underlying security.
The Fund may sell, transfer, or assign a put only in conjunction with the sale,
transfer, or assignment of the underlying security or securities. The amount
payable to the Fund upon its exercise of a "put" is normally (i) the Fund's
acquisition cost of the securities subject to the put (excluding any accrued
interest which the Fund paid on the acquisition), less any amortized market
premium or plus any accreted market or original issue discount during the period
the Fund owned the securities, plus (ii) all interest accrued on the securities
since the last interest payment date during that period. The Fund generally will
acquire puts only where the puts are available without the payment of any direct
or indirect consideration. However, if necessary or advisable, the Fund may pay
for puts either separately in cash or by paying higher price for portfolio
securities which are acquired subject to the puts (thus reducing the yield to
maturity otherwise available for the same securities).
Index options (or options on securities indices) are similar in many respects to
options on securities, except that an index option gives the holder the right to
receive, upon exercise, cash instead of securities, if the closing level of the
securities index upon which the option is based is greater than, in the case of
a call, or less than, in the case of a put, the exercise price of the option.
Because index options are settled in cash, a call writer cannot determine the
amount of its settlement obligations in advance and, unlike call writing on
specific securities, cannot provide in advance for, or cover, its potential
settlement obligations by acquiring and holding the underlying securities. The
Fund will segregate assets or otherwise cover index options that would require
it to pay cash upon exercise.
<PAGE>
A principal reason for writing put and call options is to attempt to realize,
through the receipt of premiums, a greater current return than would be realized
on the underlying securities alone. In return for the premium received for a
call option, the Fund foregoes the opportunity for profit from a price increase
in the underlying security above the exercise price so long as the option
remains open, but retains the risk of loss should the price of the security
decline. In return for the premium received for a put option, the Fund assumes
the risk that the price of the underlying security will decline below the
exercise price, in which case the put would be exercised and the Fund would
suffer a loss. The Fund may purchase put options in an effort to protect the
value of a security it owns against a possible decline in market value.
Forward Commitments, When-Issued and Delayed-Delivery Securities. The Fund may
purchase securities on a "when-issued" or "delayed-delivery" basis (i.e., for
delivery beyond the normal settlement date at a stated price and yield). In
addition, the Fund may purchase and sell securities on a "forward commitment"
basis. The Fund will engage in when-issued and delayed-delivery transactions
only for the purpose of acquiring portfolio securities consistent with its
investment objective and policies, not for investment leverage. When-issued
securities involve a risk that the yield obtained in the transaction will be
less than that available in the market when delivery takes place. The Fund will
not pay for such securities or start earning interest on them until they are
received.
When the Fund agrees to purchase securities on a "when-issued" or
"delayed-delivery" basis, its custodian will set aside cash or liquid securities
equal to the amount of the commitment in a separate account. Normally, the
custodian will set aside securities to satisfy the purchase commitment, and in
such a case, the Fund may be required subsequently to place additional assets in
the separate account in order to assure that the value of the account remains
equal to the amount of its commitment. It may be expected that the Fund
investing in securities on a when-issued or delayed delivery basis, net assets
will fluctuate to a greater degree when it sets aside securities to cover such
purchase commitments than when it sets aside cash. In addition, because the Fund
will set aside cash or liquid securities to satisfy its purchase commitments in
the manner described above, its liquidity and the ability of its investment
adviser to manage it might be affected in the event its commitments to purchase
"when-issued" or "delayed-delivery" securities ever exceeded 25% of the value of
its assets. Under normal market conditions, however, a Fund's commitment to
purchase "when-issued" or "delayed-delivery" securities will not exceed 25% of
the value of the Fund's total assets.
When the Fund engages in "when-issued" or "delayed-delivery" transactions, it
relies on the seller to consummate the trade. Failure of the seller to do so may
result in the Fund incurring a loss or missing the opportunity to obtain a price
or yield considered to be advantageous.
Mortgage-Related and Asset-Backed Securities. Investments in these and other
derivative securities will not be made for purposes of leverage or speculation,
but rather primarily for conventional investment or hedging purposes, liquidity,
flexibility and to capitalize on market inefficiencies. The Fund may, consistent
with its investment objective and policies, invest in mortgage-related
securities issued or guaranteed by the U.S. Government, its agencies and
instrumentalities. In addition, each may invest in mortgage-related securities
issued by nongovernmental entities, provided, however, that to the extent that
the Fund purchases mortgage-related securities from such issuers which may,
solely for purposes of the Investment Company Act of 1940, as amended (the "1940
Act"), be deemed to be investment companies, the Fund's investment in such
securities will be subject to the limitations on its investment in investment
company securities.
<PAGE>
Mortgage-related securities in which the Fund may invest, represent pools of
mortgage loans assembled for sale to investors by various governmental agencies
such as GNMA and government-related organizations such as FNMA and FHLMC, as
well as by nongovernmental issuers such as commercial banks, savings and loan
institutions, mortgage bankers and private mortgage insurance companies.
Although certain mortgage-related securities are guaranteed by a third party or
otherwise similarly secured, the market value of the security, which may
fluctuate, is not so secured. If the Fund purchases a mortgage-related security
at a premium, that portion may be lost if there is a decline in the market value
of the security whether resulting from changes in interest rates or prepayments
in the underlying mortgage collateral. As with other interest-bearing
securities, the prices of such securities are inversely affected by changes in
interest rates. However, though the value of a mortgage-related security may
decline when interest rates rise, the converse is not necessarily true, since in
periods of declining interest rates the mortgages underlying the securities are
prone to prepayment, thereby shortening the average life of the security and
shortening the period of time over which income at the higher rate is received.
When interest rates are rising, though, the rate of prepayment tends to
decrease, thereby lengthening the period of time over which income at the lower
rate is received. For these and other reasons, a mortgage-related security's
average maturity may be shortened or lengthened as a result of interest rate
fluctuations and, therefore, it is not possible to predict accurately the
security's return. In addition, regular payments received in respect of
mortgage-related securities include both interest and principal. No assurance
can be given as to the return the Fund will receive when these amounts are
reinvested.
There are a number of important differences among the agencies and
instrumentalities of the U.S. Government that issue mortgage related securities
and among the securities that they issue. Mortgage-related securities issued by
GNMA include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie
Maes") which are guaranteed as to the timely payment of principal and interest
by GNMA and such guarantee is backed by the full faith and credit of the United
States. GNMA is a wholly-owned U.S. Government corporation within the Department
of Housing and Urban Development. GNMA certificates also are supported by the
authority of GNMA to borrow funds from the U.S. Treasury to make payments under
its guarantee. Mortgage-related securities issued by FNMA include FNMA
Guaranteed Mortgage Pass-Through Certificates (also known as "Fannie Maes")
which are solely the obligations of FNMA and are not backed by or entitled to
the full faith and credit of the United States. FNMA is a government-sponsored
organization owned entirely by private stockholders. Fannie Maes are guaranteed
as to the timely payment of the principal and interest by FNMA. Mortgage-related
securities issued by FHLMC include FHLMC Mortgage Participation Certificates
(also known as "Freddie Macs" or "Pcs"). FHLMC is a corporate instrumentality of
the United States, created pursuant to an Act of Congress, which is owned
entirely by Federal Home Loan Banks. Freddie Macs are not guaranteed by the
United States or by any Federal Home Loan Banks and do not constitute a debt or
obligation of the United States or of any Federal Home Loan Bank. Freddie Macs
entitle the holder to the timely payment of interest, which is guaranteed by
FHLMC. FHLMC guarantees either ultimate collection or the timely payment of all
principal payments on the underlying mortgage loans. When FHLMC does not
guarantee timely payment of principal, FHLMC may remit the amount due on account
of its guarantee of ultimate payment of principal at any time after default on
an underlying mortgage, but in no event later than one year after it becomes
payable.
The Fund may invest in Collateralized Mortgage Obligations ("CMOs"). CMOs may
include stripped mortgage securities. Such securities are derivative multi-class
mortgage securities issued by agencies or instrumentalities of the U.S.
Government, or by private originators of, or investors in, mortgage loans,
including savings and loan associations, mortgage banks, commercial banks,
investment banks and special purpose subsidiaries of the foregoing. Stripped
mortgage securities are usually structured with two classes that receive
different proportions of the interest and principal distributions on a pool of
mortgage assets. A common type of stripped mortgage security will have one class
receiving all of the interest from the mortgage assets (the interest-only or
"IO" class), while the other class will receive all of the principal (the
principal-only or "PO" class). The yield to maturity on an IO class is extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and a rapid rate of principal payments may
have a material adverse effect on the securities' yield to maturity. Generally,
the market value of the PO class is unusually volatile in response to changes in
interest rates. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, the Fund may fail to fully recoup its
initial investment in these securities even if the security is rated in the
highest rating category.
<PAGE>
Like mortgages underlying mortgage-backed securities, automobile sales contracts
or credit card receivables underlying asset-backed securities are subject to
prepayment, which may reduce the overall return to certificate holders.
Nevertheless, principal prepayment rates tend not to vary much with interest
rates, and the short-term nature of the underlying car loans or other
receivables tends to dampen the impact of any change in the prepayment level.
Certificate holders may also experience delays in prepayment on the certificates
if the full amounts due on underlying sales contracts or receivables are not
realized because of unanticipated legal or administrative costs of enforcing the
contracts or because of depreciation or damage to the collateral (usually
automobiles) securing certain contracts, or other factors. In certain market
conditions, asset-backed securities may experience volatile fluctuations in
value and periods of illiquidity. If consistent with its investment objective
and policies, the Fund may invest in other asset-backed securities that may be
developed in the future.
Illiquid and Restricted Securities. "Section 4(2) securities" are securities
which are issued in reliance on the "private placement" exemption from
registration which is afforded by Section 4(2) of the 1933 Act. The Fund will
not purchase Section 4(2) securities which have not been determined to be liquid
in excess of 15% of its net assets. Section 4(2) securities are restricted as to
disposition under the federal securities laws, and generally are sold to
institutional investors such as the Fund which agree that they are purchasing
the securities for investment and not with a view to public distribution. Any
resale must also generally be made in an exempt transaction. Section 4(2)
securities are normally resold to other institutional investors through or with
the assistance of the issuer or investment dealers who make a market in such
Section 4(2) securities, thus providing liquidity. Rule 144A, a rule promulgated
under Section 4(2) of the 1933 Act, provides a safe-harbor exemption from the
registration requirements of the 1933 Act for resales to "qualified
institutional buyers" as defined in Rule 144A. With the exception of registered
broker-dealers, a qualified institutional buyer must generally own and invest on
a discretionary basis at least $100 million in securities.
Lyon Street may deem Section 4(2) securities liquid if it believes that, based
on the trading markets for such security, such security can be disposed of
within seven days in the ordinary course of business at approximately the amount
at which the Fund has valued the security. In making such determination, the
following factors, among others, may be deemed relevant: (i) the credit quality
of the issuer; (ii) the frequency of trades and quotes for the security; (iii)
the number of dealers willing to purchase or sell the security and the number of
other potential purchasers; (iv) dealer undertakings to make a market in the
security; and (v) the nature of the security and the nature of market-place
trades.
<PAGE>
Treatment of Section 4(2) securities as liquid could have the effect of
decreasing the level of the Fund's liquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities.
Investment Companies. The Fund may invest in securities issued by other
investment companies, including, but not limited to, money market investment
companies, within the limits prescribed by the 1940 Act. As a shareholder of
another investment company, the Fund would bear, along with other shareholders,
its pro rata portion of the expenses of such other investment company, including
advisory fees. These expenses would be in addition to the advisory and other
expenses that the Fund bears directly in connection with its own operations, and
may represent a duplication of fees to Shareholders of the Fund.
Lending of Portfolio Securities. The Fund, from time to time, may lend portfolio
securities to broker-dealers, banks or institutional borrowers of securities.
The Fund must receive 100% collateral, in the form of cash or U.S. Government
securities. This collateral must be valued daily, and should the market value of
the loaned securities increase, the borrower must furnish additional collateral
to the lender. During the time portfolio securities are on loan, the borrower
pays the lender any dividends or interest paid on such securities. Loans are
subject to termination by the lender or the borrower at any time. While the Fund
does not have the right to vote securities on loan, each intends to terminate
the loan and regain the right to vote if that is considered important with
respect to the investment. In the event the borrower defaults on its obligation
to the Fund, it could experience delays in recovering its securities and
possible capital losses. The Fund will only enter into loan arrangements with
broker-dealers, banks or other institutions determined to be creditworthy under
guidelines established by the Board of Trustees.
Convertible Securities. The Fund may invest in convertible securities.
Convertible securities are fixed income securities that may be exchanged or
converted into a predetermined number of the issuer's underlying common stock at
the option of the holder during a specified time period. Convertible securities
may take the form of convertible preferred stock, convertible bonds or
debentures, units consisting of "usable" bonds and warrants or a combination of
the features of several of these securities. The Fund will invest in convertible
securities that are rated "BBB" by S&P and "Baa" by Moody's, or higher, at the
time of investment, or if unrated, are of comparable quality.
<PAGE>
Convertible bonds and convertible preferred stocks are fixed income securities
that generally retain the investment characteristics of fixed income securities
until they have been converted but also react to movements in the underlying
equity securities. The holder is entitled to receive the fixed income of a bond
or the dividend preference of a preferred stock until the holder elects to
exercise the conversion privilege. Usable bonds are corporate bonds that can be
used in whole or in part, customarily at full face value, in lieu of cash to
purchase the issuer's common stock.
When owned as part of a unit along with warrants, which are options to buy the
common stock, they function as convertible bonds, except that the warrants
generally will expire before the bond's maturity. Convertible securities are
senior to equity securities, and, therefore, have a claim to assets of the
corporation prior to the holders of common stock in the case of liquidation.
However, convertible securities are generally subordinated to similar
non-convertible securities of the same company. The interest income and
dividends from convertible bonds and preferred stocks provide a stream of income
with generally higher yields than common stocks, but lower than non-convertible
securities of similar quality.
The Fund will exchange or convert the convertible securities held in its
portfolio into shares of the underlying common stock in instances in which, in
the opinion of Lyon Street, the investment characteristics of the underlying
common shares will assist the Fund in achieving its investment objective.
Otherwise, the Fund will hold or trade the convertible securities. In selecting
convertible securities for the Fund, Lyon Street evaluates the investment
characteristics of the convertible security as a fixed income instrument, and
the investment potential of the underlying equity security for capital
appreciation. In evaluating these matters with respect to a particular
convertible security, Lyon Street may consider numerous factors, including the
economic and political outlook, the value of the security relative to other
investment alternatives, trends in the determinants of the issuer's profits, and
the issuer's management capability and practices.
As with all fixed income securities, the market values of convertible securities
tend to increase when interest rates decline and, conversely, tend to decline
when interest rates increase.
Warrants. The Fund may purchase warrants and similar rights, which are
privileges issued by corporations enabling the owners to subscribe to and
purchase a specified number of shares of the corporation at a specified price
during a specified period of time. The purchase of warrants involves the risk
that the Fund could lose the purchase value of a warrant if the right to
subscribe to additional shares is not exercised prior to the warrant's
expiration. Also, the purchase of warrants involves the risk that the effective
price paid for the warrant added to the subscription price of the related
security may exceed the value of the subscribed security's market price such as
when there is no movement in the level of the underlying security.
<PAGE>
Repurchase Agreements. Securities held by the Fund may be subject to repurchase
agreements. Under the terms of a repurchase agreement, the Fund would acquire
securities from member banks of the Federal Deposit Insurance Corporation and
registered broker-dealers that Lyon Street deems creditworthy under guidelines
approved by the Board of Trustees, subject to the seller's agreement to
repurchase such securities at a mutually agreed-upon date and price, which
includes interest negotiated on the basis of current short-term rates. The
seller under a repurchase agreement will be required to maintain at all times
the value of collateral held pursuant to the agreement at not less than the
repurchase price (including accrued interest). If the seller were to default on
its repurchase obligation or become insolvent, the Fund would suffer a loss to
the extent that the proceeds from a sale of the underlying portfolio securities
were less than the repurchase price under the agreement. Securities subject to
repurchase agreements will be held by the Fund's custodian or another qualified
custodian, as appropriate, or in the Federal Reserve/Treasury book-entry system.
Reverse Repurchase Agreements. The Fund may also enter into reverse repurchase
agreements in accordance with applicable investment restrictions. Pursuant to
such reverse repurchase agreements, the Fund would sell certain of its
securities to financial institutions such as banks and broker-dealers, and agree
to repurchase them at a mutually agreed upon date and price. At the time the
Fund enters into a reverse repurchase agreement, it will place in a segregated
custodial account assets such as U.S. Government securities or other liquid
securities consistent with its investment restrictions having a value equal to
the repurchase price (including accrued interest), and will subsequently
continually monitor the account to ensure that such equivalent value is
maintained at all times. Reverse repurchase agreements involve the risk that the
market value of securities to be purchased by the Fund may decline below the
price at which it is obligated to repurchase the securities, or that the other
party may default on its obligation, so that the Fund is delayed or prevented
from completing the transaction.
Futures Contracts and Options Thereon. The Fund may enter into contracts for the
future delivery of securities or foreign currencies and futures contracts based
on a specific security, class of securities, interest rate, foreign currency or
an index, purchase or sell options on any such futures contracts and engage in
related closing transactions. A futures contract on a securities index is an
agreement obligating either party to pay, and entitling the other party to
receive, while the contract is outstanding, cash payments based on the level of
a specified securities index. The Fund may engage in such futures transactions
in an effort to hedge against market risks and to manage its cash position, but
not for leveraging purposes. This investment technique is designed primarily to
hedge against anticipated future changes in market conditions or foreign
exchange rates which otherwise might adversely affect the value of securities
which the Fund holds or intends to purchase. For example, when interest rates
are expected to rise or market values of portfolio securities are expected to
fall, the Fund can seek through the sale of futures contracts to offset a
decline in the value of its portfolio securities. When interest rates are
expected to fall or market values are expected to rise, the Fund, through the
purchase of such contracts, can attempt to secure better rates or prices than
might later be available in the market when it effects anticipated purchases.
<PAGE>
The acquisition of put and call options on futures contracts will, respectively,
give the Fund the right (but not the obligation), for a specified price, to sell
or to purchase the underlying futures contract, upon exercise of the option, at
any time during the option period.
The value of the Fund's contracts may equal or exceed 100% of its total assets,
although it will not purchase or sell a futures contract unless immediately
following such sale or purchase the aggregate amount of margin deposits on its
existing futures positions plus the amount of premiums paid for related futures
options entered into for other than bona fide hedging purposes is 5% or less of
the its net assets. Futures transactions will be limited to the extent necessary
to maintain the qualification of the Fund as a regulated investment company.
The Fund also may purchase and sell put and call options on futures contracts.
An option on a futures contract gives the purchaser the right, but not the
obligation, in return for the premium paid, to assume (in the case of a call) or
sell (in the case of a put) a position in a specified underlying futures
contract (which position may be a long or short position) a specified exercise
price at any time during the option exercise period. Sellers of options on
futures contracts, like buyers and sellers of futures contracts, make an initial
margin deposit and are subject to calls for variation margin.
Futures transactions involve brokerage costs and require the Fund to segregate
liquid assets, such as cash, U.S. Government securities or other liquid
securities to cover its obligation under such contracts. There is a possibility
that the Fund may lose the expected benefit of futures transactions if interest
rates, securities prices or foreign exchange rates move in an unanticipated
manner. Such unanticipated changes may also result in poorer overall performance
than if the Fund had not entered into any futures transactions. In addition, the
value of futures positions may not prove to be perfectly or even highly
correlated with the value of its portfolio securities and foreign currencies,
limiting the Fund's ability to hedge effectively against interest rate, foreign
exchange rate and/or market risk and giving rise to additional risks. There is
no assurance of liquidity in the secondary market for purposes of closing out
futures positions.
Regulatory Restrictions. As required by the Securities and Exchange Commission,
when purchasing or selling a futures contract or writing a put or call option or
entering into a forward foreign currency exchange purchase, the Fund will
maintain in a segregated account cash or liquid securities equal to the value of
such contracts.
<PAGE>
To the extent required to comply with Commodity Futures Trading Commission
Regulation 4.5 and thereby avoid being classified as a "commodity pool
operator," the Fund will not enter into a futures contract or purchase an option
thereon if immediately thereafter the initial margin deposits for futures
contracts held by the Fund plus premiums paid by it for open options on futures
would exceed 5% of the Fund's total assets. The Fund will not engage in
transactions in financial futures contracts or options thereon for speculation,
but only to attempt to hedge against changes in market conditions affecting the
values of securities which the Fund holds or intends to purchase. When futures
contracts or options thereon are purchased to protect against a price increase
on securities intended to be purchased later, it is anticipated that at least
25% of such intended purchases will be completed. When other futures contracts
or options thereon are purchased, the underlying value of such contracts will at
all times not exceed the sum of: (1) accrued profit on such contracts held by
the broker; (2) cash or high quality money market instruments set aside in an
identifiable manner; and (3) cash proceeds from investments due in 30 days.
INVESTMENT RESTRICTIONS
The Fund's investment objective is fundamental and may not be changed without a
vote of the holders of a majority of the Fund's outstanding Shares. In addition,
the following investment restrictions may be changed with respect to the Fund
only by a vote of a majority of the outstanding Shares of the Fund (as defined
under "ADDITIONAL INFORMATION -- Vote of a Majority of the Outstanding Shares"
in this SAI).
The Fund will not:
1. Purchase any securities which would cause more than 25% of the value
of the Fund's total assets at the time of purchase to be invested in securities
of one or more issuers conducting their principal business activities in the
same industry, provided that: (a) there is no limitation with respect to
obligations issued or guaranteed by the U.S. Government or its agencies or
instrumentalities and repurchase agreements secured by obligations of the U.S.
Government or its agencies or instrumentalities; (b) wholly owned finance
companies will be considered to be in the industries of their parents if their
activities are primarily related to financing the activities of their parents;
and (c) utilities will be divided according to their services. For example, gas,
gas transmission, electric and gas, electric and telephone will each be
considered a separate industry;
2. Purchase securities of any one issuer, other than obligations issued
or guaranteed by the U.S. Government or its agencies or instrumentalities, if,
immediately after such purchase, more than 5% of the value of the Fund's total
assets would be invested in such issuer, or the Fund would hold more than 10% of
the outstanding voting securities of the issuer, except that 25% or less of the
value of the Fund's total assets may be invested without regard to such
limitations. There is no limit to the percentage of assets that may be invested
in U.S. Treasury bills, notes, or other obligations issued or guaranteed by the
U.S. Government or its agencies or instrumentalities;
<PAGE>
3. Borrow money or issue senior securities, except that the Fund may
(i) borrow from banks, so long as immediately after each borrowing there is
asset coverage of 300%, and (ii) enter into reverse repurchase agreements (or
similar investment techniques) and enter into transactions in options, futures,
options on futures, and other derivative instruments as described in the Fund's
Prospectus and SAI from time to time;
4. Make loans, except that the Fund may purchase or hold debt
instruments and lend portfolio securities (in an amount not to exceed one-third
of its total assets), in accordance with its investment objective and policies,
make time deposits with financial institutions and enter into repurchase
agreements;
5. Underwrite securities issued by other persons, except to the extent
that the Fund may be deemed to be an underwriter under certain securities laws
in the disposition of "restricted securities";
6. Purchase or sell commodities or commodities contracts, except to the
extent disclosed in the current Prospectus and/or SAI of the Fund; and
7. Purchase or sell real estate (although investments in marketable
securities of companies engaged in such activities and securities secured by
real estate or interests therein are not prohibited by this restriction).
The following additional investment restriction is not a fundamental policy and
therefore may be changed without the vote of a majority of the outstanding
Shares of the Fund. Except as provided in the fundamental policies described
above, the Fund may not:
1. Purchase or otherwise acquire any securities if, as a result, more
than 15% of the Fund's net assets would be invested in securities that are
illiquid.
If any percentage restriction described above is satisfied at the time of
purchase, a later increase or decrease in such percentage resulting from a
change in net asset value will not constitute a violation of such restriction.
However, should a change in net asset value or other external events cause the
Fund's investments in illiquid securities to exceed the limitation set forth in
the Fund's Prospectus, the Fund will act to cause the aggregate amount of
illiquid securities to come within such limit as soon as reasonably practicable.
In such an event, however, the Fund would not be required to liquidate any
portfolio securities where the Fund would suffer a loss on the sale of such
securities.
Portfolio Turnover
Changes may be made in the Fund's portfolio consistent with the investment
objective and policies of the Fund whenever such changes are believed to be in
the best interests of the Fund and its Shareholders, and the Fund will be
managed without regard to its portfolio turnover rate. The portfolio turnover
rate for the Fund may vary greatly from year to year as well as within a
particular year, and may be affected by cash requirements for redemptions of
Shares. High portfolio turnover rates will generally result in higher
transaction costs to the Fund, including brokerage commissions.
<PAGE>
The portfolio turnover rate for the Fund is calculated by dividing the lesser of
the Fund's purchases or sales of portfolio securities for the year by the
monthly average value of the securities. The Securities and Exchange Commission
requires that the calculation exclude all securities whose remaining maturities
at the time of acquisition are one year or less.
NET ASSET VALUE
The net asset value of the Fund is determined and the Shares of the Fund are
priced on each Business Day of the Trust (other than a day on which there are
insufficient changes in the value of a Fund's portfolio securities to materially
affect the Fund's net asset value or a day on which no Shares of the Fund are
tendered for redemption and no order to purchase any Shares is received). A
"Business Day" is a day on which the New York Stock Exchange, Inc. ("NYSE") is
open for trading. Currently, the NYSE is closed on the following holidays: New
Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving, and Christmas.
Valuation of the Fund
Portfolio securities, the principal market for which is a securities exchange,
will be valued at the closing sales price on that exchange on the day of
computation, or, if there have been no sales during such day, at the latest bid
quotation. Portfolio securities, the principal market for which is not a
securities exchange, will be valued at their latest bid quotation in such
principal market. If no such bid price is available, then such securities will
be valued in good faith at their respective fair market values using methods
determined by or under the supervision of the Board of Trustees. Foreign
securities are valued based on quotations from the primary market in which they
are traded and are translated from the local currency into U.S. dollars using
current exchange rates. Shares of investment companies are valued on the basis
of their net asset values, subject to any applicable sales charge. Portfolio
securities with a remaining maturity of 60 days or less will be valued either at
amortized cost or original cost plus accrued interest, which approximates
current value.
All other assets and securities, including securities for which market
quotations are not readily available, will be valued at their fair market value
as determined in good faith under the general supervision of the Board of
Trustees.
<PAGE>
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The Shares of the Fund are sold on a continuous basis by the Fund's distributor,
and the distributor has agreed to use appropriate efforts to solicit all
purchase orders. The public offering price of Shares of the Fund is its net
asset value per Share.
The Trust may suspend the right of redemption or postpone the date of payment
for Shares during any period when (a) trading on the NYSE is restricted by
applicable rules and regulations of the Securities and Exchange Commission, (b)
the NYSE is closed for other than customary weekend and holiday closings, (c)
the Securities and Exchange Commission has by order permitted such suspension,
or (d) an emergency exists as a result of which (i) disposal by the Trust of
securities owned by it is not reasonably practical or (ii) it is not reasonably
practical for the Trust to determine the fair market value of its net assets.
Shares may be redeemed without charge on any day that net asset value is
calculated. All redemption orders are effected at the net asset value per Share
next determined after receipt by the distributor of a redemption request.
Payment for Shares redeemed normally will be made within seven days.
The Trust intends to pay cash for all Shares redeemed, but under conditions
which make payment in cash unwise, such as large-scale redemptions or market
illiquidity, payment may be made wholly or partly in portfolio securities at
their then market value equal to the redemption price. In such cases, a
Shareholder may incur brokerage costs in converting such securities to cash.
Variable Contract Owners do not deal directly with the Fund to purchase, redeem,
or exchange Shares, and Variable Contract Owners should refer to the prospectus
for the applicable Separate Account for information on the allocation of
premiums and on transfers of accumulated value among sub-accounts of the
pertinent Separate Account that invests in the Fund.
The Fund reserves the right to discontinue offering Shares at any time. In the
event that the Fund ceases offering its Shares, any investments allocated to the
Fund will, subject to any necessary regulatory approvals, be invested in another
portfolio of the Trust deemed appropriate by the Trustees.
<PAGE>
MANAGEMENT OF THE TRUST
Trustees and Officers
Overall responsibility for management of the Trust rests with its Board of
Trustees, who are elected by the Shareholders of the Trust. The Trustees elect
the officers of the Trust to supervise actively its day-to-day operations.
The names of the Trustees, their addresses, ages, and principal occupations
during the past five years are set forth below:
Name, Address, and Age Principal Occupation During Past 5 Years
- ---------------------- ----------------------------------------
James H. Woodward Chancellor, University of North Carolina at Charlotte.
University of North Carolina
at Charlotte
Charlotte, NC 28223
Age: 59
Michael Van Buskirk Chief Executive Officer, Ohio Bankers Association
37 West Broad Street (industry trade association).
Suite 1001
Columbus, OH 43215
Age: 52
Walter B. Grimm* Employee of BISYS Fund Services (6/92-present).
3435 Stelzer Road
Columbus, Oh 43219
Age: 52
* Mr. Grimm is an "interested person" of the Trust as that term is defined in
the 1940 Act.
The Trust pays each Trustee who is not an employee of BISYS or its affiliates a
retainer fee at the rate of $500 per calendar quarter, reasonable out-of-pocket
expenses, $500 for each regular meeting of the Board of Trustees attended in
person, and $250 for each regular meeting of the Board of Trustees attended by
telephone. The Trust also pays each such Trustee $500 for each special meeting
of the Board of Trustees attended in person, and $250 for each special meeting
of the Board of Trustees attended by telephone. For the fiscal year ended
December 31, 1998, the Trust paid the following compensation to the Trustees of
the Trust:
<PAGE>
Aggregate Compensation Total Compensation from
Name from Trust* Trust and Fund Complex**
James H. Woodward $4,000 $ 15,000
Michael Van Buskirk $4,000 $ 4,000
Walter B. Grimm $0 $ 0
* The Trust does not accrue pension or retirement benefits as part of
Fund expenses, and Trustees of the Trust are not entitled to benefits
upon retirement from the Board of Trustees.
** The Fund Complex consisted of the Trust, The BB&T Mutual Funds Group,
AmSouth Mutual Funds, HSBC Mutual Funds Trust, HSBC Funds Trust, and
Kent Funds.
The officers of the Trust, their addresses, ages, and principal occupations
during the past five years are as follows (unless otherwise indicated, the
address of each officer is 3435 Stelzer Road, Columbus, OH 43219):
Position(s) Held Principal Occupation
Name and Address With the Trust During Past 5 Years
- ---------------- -------------- -------------------
Walter Grimm President and Chairman of the Employee of BISYS Fund Services
Age: 54 Board (6/92-present).
Frank Deutchki Vice President Employee of BISYS Fund Services (4/96 -
Age: 45 present); Vice President, Audit Director at
Mutual Funds Services Company, a subsidiary of
United States Trust Company of New York (2/89 - 3/96).
Gregory Maddox Vice President and Assistant Employee of BISYS Fund Services (4/91 -
Columbia Square Secretary present).
Suite 500
1230 Columbia Street
San Diego, CA 92101
Age: 31
<PAGE>
Charles L. Booth Vice President and Assistant Employee of BISYS Fund Services (1988 -
Age: 39 Secretary present).
Alaina Metz Secretary Employee of BISYS Fund Services (6/95 -
Age: 32 present); Supervisor, Mutual Fund Legal
Department, Alliance Capital Management
(5/89 - 6/95).
Gary Tenkman Treasurer Employee of BISYS Fund Services (4/98 -
Age: 29 present); Audit Manager Ernst & Young LLP
(1990 - 4/98).
Nimish Bhatt Principal Financial and Employee of BISYS Fund Services (7/96 -
Age: 36 Accounting Officer and present); Assistant Vice President,
Comptroller Evergreen Funds/First Union Bank
(1995 to 7/96); Senior Tax Consultant,
Price Waterhouse, LLP (1990 - 12/94).
The officers of the Trust receive no compensation directly from the Trust for
performing the duties of their offices. BISYS Fund Services Ohio, Inc. receives
fees from the Trust for providing certain administration, fund accounting and
transfer agency services.
As of October 1, 1999, the Trustees and officers of the Trust, as a group, owned
Variable Contracts that entitled them to give voting instructions with respect
to less than one percent of the Shares of any Fund of the Trust.
Investment Adviser
Subject to the general supervision of the Trust's Board of Trustees and in
accordance with the Fund's investment objective and restrictions, investment
advisory services are provided to the Fund by Lyon Street pursuant to an
Investment Advisory Agreement dated October 1, 1999 (the "Investment Advisory
Agreement"). Lyon Street is a wholly-owned subsidiary of Old Kent Bank ("Old
Kent"). As of December 31, 1998, Lyon Street managed assets of approximately
$6.1 billion. Lyon Street is located at 111 Lyon Street, N.W., Grand Rapids, MI
49503.
<PAGE>
Old Kent is a Michigan banking corporation which, with its affiliates, provided
commercial and retail banking and trust services through more than 200 banking
offices in Michigan and Illinois as of December 31, 1998. Old Kent offers a
broad range of financial services, including commercial and consumer loans,
corporate and personal trust services, demand and time deposit accounts, letters
of credit and international financial services.
Old Kent is a subsidiary of Old Kent Financial Corporation, a bank holding
company headquartered in Grand Rapids, Michigan, with approximately $16.6
billion in total consolidated assets as of December 31, 1998. Through offices in
numerous states, Old Kent Financial Corporation and its subsidiaries provide a
broad range of financial services to individuals and businesses.
Under the Investment Advisory Agreement, Lyon Street has agreed to provide,
either directly or through one or more sub-advisers, investment advisory
services for the Fund as described in the Prospectus. For the services provided
and expenses assumed pursuant to the Investment Advisory Agreement, the Fund is
obligated to pay Lyon Street a fee, computed daily and paid monthly, at the
annual rate of 0.70%, calculated as a percentage of the average daily net assets
of the Fund.
Unless sooner terminated, the Investment Advisory Agreement continues in effect
as to the Fund for an initial term of two years, and thereafter for successive
one-year periods if such continuance is approved at least annually by the Board
of Trustees or by vote of a majority of the outstanding Shares of the Fund and a
majority of the Trustees who are not parties to the Investment Advisory
Agreement or interested persons (as defined in the 1940 Act) of any party to the
Investment Advisory Agreement by votes cast in person at a meeting called for
such purpose. The Investment Advisory Agreement is terminable as to the Fund at
any time on 60 days' written notice without penalty by the Trustees, by vote of
a majority of the outstanding Shares of the Fund, or by Lyon Street. The
Investment Advisory Agreement also terminates automatically in the event of any
assignment, as defined in the 1940 Act.
The Investment Advisory Agreement provides that Lyon Street shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Trust in connection with the performance of its duties, except a loss resulting
from a breach of fiduciary duty with respect to the receipt of compensation for
services or a loss resulting from willful misfeasance, bad faith, or gross
negligence on the part of Lyon Street or any sub-advisers in the performance of
their duties, or from reckless disregard of their duties and obligations
thereunder.
From time to time, advertisements, supplemental sales literature, and
information furnished to present or prospective Shareholders of the Fund may
include descriptions of Lyon Street including, but not limited to, (i)
descriptions of Lyon Street's operations; (ii) descriptions of certain personnel
and their functions; and (iii) statistics and rankings related to Lyon Street's
operations.
<PAGE>
Portfolio Transactions
Lyon Street determines, subject to the general supervision of the Board of
Trustees and in accordance with the Fund's investment objective and
restrictions, which securities are to be purchased and sold by the Fund, and
which brokers or dealers are to be eligible to execute such Fund's portfolio
transactions.
Purchases and sales of portfolio securities which are debt securities usually
are principal transactions in which portfolio securities are normally purchased
directly from the issuer or from an underwriter or market maker for the
securities. Purchases from underwriters of portfolio securities generally
include a commission or concession paid by the issuer to the underwriter, and
purchases from dealers serving as market makers may include the spread between
the bid and asked price. Transactions on stock exchanges involve the payment of
negotiated brokerage commissions. Transactions in the over-the-counter market
are generally principal transactions with dealers. With respect to the
over-the-counter market, the Trust, where possible, will deal directly with
dealers who make a market in the securities involved except in those
circumstances where better price and execution are available elsewhere.
Allocation of transactions, including their frequency, to various brokers and
dealers is determined by Lyon Street in its best judgment and in a manner deemed
fair and reasonable to Shareholders. In selecting a broker or dealer, Lyon
Street evaluates a wide range of criteria, including the commission rate or
dealer mark-up, execution capability, the broker's/dealer's positioning and
distribution capabilities, back office efficiency, ability to handle difficult
trades, financial stability, reputation, prior performance, and, in the case of
brokerage commissions, research. The primary consideration is the broker's
ability to provide prompt execution of orders in an effective manner at the most
favorable price for the security. Subject to this consideration, brokers and
dealers who provide supplemental investment research to Lyon Street may receive
orders for transactions on behalf of the Fund. Research may include brokers'
analyses of specific securities, performance and technical statistics, and
information databases. It may also include maintenance research, which is the
information that keeps Lyon Street informed concerning overall economic, market,
political and legal trends. Under some circumstances, Lyon Street's evaluation
of research and other broker selection criteria may result in one or a few
brokers executing a substantial percentage of a Fund's trades. This might occur,
for example, where a broker can provide best execution at a cost that is
reasonable in relation to its services and the broker offers unique or superior
research facilities, special knowledge or expertise in the Fund's relevant
markets, or access to proprietary information about companies that are a
majority of the Fund's investments.
Research information so received is in addition to and not in lieu of services
required to be performed by Lyon Street and does not reduce the fees payable to
Lyon Street by the Fund. Such information may be useful to Lyon Street in
serving both the Fund and other clients and, conversely, supplemental
information obtained by the placement of business of other clients may be useful
in carrying out its obligations to the Fund. While Lyon Street generally seeks
competitive commissions, the Fund may not necessarily pay the lowest commission
available on each brokerage transaction for reasons discussed above.
<PAGE>
Investment decisions for the Fund are made independently from those for any
other portfolio, investment company or account managed by Lyon Street. Any such
other portfolio, investment company or account may also invest in the same
securities as the Fund. When a purchase or sale of the same security is made at
substantially the same time on behalf of the Fund and another portfolio,
investment company or account, the transaction will be averaged as to price and
available investments will be allocated as to amount in a manner which Lyon
Street believes to be equitable to the Fund and such other portfolio, investment
company or account. In some instances, this investment procedure may adversely
affect the price paid or received by the Fund or the size of the position
obtained by the Fund. To the extent permitted by law, Lyon Street may aggregate
the securities to be sold by or purchased for the Fund with those to be sold or
purchased for other portfolios, investment companies or accounts in order to
obtain best execution. In making investment recommendations for the Fund, Lyon
Street will not inquire or take into consideration whether an issuer of
securities proposed for purchase or sale by the Fund is a customer of Lyon
Street or the Fund's distributor, their parents or their subsidiaries or
affiliates and, in dealing with its customers, Lyon Street, its parent,
subsidiaries, and affiliates will not inquire or take into consideration whether
securities of such customers are held by the Trust.
Glass-Steagall Act
In 1971, the United States Supreme Court held that the Federal statute commonly
referred to as the "Glass-Steagall Act" prohibits a national bank from operating
a mutual fund for the collective investment of managing agency accounts.
Subsequently, the Board of Governors of the Federal Reserve System (the "Board")
issued a regulation and interpretation to the effect that the Glass-Steagall Act
and such decision: (a) forbid a bank holding company registered under the
Federal Bank Holding Company Act of 1956 (the "Holding Company Act") or any
non-bank affiliate thereof from sponsoring, organizing, or controlling a
registered, open-end investment company continuously engaged in the issuance of
its shares, but (b) do not prohibit such a holding company or affiliate from
acting as investment adviser, transfer agent, and custodian to such an
investment company. In 1981, the United States Supreme Court determined that the
Board did not exceed its authority under the Holding Company Act when it adopted
its regulation and interpretation authorizing bank holding companies and their
nonbank affiliates to act as investment advisers to registered closed-end
investment companies. The Supreme Court also stated that if a national bank
complied with the restrictions imposed by the Board in its regulation and
interpretation authorizing bank holding companies and their nonbank affiliates
to act as investment advisers to investment companies, a national bank
performing investment advisory services for an investment company would not
violate the Glass-Steagall Act.
Lyon Street believes that it possesses the legal authority to perform the
services for the Fund contemplated by the Prospectus, this SAI, and the
Investment Advisory Agreement without violation of applicable statutes and
regulations. Future changes in either federal or state statutes and regulations
relating to the permissible activities of banks or bank holding companies and
the subsidiaries or affiliates of those entities, as well as further judicial or
administrative decisions or interpretations of present and future statutes and
regulations, could prevent Lyon Street from continuing to serve as investment
adviser to the Fund or could restrict the services which it is permitted to
perform for the Fund. In addition, such changes, decisions or interpretations
could prevent an affiliates of Lyon Street from performing Variable Contract
Owner servicing activities or from receiving compensation therefor or could
restrict the types of services such entities are permitted to provide and the
amount of compensation they are permitted to receive for such services.
Depending upon the nature of any changes in the services which could be provided
by Lyon Street, the Board of Trustees would review the Trust's relationship with
Lyon Street and consider taking all action necessary in the circumstances, and
it is probable that the Board of Trustees would either recommend to Shareholders
the selection of another qualified advisor or, if that course of action appeared
impractical, that the Fund be liquidated.
<PAGE>
Administrator
BISYS Fund Services Ohio, Inc. ("BISYS Ohio" or "Administrator"), 3435 Stelzer
Road, Columbus, Ohio 43219-3035, serves as general manager and administrator to
the Trust pursuant to a Management and Administration Agreement dated March 1,
1999 (the "Administration Agreement"). Prior to that date, BISYS Fund Services
("BISYS") served as general manager and administrator to the Trust. The
Administrator assists in supervising all operations of the Fund (other than
those performed by Lyon Street under the Investment Advisory Agreement, by BISYS
Ohio as fund accountant and dividend disbursing agent, and by the Fund's
custodians. The Administrator provides financial services to institutional
clients.
Under the Administration Agreement, the Administrator has agreed to maintain
office facilities for the Trust; furnish statistical and research data, clerical
and certain bookkeeping services and stationery and office supplies; prepare the
periodic reports to the Securities and Exchange Commission on Form N-SAR or any
replacement forms therefor; compile data for, prepare for execution by the Fund
and file certain federal and state tax returns and required tax filings; prepare
compliance filings pursuant to state laws with the advice of the Trust's
counsel; keep and maintain the financial accounts and records of the Fund,
including calculation of daily expense accruals; and generally assist in all
aspects of the Trust's operations other than those performed by Lyon Street
under the Investment Advisory Agreement, by the other investment advisers of the
Trust's portfolios, by the fund accountant and dividend disbursing agent, and by
the Fund's custodians. Under the Administration Agreement, the Administrator may
delegate all or any part of its responsibilities thereunder.
The Administrator receives a fee from the Fund for its services as Administrator
and expenses assumed pursuant to the Administration Agreement, calculated daily
and paid periodically, equal to the lesser of (a) a fee calculated at the annual
rate of 0.07% of the Fund's average daily net assets, or (b) such other fee as
may from time to time be agreed upon by the Trust and the Administrator. The
Administrator may voluntarily reduce all or a portion of its fee with respect to
the Fund in order to increase the net income of one or more of the Fund
available for distribution as dividends. For the period from June 3, 1997
(commencement of operations) through December 31, 1997, the Trust incurred
administration fees equal to $17,925, of which $13,549 was waived or reimbursed
by BISYS. For the fiscal year ended December 31, 1998, the Trust incurred
administration fees equal to $132,536, of which $50,667 was waived or reimbursed
by BISYS.
The Administration Agreement is terminable with respect to the Fund upon mutual
agreement of the parties to the Administration Agreement, upon notice given at
least 60 days prior to the expiration of the Agreement's then-current term, and
for cause (as defined in the Administration Agreement) by the party alleging
cause, on no less than 60 days' written notice by the Board of Trustees or by
the Administrator.
<PAGE>
The Administration Agreement provides that the Administrator shall not be liable
for any error of judgment or mistake of law or any loss suffered by the Trust in
connection with the matters to which the Administration Agreement relates,
except a loss resulting from willful misfeasance, bad faith, or gross negligence
in the performance of its duties, or from the reckless disregard by the
Administrator of its obligations and duties thereunder.
Expenses
Lyon Street and the Administrator bears all expenses in connection with the
performance of its services other than the cost of securities (including
brokerage commissions) purchased for the Fund. The Fund will bear the following
expenses relating to their operations: taxes, interest, fees of the Trustees of
the Trust, Securities and Exchange Commission fees, outside auditing and legal
expenses, advisory and administration fees, fees and out-of-pocket expenses of
the custodians and fund accountant, certain insurance premiums, costs of
maintenance of the Trust's existence, costs of Shareholders' reports and
meetings, and any extraordinary expenses incurred in the Fund's operations. Any
expense reimbursements will be estimated daily and reconciled and paid on a
monthly basis. Fees imposed upon customer accounts for cash management services
are not included within Trust expenses for purposes of any such expense
limitation.
Distributor
BISYS serves as distributor to the Trust pursuant to the Distribution Agreement
dated June 1, 1997 (the "Distribution Agreement"). As distributor, BISYS acts as
agent for the Fund in the distribution of its Shares and, in such capacity,
advertises and pays the cost of advertising, office space and personnel involved
in such activities. BISYS serves as distributor without remuneration from the
Fund. Unless otherwise terminated, the Distribution Agreement will remain in
effect for an initial term of two years, and thereafter continues for successive
one-year periods if approved at least annually (i) by the Board of Trustees or
by the vote of a majority of the outstanding Shares of the Trust, and (ii) by
the vote of a majority of the Trustees who are not parties to the Distribution
Agreement or interested persons (as defined in the 1940 Act) of any party to the
Distribution Agreement, cast in person at a meeting called for the purpose of
voting on such approval. The Distribution Agreement may be terminated in the
event of any assignment, as defined in the 1940 Act.
Custodian, Transfer Agent and Fund Accounting Services
The Bank of New York has been retained, pursuant to a Custodian Agreement, to
act as custodian for the Fund. The Bank of New York's address is 90 Washington
Street, New York, New York 10286. Under the Custodian Agreement, the Custodian
maintains a custody account or accounts in the name of the Fund; receives and
delivers all assets for the Fund upon purchase and upon sale or maturity;
collects and receives all income and other payments and distributions on account
of the assets of the Fund; pays all expenses of the Fund; and receives and pays
out cash for purchases and redemptions of shares of the Fund and pays out cash
if requested for dividends on shares of the Fund. Under the Custodian Agreement,
the Fund has agreed to pay the Custodian for furnishing custodian services a fee
for certain administration and transaction charges and out-of-pocket expenses.
The Board of Trustees has authorized The Bank of New York in its capacity as
custodian of each Fund to enter into Subcustodian Agreements with banks and
other entities that qualify under the 1940 Act to act as subcustodians with
respect to certain portfolio investments of the Fund.
<PAGE>
BISYS Ohio serves as transfer agent and dividend disbursing agent for the Trust
pursuant to an agreement dated as of March 1, 1999. Under this agreement, BISYS
Ohio performs the following services, among others: maintenance of Shareholder
records for each of the Trust's Shareholders of record; processing Shareholder
purchase and redemption orders; processing transfers and exchanges of Shares on
the Shareholder files and records; processing dividend payments and
reinvestments; and assistance in the mailing of Shareholder reports and proxy
solicitation materials.
In addition, BISYS Ohio provides certain fund accounting services to the Trust
pursuant to a Fund Accounting Agreement dated March 1, 1999. Under the Fund
Accounting Agreement, BISYS Ohio maintains the accounting books and records for
the Fund, including journals containing an itemized daily record of all
purchases and sales of portfolio securities, all receipts and disbursements of
cash and all other debits and credits, general and auxiliary ledgers reflecting
all asset, liability, reserve, capital, income and expense accounts, including
interest accrued and interest received, and other required separate ledger
accounts; maintains a monthly trial balance of all ledger accounts; performs
certain accounting services for the Fund, including calculation of the daily net
asset value per Share, calculation of the dividend and capital gain
distributions, if any, and of yield, reconciliation of cash movements with
custodians, affirmation to custodians of portfolio trades and cash settlements,
verification and reconciliation with custodians of daily trade activity;
provides certain reports; obtains dealer quotations, prices from a pricing
service or matrix prices on all portfolio securities in order to mark the
portfolio to the market; and prepares an interim balance sheet, statement of
income and expense, and statement of changes in net assets for the Fund.
BISYS Ohio receives an annual fee of $14 per Variable Contract Owner account,
subject to certain per-Fund base fees, for its services as transfer agent and,
for its services as fund accountant, BISYS Ohio receives a fee, computed daily
and paid periodically, at an annual rate equal to the greater of 0.03% of the
Fund's average daily net assets or $30,000.
Auditors
The firm of PricewaterhouseCoopers LLP, 100 East Broad Street, Columbus, Ohio
43215, serves as independent auditors for the Trust. Its services comprise
auditing the Trust's financial statements and advising the Trust as to certain
accounting and tax matters.
Legal Counsel
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006, is
counsel to the Trust and has passed upon the legality of the Shares offered
hereby.
<PAGE>
ADDITIONAL INFORMATION
Description of Shares
The Trust is a Massachusetts business trust that was organized on July 20, 1994.
The Trust's Declaration of Trust was filed with the Secretary of State of the
Commonwealth of Massachusetts on the same date. The Declaration of Trust, as
amended and restated, authorizes the Board of Trustees to issue an unlimited
number of Shares, which are units of beneficial interest, without par value. The
Trust currently has nine series of Shares which represent interests in each
series of the Trust. The Trust's Declaration of Trust authorizes the Board of
Trustees to divide or redivide any unissued Shares of the Trust into one or more
additional series or classes by setting or changing in any one or more respects
their respective preferences, conversion or other rights, voting power,
restrictions, limitations as to dividends, qualifications, and terms and
conditions of redemption.
Shares have no subscription or preemptive rights and only such conversion or
exchange rights as the Board of Trustees may grant in its discretion. When
issued for payment as described in the Prospectuses and this SAI, the Trust's
Shares will be fully paid and non-assessable by the Trust. In the event of a
liquidation or dissolution of the Trust, Shareholders of the Fund are entitled
to receive the assets available for distribution belonging to the Fund, and a
proportionate distribution, based upon the relative asset values of the
respective series, of any general assets not belonging to any particular series
which are available for distribution.
Each Share represents an equal proportionate interest in the Fund with other
Shares of the Fund, and is entitled to such dividends and distributions out of
the income earned on the assets belonging to the Fund as are declared at the
discretion of the Trustees. Shares are without par value. Shareholders are
entitled to one vote for each dollar of value invested and a proportionate
fractional vote for any fraction of a dollar invested. Shareholders will vote in
the aggregate and not by portfolio except as otherwise expressly required by
law.
<PAGE>
An annual or special meeting of Shareholders to conduct necessary business is
not required by the Trust's Declaration of Trust, the 1940 Act or other
authority except, under certain circumstances, to elect Trustees, amend the
Declaration of Trust, approve an investment advisory agreement and to satisfy
certain other requirements. To the extent that such a meeting is not required,
the Trust may elect not to have an annual or special meeting.
The Trust will call a special meeting of Shareholders for purposes of
considering the removal of one or more Trustees upon written request therefor
from Shareholders holding not less than 10% of the outstanding votes of the
Trust. At such a meeting, a quorum of Shareholders (constituting a majority of
votes attributable to all outstanding Shares of the Trust), by majority vote,
has the power to remove one or more Trustees. In accordance with current laws,
it is anticipated that an insurance company issuing a variable contract that
participates in the Fund will request voting instructions from variable contract
owners and will vote shares or other voting interests in the separate account in
proportion of the voting instructions received.
Rule 18f-2 under the 1940 Act provides that any matter required to be submitted
to the holders of the outstanding voting securities of an investment company
such as the Trust shall not be deemed to have been effectively acted upon unless
approved by the holders of a majority of the outstanding Shares of the Fund
affected by the matter. For purposes of determining whether the approval of a
majority of the outstanding Shares of the Fund will be required in connection
with a matter, the Fund will be deemed to be affected by a matter unless it is
clear that the interests of each Fund in the matter are identical, or that the
matter does not affect any interest of the Fund. Under Rule 18f-2, the approval
of an investment advisory agreement or any change in investment policy submitted
to Shareholders would be effectively acted upon with respect to a series only if
approved by a majority of the outstanding Shares of the Fund. However, Rule
18f-2 also provides that the ratification of independent public accountants, the
approval of principal underwriting contracts, and the election of Trustees may
be effectively acted upon by Shareholders of the Trust voting without regard to
the Fund.
Vote of a Majority of the Outstanding Shares
As used in the Fund's Prospectus and the SAI, "vote of a majority of the
outstanding Shares of the Trust or the Fund" means the affirmative vote, at an
annual or special meeting of Shareholders duly called, of the lesser of (a) 67%
or more of the votes of Shareholders of the Trust or the Fund present at such
meeting at which the holders of more than 50% of the votes attributable to the
Shareholders of record of the Trust or the Fund are represented in person or by
proxy, or (b) the holders of more than 50% of the outstanding votes of
Shareholders of the Trust or the Fund.
<PAGE>
Shareholder and Trustee Liability
Under Massachusetts law, holders of units of interest in a business trust may,
under certain circumstances, be held personally liable as partners for the
obligations of the trust. However, the Trust's Declaration of Trust provides
that Shareholders shall not be subject to any personal liability for the
obligations of the Trust. The Declaration of Trust provides for indemnification
out of the trust property of any Shareholder held personally liable solely by
reason of his or her being or having been a Shareholder. The Declaration of
Trust also provides that the Trust shall, upon request, reimburse any
Shareholder for all legal and other expenses reasonably incurred in the defense
of any claim made against the Shareholder for any act or obligation of the
Trust, and shall satisfy any judgment thereon. Thus, the risk of a Shareholder
incurring financial loss on account of Shareholder liability is limited to
circumstances in which the Trust itself would be unable to meet its obligations.
The Declaration of Trust states further that no Trustee, officer, or agent of
the Trust shall be personally liable in connection with the administration or
preservation of the assets of the Trust or the conduct of the Trust's business;
nor shall any Trustee, officer, or agent be personally liable to any person for
any action or failure to act except for his own bad faith, willful misfeasance,
gross negligence, or reckless disregard of his duties. The Declaration of Trust
also provides that all persons having any claim against the Trustees or the
Trust shall look solely to the assets of the Trust for payment.
Additional Tax Information
The following discussion summarizes certain U.S. federal tax considerations
incidental to an investment in the Fund. The Fund intends to qualify annually
and to elect to be treated as a regulated investment company under the Internal
Revenue Code of 1986, as amended (the "Code"). If the Fund so qualifies, it
generally will not be subject to federal income taxes to the extent that it
distributes on a timely basis its investment company taxable income and its net
capital gains.
To qualify as a regulated investment company, the Fund generally must, among
other things: (i) derive in each taxable year at least 90% of its gross income
from dividends, interest, payments with respect to securities loans, and gains
from the sale or other disposition of stock, securities or foreign currencies,
or other income derived with respect to its business in such stock, securities
or currencies; (ii) diversify its holdings so that, at the end of each quarter
of the taxable year (a) at least 50% of the market value of the Fund's assets is
represented by cash, U.S. Government securities, the securities of other
regulated investment companies and other securities, with such other securities
of any one issuer limited for the purposes of this calculation to an amount not
greater than 5% of the value of the Fund's total assets and 10% of the
outstanding voting securities of such issuer, and (b) not more than 25% of the
value of its total assets is invested in the securities of any one issuer (other
than U.S. Government securities or the securities of other regulated investment
companies); and (iii) distribute at least 90% of its investment company taxable
income (which includes, among other items, dividends, interest, and net
short-term capital gains in excess of any net long-term capital losses) each
taxable year.
<PAGE>
As a regulated investment company, the Fund generally will not be subject to
U.S. federal income tax on its investment company taxable income and net capital
gains (any net long-term capital gains in excess of the sum of net short-term
capital losses and capital loss carryovers from prior years), if any, that it
distributes to Shareholders. The Fund intends to distribute to its Shareholders,
at least annually, substantially all of its investment company taxable income
and any net capital gains. In addition, amounts not distributed by the Fund on a
timely basis in accordance with a calendar year distribution requirement may be
subject to a nondeductible 4% excise tax. To avoid the tax, the Fund may be
required to distribute (or be deemed to have distributed) during each calendar
year, (i) at least 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (ii) at least 98% of its capital
gains in excess of its capital losses for the twelve month period ending on
October 31 of the calendar year (adjusted for certain ordinary losses), and
(iii) all ordinary income and capital gains for previous years that were not
distributed during such years. To avoid application of the excise tax, the Fund
intends to make its distributions in accordance with the calendar year
distribution requirement. A distribution will be treated as paid on December 31
of the calendar year if it is declared by the Fund during October, November, or
December of that year to Shareholders of record on a date in such a month and
paid by the Fund during January of the following calendar year. Such
distributions will be taxable to Shareholders (such as the Separate Accounts)
for the calendar year in which the distributions are declared, rather than the
calendar year in which the distributions are actually received.
The Treasury Department announced that it would issue future regulations or
rulings addressing the circumstances in which a variable contract owner's
control of the investments of the separate account may cause the contract owner,
rather than the insurance company, to be treated as the owner of the assets held
by the separate account. If the contract owner is considered the owner of the
securities underlying the separate account, income and gains produced by those
securities would be included currently in the contract owner's gross income. It
is not known what standards will be set forth in the regulations or rulings.
In the event that rules or regulations are adopted, there can be no assurance
that the Fund will be able to operate as currently described, or that the Trust
will not have to change a Fund's investment objective or investment policies.
While the Fund's investment objective is fundamental and may be changed only by
a vote of a majority of its outstanding Shares, the investment policies of the
Fund may be modified as necessary to prevent any such prospective rules and
regulations from causing Variable Contract Owners to be considered the owners of
the Shares of the Fund.
If the Fund invests in shares of a foreign investment company, the Fund may be
subject to U.S. federal income tax on a portion of an "excess distribution"
from, or of the gain from the sale of part or all of the shares in, such
company. In addition, an interest charge may be imposed with respect to deferred
taxes arising from such distributions or gains. The Fund may, however, be able
to elect alternative tax treatment for such investments that would avoid this
unfavorable result.
<PAGE>
Under the Code, gains or losses attributable to fluctuations in exchange rates
which occur between the time the Fund accrues income or other receivables or
accrues expenses or other liabilities denominated in a foreign currency and the
time the Fund actually collects such receivables or pays such liabilities
generally are treated as ordinary income or ordinary loss. Similarly, on
disposition of debt securities denominated in a foreign currency and on
disposition of certain futures contracts, forward contracts, and options, gains
or losses attributable to fluctuations in the value of foreign currency between
the date of acquisition of the security or contract and the date of disposition
also are treated as ordinary gain or loss. These gains or losses, referred to
under the Code as "Section 988" gains or losses, may increase or decrease the
amount of a Fund's investment company taxable income to be distributed to its
Shareholders as ordinary income.
Distributions
Distributions of any investment company taxable income (which includes among
other items, dividends, interest, and any net realized short-term capital gains
in excess of net realized long-term capital losses) are treated as ordinary
income for tax purposes in the hands of a Shareholder (such as a Separate
Account). Net capital gains (the excess of any net long-term capital gains over
net short term capital losses) will, to the extent distributed, be treated as
long-term capital gains in the hands of a Shareholder regardless of the length
of time the Shareholder may have held the Shares.
Hedging Transactions
The diversification requirements applicable to the Fund's assets may limit the
extent to which the Fund will be able to engage in transactions in options,
futures contracts, or forward contracts.
Other Taxes
Distributions may also be subject to additional state, foreign and local taxes,
depending on each Shareholder's situation. Shareholders (such as Separate
Accounts) are advised to consult their own tax advisers with respect to the
particular tax consequences to them of an investment in the Fund.
Performance Information
The Fund may, from time to time, include its yield or total return in
advertisements or reports to Shareholders or prospective investors. Performance
information for the Fund will not be advertised or included in sales literature
unless accompanied by comparable performance information for a separate account
to which the Fund offer its Shares.
<PAGE>
Yields of the Fund are computed by analyzing net investment income per Share for
a recent 30-day period and dividing that amount by a Share's maximum offering
price (reduced by any undeclared earned income expected to be paid shortly as a
dividend) on the last trading day of that period. Net investment income will
reflect amortization of any market value premium or discount of fixed income
securities (except for obligations backed by mortgages or other assets) and may
include recognition of a pro rata portion of the stated dividend rate of
dividend paying portfolio securities.
The yield of the Fund will vary from time to time depending upon market
conditions, the composition of the Fund's portfolio and operating expenses of
the Trust allocated to the Fund. Yield should also be considered relative to
changes in the value of the Fund's Shares and to the relative risks associated
with the investment objective and policies of the Fund.
At any time in the future, yields may be higher or lower than past yields and
there can be no assurance that any historical results will continue.
Standardized quotations of average annual total return for Fund Shares will be
expressed in terms of the average annual compounded rate of return for a
hypothetical investment in Shares over periods of 1, 5 and 10 years or up to the
life of the Fund), calculated pursuant to the following formula: P(1 + T)n = ERV
(where P = a hypothetical initial payment of $1,000, T = the average annual
total return, n = the number of years, and ERV = the ending redeemable value of
a hypothetical $1,000 payment made at the beginning of the period). All total
return figures reflect the deduction of expenses (on an annual basis), and
assume that all dividends and distributions on Shares are reinvested when paid.
Performance information for the Fund may be compared in reports and promotional
literature to the performance of other mutual funds with comparable investment
objectives and policies through various mutual fund or market indices such as
those prepared by Dow Jones & Co., Inc., S&P, Shearson Lehman Brothers, Inc.,
the Russell 2000 Index, the Consumer Price Index, and to data prepared by Lipper
Analytical Services, Inc., a widely recognized independent service which
monitors the performance of mutual funds, or Morningstar, Inc. Comparisons may
also be made to indices or data published in Money Magazine, Forbes, Barron's,
The Wall Street Journal, The Bond Buyer's Weekly 20-Bond Index, The Bond Buyer's
Index, The Bond Buyer, The New York Times, Business Week, Pensions and
Investments, and U.S.A. Today. In addition to performance information, general
information about the Fund that appears in a publication such as those mentioned
above may be included in advertisements and in reports to Variable Contract
Owners.
The Fund may also compute aggregate total return for specified periods. The
aggregate total return is determined by dividing the net asset value of this
account at the end of the specified period by the value of the initial
investment and is expressed as a percentage. Calculation of aggregate total
return assumes reinvestment of all income dividends and capital gain
distributions during the period.
<PAGE>
The Fund also may quote annual, average annual and annualized total return and
aggregate total return performance data for various periods other than those
noted above. Such data will be computed as described above, except that the
rates of return calculated will not be average annual rates, but rather, actual
annual, annualized or aggregate rates of return.
Quotations of yield or total return for the Fund will not take into account
charges and deductions against a Separate Account to which the Fund's Shares are
sold or charges and deductions against the Variable Contracts. The Fund's yield
and total return should not be compared with mutual funds that sell their shares
directly to the public since the figures provided do not reflect charges against
the Separate Accounts or the Variable Contracts. Performance information for any
Fund reflects only the performance of a hypothetical investment in the Fund
during the particular time period in which the calculations are based.
Performance information should be considered in light of the Fund's investment
objectives and policies, characteristics and quality of the portfolios and the
market conditions during the given time period, and should not be considered as
a representation of what may be achieved in the future.
Miscellaneous
Individual Trustees are elected by the Shareholders and, subject to removal by
the vote of two-thirds of the Board of Trustees, serve for a term lasting until
the next meeting of Shareholders at which Trustees are elected. Such meetings
are not required to be held at any specific intervals. Individual Trustees may
be removed by vote of the Shareholders voting not less than a majority of the
Shares then outstanding, cast in person or by proxy at any meeting called for
that purpose, or by a written declaration signed by Shareholders voting not less
than two-thirds of the Shares then outstanding. In accordance with current laws,
it is anticipated that an insurance company issuing a Variable Contract that
participates in the Fund will request voting instructions from variable contract
owners and will vote shares or other voting interests in the Separate Account in
proportion of the voting instructions received.
The Trust is registered with the Securities and Exchange Commission as a
management investment company. Such registration does not involve supervision by
the Securities and Exchange Commission of the management or policies of the
Trust.
The Prospectuses and this SAI omit certain of the information contained in the
Registration Statement filed with the Securities and Exchange Commission. Copies
of such information may be obtained from the Securities and Exchange Commission
upon payment of the prescribed fee.
The Prospectuses and this SAI are not an offering of the securities herein
described in any state in which such offering may not lawfully be made. No
salesman, dealer, or other person is authorized to give any information or make
any representation other than those contained in the Prospectuses and this SAI.
FINANCIAL STATEMENTS
Since the Fund had not commenced operations as of the date of this SAI, there
are no financial statements to include in the SAI.
<PAGE>
APPENDIX
DESCRIPTION OF BOND RATINGS
Description of Moody's bond ratings:
Excerpts from Moody's description of its bond ratings are listed as
follows: Aaa - judged to be the best quality and they carry the smallest degree
of investment risk; Aa - judged to be of high quality by all standards -
together with the Aaa group, they comprise what are generally known as
high-grade bonds; A - possess many favorable investment attributes and are to be
considered as "upper medium grade obligations"; Baa - considered to be medium
grade obligations, i.e., they are neither highly protected nor poorly secured
- -interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time; Ba - judged to have speculative
elements, their future cannot be considered as well assured; B - generally lack
characteristics of the desirable investment; Caa - are of poor standing - such
issues may be in default or there may be present elements of danger with respect
to principal or interest; Ca - speculative in a high degree, often in default; C
- - lowest rated class of bonds, regarded as having extremely poor prospects.
Moody's also supplies numerical indicators 1, 2 and 3 to rating
categories. The modifier 1 indicates that the security is in the higher end of
its rating category; the modifier 2 indicates a mid-range ranking; and modifier
3 indicates a ranking toward the lower end of the category.
Description of S&P's bond ratings:
Excerpts from S&P's description of its bond ratings are listed as
follows: AAA - highest grade obligations, in which capacity to pay interest and
repay principal is extremely strong; AA - has a very strong capacity to pay
interest and repay principal, and differs from AAA issues only in a small
degree; A - has a strong capacity to pay interest and repay principal, although
they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories; BBB
- - regarded as having an adequate capacity to pay interest and repay principal;
whereas it normally exhibits adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt in this category than in
higher rated categories. This group is the lowest which qualifies for commercial
bank investment. BB, B, CCC, CC, C - predominantly speculative with respect to
capacity to pay interest and repay principal in accordance with terms of the
obligations; BB indicates the highest grade and C the lowest within the
speculative rating categories. D interest or principal payments are in default.
<PAGE>
S&P applies indicators "+," no character, and "-" to its rating
categories. The indicators show relative standing within the major rating
categories.
Description of Moody's ratings of short-term municipal obligations:
Moody's ratings for state and municipal short-term obligations will be
designated Moody's Investment Grade or MIG. Such ratings recognize the
differences between short-term credit and long-term risk. Short-term ratings on
issues with demand features (variable rate demand obligations) are
differentiated by the use of the VMIG symbol to reflect such characteristics as
payment upon periodic demand rather than fixed maturity dates and payments
relying on external liquidity. Ratings categories for securities in these groups
are as follows: MIG 1/VMIG 1 - denotes best quality, there is present strong
protection by established cash flows, superior liquidity support or demonstrated
broad-based access to the market for refinancing; MIG 2/VMIG 2 - denotes high
quality, margins of protection are ample although not as large as in the
preceding group; MIG 3/VMIG 3 - denotes high quality, all security elements are
accounted for but there is lacking the undeniable strength of the preceding
grades; MIG 4/VMIG 4 - denotes adequate quality, protection commonly regarded as
required of an investment security is present, but there is specific risk; SQ -
denotes speculative quality, instruments in this category lack margins of
protection.
Description of Moody's commercial paper ratings:
Excerpts from Moody's commercial paper ratings are listed as follows:
Prime - 1 - issuers (or supporting institutions) have a superior ability for
repayment of senior short-term promissory obligations; Prime - 2 - issuers (or
supporting institutions) have a strong ability for repayment of senior
short-term promissory obligations; Prime - 3 - issuers (or supporting
institutions) have an acceptable ability for repayment of senior short-term
promissory obligations; Not Prime - issuers do not fall within any of the Prime
categories.
Description of S&P's ratings for corporate and municipal bonds:
Investment grade ratings: AAA - the highest rating assigned by S&P,
capacity to pay interest and repay principal is extremely strong; AA - has a
very strong capacity to pay interest and repay principal and differs from the
highest rated issues only in a small degree; A - has strong capacity to pay
interest and repay principal although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher rated categories; BBB - regarded as having an adequate capacity to pay
interest and repay principal - whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
<PAGE>
Speculative grade ratings: BB, B, CCC, CC, C - debt rated in these
categories is regarded as having predominantly speculative characteristics with
respect to capacity to pay interest and repay principal - while such debt will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions; CI - reserved
for income bonds on which no interest is being paid; D -in default, and payment
of interest and/or repayment of principal is in arrears. Plus (+) or Minus (-) -
the ratings from "AA" to "CCC" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Description of S&P's rating for municipal notes and short-term municipal demand
obligations:
Rating categories are as follows: SP-1 - has a very strong or strong
capacity to pay principal and interest - those issues determined to possess
overwhelming safety characteristics will be given a plus (+) designation; SP-2 -
has a satisfactory capacity to pay principal and interest; SP-3 - issues
carrying this designation have a speculative capacity to pay principal and
interest.
Description of S&P's ratings for short-term corporate demand obligations and
commercial paper:
An S&P commercial paper rating is a current assessment of the
likelihood of timely repayment of debt having an original maturity of no more
than 365 days. Excerpts from S&P's description of its commercial paper ratings
are listed as follows: A-1 - the degree of safety regarding timely payment is
strong - those issues determined to possess extremely strong safety
characteristics will be denoted with a plus (+) designation; A-2 capacity for
timely payment is satisfactory - however, the relative degree of safety is not
as high as for issues designated "A-1;" A-3 - has adequate capacity for timely
payment - however, is more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations; B - regarded as
having only speculative capacity for timely payment; C - a doubtful capacity for
payment; D - in payment default - the "D" rating category is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period.
<PAGE>
Variable Insurance Funds
3435 Stelzer Road
Columbus, Ohio 43219-3035
(888) 467-8167
STATEMENT OF ADDITIONAL INFORMATION
October 1, 1999
This Statement of Additional Information ("SAI") describes three diversified
investment portfolios (each a "Fund" and collectively the "Funds") of Variable
Insurance Funds (the "Trust"). The Funds are:
. HSBC Variable Growth and Income Fund;
. HSBC Variable Fixed Income Fund; and
. HSBC Variable Cash Management Fund.
The Trust offers an indefinite number of transferable units ("Shares") of each
Fund. Shares of the Funds may be sold to segregated asset accounts ("Separate
Accounts") of insurance companies to serve as the investment medium for variable
life insurance policies and variable annuity contracts ("Variable Contracts")
issued by the insurance companies. Shares of the Funds also may be sold to
qualified pension and retirement plans, certain insurance companies, and the
investment advisers of the Funds. The Separate Accounts invest in Shares of the
Funds in accordance with allocation instructions received from owners of the
Variable Contracts ("Variable Contract Owners").
This SAI is not a Prospectus and is authorized for distribution only when
preceded or accompanied by a Prospectus of the Funds, dated October 1, 1999, as
supplemented from time to time. This SAI contains more detailed information than
that set forth in a Prospectus and should be read in conjunction with the
Prospectus. This SAI is incorporated by reference in its entirety into each
Prospectus. Copies of a Prospectus may be obtained by writing the Trust at 3435
Stelzer Road, Columbus, Ohio 43219-3035, or by telephoning the toll free numbers
set forth above.
<PAGE>
TABLE OF CONTENTS
INVESTMENT OBJECTIVES AND POLICIES............................................1
INVESTMENT RESTRICTIONS......................................................22
Portfolio Turnover..................................................23
NET ASSET VALUE..............................................................24
Valuation of the Cash Management Fund...............................24
Valuation of the Other Funds........................................24
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION...............................25
MANAGEMENT OF THE TRUST......................................................26
Trustees and Officers...............................................26
Investment Adviser..................................................28
Portfolio Transactions..............................................29
Glass-Steagall Act..................................................31
Administrator.......................................................32
Expenses............................................................33
Distributor.........................................................33
Custodian, Transfer Agent and Fund Accounting Services..............33
Auditors............................................................35
Legal Counsel.......................................................35
ADDITIONAL INFORMATION.......................................................35
Description of Shares...............................................35
Vote of a Majority of the Outstanding Shares........................36
Shareholder and Trustee Liability...................................36
Additional Tax Information..........................................37
Performance Information.............................................39
Miscellaneous.......................................................41
FINANCIAL STATEMENTS.........................................................42
APPENDIX.....................................................................43
<PAGE>
The Trust is an open-end management investment company which currently offers
nine separate Funds, each with different investment objectives. This SAI
contains information about the following three Funds which are advised by HSBC
Asset Americas Inc. ("HSBC"): the HSBC Variable Growth and Income Fund (the
"Growth and Income Fund") the HSBC Variable Fixed Income Fund (the "Fixed Income
Fund"); and the HSBC Variable Cash Management Fund (the "Cash Management Fund").
Much of the information contained in this SAI expands upon subjects discussed in
the Prospectus of the Funds described above. Capitalized terms not defined
herein are defined in such Prospectuses. No investment in a Fund should be made
without first reading the Fund's Prospectus.
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the investment objectives and policies of
the Funds as set forth in the Prospectuses.
Bank Obligations. Each Fund may invest in bank obligations consisting of
bankers' acceptances, certificates of deposit, and time deposits.
Bankers' acceptances are negotiable drafts or bills of exchange typically drawn
by an importer or exporter to pay for specific merchandise, which are "accepted"
by a bank, meaning, in effect, that the bank unconditionally agrees to pay the
face value of the instrument on maturity.
Certificates of deposit are negotiable certificates issued against funds
deposited in a commercial bank or a savings and loan association for a definite
period of time and earning a specified return.
Fixed time deposits are obligations of foreign branches of United States banks
or foreign banks which are payable on a stated maturity date and bear a fixed
rate of interest. Although fixed time deposits do not have a market, there are
no contractual restrictions on the right to transfer a beneficial interest in
the deposit to a third party.
The Cash Management Fund may invest more than 25% of the current value of its
total assets in domestic bank obligations (including bank obligations subject to
repurchase agreements). The Cash Management Fund will not invest in any
obligations of HSBC Holdings plc or its affiliates (as defined under the
Investment Company Act of 1940 (the "1940 Act")). The Cash Management Fund is
permitted to invest in obligations of correspondent banks of HSBC Holdings plc
which are not affiliates of the Trust, but the Fund will not give preference in
its investment selections to those obligations.
<PAGE>
The Cash Management Fund limits its investments in United States bank
obligations to obligations of United States banks (including foreign branches)
which have more than $1 billion in total assets at the time of investment and
are members of the Federal Reserve System or are examined by the Comptroller of
the Currency or whose deposits are insured by the Federal Deposit Insurance
Corporation.
The Cash Management Fund limits its investments in foreign bank obligations to
United States dollar denominated obligations of foreign banks (including United
States branches) which at the time of investment (i) have more than $10 billion,
or the equivalent in other currencies, in total assets; (ii) have branches or
agencies in the United States; and (iii) in the opinion of the Fund's investment
adviser, are of an investment quality comparable to obligations of United States
banks which may be purchased by the Fund and present minimal credit risk. The
Cash Management Fund may not invest in fixed time deposits subject to withdrawal
penalties maturing in more than seven calendar days; investments in fixed time
deposits subject to withdrawal penalties maturing from two business days through
seven calendar days may not exceed 10% of the value of the total assets of the
Fund.
The Growth and Income Fund and the Fixed Income Fund may invest a portion of its
assets in the obligations of foreign banks and foreign branches of domestic
banks. Such obligations include Eurodollar Certificates of Deposit ("ECDs")
which are U.S. dollar-denominated certificates of deposit issued by offices of
foreign and domestic banks located outside the United States; Eurodollar Time
Deposits ("ETDs") which are U.S. dollar-denominated deposits in a foreign branch
of a U.S. bank or a foreign bank; Canadian Time Deposits ("CTDs") which are
essentially the same as ETDs except they are issued by Canadian offices of major
Canadian banks; Schedule Bs, which are obligations issued by Canadian branches
of foreign or domestic banks; Yankee Certificates of Deposit ("Yankee CDs")
which are U.S. dollar-denominated certificates of deposit issued by a U.S.
branch of a foreign bank and held in the United States; and Yankee Bankers'
Acceptances ("Yankee BAs") which are U.S. dollar-denominated bankers'
acceptances issued by a U.S. branch of a foreign bank and held in the United
States.
Although the Funds may invest in obligations of foreign banks or foreign
branches of U.S. banks only when the investment adviser deems the instrument to
present minimal credit risk, such investments nevertheless entail risks that are
different from those of investments in domestic obligations of U.S. banks. These
additional risks include future political and economic developments, the
possible imposition of withholding taxes on interest income, possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls, or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on such obligations. In
addition, foreign branches of U.S. banks and U.S. branches of foreign banks may
be subject to less stringent reserve requirements and to different accounting,
auditing, reporting and record keeping standards than those applicable to
domestic branches of U.S. banks.
Commercial Paper. Commercial paper consists of unsecured promissory notes issued
by corporations. Except as noted below with respect to variable amount master
demand notes, issues of commercial paper normally have maturities of less than
nine months and fixed rates of return.
<PAGE>
The Funds may invest in short-term promissory notes (including variable amount
master demand notes) issued by corporations and other entities, such as
municipalities, rated at the time of purchase within the two highest categories
assigned by two nationally recognized statistical rating organization ("NRSRO")
(e.g., A-2 or better by Standard & Poor's Ratings Services ("S&P"), Prime-2 or
better by Moody's Investors Service, Inc. ("Moody's") or F-2 or better by Fitch
Investors Service ("Fitch")) or, if not rated, determined to be of comparable
quality to instruments that are so rated.
Commercial paper may include variable and floating rate instruments. Commercial
paper issues include securities issued by corporations without registration
under the Securities Act of 1933, as amended (the "1933 Act"), in reliance on
the exemption in Section 3(a)(3), and commercial paper issued in reliance on the
so-called "private placement" exemption in Section 4(2) ("Section 4(2) Paper").
Section 4(2) Paper is restricted as to disposition under the federal securities
laws in that any resale must similarly be made in an exempt transaction. Section
4(2) Paper is normally resold to other institutional investors through or with
the assistance of investment dealers which make a market in Section 4(2) Paper,
thus providing liquidity. For purposes of a Fund's limitation on purchases of
illiquid instruments, Section 4(2) Paper will not be considered illiquid if the
investment adviser has determined, in accordance with guidelines approved by the
Board of Trustees, that an adequate trading market exists for such securities.
Variable Amount Master Demand Notes. The Funds may invest in variable amount
master demand notes, which are unsecured demand notes that permit the
indebtedness thereunder to vary and provide for periodic adjustments in the
interest rate according to the terms of the instrument. Because master demand
notes are direct lending arrangements between a Fund and the issuer, they are
not normally traded. Although there is no secondary market in the notes, the
Funds may demand payment of principal and accrued interest at any time. While
the notes are not typically rated by credit rating agencies, issuers of variable
amount master demand notes (which are normally manufacturing, retail, financial,
and other business concerns) must satisfy the same criteria as set forth above
for commercial paper. HSBC will consider the earning power, cash flow, and other
liquidity ratios of the issuers of such notes and will continuously monitor
their financial status and ability to meet payment on demand. In determining
dollar weighted average portfolio maturity, a variable amount master demand note
will be deemed to have a maturity equal to the longer of the period of time
remaining until the next interest rate adjustment or the period of time
remaining until the principal amount can be recovered from the issuer through
demand.
Variable And Floating Rate Demand Notes. The Funds may, from time to time, buy
variable or floating rate demand notes issued by corporations, bank holding
companies and financial institutions and similar taxable and tax-exempt
instruments issued by government agencies and instrumentalities. These
securities will typically have a maturity over one year but carry with them the
right of the holder to put the securities to a remarketing agent or other entity
at designated time intervals and on specified notice. The obligation of the
issuer of the put to repurchase the securities may be backed by a letter of
credit or other obligation issued by a financial institution. The purchase price
is ordinarily par plus accrued and unpaid interest. Generally, the remarketing
agent will adjust the interest rate every seven days (or at other specified
intervals) in order to maintain the interest rate at the prevailing rate for
securities with a seven-day or other designated maturity.
<PAGE>
Short-Term Obligations. The Funds may invest in high quality short-term
obligations (with maturities of 12 months or less) such as domestic and foreign
commercial paper (including variable amount master demand notes), bankers'
acceptances, certificates of deposit, demand and time deposits of domestic and
foreign branches of U.S. banks and foreign banks, and repurchase agreements, in
order to acquire interest income combined with liquidity. Pending investment or
to meet anticipated redemption requests, a Fund may invest without limitation in
short-term obligations. For temporary defensive purposes, these investments may
constitute 100% of a Fund's portfolio and, in such circumstances, will
constitute a temporary suspension of its attempts to achieve its investment
objective.
Short-Term Trading. In order to generate income, the Growth and Income Fund and
the Fixed Income Fund may engage in the technique of short-term trading. Such
trading involves the selling of securities held for a short time, ranging from
several months to less than a day. The object of such short-term trading is to
increase the potential for capital appreciation and/or income of a Fund in order
to take advantage of what its adviser or sub-adviser believes are changes in
market, industry or individual company conditions or outlook. Any such trading
would increase the portfolio turnover rate of a Fund and its transaction costs.
Corporate Debt Securities. The Cash Management Fund's investments in these
securities are limited to securities such as bonds and debentures which have
thirteen months or less remaining to maturity and which are rated "A" or better
by S&P and "A" or better by Moody's and of comparable high quality ratings by
other nationally recognized statistical rating organizations ("NRSROs") that
have rated such securities.
After purchase by the Cash Management Fund, a security may cease to be rated or
its rating may be reduced below the minimum required for purchase. Neither event
will require a sale of such security. However if the security is downgraded to a
level below that permitted for money market funds under applicable regulations,
HSBC must report such event to the Board of Trustees as soon as possible to
permit the Board to reassess the security promptly to determine whether it may
be retained as an eligible investment for the Cash Management Fund. To the
extent the ratings given by a NRSRO may change as a result of changes in such
organizations or their rating systems, the Cash Management Fund will attempt to
use comparable ratings as standards for investments in accordance with the
investment policies contained in the Prospectus and in this SAI.
The other Funds also may invest in U.S. dollar-denominated debt obligations
issued or guaranteed by U.S. corporations or U.S. commercial banks, U.S.
dollar-denominated obligations of foreign issuers and debt obligations of
foreign issuers denominated in foreign currencies. Such debt obligations
include, among others, bonds, notes, debentures and variable rate demand notes.
In choosing corporate debt securities on behalf of a Fund, its investment
adviser may consider (i) general economic and financial conditions; (ii) the
specific issuer's (a) business and management, (b) cash flow, (c) earnings
coverage of interest and dividends, (d) ability to operate under adverse
economic conditions, (e) fair market value of assets, and (f) in the case of
foreign issuers, unique political, economic or social conditions applicable to
such issuer's country; and, (iii) other considerations deemed appropriate.
<PAGE>
The Growth and Income Fund and Fixed Income Fund will not purchase corporate
debt securities rated below Baa by Moody's or BBB by S&P or to the extent
certain U.S. or foreign debt obligations are unrated or rated by other rating
agencies, are determined to be of comparable quality ("Medium-Grade
Securities"). While "Baa"/"BBB" and comparable unrated securities may produce a
higher return than higher rated securities, they are subject to a greater degree
of market fluctuation and credit risk than the higher quality securities in
which the Funds may invest and may be regarded as having speculative
characteristics as well.
As with other fixed-income securities, Medium-Grade Securities are subject to
credit risk and market risk. Market risk relates to changes in a security's
value as a result of changes in interest rates. Credit risk relates to the
ability of the issuer to make payments of principal and interest.
Medium-Grade Securities are generally subject to greater credit risk than
comparable higher-rated securities because issuers are more vulnerable to
economic downturns, higher interest rates or adverse issuer-specific
developments. In addition, the prices of Medium-Grade Securities are generally
subject to greater market risk and therefore react more sharply to changes in
interest rates. The value and liquidity of Medium-Grade Securities may be
diminished by adverse publicity and investor perceptions.
Because certain Medium-Grade Securities are traded only in markets where the
number of potential purchasers and sellers, if any, is limited, the ability of a
Fund to sell such securities at their fair market value either to meet
redemption requests or to respond to changes in the financial markets may be
limited.
Particular types of Medium-Grade Securities may present special concerns. The
prices of payment-in-kind or zero-coupon securities may react more strongly to
changes in interest rates than the prices of other Medium-Grade Securities. Some
Medium-Grade Securities in which a Fund may invest may be subject to redemption
or call provisions that may limit increases in market value that might otherwise
result from lower interest rates while increasing the risk that a Fund may be
required to reinvest redemption or call proceeds during a period of relatively
low interest rates.
The credit ratings issued by NRSROs are subject to various limitations. For
example, while such ratings evaluate credit risk, they ordinarily do not
evaluate the market risk of Medium-Grade Securities. In certain circumstances,
the ratings may not reflect in a timely fashion adverse developments affecting
an issuer. For these reasons, an investment adviser will conduct their own
independent credit analysis of Medium-Grade Securities.
<PAGE>
After purchase, a security may cease to be rated or its rating may be reduced
below the minimum required for purchase by the Funds. Neither event will require
a sale of such security. However, HSBC will consider such event in its
determination of whether a Fund should continue to hold the security. A security
which has had its rating downgraded or revoked may be subject to greater risk to
principal and income, and often involve greater volatility of price, than
securities in the higher rating categories. Such securities are also subject to
greater credit risks (including, without limitation, the possibility of default
by or bankruptcy of the issuers of such securities) than securities in higher
rating categories.
Foreign Investments. The Funds may invest in foreign securities, although the
Cash Management Fund will limit such investments to U.S. dollar-denominated
obligations of foreign banks or foreign branches of U.S. banks.
Investment in foreign securities is subject to special investment risks that
differ in some respects from those related to investments in securities of U.S.
domestic issuers. Such risks include political, social or economic instability
in the country of the issuer, the difficulty of predicting international trade
patterns, the possibility of the imposition of exchange controls, expropriation,
limits on removal of currency or other assets, nationalization of assets,
foreign withholding and income taxation, and foreign trading practices
(including higher trading commissions, custodial charges and delayed
settlements). Such securities may be subject to greater fluctuations in price
than securities issued by U.S. corporations or issued or guaranteed by the U.S.
Government, its agencies or instrumentalities. The markets on which such
securities trade may have less volume and liquidity, and may be more volatile
than securities markets in the U.S. In addition, there may be less publicly
available information about a foreign company than about a U.S. domiciled
company. Foreign companies generally are not subject to uniform accounting,
auditing and financial reporting standards comparable to those applicable to
U.S. domestic companies. There is generally less government regulation of
securities exchanges, brokers and listed companies abroad than in the U.S.
Confiscatory taxation or diplomatic developments could also affect investment in
those countries. In addition, foreign branches of U.S. banks, foreign banks and
foreign issuers may be subject to less stringent reserve requirements and to
different accounting, auditing, reporting, and recordkeeping standards than
those applicable to domestic branches of U.S. banks and U.S. domestic issuers.
Because foreign companies are not subject to uniform accounting, auditing and
financial reporting standards, practices and requirements comparable to those
applicable to U.S. companies, there may be less publicly available information
about a foreign company than about a U.S. company. Volume and liquidity in most
foreign bond markets are less than in the U.S., and securities of many foreign
companies are less liquid and more volatile than securities of comparable U.S.
companies. Fixed commissions on foreign securities exchanges are generally
higher than negotiated commissions on U.S. exchanges, although the Funds will
endeavor to achieve the most favorable net results on portfolio transactions.
There is generally less government supervision and regulation of securities
exchanges, brokers, dealers and listed companies than in the U.S., thus
increasing the risk of delayed settlements of portfolio transactions or loss of
certificates for portfolio securities.
<PAGE>
Foreign markets also have different clearance and settlement procedures, and in
certain markets, there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Such delays in settlement could result in temporary periods
when a portion of the assets of a Fund is uninvested and no return is earned
thereon. The inability of a Fund to make intended security purchases due to
settlement problems could cause the Fund to miss attractive investment
opportunities. Losses to a Fund due to subsequent declines in the value of
portfolio securities, or losses arising out of an inability to fulfill a
contract to sell such securities, could result in potential liability to the
Fund. In addition, with respect to certain foreign countries, there is the
possibility of expropriation or confiscatory taxation, political or social
instability, or diplomatic developments which could affect the investments in
those countries. Moreover, individual foreign economies may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross national
product, rate of inflation, capital reinvestment, resource self-sufficiency and
balance of payments position.
Additionally, the Growth and Income Fund and Fixed Income Fund may invest in
countries with emerging economies or securities markets. Political and economic
structures in many of these countries may be undergoing significant evolution
and rapid development, and these countries may lack the social, political and
economic stability characteristics of more developed countries. Some of these
countries may have in the past failed to recognize private property rights and
have at time nationalized or expropriated the assets of private companies. As a
result, the risks described above, including the risks of nationalization or
expropriation of assets, may be heightened. In addition, unanticipated political
or social developments may affect the value of investments in these countries
and the availability to the Funds of additional investments in emerging market
countries. The small size and inexperience of the securities markets in certain
of these countries and the limited volume of trading in securities in these
countries may make investments in the countries illiquid and more volatile than
investments in more developed countries. There may be little financial or
accounting information available with respect to issuers located in certain
emerging market countries, and it may be difficult as a result to assess the
value or prospects of an investment in such issuers.
In many instances, foreign debt securities may provide higher yields than
securities of domestic issuers which have similar maturities and quality. Under
certain market conditions these investments may be less liquid than the
securities of U.S. corporations and are certainly less liquid than securities
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities. Finally, in the event of a default of any such foreign debt
obligations, it may be more difficult to obtain or to enforce a judgment against
the issuers of such securities.
<PAGE>
If a security is denominated in foreign currency, the value of the security to a
Fund will be affected by changes in currency exchange rates and in exchange
control regulations, and costs will be incurred in connection with conversions
between currencies. Currency risks generally increase in lesser developed
markets. Exchange rate movements can be large and can endure for extended
periods of time, affecting either favorably or unfavorably the value of a Fund's
assets. The value of the assets of a Fund as measured in U.S. dollars may be
affected favorably or unfavorably by changes in foreign currency exchange rates
and exchange control regulations.
A change in the value of any foreign currency against the U.S. dollar will
result in a corresponding change in the U.S. dollar value of securities
denominated in that currency. Such changes will also affect the income and
distributions to Shareholders of the Funds investing in securities that are not
U.S. dollar-denominated. In addition, although such Funds will receive income on
foreign securities in such currencies, a Fund will be required to compute and
distribute income in U.S. dollars. Therefore, if the exchange rate for any such
currency declines materially after income has been accrued and translated into
U.S. dollars, the Funds could be required to liquidate portfolio securities to
make required distributions. Similarly, if an exchange rate declines between the
time a Fund incurs expenses in U.S. dollars and the time such expenses are paid,
the amount of such currency required to be converted into U.S. dollars in order
to pay such expenses in U.S. dollars will be greater.
For many foreign securities, U.S. dollar denominated American Depositary
Receipts ("ADRs"), which are traded in the United States on exchanges or
over-the-counter, are issued by domestic banks. ADRs represent the right to
receive securities of foreign issuers deposited in a domestic bank or a
correspondent bank. ADRs do not eliminate all the risk inherent in investing in
the securities of foreign issuers' stock. However, by investing in ADRs rather
than directly in foreign issuers' stock, the HSBC Growth and Income Fund can
avoid currency risks during the settlement period for either purchase or sales.
In general, there is a large, liquid market in the United States for many ADRs.
The information available for ADRs is subject to the accounting, auditing and
financial reporting standards of the domestic market or exchange on which they
are traded, which standards are more uniform and more exacting than those to
which many foreign issuers may be subject. Certain ADRs, typically those
denominated as unsponsored, require the holders thereof to bear most of the
costs of such facilities, while issuers of sponsored facilities normally pay
more of the costs thereof. The depository of an unsponsored facility frequently
is under no obligation to distribute shareholder communications received from
the issuer of the deposited securities or to pass through the voting rights to
facility holders with respect to the deposited securities, whereas the
depository of a sponsored facility typically distributes shareholder
communications and passes through the voting rights.
<PAGE>
The Growth and Income Fund may invest in both sponsored and unsponsored ADRs and
European Depositary Receipts ("EDRs"), Global Depositary Receipts ("GDRs") and
other similar global instruments. EDRs, which are sometimes referred to as
Continental Depositary Receipts, are receipts issued in Europe, typically by
foreign banks and trust companies, that evidence ownership of either foreign or
domestic underlying securities. GDRs are depositary receipts structured like
global debt issues to facilitate trading on an international basis. Unsponsored
ADR, EDR and GDR programs are organized independently and without the
cooperation of the issuer of the underlying securities. As a result, available
information concerning the issuers may not be as current as for sponsored ADRs,
EDRs, and GDRs, and the prices of unsponsored depositary receipts may be more
volatile than if such instruments were sponsored by the issuer.
Securities Of Foreign Governments And Supranational Organizations. The Growth
and Income Fund and Fixed Income Fund may invest in U.S. dollar - denominated
debt securities issued by foreign governments, their political subdivisions,
governmental authorities, agencies and instrumentalities and supranational
organizations. A supranational organization is an entity designated or supported
by the national government of one or more countries to promote economic
reconstruction or development. Examples of supranational organizations include,
among others, the International Bank for Reconstruction and Development (World
Bank), the European Economic Community, the European Coal and Steel Community,
the European Investment Bank, the Inter- American Development Bank, the Asian
Development Bank, and the African Development Bank. These Funds may also invest
in "quasi-government securities" which are debt obligations issued by entities
owned by either a national, state or equivalent government or are obligations of
such a government jurisdiction which are not backed by its full faith and credit
and general taxing powers.
Investing in foreign government and quasi-government securities involves
considerations and possible risks not typically associated with investing in
obligations issued by the U.S. Government. The values of foreign investments are
affected by changes in governmental administration or economic or monetary
policy (in the U.S. or other countries) or changed circumstances in dealings
between countries. In addition, investments in foreign countries could be
affected by other factors not present in the United States, including
expropriation, confiscatory taxation and lack of uniform accounting and auditing
standards.
Foreign Currency Transactions. The value of the assets of the Growth and Income
Fund and Fixed Income Fund as measured in U.S. dollars may be affected favorably
or unfavorably by changes in foreign currency exchange rates and exchange
control regulations, and such Funds may incur costs in connection with
conversions between various currencies. The Funds will conduct foreign currency
exchange transactions either on a spot (i.e., cash) basis at the spot rate
prevailing in the foreign currency exchange market, or through forward contracts
to purchase or sell foreign currencies. A forward foreign currency exchange
contract ("forward currency contract") involves an obligation 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 agreed upon by the parties, at a price set at the
time of the contract. These forward currency contracts are traded directly
between currency traders (usually large commercial banks) and their customers.
The Funds may enter into forward currency contracts in order to hedge against
adverse movements in exchange rates between currencies.
<PAGE>
By entering into a forward currency contract in U.S. dollars for the purchase or
sale of the amount of foreign currency involved in an underlying security
transaction, a Fund is able to protect itself against a possible loss between
trade and settlement dates resulting from an adverse change in the relationship
between the U.S. dollar and such foreign currency. However, this tends to limit
potential gains which might result from a positive change in such currency
relationships. The Funds also may hedge foreign currency exchange rate risk by
engaging in a currency financial futures and options transactions, which are
described below. The forecasting of short-term currency market movements is
extremely difficult and whether such a short-term heading strategy will be
successful is highly uncertain.
It is impossible to forecast with precision the market value of portfolio
securities at the expiration of a forward currency contract. Accordingly, it may
be necessary for a Fund to purchase additional currency on the spot market if
the market value of the security is less than the amount of foreign currency the
Fund is obligated to deliver when a decision is made to sell the security and
make delivery of the foreign currency in settlement of a forward contract.
Conversely, it may be necessary to sell on the spot market some of the foreign
currency received upon the sale of the portfolio security if its market value
exceeds the amount of foreign currency the Fund is obligated to deliver.
If a Fund retains the portfolio security and engages in an offsetting
transaction, it will incur a gain or a loss to the extent that there has been
movement in forward currency contract prices. If a Fund engages in an offsetting
transaction, it may subsequently enter into a new forward currency contract to
sell the foreign currency. Although such contracts tend to minimize the risk of
loss due to a decline in the value of the hedged currency, they also tend to
limit any potential gain which might result should the value of such currency
increase. The Funds will have to convert their holdings of foreign currencies
into U.S. dollars from time to time. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on the difference
(the "spread") between the prices at which they are buying and selling various
currencies.
Standard & Poor's Depository Receipts. The Growth and Income Fund may invest in
Standard & Poor's Depository Receipts ("SPDRs"). SPDRs represent interests in
trusts sponsored by a subsidiary of the American Stock Exchange, Inc. and are
structured to provide investors proportionate undivided interests in a
securities portfolio constituting substantially all the common stocks (in
substantially the same weighting) as the component common stocks of a particular
Standard & Poor's Index ("S&P Index"), such as the S&P 500. SPDRs are not
redeemable, but are exchange traded. SPDRs represent interests in an investment
company that is not actively managed, and instead holds securities in an effort
to track the performance of the pertinent S&P Index and not for the purpose of
selecting securities that are considered superior investments. The results of
SPDRs will not replicate exactly the performance of the pertinent S&P Index due
to reductions in the SPDRs' performance attributable to transaction and other
expenses, including fees to service providers, borne by the SPDRs. SPDRs
distribute dividends on a quarterly basis. The Fund must limit investments in an
SPDR to 5% of its total assets and 3% of the outstanding voting securities of
the SPDR issuer. Moreover, the Fund's investments in SPDRs, when aggregated with
all other investments in investment companies, may not exceed 10% of the total
assets of the Fund.
<PAGE>
U.S. Government Obligations. The Funds may invest in obligations issued or
guaranteed by the U.S. Government, its agencies and instrumentalities, including
bills, notes and bonds issued by the U.S. Treasury, as well as "stripped" U.S.
Treasury obligations such as Treasury Receipts issued by the U.S. Treasury
representing either future interest or principal payments. Stripped securities
are issued at a discount to their "face value," and may exhibit greater price
volatility than ordinary debt securities because of the manner in which their
principal and interest are returned to investors. The stripped Treasury
obligations in which the Funds may invest do not include Certificates of Accrual
on Treasury Securities ("CATS") or Treasury Income Growth Receipts ("TIGRs").
Obligations of certain agencies and instrumentalities of the U.S. Government,
such as the Government National Mortgage Association ("GNMA"), are supported by
the full faith and credit of the U.S. Treasury; others, such as those of the
Federal National Mortgage Association ("FNMA"), are supported by the right of
the issuer to borrow from the Treasury; others, such as those of the Student
Loan Marketing Association ("SLMA"), are supported by the discretionary
authority of the U.S. Government to purchase the agency's obligations; still
others, such as those of the Federal Farm Credit Bureau or the Federal Home Loan
Mortgage Corporation ("FHLMC"), are supported only by the credit of the
instrumentality. No assurance can be given that the U.S. Government would
provide financial support to U.S. Government-sponsored agencies or
instrumentalities if it is not obligated to do so by law. Each of the Funds will
invest in the obligations of such agencies or instrumentalities only when HSBC
believes that the credit risk with respect thereto is minimal.
The Growth and Income Fund and Fixed Income Fund may also invest in "zero
coupon" U.S. Government securities. These securities tend to be more volatile
than other types of U.S. Government securities. Zero coupon securities are debt
instruments that do not pay current interest and are typically sold at prices
greatly discounted from par value. The return on a zero coupon obligation, when
held to maturity, equals the difference between the par value and the original
purchase price.
Options. The Growth and Income Fund and Fixed Income Fund may purchase put and
call options on securities, securities indices and foreign currencies and may
write (sell) covered put and call options. The Fixed Income Fund will engage in
options trading principally for hedging purposes.
A call option gives the purchaser the right to buy, and a writer has the
obligation to sell, the underlying security or foreign currency at the stated
exercise price at any time prior to the expiration of the option, regardless of
the market price or exchange rate of the security or foreign currency, as the
case may be. The premium paid to the writer is consideration for undertaking the
obligations under the option contract. A put option gives the purchaser the
right to sell the underlying security or foreign currency at the stated exercise
price at any time prior to the expiration date of the option, regardless of the
market price or exchange rate of the security or foreign currency, as the case
may be. A call option is covered if a Fund owns the underlying security covered
by the call or has an absolute and immediate right to acquire that security
without additional cash consideration (or for additional cash consideration if
the underlying security is held in a segregated account by its custodian) upon
conversion or exchange of other securities held in its portfolio. A put option
is covered if a Fund maintains cash, or other liquid assets with a value equal
to the exercise price in a segregated account with its custodian. Put and call
options will be valued at the last sale price, or in the absence of such a
price, at the mean between bid and asked price.
<PAGE>
When a portfolio security or currency subject to a call option is sold, a Fund
will effect a "closing purchase transaction"--the purchase of a call option on
the same security or currency with the same exercise price and expiration date
as the call option which the Fund previously has written. If a Fund is unable to
effect a closing purchase transaction, it will not be able to sell the
underlying security or currency until the option expires or the Fund delivers
the underlying security or currency upon exercise. In addition, upon the
exercise of a call option by the holder thereof, a Fund will forego the
potential benefit represented by market appreciation over the exercise price.
When a Fund writes an option, an amount equal to the net premium (the premium
less the commission) received by the Fund is included in the liability section
of its statement of assets and liabilities as a deferred credit. The amount of
the deferred credit will be subsequently marked-to-market to reflect the current
value of the option written. The current value of the traded option is the last
sale price or, in the absence of a sale, the average of the closing bid and
asked prices. If an option expires on the stipulated expiration date, or if a
Fund enters into a closing purchase transaction, it will realize a gain (or a
loss if the cost of a closing purchase transaction exceeds the net premium
received when the option is sold) and the deferred credit related to such option
will be eliminated. If an option is exercised, the Fund may deliver the
underlying security in the open market. In either event, the proceeds of the
sale will be increased by the net premium originally received and the Fund will
realize a gain or loss.
Covered call options must be listed on a national securities exchange and issued
by the Options Clearing Corporation. The purpose of writing covered call options
is to generate additional premium income for a Fund. This premium income will
serve to enhance the Fund's total return and will reduce the effect of any price
decline of the security involved in the option. Covered call options will
generally be written on securities which are not expected to make any major
price moves in the near future but which, over the long term, are deemed to be
attractive investments for the Fund.
<PAGE>
Once the decision to write a call option has been made, HSBC, in determining
whether a particular call option should be written on a particular security,
will consider the reasonableness of the anticipated premium and the likelihood
that a liquid secondary market will exist for those options. Closing
transactions will be effected in order to realize a profit on an outstanding
call option, to prevent an underlying security from being called, or to permit
the sale of the underlying security. Furthermore, effecting a closing
transaction will permit a Fund to write another call option on the underlying
security with either a different exercise price or expiration date or both. If a
Fund desires to sell a particular security from its portfolio on which it has
written a call option, it will seek to effect a closing transaction prior to, or
concurrently with, the sale of the security. There is, of course, no assurance
that the Fund will be able to effect such closing transactions at a favorable
price. If a Fund cannot enter into such a transaction, it may be required to
hold a security that it might otherwise have sold, in which case it would
continue to be at market risk on the security. This could result in higher
transaction costs. A Fund will pay transaction costs in connection with the
writing of options to close out previously written options. Such transaction
costs are normally higher than those applicable to purchases and sales of
portfolio securities.
Exercise prices of options may be below, equal to, or above the current market
values of the underlying securities at the time the options are written. From
time to time, a Fund may purchase an underlying security for delivery in
accordance with an exercise notice of a call option assigned to it, rather than
delivering such security from its portfolio. In such cases, additional costs
will be incurred. A Fund will realize a profit or loss from a closing purchase
transaction if the cost of the transaction is less or more than the premium
received from the writing of the option. Because increases in the market price
of a call option will generally reflect increases in the market price of the
underlying security, any loss resulting from the repurchase of a call option is
likely to be offset in whole or in part by appreciation of the underlying
security owned by a Fund.
Where a Fund may purchase put options, that Fund is purchasing the right to sell
a specified security (or securities) within a specified period of time at a
specified exercise price. Puts may be acquired to facilitate the liquidity of
the portfolio assets. Puts may also be used to facilitate the reinvestment of
assets at a rate of return more favorable than that of the underlying security.
A Fund may sell, transfer, or assign a put only in conjunction with the sale,
transfer, or assignment of the underlying security or securities. The amount
payable to a Fund upon its exercise of a "put" is normally (i) the Fund's
acquisition cost of the securities subject to the put (excluding any accrued
interest which the Fund paid on the acquisition), less any amortized market
premium or plus any accreted market or original issue discount during the period
the Fund owned the securities, plus (ii) all interest accrued on the securities
since the last interest payment date during that period. A Fund generally will
acquire puts only where the puts are available without the payment of any direct
or indirect consideration. However, if necessary or advisable, a Fund may pay
for puts either separately in cash or by paying higher price for portfolio
securities which are acquired subject to the puts (thus reducing the yield to
maturity otherwise available for the same securities).
<PAGE>
Index options (or options on securities indices) are similar in many respects to
options on securities, except that an index option gives the holder the right to
receive, upon exercise, cash instead of securities, if the closing level of the
securities index upon which the option is based is greater than, in the case of
a call, or less than, in the case of a put, the exercise price of the option.
Because index options are settled in cash, a call writer cannot determine the
amount of its settlement obligations in advance and, unlike call writing on
specific securities, cannot provide in advance for, or cover, its potential
settlement obligations by acquiring and holding the underlying securities. A
Fund will segregate assets or otherwise cover index options that would require
it to pay cash upon exercise.
A principal reason for writing put and call options is to attempt to realize,
through the receipt of premiums, a greater current return than would be realized
on the underlying securities alone. In return for the premium received for a
call option, a Fund foregoes the opportunity for profit from a price increase in
the underlying security above the exercise price so long as the option remains
open, but retains the risk of loss should the price of the security decline. In
return for the premium received for a put option, a Fund assumes the risk that
the price of the underlying security will decline below the exercise price, in
which case the put would be exercised and the Fund would suffer a loss. A Fund
may purchase put options in an effort to protect the value of a security it owns
against a possible decline in market value.
Bond Options. The Fixed Income Fund may purchase put and call options and write
covered put and call options on securities in which that Fund may invest
directly, and that are traded on registered domestic securities exchanges or
that result from separate, privately negotiated transactions with primary U.S.
Government securities dealers recognized by the Board of Governors of the
Federal Reserve System (i.e., over-the-counter (OTC) options).
Forward Commitments, When-Issued and Delayed-Delivery Securities. The Growth and
Income Fund and the Fixed Income Fund may purchase securities on a "when-issued"
or "delayed-delivery" basis (i.e., for delivery beyond the normal settlement
date at a stated price and yield). In addition, these Funds may purchase and
sell securities on a "forward commitment" basis. These Funds will engage in
when-issued and delayed-delivery transactions only for the purpose of acquiring
portfolio securities consistent with its investment objective and policies, not
for investment leverage. When-issued securities involve a risk that the yield
obtained in the transaction will be less than that available in the market when
delivery takes place. These Funds will not pay for such securities or start
earning interest on them until they are received.
When one of these Funds agrees to purchase securities on a "when-issued" or
"delayed-delivery" basis, its custodian will set aside cash or liquid securities
equal to the amount of the commitment in a separate account. Normally, the
custodian will set aside securities to satisfy the purchase commitment, and in
such a case, a Fund may be required subsequently to place additional assets in
the separate account in order to assure that the value of the account remains
equal to the amount of its commitment. It may be expected that a Fund investing
in securities on a when-issued or delayed delivery basis, net assets will
fluctuate to a greater degree when it sets aside securities to cover such
purchase commitments than when it sets aside cash. In addition, because a Fund
will set aside cash or liquid securities to satisfy its purchase commitments in
the manner described above, its liquidity and the ability of its investment
adviser to manage it might be affected in the event its commitments to purchase
"when-issued" or "delayed-delivery" securities ever exceeded 25% of the value of
its assets. Under normal market conditions, however, a Fund's commitment to
purchase "when-issued" or "delayed-delivery" securities will not exceed 25% of
the value of each Fund's total assets.
<PAGE>
When a Fund engages in "when-issued" or "delayed-delivery" transactions, it
relies on the seller to consummate the trade. Failure of the seller to do so may
result in a Fund incurring a loss or missing the opportunity to obtain a price
or yield considered to be advantageous.
Mortgage-Related and Asset-Backed Securities. Investments in these and other
derivative securities will not be made for purposes of leverage or speculation,
but rather primarily for conventional investment or hedging purposes, liquidity,
flexibility and to capitalize on market inefficiencies. The Growth and Income
Fund and Fixed Income Fund each may, consistent with its investment objective
and policies, invest in mortgage-related securities issued or guaranteed by the
U.S. Government, its agencies and instrumentalities. In addition, each may
invest in mortgage-related securities issued by nongovernmental entities,
provided, however, that to the extent that a Fund purchases mortgage-related
securities from such issuers which may, solely for purposes of the 1940 Act, be
deemed to be investment companies, the Fund's investment in such securities will
be subject to the limitations on its investment in investment company
securities.
Mortgage-related securities in which these Funds may invest, represent pools of
mortgage loans assembled for sale to investors by various governmental agencies
such as GNMA and government-related organizations such as FNMA and FHLMC, as
well as by nongovernmental issuers such as commercial banks, savings and loan
institutions, mortgage bankers and private mortgage insurance companies.
Although certain mortgage-related securities are guaranteed by a third party or
otherwise similarly secured, the market value of the security, which may
fluctuate, is not so secured. If a Fund purchases a mortgage-related security at
a premium, that portion may be lost if there is a decline in the market value of
the security whether resulting from changes in interest rates or prepayments in
the underlying mortgage collateral. As with other interest-bearing securities,
the prices of such securities are inversely affected by changes in interest
rates. However, though the value of a mortgage-related security may decline when
interest rates rise, the converse is not necessarily true, since in periods of
declining interest rates the mortgages underlying the securities are prone to
prepayment, thereby shortening the average life of the security and shortening
the period of time over which income at the higher rate is received. When
interest rates are rising, though, the rate of prepayment tends to decrease,
thereby lengthening the period of time over which income at the lower rate is
received. For these and other reasons, a mortgage-related security's average
maturity may be shortened or lengthened as a result of interest rate
fluctuations and, therefore, it is not possible to predict accurately the
security's return. In addition, regular payments received in respect of
mortgage-related securities include both interest and principal. No assurance
can be given as to the return the Funds will receive when these amounts are
reinvested.
<PAGE>
There are a number of important differences among the agencies and
instrumentalities of the U.S. Government that issue mortgage related securities
and among the securities that they issue. Mortgage-related securities issued by
GNMA include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie
Maes") which are guaranteed as to the timely payment of principal and interest
by GNMA and such guarantee is backed by the full faith and credit of the United
States. GNMA is a wholly-owned U.S. Government corporation within the Department
of Housing and Urban Development. GNMA certificates also are supported by the
authority of GNMA to borrow funds from the U.S. Treasury to make payments under
its guarantee. Mortgage-related securities issued by FNMA include FNMA
Guaranteed Mortgage Pass-Through Certificates (also known as "Fannie Maes")
which are solely the obligations of FNMA and are not backed by or entitled to
the full faith and credit of the United States. FNMA is a government-sponsored
organization owned entirely by private stockholders. Fannie Maes are guaranteed
as to the timely payment of the principal and interest by FNMA. Mortgage-related
securities issued by FHLMC include FHLMC Mortgage Participation Certificates
(also known as "Freddie Macs" or "Pcs"). FHLMC is a corporate instrumentality of
the United States, created pursuant to an Act of Congress, which is owned
entirely by Federal Home Loan Banks. Freddie Macs are not guaranteed by the
United States or by any Federal Home Loan Banks and do not constitute a debt or
obligation of the United States or of any Federal Home Loan Bank. Freddie Macs
entitle the holder to the timely payment of interest, which is guaranteed by
FHLMC. FHLMC guarantees either ultimate collection or the timely payment of all
principal payments on the underlying mortgage loans. When FHLMC does not
guarantee timely payment of principal, FHLMC may remit the amount due on account
of its guarantee of ultimate payment of principal at any time after default on
an underlying mortgage, but in no event later than one year after it becomes
payable.
These Funds may invest in Collateralized Mortgage Obligations ("CMOs"). CMOs may
include stripped mortgage securities. Such securities are derivative multi-class
mortgage securities issued by agencies or instrumentalities of the U.S.
Government, or by private originators of, or investors in, mortgage loans,
including savings and loan associations, mortgage banks, commercial banks,
investment banks and special purpose subsidiaries of the foregoing. Stripped
mortgage securities are usually structured with two classes that receive
different proportions of the interest and principal distributions on a pool of
mortgage assets. A common type of stripped mortgage security will have one class
receiving all of the interest from the mortgage assets (the interest-only or
"IO" class), while the other class will receive all of the principal (the
principal-only or "PO" class). The yield to maturity on an IO class is extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and a rapid rate of principal payments may
have a material adverse effect on the securities' yield to maturity. Generally,
the market value of the PO class is unusually volatile in response to changes in
interest rates. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, a Fund may fail to fully recoup its
initial investment in these securities even if the security is rated in the
highest rating category.
<PAGE>
Like mortgages underlying mortgage-backed securities, automobile sales contracts
or credit card receivables underlying asset-backed securities are subject to
prepayment, which may reduce the overall return to certificate holders.
Nevertheless, principal prepayment rates tend not to vary much with interest
rates, and the short-term nature of the underlying car loans or other
receivables tends to dampen the impact of any change in the prepayment level.
Certificate holders may also experience delays in prepayment on the certificates
if the full amounts due on underlying sales contracts or receivables are not
realized because of unanticipated legal or administrative costs of enforcing the
contracts or because of depreciation or damage to the collateral (usually
automobiles) securing certain contracts, or other factors. In certain market
conditions, asset-backed securities may experience volatile fluctuations in
value and periods of illiquidity. If consistent with its investment objective
and policies, Growth and Income Fund and Fixed Income Fund may invest in other
asset-backed securities that may be developed in the future.
Illiquid and Restricted Securities. "Section 4(2) securities" are securities
which are issued in reliance on the "private placement" exemption from
registration which is afforded by Section 4(2) of the 1933 Act. A Fund will not
purchase Section 4(2) securities which have not been determined to be liquid in
excess of 15% (10% in the case of the Cash Management Fund) of its net assets.
Section 4(2) securities are restricted as to disposition under the federal
securities laws, and generally are sold to institutional investors such as the
Funds which agree that they are purchasing the securities for investment and not
with a view to public distribution. Any resale must also generally be made in an
exempt transaction. Section 4(2) securities are normally resold to other
institutional investors through or with the assistance of the issuer or
investment dealers who make a market in such Section 4(2) securities, thus
providing liquidity. Rule 144A, a rule promulgated under Section 4(2) of the
1933 Act, provides a safe-harbor exemption from the registration requirements of
the 1933 Act for resales to "qualified institutional buyers" as defined in Rule
144A. With the exception of registered broker-dealers, a qualified institutional
buyer must generally own and invest on a discretionary basis at least $100
million in securities.
HSBC may deem Section 4(2) securities liquid if it believes that, based on the
trading markets for such security, such security can be disposed of within seven
days in the ordinary course of business at approximately the amount at which the
Fund has valued the security. In making such determination, the following
factors, among others, may be deemed relevant: (i) the credit quality of the
issuer; (ii) the frequency of trades and quotes for the security; (iii) the
number of dealers willing to purchase or sell the security and the number of
other potential purchasers; (iv) dealer undertakings to make a market in the
security; and (v) the nature of the security and the nature of market-place
trades.
Treatment of Section 4(2) securities as liquid could have the effect of
decreasing the level of a Fund's liquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities.
<PAGE>
Investments in Municipal Securities. The Fixed Income Fund may, when deemed
appropriate by HSBC and consistent with the investment objective of the Fund,
invest in obligations of state and local governmental issuers which carry
taxable yields that are comparable to yields of other fixed income instruments
of comparable quality, or which HSBC believes offer the potential for capital
appreciation. Municipal obligations may include bonds which may be categorized
as 19 either "general obligation" or "revenue" bonds. General obligation bonds
are secured by the issuer's pledge of its full faith, credit and taxing power
for the payment of principal and interest. Revenue bonds are secured by the net
revenue derived from a particular facility or group of facilities or, in some
cases, the proceeds of a special excise or other specific revenue source, but
not by the general taxing power of the issuer.
The Fixed Income Fund may also invest in municipal notes rated at least MIG-1 by
Moody's or SP-1 by S&P. Municipal notes will consist of tax anticipation notes,
bond anticipation notes, revenue anticipation notes and construction loan notes.
Notes sold as interim financing in anticipation of collection of taxes, a bond
sale or receipt of other revenues are usually general obligations of the issuer.
The Fund also may invest in municipal commercial paper, provided such commercial
paper is rated at least "Prime-1" by Moody's or "A-1" by S&P or, if unrated, is
of comparable investment quality as determined by HSBC.
Investment Companies. The Funds may invest in securities issued by other
investment companies, including, but not limited to, money market investment
companies, within the limits prescribed by the 1940 Act. As a shareholder of
another investment company, a Fund would bear, along with other shareholders,
its pro rata portion of the expenses of such other investment company, including
advisory fees. These expenses would be in addition to the advisory and other
expenses that a Fund bears directly in connection with its own operations, and
may represent a duplication of fees to Shareholders of a Fund.
Lending of Portfolio Securities. The Funds, from time to time, may lend
portfolio securities to broker-dealers, banks or institutional borrowers of
securities. The Funds must receive 100% collateral, in the form of cash or U.S.
Government securities. This collateral must be valued daily, and should the
market value of the loaned securities increase, the borrower must furnish
additional collateral to the lender. During the time portfolio securities are on
loan, the borrower pays the lender any dividends or interest paid on such
securities. Loans are subject to termination by the lender or the borrower at
any time. While the Funds do not have the right to vote securities on loan, each
intends to terminate the loan and regain the right to vote if that is considered
important with respect to the investment. In the event the borrower defaults on
its obligation to a Fund, it could experience delays in recovering its
securities and possible capital losses. The Funds will only enter into loan
arrangements with broker-dealers, banks or other institutions determined to be
creditworthy under guidelines established by the Board of Trustees.
<PAGE>
Convertible Securities. The Growth and Income Fund may invest in convertible
securities. Convertible securities are fixed income securities that may be
exchanged or converted into a predetermined number of the issuer's underlying
common stock at the option of the holder during a specified time period.
Convertible securities may take the form of convertible preferred stock,
convertible bonds or debentures, units consisting of "usable" bonds and warrants
or a combination of the features of several of these securities. The Fund will
invest in convertible securities that are rated "BBB" by S&P and "Baa" by
Moody's, or higher, at the time of investment, or if unrated, are of comparable
quality. Convertible bonds and convertible preferred stocks are fixed income
securities that generally retain the investment characteristics of fixed income
securities until they have been converted but also react to movements in the
underlying equity securities. The holder is entitled to receive the fixed income
of a bond or the dividend preference of a preferred stock until the holder
elects to exercise the conversion privilege. Usable bonds are corporate bonds
that can be used in whole or in part, customarily at full face value, in lieu of
cash to purchase the issuer's common stock.
When owned as part of a unit along with warrants, which are options to buy the
common stock, they function as convertible bonds, except that the warrants
generally will expire before the bond's maturity. Convertible securities are
senior to equity securities, and, therefore, have a claim to assets of the
corporation prior to the holders of common stock in the case of liquidation.
However, convertible securities are generally subordinated to similar
non-convertible securities of the same company. The interest income and
dividends from convertible bonds and preferred stocks provide a stream of income
with generally higher yields than common stocks, but lower than non-convertible
securities of similar quality.
The Fund will exchange or convert the convertible securities held in its
portfolio into shares of the underlying common stock in instances in which, in
the opinion of HSBC, the investment characteristics of the underlying common
shares will assist the Fund in achieving its investment objective. Otherwise,
the Funds will hold or trade the convertible securities. In selecting
convertible securities for the Fund, HSBC evaluates the investment
characteristics of the convertible security as a fixed income instrument, and
the investment potential of the underlying equity security for capital
appreciation. In evaluating these matters with respect to a particular
convertible security, HSBC may consider numerous factors, including the economic
and political outlook, the value of the security relative to other investment
alternatives, trends in the determinants of the issuer's profits, and the
issuer's management capability and practices.
As with all fixed income securities, the market values of convertible securities
tend to increase when interest rates decline and, conversely, tend to decline
when interest rates increase.
<PAGE>
Warrants. The Growth and Income Fund may purchase warrants and similar rights,
which are privileges issued by corporations enabling the owners to subscribe to
and purchase a specified number of shares of the corporation at a specified
price during a specified period of time. The purchase of warrants involves the
risk that the Fund could lose the purchase value of a warrant if the right to
subscribe to additional shares is not exercised prior to the warrant's
expiration. Also, the purchase of warrants involves the risk that the effective
price paid for the warrant added to the subscription price of the related
security may exceed the value of the subscribed security's market price such as
when there is no movement in the level of the underlying security.
Repurchase Agreements. Securities held by the Funds may be subject to repurchase
agreements. Under the terms of a repurchase agreement, a Fund would acquire
securities from member banks of the Federal Deposit Insurance Corporation and
registered broker-dealers that HSBC deems creditworthy under guidelines approved
by the Board of Trustees, subject to the seller's agreement to repurchase such
securities at a mutually agreed-upon date and price, which includes interest
negotiated on the basis of current short-term rates. The seller under a
repurchase agreement will be required to maintain at all times the value of
collateral held pursuant to the agreement at not less than the repurchase price
(including accrued interest). If the seller were to default on its repurchase
obligation or become insolvent, a Fund holding such obligation would suffer a
loss to the extent that the proceeds from a sale of the underlying portfolio
securities were less than the repurchase price under the agreement. Securities
subject to repurchase agreements will be held by the Fund's custodian or another
qualified custodian, as appropriate, or in the Federal Reserve/Treasury
book-entry system.
Reverse Repurchase Agreements. The Funds may also enter into reverse repurchase
agreements in accordance with applicable investment restrictions. Pursuant to
such reverse repurchase agreements, a Fund would sell certain of its securities
to financial institutions such as banks and broker-dealers, and agree to
repurchase them at a mutually agreed upon date and price. At the time a Fund
enters into a reverse repurchase agreement, it will place in a segregated
custodial account assets such as U.S. Government securities or other liquid
securities consistent with its investment restrictions having a value equal to
the repurchase price (including accrued interest), and will subsequently
continually monitor the account to ensure that such equivalent value is
maintained at all times. Reverse repurchase agreements involve the risk that the
market value of securities to be purchased by a Fund may decline below the price
at which it is obligated to repurchase the securities, or that the other party
may default on its obligation, so that the Fund is delayed or prevented from
completing the transaction.
Futures Contracts and Options Thereon. The Growth and Income Fund and Fixed
Income Fund may enter into contracts for the future delivery of securities or
foreign currencies and futures contracts based on a specific security, class of
securities, interest rate, foreign currency or an index, purchase or sell
options on any such futures contracts and engage in related closing
transactions. A futures contract on a securities index is an agreement
obligating either party to pay, and entitling the other party to receive, while
the contract is outstanding, cash payments based on the level of a specified
securities index. A Fund may engage in such futures transactions in an effort to
hedge against market risks and to manage its cash position, but not for
leveraging purposes. This investment technique is designed primarily to hedge
against anticipated future changes in market conditions or foreign exchange
rates which otherwise might adversely affect the value of securities which these
Funds hold or intend to purchase. For example, when interest rates are expected
to rise or market values of portfolio securities are expected to fall, these
Funds can seek through the sale of futures contracts to offset a decline in the
value of its portfolio securities. When interest rates are expected to fall or
market values are expected to rise, these Funds, through the purchase of such
contracts, can attempt to secure better rates or prices than might later be
available in the market when it effects anticipated purchases.
<PAGE>
The acquisition of put and call options on futures contracts will, respectively,
give a Fund the right (but not the obligation), for a specified price, to sell
or to purchase the underlying futures contract, upon exercise of the option, at
any time during the option period.
The value of a Fund's contracts may equal or exceed 100% of its total assets,
although it will not purchase or sell a futures contract unless immediately
following such sale or purchase the aggregate amount of margin deposits on its
existing futures positions plus the amount of premiums paid for related futures
options entered into for other than bona fide hedging purposes is 5% or less of
the its net assets. Futures transactions will be limited to the extent necessary
to maintain the qualification of these Funds as regulated investment companies.
The Funds also may purchase and sell put and call options on futures contracts.
An option on a futures contract gives the purchaser the right, but not the
obligation, in return for the premium paid, to assume (in the case of a call) or
sell (in the case of a put) a position in a specified underlying futures
contract (which position may be a long or short position) a specified exercise
price at any time during the option exercise period. Sellers of options on
futures contracts, like buyers and sellers of futures contracts, make an initial
margin deposit and are subject to calls for variation margin.
Futures transactions involve brokerage costs and require a Fund to segregate
liquid assets, such as cash, U.S. Government securities or other liquid
securities to cover its obligation under such contracts. There is a possibility
that these Fund may lose the expected benefit of futures transactions if
interest rates, securities prices or foreign exchange rates move in an
unanticipated manner. Such unanticipated changes may also result in poorer
overall performance than if a Fund had not entered into any futures
transactions. In addition, the value of futures positions may not prove to be
perfectly or even highly correlated with the value of its portfolio securities
and foreign currencies, limiting the Fund's ability to hedge effectively against
interest rate, foreign exchange rate and/or market risk and giving rise to
additional risks. There is no assurance of liquidity in the secondary market for
purposes of closing out futures positions.
Regulatory Restrictions. As required by the Securities and Exchange Commission,
when purchasing or selling a futures contract or writing a put or call option or
entering into a forward foreign currency exchange purchase, a Fund will maintain
in a segregated account cash or liquid securities equal to the value of such
contracts.
To the extent required to comply with Commodity Futures Trading Commission
Regulation 4.5 and thereby avoid being classified as a "commodity pool
operator," a Fund will not enter into a futures contract or purchase an option
thereon if immediately thereafter the initial margin deposits for futures
contracts held by such Fund plus premiums paid by it for open options on futures
would exceed 5% of such Fund's total assets. Such Fund will not engage in
transactions in financial futures contracts or options thereon for speculation,
but only to attempt to hedge against changes in market conditions affecting the
values of securities which such Fund holds or intends to purchase. When futures
contracts or options thereon are purchased to protect against a price increase
on securities intended to be purchased later, it is anticipated that at least
25% of such intended purchases will be completed. When other futures contracts
or options thereon are purchased, the underlying value of such contracts will at
all times not exceed the sum of: (1) accrued profit on such contracts held by
the broker; (2) cash or high quality money market instruments set aside in an
identifiable manner; and (3) cash proceeds from investments due in 30 days.
<PAGE>
INVESTMENT RESTRICTIONS
Each Fund's investment objective is fundamental and may not be changed without a
vote of the holders of a majority of the Fund's outstanding Shares. In addition,
the following investment restrictions may be changed with respect to a
particular Fund only by a vote of a majority of the outstanding Shares of that
Fund (as defined under "ADDITIONAL INFORMATION -- Vote of a Majority of the
Outstanding Shares" in this SAI).
None of the Funds will:
1. Purchase any securities which would cause more than 25% of the value
of the Fund's total assets at the time of purchase to be invested in securities
of one or more issuers conducting their principal business activities in the
same industry, provided that: (a) there is no limitation with respect to
obligations issued or guaranteed by the U.S. Government or its agencies or
instrumentalities and repurchase agreements secured by obligations of the U.S.
Government or its agencies or instrumentalities; (b) wholly owned finance
companies will be considered to be in the industries of their parents if their
activities are primarily related to financing the activities of their parents;
and (c) utilities will be divided according to their services. For example, gas,
gas transmission, electric and gas, electric and telephone will each be
considered a separate industry. With respect to the Cash Management Fund, this
restriction does not apply to securities or obligations issued by U.S. banks;
2. Purchase securities of any one issuer, other than obligations issued
or guaranteed by the U.S. Government or its agencies or instrumentalities, if,
immediately after such purchase, more than 5% of the value of the Fund's total
assets would be invested in such issuer, or the Fund would hold more than 10% of
the outstanding voting securities of the issuer, except that 25% or less of the
value of a Fund's total assets may be invested without regard to such
limitations. There is no limit to the percentage of assets that may be invested
in U.S. Treasury bills, notes, or other obligations issued or guaranteed by the
U.S. Government or its agencies or instrumentalities;
3. Borrow money or issue senior securities, except that a Fund may (i)
borrow from banks, so long as immediately after each borrowing there is asset
coverage of 300%, and (ii) enter into reverse repurchase agreements (or similar
investment techniques) and enter into transactions in options, futures, options
on futures, and other derivative instruments as described in the Funds'
Prospectuses and SAI from time to time;
<PAGE>
4. Make loans, except that a Fund may purchase or hold debt instruments
and lend portfolio securities (in an amount not to exceed one-third of its total
assets), in accordance with its investment objective and policies, make time
deposits with financial institutions and enter into repurchase agreements;
5. Underwrite securities issued by other persons, except to the extent
that a Fund may be deemed to be an underwriter under certain securities laws in
the disposition of "restricted securities";
6. Purchase or sell commodities or commodities contracts, except to the
extent disclosed in the current Prospectus and/or SAI of the Fund; and
7. Purchase or sell real estate (although investments in marketable
securities of companies engaged in such activities and securities secured by
real estate or interests therein are not prohibited by this restriction).
The following additional investment restriction is not a fundamental policy and
therefore may be changed without the vote of a majority of the outstanding
Shares of a Fund. Except as provided in the fundamental policies described
above, none of the Funds may:
1. Purchase or otherwise acquire any securities if, as a result, more
than 15% of the Fund's net assets (10% of the Cash Management Fund's net assets)
would be invested in securities that are illiquid.
If any percentage restriction described above is satisfied at the time of
purchase, a later increase or decrease in such percentage resulting from a
change in net asset value will not constitute a violation of such restriction.
However, should a change in net asset value or other external events cause a
Fund's investments in illiquid securities to exceed the limitation set forth in
such Fund's Prospectus, that Fund will act to cause the aggregate amount of
illiquid securities to come within such limit as soon as reasonably practicable.
In such an event, however, that Fund would not be required to liquidate any
portfolio securities where the Fund would suffer a loss on the sale of such
securities.
Portfolio Turnover
Changes may be made in a Fund's portfolio consistent with the investment
objective and policies of the Fund whenever such changes are believed to be in
the best interests of the Fund and its Shareholders, and each Fund will be
managed without regard to its portfolio turnover rate. The portfolio turnover
rates for all of the Funds may vary greatly from year to year as well as within
a particular year, and may be affected by cash requirements for redemptions of
Shares. High portfolio turnover rates will generally result in higher
transaction costs to a Fund, including brokerage commissions.
<PAGE>
The portfolio turnover rate for each of the Funds is calculated by dividing the
lesser of a Fund's purchases or sales of portfolio securities for the year by
the monthly average value of the securities. The Securities and Exchange
Commission requires that the calculation exclude all securities whose remaining
maturities at the time of acquisition are one year or less.
NET ASSET VALUE
The net asset value of each Fund is determined and the Shares of each Fund are
priced on each Business Day of the Trust (other than a day on which there are
insufficient changes in the value of a Fund's portfolio securities to materially
affect the Fund's net asset value or a day on which no Shares of the Fund are
tendered for redemption and no order to purchase any Shares is received). A
"Business Day" is a day on which the New York Stock Exchange, Inc. ("NYSE") is
open for trading. Currently, the NYSE is closed on the following holidays: New
Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving, and Christmas.
Valuation of the Cash Management Fund
The Cash Management Fund's portfolio securities are valued using the amortized
cost method of valuation. This involves valuing a security at cost on the date
of acquisition and thereafter assuming a constant accretion of a discount or
amortization of a premium to maturity, regardless of the impact of fluctuating
interest rates on the market value of the instrument. While this method provides
certainty in valuation, it may result in periods during which value, as
determined by amortized cost, is higher or lower than the price the Fund would
receive if it sold the instrument. During such periods the yield to investors in
the Fund may differ somewhat from that obtained in a similar investment company
which uses available market quotations to value all of its portfolio securities.
Valuation of the Other Funds
Portfolio securities, the principal market for which is a securities exchange,
will be valued at the closing sales price on that exchange on the day of
computation, or, if there have been no sales during such day, at the latest bid
quotation. Portfolio securities, the principal market for which is not a
securities exchange, will be valued at their latest bid quotation in such
principal market. If no such bid price is available, then such securities will
be valued in good faith at their respective fair market values using methods
determined by or under the supervision of the Board of Trustees. Foreign
securities are valued based on quotations from the primary market in which they
are traded and are translated from the local currency into U.S. dollars using
current exchange rates. Shares of investment companies are valued on the basis
of their net asset values, subject to any applicable sales charge. Portfolio
securities with a remaining maturity of 60 days or less will be valued either at
amortized cost or original cost plus accrued interest, which approximates
current value.
<PAGE>
All other assets and securities, including securities for which market
quotations are not readily available, will be valued at their fair market value
as determined in good faith under the general supervision of the Board of
Trustees.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The Shares of each Fund are sold on a continuous basis by the Funds'
distributor, and the distributor has agreed to use appropriate efforts to
solicit all purchase orders. The public offering price of Shares of the Funds is
their net asset value per Share.
The Trust may suspend the right of redemption or postpone the date of payment
for Shares during any period when (a) trading on the NYSE is restricted by
applicable rules and regulations of the Securities and Exchange Commission, (b)
the NYSE is closed for other than customary weekend and holiday closings, (c)
the Securities and Exchange Commission has by order permitted such suspension,
or (d) an emergency exists as a result of which (i) disposal by the Trust of
securities owned by it is not reasonably practical or (ii) it is not reasonably
practical for the Trust to determine the fair market value of its net assets.
Shares may be redeemed without charge on any day that net asset value is
calculated. All redemption orders are effected at the net asset value per Share
next determined after receipt by the distributor of a redemption request.
Payment for Shares redeemed normally will be made within seven days.
The Trust intends to pay cash for all Shares redeemed, but under conditions
which make payment in cash unwise, such as large-scale redemptions or market
illiquidity, payment may be made wholly or partly in portfolio securities at
their then market value equal to the redemption price. In such cases, a
Shareholder may incur brokerage costs in converting such securities to cash.
Variable Contract Owners do not deal directly with the Funds to purchase,
redeem, or exchange Shares, and Variable Contract Owners should refer to the
prospectus for the applicable Separate Account for information on the allocation
of premiums and on transfers of accumulated value among sub-accounts of the
pertinent Separate Account that invests in the Funds.
Each Fund reserves the right to discontinue offering Shares at any time. In the
event that a Fund ceases offering its Shares, any investments allocated to the
Fund will, subject to any necessary regulatory approvals, be invested in another
portfolio of the Trust deemed appropriate by the Trustees.
<PAGE>
MANAGEMENT OF THE TRUST
Trustees and Officers
Overall responsibility for management of the Trust rests with its Board of
Trustees, who are elected by the Shareholders of the Trust. The Trustees elect
the officers of the Trust to supervise actively its day-to-day operations.
The names of the Trustees, their addresses, ages, and principal occupations
during the past five years are set forth below:
Name, Address, and Age Principal Occupation During Past 5 Years
- ---------------------- ----------------------------------------
James H. Woodward Chancellor, University of North Carolina at Charlotte.
University of North Carolina
at Charlotte
Charlotte, NC 28223
Age: 59
Michael Van Buskirk Chief Executive Officer, Ohio Bankers Association
37 West Broad Street (industry trade association).
Suite 1001
Columbus, OH 43215
Age: 52
Walter B. Grimm* Employee of BISYS Fund Services (6/92-present).
3435 Stelzer Road
Columbus, Oh 43219
Age: 52
* Mr. Grimm is an "interested person" of the Trust as that term is defined
in the 1940 Act.
The Trust pays each Trustee who is not an employee of BISYS or its affiliates a
retainer fee at the rate of $500 per calendar quarter, reasonable out-of-pocket
expenses, $500 for each regular meeting of the Board of Trustees attended in
person, and $250 for each regular meeting of the Board of Trustees attended by
telephone. The Trust also pays each such Trustee $500 for each special meeting
of the Board of Trustees attended in person, and $250 for each special meeting
of the Board of Trustees attended by telephone. For the fiscal year ended
December 31, 1998, the Trust paid the following compensation to the Trustees of
the Trust:
<PAGE>
Aggregate Compensation Total Compensation from
Name from Trust* Trust and Fund Complex**
James H. Woodward $4,000 $ 15,000
Michael Van Buskirk $4,000 $ 4,000
Walter B. Grimm $0 $ 0
* The Trust does not accrue pension or retirement benefits as part of
Fund expenses, and Trustees of the Trust are not entitled to benefits
upon retirement from the Board of Trustees.
** The Fund Complex consisted of the Trust, The BB&T Mutual Funds Group,
AmSouth Mutual Funds, HSBC Mutual Funds Trust, HSBC Funds Trust, and
Kent Funds.
The officers of the Trust, their addresses, ages, and principal occupations
during the past five years are as follows (unless otherwise indicated, the
address of each officer is 3435 Stelzer Road, Columbus, OH 43219):
Position(s) Held Principal Occupation
Name and Address With the Trust During Past 5 Years
---------------- -------------- -------------------
Walter Grimm President and Chairman of the Employee of BISYS Fund Services
Age: 54 Board (6/92-present).
Frank Deutchki Vice President Employee of BISYS Fund Services (4/96 -
Age: 45 present); Vice President, Audit Director at
Mutual Funds Services Company, a subsidiary
of United States Trust Company of New
York (2/89 - 3/96).
Gregory Maddox Vice President and Assistant Employee of BISYS Fund Services (4/91 -
Columbia Square Secretary present).
Suite 500
1230 Columbia Street
San Diego, CA 92101
Age: 31
<PAGE>
Charles L. Booth Vice President and Assistant Employee of BISYS Fund Services (1988 -
Age: 39 Secretary present).
Alaina Metz Secretary Employee of BISYS Fund Services (6/95 -
Age: 32 present); Supervisor, Mutual Fund Legal
Department, Alliance Capital Management
(5/89 - 6/95).
Gary Tenkman Treasurer Employee of BISYS Fund Services (4/98 -
Age: 29 present); Audit Manager Ernst & Young LLP
(1990 - 4/98).
Nimish Bhatt Principal Financial and Employee of BISYS Fund Services (7/96 -
Age: 36 Accounting Officer and present); Assistant Vice President,
Comptroller Evergreen Funds/First Union Bank (1995 to 7/96); Senior Tax
Consultant, PriceWaterhouse, LLP (1990 - 12/94).
The officers of the Trust receive no compensation directly from the Trust for
performing the duties of their offices. BISYS Fund Services Ohio, Inc. receives
fees from the Trust for providing certain administration, fund accounting and
transfer agency services.
As of October 1, 1999, the Trustees and officers of the Trust, as a group, owned
Variable Contracts that entitled them to give voting instructions with respect
to less than one percent of the Shares of any Fund of the Trust.
Investment Adviser
Subject to the general supervision of the Trust's Board of Trustees and in
accordance with the Funds' investment objectives and restrictions, investment
advisory services are provided to the Growth and Income Fund, Fixed Income Fund,
and Cash Management Fund by HSBC pursuant to an Investment Advisory Agreement
dated October 1, 1999 (the "Investment Advisory Agreement"). HSBC is the North
American investment affiliate of HSBC Holdings PLC (Hong Kong and Shanghai
Banking Corporation) and HSBC Bank USA, and is located at 140 Broadway, New
York, New York 10005.
Under the Investment Advisory Agreement, HSBC has agreed to provide, either
directly or through one or more sub-advisers, investment advisory services for
each of the Funds as described in the Prospectus. For the services provided and
expenses assumed pursuant to the Investment Advisory Agreement, each of the
following Funds is obligated to pay HSBC a fee, computed daily and paid monthly,
at the following annual rates, calculated as a percentage of the average daily
net assets of such Fund: 0.55% for the Growth and Income Fund, 0.55% for the
Fixed Income Fund, and 0.35% for the Cash Management Fund.
Unless sooner terminated, the Investment Advisory Agreement continues in effect
as to a particular Fund for an initial term of two years, and thereafter for
successive one-year periods if such continuance is approved at least annually by
the Board of Trustees or by vote of a majority of the outstanding Shares of such
Fund and a majority of the Trustees who are not parties to the Investment
Advisory Agreement or interested persons (as defined in the 1940 Act) of any
party to the Investment Advisory Agreement by votes cast in person at a meeting
called for such purpose. The Investment Advisory Agreement is terminable as to a
particular Fund at any time on 60 days' written notice without penalty by the
Trustees, by vote of a majority of the outstanding Shares of that Fund, or by
HSBC. The Investment Advisory Agreement also terminates automatically in the
event of any assignment, as defined in the 1940 Act.
The Investment Advisory Agreement provides that HSBC shall not be liable for any
error of judgment or mistake of law or for any loss suffered by the Trust in
connection with the performance of its duties, except a loss resulting from a
breach of fiduciary duty with respect to the receipt of compensation for
services or a loss resulting from willful misfeasance, bad faith, or gross
negligence on the part of HSBC or any sub-advisers in the performance of their
duties, or from reckless disregard of their duties and obligations thereunder.
From time to time, advertisements, supplemental sales literature, and
information furnished to present or prospective Shareholders of the Funds may
include descriptions of HSBC including, but not limited to, (i) descriptions of
HSBC's operations; (ii) descriptions of certain personnel and their functions;
and (iii) statistics and rankings related to HSBC's operations.
Portfolio Transactions
HSBC determines, subject to the general supervision of the Board of Trustees and
in accordance with each Fund's investment objective and restrictions, which
securities are to be purchased and sold by a Fund, and which brokers or dealers
are to be eligible to execute such Fund's portfolio transactions.
<PAGE>
Purchases and sales of portfolio securities which are debt securities usually
are principal transactions in which portfolio securities are normally purchased
directly from the issuer or from an underwriter or market maker for the
securities. Purchases from underwriters of portfolio securities generally
include a commission or concession paid by the issuer to the underwriter, and
purchases from dealers serving as market makers may include the spread between
the bid and asked price. Transactions on stock exchanges involve the payment of
negotiated brokerage commissions. Transactions in the over-the-counter market
are generally principal transactions with dealers. With respect to the
over-the-counter market, the Trust, where possible, will deal directly with
dealers who make a market in the securities involved except in those
circumstances where better price and execution are available elsewhere.
Allocation of transactions, including their frequency, to various brokers and
dealers is determined by HSBC in its best judgment and in a manner deemed fair
and reasonable to Shareholders. In selecting a broker or dealer, HSBC evaluates
a wide range of criteria, including the commission rate or dealer mark-up,
execution capability, the broker's/dealer's positioning and distribution
capabilities, back office efficiency, ability to handle difficult trades,
financial stability, reputation, prior performance, and, in the case of
brokerage commissions, research. The primary consideration is the broker's
ability to provide prompt execution of orders in an effective manner at the most
favorable price for the security. Subject to this consideration, brokers and
dealers who provide supplemental investment research to HSBC may receive orders
for transactions on behalf of the Funds. Research may include brokers' analyses
of specific securities, performance and technical statistics, and information
databases. It may also include maintenance research, which is the information
that keeps HSBC informed concerning overall economic, market, political and
legal trends. Under some circumstances, HSBC's evaluation of research and other
broker selection criteria may result in one or a few brokers executing a
substantial percentage of a Fund's trades. This might occur, for example, where
a broker can provide best execution at a cost that is reasonable in relation to
its services and the broker offers unique or superior research facilities,
special knowledge or expertise in a Fund's relevant markets, or access to
proprietary information about companies that are a majority of a Fund's
investments.
Research information so received is in addition to and not in lieu of services
required to be performed by HSBC and does not reduce the fees payable to HSBC by
the Trust. Such information may be useful to HSBC in serving both the Trust and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful in carrying out its
obligations to the Funds. While HSBC generally seeks competitive commissions,
the Funds may not necessarily pay the lowest commission available on each
brokerage transaction for reasons discussed above.
Investment decisions for each Fund are made independently from those for the
other Funds or any other portfolio, investment company or account managed by
HSBC. Any such other portfolio, investment company or account may also invest in
the same securities as the Funds. When a purchase or sale of the same security
is made at substantially the same time on behalf of a Fund and another Fund,
portfolio, investment company or account, the transaction will be averaged as to
price and available investments will be allocated as to amount in a manner which
HSBC believes to be equitable to the Fund(s) and such other portfolio,
investment company or account. In some instances, this investment procedure may
adversely affect the price paid or received by a Fund or the size of the
position obtained by a Fund. To the extent permitted by law, HSBC may aggregate
the securities to be sold or purchased for a Fund with those to be sold or
purchased for other Funds or for other portfolios, investment companies or
accounts in order to obtain best execution. In making investment recommendations
for a Fund, HSBC will not inquire or take into consideration whether an issuer
of securities proposed for purchase or sale by a Fund is a customer of HSBC or
the Funds' distributor, their parents or their subsidiaries or affiliates and,
in dealing with its customers, HSBC, its parent, subsidiaries, and affiliates
will not inquire or take into consideration whether securities of such customers
are held by the Trust.
<PAGE>
Glass-Steagall Act
In 1971, the United States Supreme Court held that the Federal statute commonly
referred to as the "Glass-Steagall Act" prohibits a national bank from operating
a mutual fund for the collective investment of managing agency accounts.
Subsequently, the Board of Governors of the Federal Reserve System (the "Board")
issued a regulation and interpretation to the effect that the Glass-Steagall Act
and such decision: (a) forbid a bank holding company registered under the
Federal Bank Holding Company Act of 1956 (the "Holding Company Act") or any
non-bank affiliate thereof from sponsoring, organizing, or controlling a
registered, open-end investment company continuously engaged in the issuance of
its shares, but (b) do not prohibit such a holding company or affiliate from
acting as investment adviser, transfer agent, and custodian to such an
investment company. In 1981, the United States Supreme Court determined that the
Board did not exceed its authority under the Holding Company Act when it adopted
its regulation and interpretation authorizing bank holding companies and their
nonbank affiliates to act as investment advisers to registered closed-end
investment companies. The Supreme Court also stated that if a national bank
complied with the restrictions imposed by the Board in its regulation and
interpretation authorizing bank holding companies and their nonbank affiliates
to act as investment advisers to investment companies, a national bank
performing investment advisory services for an investment company would not
violate the Glass-Steagall Act.
HSBC believes that it possesses the legal authority to perform the services for
the Funds contemplated by the Prospectus, this SAI, and the Investment Advisory
Agreement without violation of applicable statutes and regulations. Future
changes in either federal or state statutes and regulations relating to the
permissible activities of banks or bank holding companies and the subsidiaries
or affiliates of those entities, as well as further judicial or administrative
decisions or interpretations of present and future statutes and regulations,
could prevent HSBC from continuing to serve as investment adviser to the Funds
or could restrict the services which it is permitted to perform for the Funds.
In addition, such changes, decisions or interpretations could prevent an
affiliates of HSBC from performing Variable Contract Owner servicing activities
or from receiving compensation therefor or could restrict the types of services
such entities are permitted to provide and the amount of compensation they are
permitted to receive for such services. Depending upon the nature of any changes
in the services which could be provided by HSBC, the Board of Trustees would
review the Trust's relationship with HSBC and consider taking all action
necessary in the circumstances, and it is probable that the Board of Trustees
would either recommend to Shareholders the selection of another qualified
advisor or, if that course of action appeared impractical, that the Funds be
liquidated.
<PAGE>
Administrator
BISYS Fund Services Ohio, Inc. ("BISYS Ohio" or "Administrator"), 3435 Stelzer
Road, Columbus, Ohio 43219-3035, serves as general manager and administrator to
the Trust pursuant to a Management and Administration Agreement dated March 1,
1999 (the "Administration Agreement"). Prior to that date, BISYS Fund Services
("BISYS") served as general manager and administrator to the Trust. The
Administrator assists in supervising all operations of each Fund (other than
those performed by HSBC under the Investment Advisory Agreement, by BISYS Ohio
as fund accountant and dividend disbursing agent, and by the Funds' custodians.
The Administrator provides financial services to institutional clients.
Under the Administration Agreement, the Administrator has agreed to maintain
office facilities for the Trust; furnish statistical and research data, clerical
and certain bookkeeping services and stationery and office supplies; prepare the
periodic reports to the Securities and Exchange Commission on Form N-SAR or any
replacement forms therefor; compile data for, prepare for execution by the Funds
and file certain federal and state tax returns and required tax filings; prepare
compliance filings pursuant to state laws with the advice of the Trust's
counsel; keep and maintain the financial accounts and records of the Funds,
including calculation of daily expense accruals; and generally assist in all
aspects of the Trust's operations other than those performed by HSBC under the
Investment Advisory Agreement, by the other investment advisers of the Trust's
portfolios, by the fund accountant and dividend disbursing agent, and by the
Fund's custodians. Under the Administration Agreement, the Administrator may
delegate all or any part of its responsibilities thereunder.
The Administrator receives a fee from each Fund for its services as
Administrator and expenses assumed pursuant to the Administration Agreement,
calculated daily and paid periodically, equal to the lesser of (a) a fee
calculated at the annual rate of 0.20% of each Fund's average daily net assets,
or (b) such other fee as may from time to time be agreed upon by the Trust and
the Administrator. The Administrator may voluntarily reduce all or a portion of
its fee with respect to any Fund in order to increase the net income of one or
more of the Funds available for distribution as dividends. For the period from
June 3, 1997 (commencement of operations) through December 31, 1997, the Trust
incurred administration fees equal to $17,925, of which $13,549 was waived or
reimbursed by BISYS. For the fiscal year ended December 31, 1998, the Trust
incurred administration fees equal to $132,536, of which $50,667 was waived or
reimbursed by BISYS.
The Administration Agreement is terminable with respect to a particular Fund
upon mutual agreement of the parties to the Administration Agreement, upon
notice given at least 60 days prior to the expiration of the Agreement's
then-current term, and for cause (as defined in the Administration Agreement) by
the party alleging cause, on no less than 60 days' written notice by the Board
of Trustees or by the Administrator.
<PAGE>
The Administration Agreement provides that the Administrator shall not be liable
for any error of judgment or mistake of law or any loss suffered by the Trust in
connection with the matters to which the Administration Agreement relates,
except a loss resulting from willful misfeasance, bad faith, or gross negligence
in the performance of its duties, or from the reckless disregard by the
Administrator of its obligations and duties thereunder.
Expenses
HSBC and the Administrator bears all expenses in connection with the performance
of its services other than the cost of securities (including brokerage
commissions) purchased for the Funds. The Funds will bear the following expenses
relating to their operations: taxes, interest, fees of the Trustees of the
Trust, Securities and Exchange Commission fees, outside auditing and legal
expenses, advisory and administration fees, fees and out-of-pocket expenses of
the custodians and fund accountant, certain insurance premiums, costs of
maintenance of the Trust's existence, costs of Shareholders' reports and
meetings, and any extraordinary expenses incurred in the Funds' operations. Any
expense reimbursements will be estimated daily and reconciled and paid on a
monthly basis. Fees imposed upon customer accounts for cash management services
are not included within Trust expenses for purposes of any such expense
limitation.
Distributor
BISYS serves as distributor to the Trust pursuant to the Distribution Agreement
dated June 1, 1997 (the "Distribution Agreement"). As distributor, BISYS acts as
agent for the Funds in the distribution of their Shares and, in such capacity,
advertises and pays the cost of advertising, office space and personnel involved
in such activities. BISYS serves as distributor without remuneration from the
Funds. Unless otherwise terminated, the Distribution Agreement will remain in
effect for an initial term of two years, and thereafter continues for successive
one-year periods if approved at least annually (i) by the Board of Trustees or
by the vote of a majority of the outstanding Shares of the Trust, and (ii) by
the vote of a majority of the Trustees who are not parties to the Distribution
Agreement or interested persons (as defined in the 1940 Act) of any party to the
Distribution Agreement, cast in person at a meeting called for the purpose of
voting on such approval. The Distribution Agreement may be terminated in the
event of any assignment, as defined in the 1940 Act.
Custodian, Transfer Agent and Fund Accounting Services
The Bank of New York has been retained, pursuant to a Custodian Agreement, to
act as custodian for the Funds. The Bank of New York's address is 90 Washington
Street, New York, New York 10286. Under the Custodian Agreement, the Custodian
maintains a custody account or accounts in the name of each Fund; receives and
delivers all assets for each Fund upon purchase and upon sale or maturity;
collects and receives all income and other payments and distributions on account
of the assets of each Fund; pays all expenses of each Fund; receives and pays
out cash for purchases and redemptions of shares of each Fund and pays out cash
if requested for dividends on shares of each Fund; calculates the daily value of
the assets of the Fixed Income Fund; determines the daily net asset value per
share, net investment income and dividend rate for the Fixed Income Fund; and
maintains records for the foregoing services. Under the Custodian Agreement,
each Fund has agreed to pay the Custodian for furnishing custodian services a
fee for certain administration and transaction charges and out-of-pocket
expenses.
<PAGE>
The Board of Trustees has authorized The Bank of New York in its capacity as
custodian of each Fund to enter into Subcustodian Agreements with banks and
other entities that qualify under the 1940 Act to act as subcustodians with
respect to certain portfolio investments of the Funds.
BISYS Ohio serves as transfer agent and dividend disbursing agent for the Trust
pursuant to an agreement dated as of March 1, 1999. Under this agreement, BISYS
Ohio performs the following services, among others: maintenance of Shareholder
records for each of the Trust's Shareholders of record; processing Shareholder
purchase and redemption orders; processing transfers and exchanges of Shares on
the Shareholder files and records; processing dividend payments and
reinvestments; and assistance in the mailing of Shareholder reports and proxy
solicitation materials.
In addition, BISYS Ohio provides certain fund accounting services to the Trust
pursuant to a Fund Accounting Agreement dated March 1, 1999. Under the Fund
Accounting Agreement, BISYS Ohio maintains the accounting books and records for
the Funds, including journals containing an itemized daily record of all
purchases and sales of portfolio securities, all receipts and disbursements of
cash and all other debits and credits, general and auxiliary ledgers reflecting
all asset, liability, reserve, capital, income and expense accounts, including
interest accrued and interest received, and other required separate ledger
accounts; maintains a monthly trial balance of all ledger accounts; performs
certain accounting services for the Funds, including calculation of the daily
net asset value per Share, calculation of the dividend and capital gain
distributions, if any, and of yield, reconciliation of cash movements with
custodians, affirmation to custodians of portfolio trades and cash settlements,
verification and reconciliation with custodians of daily trade activity;
provides certain reports; obtains dealer quotations, prices from a pricing
service or matrix prices on all portfolio securities in order to mark the
portfolio to the market; and prepares an interim balance sheet, statement of
income and expense, and statement of changes in net assets for the Funds.
BISYS Ohio receives an annual fee per Variable Contract Owner account, subject
to certain per-Fund base fees, for its services as transfer agent.
<PAGE>
Auditors
The firm of PricewaterhouseCoopers LLP, 100 East Broad Street, Columbus, Ohio
43215, serves as independent auditors for the Trust. Its services comprise
auditing the Trust's financial statements and advising the Trust as to certain
accounting and tax matters.
Legal Counsel
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006, is
counsel to the Trust and has passed upon the legality of the Shares offered
hereby.
ADDITIONAL INFORMATION
Description of Shares
The Trust is a Massachusetts business trust that was organized on July 20, 1994.
The Trust's Declaration of Trust was filed with the Secretary of State of the
Commonwealth of Massachusetts on the same date. The Declaration of Trust, as
amended and restated, authorizes the Board of Trustees to issue an unlimited
number of Shares, which are units of beneficial interest, without par value. The
Trust currently has nine series of Shares which represent interests in each
series of the Trust. The Trust's Declaration of Trust authorizes the Board of
Trustees to divide or redivide any unissued Shares of the Trust into one or more
additional series or classes by setting or changing in any one or more respects
their respective preferences, conversion or other rights, voting power,
restrictions, limitations as to dividends, qualifications, and terms and
conditions of redemption.
Shares have no subscription or preemptive rights and only such conversion or
exchange rights as the Board of Trustees may grant in its discretion. When
issued for payment as described in the Prospectuses and this SAI, the Trust's
Shares will be fully paid and non-assessable by the Trust. In the event of a
liquidation or dissolution of the Trust, Shareholders of a Fund are entitled to
receive the assets available for distribution belonging to that Fund, and a
proportionate distribution, based upon the relative asset values of the
respective series, of any general assets not belonging to any particular series
which are available for distribution.
Each Share represents an equal proportionate interest in the Fund with other
Shares of the Fund, and is entitled to such dividends and distributions out of
the income earned on the assets belonging to the Fund as are declared at the
discretion of the Trustees. Shares are without par value. Shareholders are
entitled to one vote for each dollar of value invested and a proportionate
fractional vote for any fraction of a dollar invested. Shareholders will vote in
the aggregate and not by portfolio except as otherwise expressly required by
law.
An annual or special meeting of Shareholders to conduct necessary business is
not required by the Trust's Declaration of Trust, the 1940 Act or other
authority except, under certain circumstances, to elect Trustees, amend the
Declaration of Trust, approve an investment advisory agreement and to satisfy
certain other requirements. To the extent that such a meeting is not required,
the Trust may elect not to have an annual or special meeting.
<PAGE>
The Trust will call a special meeting of Shareholders for purposes of
considering the removal of one or more Trustees upon written request therefor
from Shareholders holding not less than 10% of the outstanding votes of the
Trust. At such a meeting, a quorum of Shareholders (constituting a majority of
votes attributable to all outstanding Shares of the Trust), by majority vote,
has the power to remove one or more Trustees. In accordance with current laws,
it is anticipated that an insurance company issuing a variable contract that
participates in the Fund will request voting instructions from variable contract
owners and will vote shares or other voting interests in the separate account in
proportion of the voting instructions received.
Rule 18f-2 under the 1940 Act provides that any matter required to be submitted
to the holders of the outstanding voting securities of an investment company
such as the Trust shall not be deemed to have been effectively acted upon unless
approved by the holders of a majority of the outstanding Shares of each Fund
affected by the matter. For purposes of determining whether the approval of a
majority of the outstanding Shares of a Fund will be required in connection with
a matter, a Fund will be deemed to be affected by a matter unless it is clear
that the interests of each Fund in the matter are identical, or that the matter
does not affect any interest of the Fund. Under Rule 18f-2, the approval of an
investment advisory agreement or any change in investment policy submitted to
Shareholders would be effectively acted upon with respect to a series only if
approved by a majority of the outstanding Shares of such Fund. However, Rule
18f-2 also provides that the ratification of independent public accountants, the
approval of principal underwriting contracts, and the election of Trustees may
be effectively acted upon by Shareholders of the Trust voting without regard to
Fund.
Vote of a Majority of the Outstanding Shares
As used in the Funds' Prospectus and the SAI, "vote of a majority of the
outstanding Shares of the Trust or the Fund" means the affirmative vote, at an
annual or special meeting of Shareholders duly called, of the lesser of (a) 67%
or more of the votes of Shareholders of the Trust or the Fund present at such
meeting at which the holders of more than 50% of the votes attributable to the
Shareholders of record of the Trust or the Fund are represented in person or by
proxy, or (b) the holders of more than 50% of the outstanding votes of
Shareholders of the Trust or the Fund.
Shareholder and Trustee Liability
Under Massachusetts law, holders of units of interest in a business trust may,
under certain circumstances, be held personally liable as partners for the
obligations of the trust. However, the Trust's Declaration of Trust provides
that Shareholders shall not be subject to any personal liability for the
obligations of the Trust. The Declaration of Trust provides for indemnification
out of the trust property of any Shareholder held personally liable solely by
reason of his or her being or having been a Shareholder. The Declaration of
Trust also provides that the Trust shall, upon request, reimburse any
Shareholder for all legal and other expenses reasonably incurred in the defense
of any claim made against the Shareholder for any act or obligation of the
Trust, and shall satisfy any judgment thereon. Thus, the risk of a Shareholder
incurring financial loss on account of Shareholder liability is limited to
circumstances in which the Trust itself would be unable to meet its obligations.
<PAGE>
The Declaration of Trust states further that no Trustee, officer, or agent of
the Trust shall be personally liable in connection with the administration or
preservation of the assets of the Trust or the conduct of the Trust's business;
nor shall any Trustee, officer, or agent be personally liable to any person for
any action or failure to act except for his own bad faith, willful misfeasance,
gross negligence, or reckless disregard of his duties. The Declaration of Trust
also provides that all persons having any claim against the Trustees or the
Trust shall look solely to the assets of the Trust for payment.
Additional Tax Information
The following discussion summarizes certain U.S. federal tax considerations
incidental to an investment in a Fund. Each Fund intends to qualify annually and
to elect to be treated as a regulated investment company under the Internal
Revenue Code of 1986, as amended (the "Code"). If a Fund so qualifies, it
generally will not be subject to federal income taxes to the extent that it
distributes on a timely basis its investment company taxable income and its net
capital gains.
To qualify as a regulated investment company, each Fund generally must, among
other things: (i) derive in each taxable year at least 90% of its gross income
from dividends, interest, payments with respect to securities loans, and gains
from the sale or other disposition of stock, securities or foreign currencies,
or other income derived with respect to its business in such stock, securities
or currencies; (ii) diversify its holdings so that, at the end of each quarter
of the taxable year (a) at least 50% of the market value of the Fund's assets is
represented by cash, U.S. Government securities, the securities of other
regulated investment companies and other securities, with such other securities
of any one issuer limited for the purposes of this calculation to an amount not
greater than 5% of the value of the Fund's total assets and 10% of the
outstanding voting securities of such issuer, and (b) not more than 25% of the
value of its total assets is invested in the securities of any one issuer (other
than U.S. Government securities or the securities of other regulated investment
companies); and (iii) distribute at least 90% of its investment company taxable
income (which includes, among other items, dividends, interest, and net
short-term capital gains in excess of any net long-term capital losses) each
taxable year.
<PAGE>
As a regulated investment company, a Fund generally will not be subject to U.S.
federal income tax on its investment company taxable income and net capital
gains (any net long-term capital gains in excess of the sum of net short-term
capital losses and capital loss carryovers from prior years), if any, that it
distributes to Shareholders. Each Fund intends to distribute to its
Shareholders, at least annually, substantially all of its investment company
taxable income and any net capital gains. In addition, amounts not distributed
by a Fund on a timely basis in accordance with a calendar year distribution
requirement may be subject to a nondeductible 4% excise tax. To avoid the tax, a
Fund may be required to distribute (or be deemed to have distributed) during
each calendar year, (i) at least 98% of its ordinary income (not taking into
account any capital gains or losses) for the calendar year, (ii) at least 98% of
its capital gains in excess of its capital losses for the twelve month period
ending on October 31 of the calendar year (adjusted for certain ordinary
losses), and (iii) all ordinary income and capital gains for previous years that
were not distributed during such years. To avoid application of the excise tax,
each Fund intends to make its distributions in accordance with the calendar year
distribution requirement. A distribution will be treated as paid on December 31
of the calendar year if it is declared by a Fund during October, November, or
December of that year to Shareholders of record on a date in such a month and
paid by the Fund during January of the following calendar year. Such
distributions will be taxable to Shareholders (such as the Separate Accounts)
for the calendar year in which the distributions are declared, rather than the
calendar year in which the distributions are actually received.
The Treasury Department announced that it would issue future regulations or
rulings addressing the circumstances in which a variable contract owner's
control of the investments of the separate account may cause the contract owner,
rather than the insurance company, to be treated as the owner of the assets held
by the separate account. If the contract owner is considered the owner of the
securities underlying the separate account, income and gains produced by those
securities would be included currently in the contract owner's gross income. It
is not known what standards will be set forth in the regulations or rulings.
In the event that rules or regulations are adopted, there can be no assurance
that the Funds will be able to operate as currently described, or that the Trust
will not have to change a Fund's investment objective or investment policies.
While each Fund's investment objective is fundamental and may be changed only by
a vote of a majority of its outstanding Shares, the investment policies of a
Fund may be modified as necessary to prevent any such prospective rules and
regulations from causing Variable Contract Owners to be considered the owners of
the Shares of a Fund.
If a Fund invests in shares of a foreign investment company, the Fund may be
subject to U.S. federal income tax on a portion of an "excess distribution"
from, or of the gain from the sale of part or all of the shares in, such
company. In addition, an interest charge may be imposed with respect to deferred
taxes arising from such distributions or gains. The Fund may, however, be able
to elect alternative tax treatment for such investments that would avoid this
unfavorable result.
Under the Code, gains or losses attributable to fluctuations in exchange rates
which occur between the time a Fund accrues income or other receivables or
accrues expenses or other liabilities denominated in a foreign currency and the
time that Fund actually collects such receivables or pays such liabilities
generally are treated as ordinary income or ordinary loss. Similarly, on
disposition of debt securities denominated in a foreign currency and on
disposition of certain futures contracts, forward contracts, and options, gains
or losses attributable to fluctuations in the value of foreign currency between
the date of acquisition of the security or contract and the date of disposition
also are treated as ordinary gain or loss. These gains or losses, referred to
under the Code as "Section 988" gains or losses, may increase or decrease the
amount of a Fund's investment company taxable income to be distributed to its
Shareholders as ordinary income.
<PAGE>
Distributions
Distributions of any investment company taxable income (which includes among
other items, dividends, interest, and any net realized short-term capital gains
in excess of net realized long-term capital losses) are treated as ordinary
income for tax purposes in the hands of a Shareholder (such as a Separate
Account). Net capital gains (the excess of any net long-term capital gains over
net short term capital losses) will, to the extent distributed, be treated as
long-term capital gains in the hands of a Shareholder regardless of the length
of time the Shareholder may have held the Shares.
Hedging Transactions
The diversification requirements applicable to a Fund's assets may limit the
extent to which a Fund will be able to engage in transactions in options,
futures contracts, or forward contracts.
Other Taxes
Distributions may also be subject to additional state, foreign and local taxes,
depending on each Shareholder's situation. Shareholders (such as Separate
Accounts) are advised to consult their own tax advisers with respect to the
particular tax consequences to them of an investment in a Fund.
Performance Information
Each Fund may, from time to time, include its yield or total return in
advertisements or reports to Shareholders or prospective investors. Performance
information for the Funds will not be advertised or included in sales literature
unless accompanied by comparable performance information for a separate account
to which the Funds offer their Shares.
Yields of the Growth and Income Fund and Fixed Income Fund are computed by
analyzing net investment income per Share for a recent 30-day period and
dividing that amount by a Share's maximum offering price (reduced by any
undeclared earned income expected to be paid shortly as a dividend) on the last
trading day of that period. Net investment income will reflect amortization of
any market value premium or discount of fixed income securities (except for
obligations backed by mortgages or other assets) and may include recognition of
a pro rata portion of the stated dividend rate of dividend paying portfolio
securities.
<PAGE>
The standardized seven-day yield for the Cash Management Fund is computed by
determining the net change, exclusive of capital changes, in the value of a
hypothetical pre-existing account in that Fund having a balance of one Share at
the beginning of the period, subtracting a hypothetical charge reflecting
deductions from Shareholder accounts, and dividing the difference by the value
of the account at the beginning of the base period to obtain the based period
return, and then multiplying the base period return by (365/base period). The
net change in the account value of the Cash Management Fund includes the value
of additional Shares purchased with dividends from the original Share, dividends
declared on both the original Share and any such additional Shares, and all
fees, other than nonrecurring account or sales charges, that are charged to all
Shareholder accounts in proportion to the length of the base period and assuming
that Fund's average account size. The capital changes to be excluded from the
calculation of the net change in account value are net realized gains and losses
from the sale of securities and unrealized appreciation and depreciation.
The effective yield for the Cash Management Fund is computed by compounding the
base period return, as calculated above by adding 1 to the base period, raising
the sum to a power equal to 365 divided by base period and subtracting 1 from
the result.
The 30-day yield and effective yield for the Cash Management Fund are calculated
as described above except that the base period is 30 days rather then seven
days.
The yield of each Fund will vary from time to time depending upon market
conditions, the composition of the Fund's portfolio and operating expenses of
the Trust allocated to the Fund. Yield should also be considered relative to
changes in the value of a Fund's Shares and to the relative risks associated
with the investment objective and policies of each of the Funds.
At any time in the future, yields may be higher or lower than past yields and
there can be no assurance that any historical results will continue.
Standardized quotations of average annual total return for Fund Shares will be
expressed in terms of the average annual compounded rate of return for a
hypothetical investment in Shares over periods of 1, 5 and 10 years or up to the
life of the Fund), calculated pursuant to the following formula: P(1 + T)n = ERV
(where P = a hypothetical initial payment of $1,000, T = the average annual
total return, n = the number of years, and ERV = the ending redeemable value of
a hypothetical $1,000 payment made at the beginning of the period). All total
return figures reflect the deduction of expenses (on an annual basis), and
assume that all dividends and distributions on Shares are reinvested when paid.
<PAGE>
Performance information for the Funds may be compared in reports and promotional
literature to the performance of other mutual funds with comparable investment
objectives and policies through various mutual fund or market indices such as
those prepared by Dow Jones & Co., Inc., S&P, Shearson Lehman Brothers, Inc.,
the Russell 2000 Index, the Consumer Price Index, and to data prepared by Lipper
Analytical Services, Inc., a widely recognized independent service which
monitors the performance of mutual funds, or Morningstar, Inc. Comparisons may
also be made to indices or data published in Money Magazine, Forbes, Barron's,
The Wall Street Journal, The Bond Buyer's Weekly 20-Bond Index, The Bond Buyer's
Index, The Bond Buyer, The New York Times, Business Week, Pensions and
Investments, and U.S.A. Today. In addition to performance information, general
information about these Funds that appears in a publication such as those
mentioned above may be included in advertisements and in reports to Variable
Contract Owners.
Each Fund may also compute aggregate total return for specified periods. The
aggregate total return is determined by dividing the net asset value of this
account at the end of the specified period by the value of the initial
investment and is expressed as a percentage. Calculation of aggregate total
return assumes reinvestment of all income dividends and capital gain
distributions during the period.
The Funds also may quote annual, average annual and annualized total return and
aggregate total return performance data for various periods other than those
noted above. Such data will be computed as described above, except that the
rates of return calculated will not be average annual rates, but rather, actual
annual, annualized or aggregate rates of return.
Quotations of yield or total return for the Funds will not take into account
charges and deductions against a Separate Account to which the Funds' Shares are
sold or charges and deductions against the Variable Contracts. The Funds' yield
and total return should not be compared with mutual funds that sell their shares
directly to the public since the figures provided do not reflect charges against
the Separate Accounts or the Variable Contracts. Performance information for any
Fund reflects only the performance of a hypothetical investment in the Fund
during the particular time period in which the calculations are based.
Performance information should be considered in light of the Funds' investment
objectives and policies, characteristics and quality of the portfolios and the
market conditions during the given time period, and should not be considered as
a representation of what may be achieved in the future.
Miscellaneous
Individual Trustees are elected by the Shareholders and, subject to removal by
the vote of two-thirds of the Board of Trustees, serve for a term lasting until
the next meeting of Shareholders at which Trustees are elected. Such meetings
are not required to be held at any specific intervals. Individual Trustees may
be removed by vote of the Shareholders voting not less than a majority of the
Shares then outstanding, cast in person or by proxy at any meeting called for
that purpose, or by a written declaration signed by Shareholders voting not less
than two-thirds of the Shares then outstanding. In accordance with current laws,
it is anticipated that an insurance company issuing a Variable Contract that
participates in the Funds will request voting instructions from variable
contract owners and will vote shares or other voting interests in the Separate
Account in proportion of the voting instructions received.
<PAGE>
The Trust is registered with the Securities and Exchange Commission as a
management investment company. Such registration does not involve supervision by
the Securities and Exchange Commission of the management or policies of the
Trust.
The Prospectus and this SAI omit certain of the information contained in the
Registration Statement filed with the Securities and Exchange Commission. Copies
of such information may be obtained from the Securities and Exchange Commission
upon payment of the prescribed fee.
The Prospectus and this SAI are not an offering of the securities herein
described in any state in which such offering may not lawfully be made. No
salesman, dealer, or other person is authorized to give any information or make
any representation other than those contained in the Prospectuses and this SAI.
FINANCIAL STATEMENTS
Since the Funds had not commenced operations as of the date of this SAI, there
are no financial statements to include in the SAI.
<PAGE>
APPENDIX
DESCRIPTION OF BOND RATINGS
Description of Moody's bond ratings:
Excerpts from Moody's description of its bond ratings are listed as
follows: Aaa - judged to be the best quality and they carry the smallest degree
of investment risk; Aa - judged to be of high quality by all standards -
together with the Aaa group, they comprise what are generally known as
high-grade bonds; A - possess many favorable investment attributes and are to be
considered as "upper medium grade obligations"; Baa - considered to be medium
grade obligations, i.e., they are neither highly protected nor poorly secured
- -interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time; Ba - judged to have speculative
elements, their future cannot be considered as well assured; B - generally lack
characteristics of the desirable investment; Caa - are of poor standing - such
issues may be in default or there may be present elements of danger with respect
to principal or interest; Ca - speculative in a high degree, often in default; C
- - lowest rated class of bonds, regarded as having extremely poor prospects.
Moody's also supplies numerical indicators 1, 2 and 3 to rating
categories. The modifier 1 indicates that the security is in the higher end of
its rating category; the modifier 2 indicates a mid-range ranking; and modifier
3 indicates a ranking toward the lower end of the category.
Description of S&P's bond ratings:
Excerpts from S&P's description of its bond ratings are listed as
follows: AAA - highest grade obligations, in which capacity to pay interest and
repay principal is extremely strong; AA - has a very strong capacity to pay
interest and repay principal, and differs from AAA issues only in a small
degree; A - has a strong capacity to pay interest and repay principal, although
they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories; BBB
- - regarded as having an adequate capacity to pay interest and repay principal;
whereas it normally exhibits adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt in this category than in
higher rated categories. This group is the lowest which qualifies for commercial
bank investment. BB, B, CCC, CC, C - predominantly speculative with respect to
capacity to pay interest and repay principal in accordance with terms of the
obligations; BB indicates the highest grade and C the lowest within the
speculative rating categories. D interest or principal payments are in default.
<PAGE>
S&P applies indicators "+," no character, and "-" to its rating
categories. The indicators show relative standing within the major rating
categories.
Description of Moody's ratings of short-term municipal obligations:
Moody's ratings for state and municipal short-term obligations will be
designated Moody's Investment Grade or MIG. Such ratings recognize the
differences between short-term credit and long-term risk. Short-term ratings on
issues with demand features (variable rate demand obligations) are
differentiated by the use of the VMIG symbol to reflect such characteristics as
payment upon periodic demand rather than fixed maturity dates and payments
relying on external liquidity. Ratings categories for securities in these groups
are as follows: MIG 1/VMIG 1 - denotes best quality, there is present strong
protection by established cash flows, superior liquidity support or demonstrated
broad-based access to the market for refinancing; MIG 2/VMIG 2 - denotes high
quality, margins of protection are ample although not as large as in the
preceding group; MIG 3/VMIG 3 - denotes high quality, all security elements are
accounted for but there is lacking the undeniable strength of the preceding
grades; MIG 4/VMIG 4 - denotes adequate quality, protection commonly regarded as
required of an investment security is present, but there is specific risk; SQ -
denotes speculative quality, instruments in this category lack margins of
protection.
Description of Moody's commercial paper ratings:
Excerpts from Moody's commercial paper ratings are listed as follows:
Prime - 1 - issuers (or supporting institutions) have a superior ability for
repayment of senior short-term promissory obligations; Prime - 2 - issuers (or
supporting institutions) have a strong ability for repayment of senior
short-term promissory obligations; Prime - 3 - issuers (or supporting
institutions) have an acceptable ability for repayment of senior short-term
promissory obligations; Not Prime - issuers do not fall within any of the Prime
categories.
Description of S&P's ratings for corporate and municipal bonds:
Investment grade ratings: AAA - the highest rating assigned by S&P,
capacity to pay interest and repay principal is extremely strong; AA - has a
very strong capacity to pay interest and repay principal and differs from the
highest rated issues only in a small degree; A - has strong capacity to pay
interest and repay principal although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher rated categories; BBB - regarded as having an adequate capacity to pay
interest and repay principal - whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
<PAGE>
Speculative grade ratings: BB, B, CCC, CC, C - debt rated in these
categories is regarded as having predominantly speculative characteristics with
respect to capacity to pay interest and repay principal - while such debt will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions; CI - reserved
for income bonds on which no interest is being paid; D -in default, and payment
of interest and/or repayment of principal is in arrears. Plus (+) or Minus (-) -
the ratings from "AA" to "CCC" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Description of S&P's rating for municipal notes and short-term municipal demand
obligations:
Rating categories are as follows: SP-1 - has a very strong or strong
capacity to pay principal and interest - those issues determined to possess
overwhelming safety characteristics will be given a plus (+) designation; SP-2 -
has a satisfactory capacity to pay principal and interest; SP-3 - issues
carrying this designation have a speculative capacity to pay principal and
interest.
Description of S&P's ratings for short-term corporate demand obligations and
commercial paper:
An S&P commercial paper rating is a current assessment of the
likelihood of timely repayment of debt having an original maturity of no more
than 365 days. Excerpts from S&P's description of its commercial paper ratings
are listed as follows: A-1 - the degree of safety regarding timely payment is
strong - those issues determined to possess extremely strong safety
characteristics will be denoted with a plus (+) designation; A-2 capacity for
timely payment is satisfactory - however, the relative degree of safety is not
as high as for issues designated "A-1;" A-3 - has adequate capacity for timely
payment - however, is more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations; B - regarded as
having only speculative capacity for timely payment; C - a doubtful capacity for
payment; D - in payment default - the "D" rating category is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period.
<PAGE>
PART C
OTHER INFORMATION
Item 23. Exhibits
(a) (1) Amended and Restated Declaration of Trust dated July 20, 1994, as amended and restated
February 5, 1997(1)
(2) Establishment and Designation of Series effective February 5, 1997(1)
(3) Redesignation of Two Existing Series and Establishment and Designation of Two
Additional Series effective August 13, 1997(3)
(4) Establishment and Designation of Series effective February 25, 1999(6)
(5) Establishment and Designation of Series effective August 31, 1999
(b) By-Laws(1)
(c) Articles V and VI of the Registrant's Amended and Restated
Declaration of Trust define rights of holders of Shares.
(d) (1) Form of Investment Advisory Agreement between Registrant and Branch Banking and Trust
Company(2)
(2) Form of Investment Advisory Agreement between Registrant and AmSouth Bank(4)
(3) Form of Sub-Advisory Agreement between AmSouth Bank and Rockhaven Asset Management,
LLC(4)
(4) Form of Sub-Advisory Agreement between AmSouth Bank and
OakBrook Investments, LLC(6)
(5) Form of Investment Advisory Agreement between Registrant and HSBC Asset Management
(Americas) Inc.
(6) Form of Investment Advisory Agreement between Registrant and Lyon Street Asset
Management Company
(e) Form of Distribution Agreement between Registrant and BISYS Fund Services(3)
(f) Not Applicable
(g) (1) Form of Custodian Agreement between Registrant and Fifth Third Bank(2)
(2) Form of Custodian Agreement between Registrant and AmSouth Bank(4)
(3) Form of Custodian Agreement between Registrant and The Bank of New York*
<PAGE>
(h) (1) Form of Management and Administration Agreement
between Registrant and BISYS Fund Services Ohio,
Inc.(6)
(2) Form of Fund Accounting Agreement between Registrant and BISYS Fund Services Ohio,
Inc.(6)
(3) Form of Transfer Agency Agreement between Registrant and BISYS Fund Services Ohio,
Inc.(6)
(4) Form of Fund Participation Agreement with Hartford Life Insurance Company(4)
(5) Form of Fund Participation Agreement with Allstate Insurance Company
(6) Form of Variable Contract Owner Servicing Agreement(6)
(i) Opinion and Consent of Counsel(2)
(j) Consent of Independent Auditors
(k) Not Applicable
(l) Purchase Agreement(2)
(m) Not Applicable
(n) Financial Data Schedules Pursuant to Rule 483 (filed as Exhibit 27)
(o) Not Applicable
(p) (1) Secretary's Certificate Pursuant to Rule 483(b)(2)
(2) Powers of Attorney(2)
(3) Power of Attorney (Gary Tenkman)(5)
(4) Power of Attorney (Nimish Bhatt)(6)
- -----------------------
* To be filed by amendment.
1 Filed with Pre-Effective Amendment No. 1 to Registrant's Registration Statement on February 5, 1997.
2 Filed with Pre-Effective Amendment No. 2 to Registrant's Registration Statement on May 29, 1997.
3 Filed with Post-Effective Amendment No. 1 to Registrant's Registration Statement on July 3, 1997.
4 Filed with Post-Effective Amendment No. 2 to Registrant's Registration Statement on September 15, 1997.
5 Filed with Post-Effective Amendment No. 5 to Registrant's Registration Statement on January 20, 1999.
6 Filed with Post-Effective Amendment No. 6 to Registrant's Registration Statement on April 1, 1999.
<PAGE>
Item 24. Persons Controlled by or Under Common Control with Registrant
Not Applicable
Item 25. Indemnification
Reference is made to Article IV of the Registrant's Amended and
Restated Declaration of Trust (Exhibit a(1)) which is incorporated by
reference herein.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to trustees, officers and controlling
persons of the Registrant by the Registrant pursuant to Registrant's
Amended and Restated Declaration of Trust, its By-Laws or otherwise,
the Registrant is aware that in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as
expressed in the Act and, therefore, is unenforceable. In the event
that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by trustees,
officers or controlling persons of the Registrant in connection with
the successful defense of any act, suit or proceeding) is asserted by
such trustees, officers or controlling persons in connection with
shares being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issues.
Item 26. Business and Other Connections of Investment Advisers and their
Officers and Directors
The business of each of the Investment Advisers is summarized under
"Management of the Fund" in the Prospectuses constituting Part A and
"Management of the Trust" in the Statements of Additional Information
constituting Part B of this Registration Statement, which summaries are
incorporated herein by reference.
Information relating to the business and other connections of Branch
Banking and Trust Company ("BB&T") and each director, officer or
partner of BB&T is hereby incorporated by reference to disclosure in
Item 28 of the registration statement on Form N-1A of BB&T Mutual Funds
Group (File Nos. 33-49098 and 811-06719). Information relating to the
business and other connections of AmSouth Bank, Rockhaven Asset
Management, LLC, and OakBrook Investments, LLC, and each director,
officer or partner of each, is hereby incorporated by reference to
disclosure in Item 28 of the registration statement on Form N-1A of
AmSouth Mutual Funds (File Nos. 33-21660 and 811-5551).
Information relating to the business and other connections of HSBC
Asset Management (Americas) Inc. ("HSBC") and each director, officer or
partner of HSBC is hereby incorporated by reference to disclosure in
Item 26 of the registration statement of Form N-1A of HSBC Mutual Funds
Trust (File Nos. 33-33739 and 811-06057). Information relating to the
business and other connections of Lyon Street Asset Management Company
("Lyon Street") and each director, officer or partner of Lyon Street is
hereby incorporated by reference to Schedules A and D of Lyon Street
Asset Management Company's Form ADV (File No. 801-55015) filed on March
2, 1998, as amended.
<PAGE>
Item 27. Principal Underwriter
(a) BISYS Fund Services ("BISYS") acts as distributor for
Registrant. BISYS also distributes the securities of The
Victory Portfolios, The AmSouth Mutual Funds, The Alpine
Equity Trust, The Sessions Group, The Coventry Group, The
BB&T Mutual Funds Group, The American Performance Funds, The
ARCH Funds, Inc., MMA Praxis Mutual Funds, The Magna Funds,
The Meyers Investment Trust, The Pacific Capital Funds, The
Riverfront Funds, Inc., The Summit Investment Trust,
Governor Funds, Gradison Custodian Trust, Gradison Growth
Trust, Gradison-McDonald Cash Reserves Trust,
Gradison-McDonald Municipal Custodians Trust, The Fifth
Third Funds, INTRUST Funds Trust, The Kent Funds, The HSBC
Funds Trust and HSBC Mutual Funds Trust, The Infinity Mutual
Funds, Inc., Pegasus Funds, The Parkstone Advantage Funds,
The Republic Funds Trust and Republic Advisor Funds Trust,
ESC Strategic Funds, Inc., The Eureka Funds, Hirtle
Callaghan Trust, M.S.D. & T. Funds, Puget Sound Alternative
Investment Series Trust, The Sefton Funds Trust, The Victory
Variable Insurance Funds, and Vintage Mutual Fund, Inc.,
each of which is a management investment company.
(b) Partners of BISYS Fund Services are as follows:
Positions and Positions and
Name and Principal Offices with Offices with
Business Address BISYS Fund Services Registrant
- ------------------ ------------------- ------------------
BISYS Group, Inc. Sole Shareholder None
150 Clove Road
Little Falls, NJ 07424
BISYS Fund Services, Inc. Sole General Partner None
3435 Stelzer Road
Columbus, Ohio 43219-3035
WC Subsidiary Corporation Sole Limited Partner None
3435 Stelzer Road
Columbus, Ohio 43219-3035
(c) Not Applicable
</TABLE>
Item 28. Location of Accounts and Records
The accounts, books, and other documents required to be maintained by
Registrant pursuant to Section 31(a) of the Investment Company Act of
1940 and rules promulgated thereunder are in the possession of: Banking
and Trust Company, 434 Fayetteville Street Mall, Raleigh, NC 27601;
AmSouth Bank, 1901 Sixth Avenue North, Birmingham, Alabama 35203;
Rockhaven Asset Management, LLC, 100 First Avenue, Suite 1050,
Pittsburgh, PA 15222; OakBrook Investments, LLC, 701 Warrenville Road,
Suite 135, Lisle, IL 60532; HSBC Asset Management Americas, Inc., 140
Broadway, New York, NY 10005; and Lyon Street Asset Management Company,
111 Lyon Street, N.W., Grand Rapids, MI 49503 (records relating to
their functions as advisers for Registrant); BISYS Fund Services, 3435
Stelzer Road, Columbus, Ohio 43219-3035 (records relating to its
functions as distributor); and BISYS Fund Services Ohio, Inc., 3435
Stelzer Road, Columbus, Ohio 43219-3035 (records relating to its
functions as administrator, transfer agent, and fund accountant).
Item 29. Management Services
Not Applicable
Item 30. Undertakings
(a) Registrant undertakes to furnish each person to whom a
prospectus is delivered with a copy of the Registrant's
latest Annual Report to Shareholders, upon request and
without charge.
(b) Registrant undertakes to call a meeting of Shareholders for
the purpose of voting upon the question of removal of a
Trustee or Trustees when requested to do so by the holders
of at least 10% of the Registrant's outstanding shares of
beneficial interest and in connection with such meeting to
comply with the shareholders communications provisions of
Section 16(c) of the Investment Company Act of 1940.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant certifies that it meets all of the
requirements for effectiveness of this Registration Statement under Rule 485(b)
under the Securities Act and has duly caused this Post-Effective Amendment No. 8
to its Registration Statement to be signed on its behalf by the undersigned
thereunto duly authorized in the city of Washington, D.C. on the 29th day of
September, 1999.
VARIABLE INSURANCE FUNDS
By: _______*__________
Walter Grimm
President
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement on Form N-1A has been signed below by the following persons on behalf
of Variable Insurance Funds in the capacity and on the date indicated:
Signatures Title Date
- ----------- ------- ----
______*_________ President, Chairman September 29, 1999
Walter Grimm of the Board, and Trustee
______*_________ Principal Financial and September 29, 1999
Nimish Bhatt Accounting Officer
and Comptroller
______*_________ Trustee September 29, 1999
Michael Van Buskirk
______*__________ Trustee September 29, 1999
James Woodward
* By: /s/ Keith T. Robinson
-----------------
Keith T. Robinson as attorney-in-fact, pursuant to powers of attorney
filed as Exhibit 19(b) (since redesignated as Exhibit p(2)) to
Pre-Effective Amendment No. 2 and Exhibit p(4) to Post-Effective
Amendment No. 6 to the Registrant's Registration Statement.
<PAGE>
VARIABLE INSURANCE FUNDS INDEX TO EXHIBITS
FILED WITH POST-EFFECTIVE AMENDMENT NO. 7
Exhibit Designation Exhibit Description
(a)(5) Establishment and Designation of Series
(d)(5) Form of Investment Advisory Agreement between
Registrant and HSBC Asset Management
(Americas) Inc.
(d)(6) Form of Investment Advisory Agreement between
Registrant and Lyon Street Asset Management Company
(h) Form of Fund Participation Agreement with Allstate
Insurance Company
(j) (filed as EX-99.B11(j)) Consent of PricewaterhouseCoopers LLP
(n) (filed as EX-27) Financial Data Schedules Pursuant to Rule 483
VARIABLE INSURANCE FUNDS
Establishment and Designation of Four Additional Series
The undersigned, being all of the Trustees of Variable Insurance Funds (the
`Trust'), a Massachusetts business trust, acting pursuant to Section 5.11 of the
Declaration of Trust dated July 20, 1994, as amended and restated February 5,
1997 (the `Declaration of Trust'), hereby divide the shares of beneficial
interest (`Shares') of the Trust into four additional separate series (each a
`Fund,' collectively the `Funds'), of a single class, the Funds hereby created
having the following special and relative rights:
1. The Funds shall be designated as follows:
Kent Variable Growth and Income Fund
HSBC Variable Growth and Income Fund
HSBC Variable Fixed Income Fund
HSBC Variable Cash Management Fund
2. The Funds shall be authorized to invest in cash, securities,
instruments and other property as from time to time described in the then
current prospectus and registration statement materials for the Funds under the
Securities Act of 1933. Each Share of each Fund shall be redeemable, shall
represent a pro rata beneficial interest in the assets of the Funds, and shall
be entitled to receive its pro rata share of net assets allocable to such Shares
of the Funds upon liquidation of the Funds, all as provided in the Declaration
of Trust. The proceeds of sales of Shares of the Funds, together with any income
and gain thereon, less any diminution or expenses thereof, shall irrevocably
belong to the Funds, unless otherwise required by law.
3. Each Share of each Fund shall be entitled to one vote for each
dollar of value invested (or fraction thereof in respect of a fractional Share)
on matters on which such Shares shall be entitled to vote, except to the extent
otherwise required by the Investment Company Act of 1940 or when the Trustees
have determined that the matter affects only the interest of Shareholders of
certain series or classes, in which case only the Shareholders of such series or
classes shall be entitled to vote thereon. Any matter shall be deemed to have
been effectively acted upon with respect to the Funds if acted upon as provided
in Rule 18f-2 under such Act, or any successor rule, and in the Declaration of
Trust.
4. The assets and liabilities of the Trust shall be allocated among the
Funds and all other series of the Trust (also referred to herein as the "Funds")
as set forth in Section 5.11 of the Declaration of Trust, except as described
below.
(a) Costs incurred by the Trust on behalf of the Funds in
connection with the organization and registration and public
offering of Shares of the Funds shall be amortized for the
Funds over the lesser of the life of a Fund, the two year
period beginning on the date such costs become payable, or
such other period as required by applicable law; costs
incurred by the Trust on behalf of pre-existing Funds in
connection with the organization and initial registration
and public offering of Shares of those Funds shall be
amortized for the Funds over the lesser of the life of each
such Fund, the two year period beginning on the date such
costs become payable, or such other period as required by
applicable law.
(b) The Trustees may from time to time in particular cases make
specific allocations of assets or liabilities among the
Funds, and each allocation of liabilities, expenses, costs,
charges and reserves by the Trustees shall be conclusive and
binding upon the Shareholders of all Funds for all purposes.
5. The Trustees (including any successor Trustee) shall have the right
at any time and from time to time to reallocate assets and expenses or to change
the designation of any Fund now or hereafter created or to otherwise change the
special and relative rights of any such Fund, provided that such change shall
not adversely affect the rights of the Shareholders of such Fund.
<PAGE>
IN WITNESS WHEREOF, the undersigned have executed this instrument as of
the date set forth below.
Date: August 31, 1999
--------------------------------
James H. Woodward, as Trustee
-------------------------------
Michael Van Buskirk, as Trustee
-------------------------------
Walter B. Grimm, as Trustee
INVESTMENT ADVISORY AGREEMENT
AGREEMENT made as of October 1, 1999, between VARIABLE INSURANCE
FUNDS, a Massachusetts business trust (herein called the "Trust"), and HSBC
Asset Management (Americas) Inc., a [ ] corporation with its principal place of
business at 140 Broadway, New York, New York 10005 (herein called the
"Investment Adviser")
WHEREAS, the Trust is registered as an open-end, management investment
company under the Investment Company Act of 1940, as amended ("1940 Act"); and
WHEREAS. the Trust desires to retain the Investment Adviser to furnish
investment advisory services to certain investment portfolios of the Trust (the
"Funds") and the Investment Adviser represents that it is willing and possesses
the legal authority to so furnish such services;
NOW, THEREFORE, in consideration of the premises and mutual covenants
herein contained, it is agreed between the parties hereto as follows:
1. Appointment. The Trust hereby appoints the Investment Adviser to
act as investment adviser to the Funds identified on Schedule A hereto for the
period and on the terms set forth in this Agreement. The Investment Adviser
accepts such appointment and agrees to furnish the services herein set forth for
the compensation herein provided.
2. Availability of Documents. The Trust has made available to
Investment Adviser copies properly certified or authenticated of each of the
following:
(a) the Trust's Amended and Restated Declaration of Trust dated as
of July 20, 1994 and amended and restated as of February 5, 1997, and all
amendments thereto or restatements thereof (such Declaration, as presently in
effect and as it shall from time to time be amended or restated, is herein
called the "Declaration of Trust");
(b) the Trust's By-laws and amendments thereto;
(c) resolutions of the Trust's Board of Trustees authorizing the
appointment of the Investment Adviser and approving this Agreement;
(d) the Trust's Notification of Registration on Form N-8A under the
1940 Act as filed with the Securities and Exchange Commission on July 20, 1994
and all amendments thereto;
(e) the Trust's Registration Statement on Form N-lA under the
Securities Act of 1933, as amended ("1933 Act"), (File No. 33-81800) and under
the 1940 Act as filed with the Securities and Exchange Commission and all
amendments thereto; and
(f) the Funds' most recent prospectuses and Statement of Additional
Information (such prospectus and Statement of Additional Information, as
presently in effect, and all amendments and supplements thereto are herein
collectively called the "Prospectus").
The Trust will make available to the Investment Adviser from time
to time copies of all amendments of or supplements to the foregoing.
<PAGE>
3. Management. Subject to the supervision of the Trust's Board of
Trustees, the Investment Adviser will provide a continuous investment program
for each Fund, including investment research and management with respect to all
securities and investments and cash equivalents in said Funds. The Investment
Adviser will determine from time to time what securities and other investments
will be purchased, retained or sold by the Trust with respect to the Funds. The
Investment Adviser will provide the services under this Agreement in accordance
with each Fund's investment objective, policies, and restrictions as stated in
the Prospectus and resolutions of the Trust's Board of Trustees. The Investment
Adviser further agrees that it:
(a) will use the same skill and care in providing such services as
it uses in providing services to fiduciary accounts for which it has investment
responsibilities;
(b) will conform with all applicable Rules and Regulations of the
Securities and Exchange Commission and in addition will conduct its activities
under this Agreement in accordance with any applicable regulations of any
governmental authority pertaining to the investment advisory activities of the
Investment Adviser;
(c) will not make loans to any person to purchase or carry units of
beneficial interest in the Trust or make loans to the Trust;
(d) will place orders pursuant to its investment determinations for
the Trust either directly with the issuer or with any broker or dealer. In
placing orders with brokers and dealers, the Investment Adviser will attempt to
obtain prompt execution of orders in an effective manner at the most favorable
price. Consistent with this obligation, when the execution and price offered by
two or more brokers or dealers are comparable, the Investment Adviser may, in
its discretion, purchase and sell portfolio securities to and from brokers and
dealers who provide the Investment Adviser with research advice and other
services. In no instance will portfolio securities be purchased from or sold to
BISYS Fund Services ("BISYS"), HSBC Asset Americas, Inc., or any affiliated
person of either the Trust, BISYS or HSBC Asset Americas, Inc., except to the
extent permitted by the 1940 Act and the Securities and Exchange Commission;
(e) will maintain all books and records with respect to the Trust's
securities transactions and will furnish the Trust's Board of Trustees such
periodic and special reports as the Board may request;
(f) will treat confidentially and as proprietary information of the
Trust all records and other information relative to the Trust and prior,
present, or potential interestholders, and will not use such records and
information for any purpose other than performance of its responsibilities and
duties hereunder, except after prior notification to and approval in writing by
the Trust, which approval shall not be unreasonably withheld and may not be
withheld where the Investment Adviser may be exposed to civil or criminal
contempt proceedings for failure to comply, when requested to divulge such
information by duly constituted authorities, or when so requested by the Trust;
and
(g) will maintain its policy and practice of conducting its
fiduciary functions independently. In making investment recommendations for the
Trust, the Investment Adviser's personnel will not inquire or take into
consideration whether the issuers of securities proposed for purchase or sale
for the Trust's account are customers of the Investment Adviser or of its parent
or its subsidiaries or affiliates. In dealing with such customers, the
Investment Adviser and its parent, subsidiaries, and affiliates will not inquire
or take into consideration whether securities of those customers are held by the
Trust.
<PAGE>
4. Services Not Exclusive. The investment management services
furnished by the Investment Adviser hereunder are not to be deemed exclusive,
and the Investment Adviser shall be free to furnish similar services to others
so long as its services under this Agreement are not impaired thereby.
5. Books and Records. In compliance with the requirements of Rule
31a-3 under the 1940 Act, the Investment Adviser hereby agrees that all records
which it maintains for the Trust are the property of the Trust and further
agrees to surrender promptly to the Trust any of such records upon the Trust's
request. The Investment Adviser further agrees to preserve for the periods
prescribed by Rule 31a-2 under the 1940 Act the records required to be
maintained by Rule 31a-1 under the 1940 Act.
6. Expenses. During the term of this Agreement, the Investment Adviser
will pay all expenses incurred by it in connection with its activities under
this Agreement other than the cost of securities (including brokerage
commissions, if any) purchased for the Trust.
7. Compensation. For the services provided and the expenses assumed
pursuant to this Agreement, each of the Funds will pay the Investment Adviser
and the Investment Adviser will accept as full compensation therefor a fee
computed daily and paid monthly at the applicable annual rate set forth on
Schedule A hereto. Each Fund's obligation to pay the above-described fee to the
Investment Adviser will begin as of the date of the initial public sale of
shares in that Fund. The fee attributable to each Fund shall be the obligation
of that Fund and not of any other Fund.
If in any fiscal year the aggregate expenses of any of the Funds exceed
any applicable expense limitation, the Investment Adviser will reimburse the
Fund for a portion of such excess expenses equal to such excess times the ratio
of the fees otherwise payable by the Fund to the Investment Adviser hereunder to
the aggregate fees otherwise payable by the Fund to the Investment Adviser
hereunder and to BISYS Fund Services Ohio, Inc. ("BISYS Ohio:") under the
Administration Agreement, between BISYS Ohio and the Trust. The obligation of
the Investment Adviser to reimburse the Funds hereunder is limited in any fiscal
year to the amount of its fee hereunder for such fiscal year, provided; however,
that notwithstanding the foregoing, the Investment Adviser shall reimburse the
Funds for such proportion of such excess expenses regardless of the amount of
fees paid to it during such fiscal year to the extent that the securities
regulations of any state having jurisdiction over the Trust so require. Such
expense reimbursement, if any, will be estimated daily and reconciled and paid
on a monthly basis.
8. Limitation of Liability. The Investment Adviser shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Funds in connection with the performance of this Agreement, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith or gross negligence on the part of the Investment Adviser in the
performance of its duties or from reckless disregard by it of its obligations
and duties under this Agreement.
<PAGE>
9. Duration and Termination. This Agreement will become effective as
to a particular Fund as of the date first written above (or, if a particular
Fund is not in existence on that date, on the date a registration statement
relating to that Fund becomes effective with the Commission), provided that it
shall have been approved by vote of a majority of the outstanding voting
securities of such Fund, in accordance with the requirements under the 1940 Act.
Unless sooner terminated, this Agreement shall continue in effect for an initial
term of two years and thereafter shall continue in effect for successive periods
of one year, provide such continuance is specifically approved at least annually
(a) by the vote of a majority of those members of the Trust's Board of Trustees
who are not parties to this Agreement or interested persons of any party to this
Agreement, cast in person at a meeting called for the purpose of voting on such
approval, and (b) by the vote of a majority of the Trust's Board of Trustees or
by the vote of a majority of all votes attributable to the outstanding Shares of
such Fund. Notwithstanding the foregoing, this Agreement may be terminated at
any time on sixty days' written notice, without the payment of any penalty, by
the Trust (by vote of the Trust's Board of Trustees or by vote of a majority of
the outstanding voting securities of such Fund) or by the Investment Adviser.
This Agreement will immediately terminate in the event of its assignment. (As
used in this Agreement, the terms "majority of the outstanding voting
securities," "interested persons" and "assignment" shall have the same meaning
of such terms in the 1940 Act.)
10. Investment Adviser's Representations. The Investment Adviser
hereby represents and warrants as follows:
(a) it will manage each Fund so that each Fund will qualify as a
regulated investment company under Subchapter M of the Internal Revenue Code and
will comply with the diversification requirements of Section 817(h) of the
Internal Revenue Code and the regulations issued thereunder, and any other rules
and regulations pertaining to investment vehicles underlying variable annuity or
variable life insurance contracts;
(b) It shall immediately notify the Trust upon having a reasonable
basis for believing that any Fund has ceased to comply with the diversification
provisions of Section 817(h) of the Internal Revenue Code or the regulations
thereunder; and
(c) it shall be responsible for making inquiries and for reasonably
ensuring that any employee of the Investment Adviser, any person or firm that
the Investment Adviser has employed or with which it has associated, or any
employee thereof has not, to the best of the Investment Adviser's knowledge, in
any material connection with the handling of Trust assets: (i) been convicted,
in the last ten (10) years, of any felony or misdemeanor arising out of conduct
involving embezzlement, fraudulent conversion, or misappropriation of funds or
securities, or involving violations of Sections 1341, 1342, or 1343 of Title 18,
United States Code; or (ii) been found by any state regulatory authority, within
the last ten (10) years, to have violated or to have acknowledged violation of
any provision of any state insurance law involving fraud, deceit, or knowing
misrepresentation; or (iii) been found by any federal or state regulatory
authorities, within the last ten (10) years, to have violated or to have
acknowledged violation of any provisions of federal or state securities laws
involving fraud, deceit or knowing misrepresentation.
<PAGE>
11. Insurance Company Offerees. All parties acknowledge that the Trust
will offer its shares so that it may serve as an investment vehicle for variable
annuity contracts and variable life insurance policies issued by insurance
companies, as well as to qualified pension and retirement plans. The Trust and
the Investment Adviser agree that shares of the Funds may be offered only to the
separate accounts and general accounts of insurance companies that are approved
in writing by the Investment Adviser. The Investment Adviser agrees that shares
of the Funds may be offered to separate accounts and the general account of
Allstate Life Insurance Company and to separate accounts and the general
accounts of any insurance companies that are affiliated with Allstate Life
Insurance Company. The Investment Adviser and the Trust agree that the
Investment Adviser shall be under no obligation to investigate insurance
companies to which the Trust offers or proposes to offer its shares.
12. Amendment of this Agreement. No provision of its Agreement may be
changed, waived, discharged or terminated orally, but only by an instrument in
writing signed by the party against which enforcement of the change, waiver,
discharge or termination is sought.
13. Miscellaneous. The captions in this Agreement are included for
convenience of reference only and in no way define or delimit any of the
provisions hereof or otherwise affect their construction or effect. If any
provision of this Agreement shall be held or made invalid by a court decision,
statute, rule or otherwise, the remainder of this Agreement shall not be
affected thereby. This Agreement shall be binding upon and shall inure to the
benefit of the parties hereto and their respective successors and shall be
governed by the law of The Commonwealth of Massachusetts.
The names "Variable Insurance Funds" and "Trustees of Variable
Insurance Funds" refer respectively to the Trust created and the Trustees, as
trustees but not individually or personally, acting from time to time under the
Declaration of Trust to which reference is hereby made and a copy of which is on
file at the office of the Secretary of State of The Commonwealth of
Massachusetts and elsewhere as required by law, and to any and all amendments
thereto so filed or hereafter filed. The obligations of "Variable Insurance
Funds" entered into in the name or on behalf thereof by any of the Trustees,
representatives or agents are made not individually, but in such capacities, and
are not binding upon any of the Trustees, interestholders or representatives of
the Trust personally, but bind only the assets of the Trust, and all persons
dealing with any Fund must look solely to the assets of the Trust belonging to
such Fund for the enforcement of any claims against the Trust.
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this instrument to
be executed by their officers designated below as of the day and year first
above written.
VARIABLE INSURANCE FUNDS
Seal By:______________________________________
Name:____________________________________
Title: __________________________________
HSBC ASSET MANAGEMENT (AMERICAS) INC.
Seal
By:_______________________________________
Name:_____________________________________
Title:____________________________________
<PAGE>
Dated: October 1, 1999
Schedule A
to the Investment Advisory Agreement
between Variable Insurance Funds and HSBC Asset Management (Americas) Inc.
NAME OF FUND COMPENSATION*
HSBC Variable Growth and Income Fund Annual rate of fifty-five
hundredths of one percent
(.55%) of the average
daily net assets of such
Fund.
HSBC Variable Fixed Income Fund Annual rate of fifty-five
hundredths of one percent
(55%) of the average
daily net assets of such
Fund.
HSBC Variable Cash Management Fund Annual rate of
thirty-five hundredths of
one percent (35%) of the
average daily net assets
of such Fund.
- --------------------------------------------------------------------------------
*All fees are computed daily and paid monthly.
VARIABLE INSURANCE FUNDS
By:_________________________________
Name:_______________________________
Title:______________________________
HSBC ASSET MANAGEMENT AMERICAS INC.
By:_________________________________
Name:_______________________________
Title:______________________________
INVESTMENT ADVISORY AGREEMENT
AGREEMENT made as of October 1, 1999, between VARIABLE INSURANCE FUNDS,
a Massachusetts business trust (herein called the "Trust"), and Lyon Street
Asset Management Company, a [ ] corporation with its principal place of business
at 111 Lyon Street, N.W., Grand Rapids, Michigan 49503 (herein called the
"Investment Adviser").
WHEREAS, the Trust is registered as an open-end, management investment
company under the Investment Company Act of 1940, as amended ("1940 Act"); and
WHEREAS, the Trust desires to retain the Investment Adviser to furnish
investment advisory services to certain investment portfolios of the Trust (the
"Funds") and the Investment Adviser represents that it is willing and possesses
legal authority to so furnish such services;
NOW, THEREFORE, in consideration of the premises and mutual covenants
herein contained, it is agreed between the parties hereto as follows:
1. Appointment. The Trust hereby appoints the Investment Adviser to act
as investment adviser to the Funds identified on Schedule A hereto for the
period and on the terms set forth in this Agreement. The Investment Adviser
accepts such appointment and agrees to furnish the services herein set forth for
the compensation herein provided.
2. Availability of Documents. The Trust has made available to the
Investment Adviser copies properly certified or authenticated of each of the
following:
(a) the Trust's Amended and Restated Declaration of Trust dated as
of July 20, 1994 and amended and restated as of February 5, 1997, and all
amendments thereto or restatements thereof (such Declaration, as presently in
effect and as it shall from time to time be amended or restated, is herein
called the "Declaration of Trust");
(b) the Trust's By-laws and amendments thereto;
(c) resolutions of the Trust's Board of Trustees authorizing the
appointment of the Investment Adviser and approving this Agreement;
(d) the Trust's Notification of Registration on Form N-8A under the
1940 Act as filed with the Securities and Exchange Commission on July 20, 1994
and all amendments thereto;
(e) the Trust's Registration Statement on Form N-lA under the
Securities Act of 1933, as amended ("1933 Act"), (File No. 33-81800) and under
the 1940 Act as filed with the Securities and Exchange Commission and all
amendments thereto; and
<PAGE>
(f) the Funds' most recent prospectuses and Statement of Additional
Information (such prospectus and Statement of Additional Information, as
presently in effect, and all amendments and supplements thereto are herein
collectively called the "Prospectus").
The Trust will make available to the Investment Adviser from time to
time copies of all amendments of or supplements to the foregoing.
3. Management. Subject to the supervision of the Trust's Board of
Trustees, the Investment Adviser will provide a continuous investment program
for each Fund, including investment research and management with respect to all
securities and investments and cash equivalents in said Funds. The Investment
Adviser will determine from time to time what securities and other investments
will be purchased, retained or sold by the Trust with respect to the Funds. The
Investment Adviser will provide the services under this Agreement in accordance
with each Fund's investment objective, policies, and restrictions as stated in
the Prospectus and resolutions of the Trust's Board of Trustees. The Investment
Adviser further agrees that it:
(a) will use the same skill and care in providing such services as
it uses in providing services to fiduciary accounts for which it has investment
responsibilities;
(b) will conform with all applicable Rules and Regulations of the
Securities and Exchange Commission and in addition will conduct its activities
under this Agreement in accordance with any applicable regulations of any
governmental authority pertaining to the investment advisory activities of the
Investment Adviser;
(c) will not knowingly make loans to any person to purchase or carry
units of beneficial interest in the Trust or make loans to the Trust;
(d) will place orders pursuant to its investment determinations for
the Trust either directly with the issuer or with any broker or dealer. In
placing orders with brokers and dealers, the Investment Adviser will attempt to
obtain prompt execution of orders in an effective manner at the most favorable
price. Consistent with this obligation, when the execution and price offered by
two or more brokers or dealers are comparable, the Investment Adviser may, in
its discretion, purchase and sell portfolio securities to and from brokers and
dealers who provide the Investment Adviser with research advice and other
services. In no instance will portfolio securities be purchased from or sold to
BISYS Fund Services ("BISYS"), Lyon Street Asset Management Corporation, or any
affiliated person of either the Trust, BISYS, or Lyon Street Asset Management
Corporation, except to the extent permitted by the 1940 Act and the Securities
and Exchange Commission;
(e) will maintain all books and records with respect to its
transactions with the Trust, to the extent required by Rule 31a-1(f) under the
1940 Act, and will furnish the Trust's Board of Trustees such periodic and
special reports as the Board reasonably may request;
<PAGE>
(f) will treat confidentially and as proprietary information of the
Trust all records and other information relative to the Trust and prior,
present, or potential interestholders, and will not use such records and
information for any purpose other than performance of its responsibilities and
duties hereunder, except after prior notification to and approval in writing by
the Trust, which approval shall not be unreasonably withheld and may not be
withheld where the Investment Adviser may be exposed to civil or criminal
contempt proceedings for failure to comply, when requested to divulge such
information by duly constituted authorities, or when so requested by the Trust;
and
(g) will maintain its policy and practice of conducting its
fiduciary functions independently. In making investment recommendations for the
Trust, the Investment Adviser's personnel will not inquire or take into
consideration whether the issuers of securities proposed for purchase or sale
for the Trust's account are customers of the Investment Adviser or of its parent
or its subsidiaries or affiliates. In dealing with such customers, the
Investment Adviser and its parent, subsidiaries, and affiliates will not inquire
or take into consideration whether securities of those customers are held by the
Trust.
4. Services Not Exclusive. The investment management services furnished
by the Investment Adviser hereunder are not to be deemed exclusive, and the
Investment Adviser shall be free to furnish similar services to others so long
as its services under this Agreement are not impaired thereby.
5. Books and Records. In compliance with the requirements of Rule 31a-3
under the 1940 Act, the Investment Adviser hereby agrees that all records which
it maintains for the Trust are the property of the Trust and further agrees to
surrender promptly to the Trust any of such records upon the Trust's request.
The Investment Adviser further agrees to preserve for the periods prescribed by
Rule 31a-2(e) under the 1940 Act all records maintained by it pursuant to Rule
31a-1(f) under the 1940 Act, and also to preserve for the periods prescribed by
31a-2 all other records the Investment Adviser agrees in writing to maintain
pursuant to Rule 31a-1.
6. Expenses. During the term of this Agreement, the Investment Adviser
will pay all expenses incurred by it in connection with its activities under
this Agreement other than the cost of securities (including brokerage
commissions, if any) purchased for the Trust.
7. Compensation. For the services provided and the expenses assumed
pursuant to this Agreement, each of the Funds will pay the Investment Adviser
and the Investment Adviser will accept as full compensation therefor a fee
computed daily and paid monthly at the applicable annual rate set forth on
Schedule A hereto. Each Fund's obligation to pay the above-described fee to the
Investment Adviser will begin as of the date of the initial public sale of
shares in that Fund. The fee attributable to each Fund shall be the obligation
of that Fund and not of any other Fund.
<PAGE>
If in any fiscal year the aggregate expenses of any of the Funds
exceed any applicable expense limitation imposed by law or regulation, the
Investment Adviser will reimburse the Fund for a portion of such excess expenses
(after repayment of fees received in excess of contractual fee rates) equal to
such excess times the ratio of the fees otherwise payable by the Fund to the
Investment Adviser hereunder to the aggregate fees otherwise payable by the Fund
to the Investment Adviser hereunder and to BISYS Fund Services Ohio, Inc.
("BISYS Ohio") under the Administration Agreement between BISYS Ohio and the
Trust, unless otherwise agreed by the Investment Adviser and BISYS Ohio. The
obligation of the Investment Adviser to reimburse the Funds hereunder is limited
in any fiscal year to the amount of its fee hereunder for such fiscal year,
provided, however, that notwithstanding the foregoing, the Investment Adviser
shall reimburse the Funds for such proportion of such excess expenses regardless
of the amount of fees paid to it during such fiscal year to the extent that the
securities regulations of any state having jurisdiction over the Trust so
require. Such expense reimbursement, if any, will be estimated daily and
reconciled and paid on a monthly basis.
8. Limitation of Liability. The Investment Adviser shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Funds in connection with the performance of this Agreement, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith or gross negligence on the part of the Investment Adviser in the
performance of its duties or from reckless disregard by it of its obligations
and duties under this Agreement.
9. Duration and Termination. This Agreement will become effective as to
a particular Fund as of the date first written above (or, if a particular Fund
is not in existence on that date, on the date a registration statement relating
to that Fund becomes effective with the Commission), provided that it shall have
been approved by vote of a majority of the outstanding voting securities of such
Fund, in accordance with the requirements under the 1940 Act. Unless sooner
terminated, this Agreement shall continue in effect for an initial term of two
years and thereafter shall continue in effect for successive periods of one
year, provided such continuance is specifically approved at least annually (a)
by the vote of a majority of those members of the Trust's Board of Trustees who
are not parties to this Agreement or interested persons of any party to this
Agreement, cast in person at a meeting called for the purpose of voting on such
approval, and (b) by the vote of a majority of the Trust's Board of Trustees or
by the vote of a majority of all votes attributable to the outstanding Shares of
such Fund. Notwithstanding the foregoing, this Agreement may be terminated at
any time on sixty days' written notice, without the payment of any penalty, by
the Trust (by vote of the Trust's Board of Trustees or by vote of a majority of
the outstanding voting securities of such Fund) or by the Investment Adviser.
This Agreement will immediately terminate in the event of its assignment. (As
used in this Agreement, the terms "majority of the outstanding voting
securities," "interested persons" and "assignment" shall have the same meaning
of such terms in the 1940 Act.)
<PAGE>
10. Investment Adviser's Representations. The Investment Adviser hereby
represents and warrants as follows:
(a) it will manage each Fund so that each Fund will qualify as a
regulated investment company under Subchapter M of the Internal Revenue Code and
will comply with the diversification requirements of Section 817(h) of the
Internal Revenue Code and the regulations issued thereunder, and any other rules
and regulations pertaining to investment vehicles underlying variable annuity or
variable life insurance contracts;
(b) It shall immediately notify the Trust upon having a reasonable
basis for believing that any Fund has ceased to comply with the diversification
provisions of Section 817(h) of the Internal Revenue Code or the regulations
thereunder; and
(c) it shall be responsible for making inquiries and for reasonably
ensuring that any employee of the Investment Adviser, any person or firm that
the Investment Adviser has employed or with which it has associated, or any
employee thereof has not, to the best of the Investment Adviser's knowledge, in
any material connection with the handling of Trust assets: (i) been convicted,
in the last ten (10) years, of any felony or misdemeanor arising out of conduct
involving embezzlement, fraudulent conversion, or misappropriation of funds or
securities, or involving violations of Sections 1341, 1342, or 1343 of Title 18,
United States Code; or (ii) been found by any state regulatory authority, within
the last ten (10) years, to have violated or to have acknowledged violation of
any provision of any state insurance law involving fraud, deceit, or knowing
misrepresentation; or (iii) been found by any federal or state regulatory
authorities, within the last ten (10) years, to have violated or to have
acknowledged violation of any provisions of federal or state securities laws
involving fraud, deceit or knowing misrepresentation.
11. Insurance Company Offerees. All parties acknowledge that the Trust
will offer its shares so that it may serve as an investment vehicle for variable
annuity contracts and variable life insurance policies issued by insurance
companies, as well as to qualified pension and retirement plans. The Trust and
the Investment Adviser agree that shares of the Funds may be offered only to the
separate accounts and general accounts of insurance companies that are approved
in writing by the Investment Adviser. The Investment Adviser agrees that shares
of the Funds may be offered to separate accounts and the general account of
Allstate Life Insurance Company and to separate accounts and the general
accounts of any insurance companies that are affiliated with Allstate Life
Insurance Company. The Investment Adviser and the Trust agree that the
Investment Adviser shall be under no obligation to investigate insurance
companies to which the Trust offers or proposes to offer its shares.
12. Amendment of this Agreement. No provision of this Agreement may be
changed, waived, discharged or terminated orally, but only by an instrument in
writing signed by the party against which enforcement of the change, waiver,
discharge or termination is sought.
<PAGE>
13. Miscellaneous. The captions in this Agreement are included for
convenience of reference only and in no way define or delimit any of the
provisions hereof or otherwise affect their construction or effect. If any
provision of this Agreement shall be held or made invalid by a court decision,
statute, rule or otherwise, the remainder of this Agreement shall not be
affected thereby. This Agreement shall be binding upon and shall inure to the
benefit of the parties hereto and their respective successors and shall be
governed by the law of The Commonwealth of Massachusetts.
The names "Variable Insurance Funds" and "Trustees of Variable
Insurance Funds" refer respectively to the Trust created and the Trustees, as
trustees but not individually or personally, acting from time to time under the
Declaration of Trust to which reference is hereby made and a copy of which is on
file at the office of the Secretary of State of The Commonwealth of
Massachusetts and elsewhere as required by law, and to any and all amendments
thereto so filed or hereafter filed. The obligations of "Variable Insurance
Funds" entered into in the name or on behalf thereof by any of the Trustees,
representatives or agents are made not individually, but in such capacities, and
are not binding upon any of the Trustees, interestholders or representatives of
the Trust personally, but bind only the assets of the Trust, and all persons
dealing with any Fund must look solely to the assets of the Trust belonging to
such Fund for the enforcement of any claims against the Trust.
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this instrument
to be executed by their officers designated below as of the day and year first
above written.
VARIABLE INSURANCE FUNDS
Seal By:
Name:
Title:
LYON STREET ASSET MANAGEMENT COMPANY
Seal
By:
Name:
Title:
<PAGE>
Dated: October 1, 1999
Schedule A
to the Investment Advisory Agreement
between Variable Insurance Funds and Lyon Street Asset Management Company
NAME OF FUND COMPENSATION*
Kent Variable Growth and Income Fund Annual rate of
seventy one-hundredths of
one percent (.70%)
of the average daily
net assets of such
Fund.
* All fees are computed daily and paid monthly.
VARIABLE INSURANCE FUNDS
By:_______________________________
Name:_____________________________
Title:____________________________
LYON STREET ASSET MANAGEMENT COMPANY
By:________________________________
Name:______________________________
Title: ___________________________
PARTICIPATION AGREEMENT
Among
ALLSTATE LIFE INSURANCE COMPANY,
VARIABLE INSURANCE FUNDS,
and
HSBC ASSET MANAGEMENT AMERICAS INC.
THIS AGREEMENT, dated as of the ___ day of , 1999, by and among
Allstate Life Insurance Company (the "Company"), an Illinois life insurance
company, on its own behalf and on behalf of each segregated asset account of the
Company set forth on Schedule A hereto as may be amended from time to time (each
account hereinafter referred to as the "Account"), Variable Insurance Funds (the
"Fund"), a Massachusetts business trust, and HSBC Asset Management Americas Inc.
(the "Adviser"), a [insert state] corporation.
WHEREAS, the Fund engages in business as an open-end management
investment company and is available to act as the investment vehicle for
separate accounts established for variable life insurance and variable annuity
contracts (the "Variable Insurance Products") to be offered by insurance
companies which have entered into participation agreements with the Fund and the
Adviser ("Participating Insurance Companies");
WHEREAS, the shares of beneficial interest of the Fund are divided into
several series of shares, each designated a "Portfolio" and representing the
interest in a particular managed portfolio of securities and other assets;
WHEREAS, the Fund has obtained an order from the Securities and
Exchange Commission (the "SEC") dated December 10, 1998 (Variable Insurance
Funds, et al., File No. 812-10694, Investment Company Act Rel. No. 23594)
granting Participating Insurance Companies and variable annuity and variable
life insurance separate accounts exemptions from the provisions of sections
9(a), 13(a), 15(a), and 15(b) of the Investment Company Act of 1940, as amended
(the "1940 Act"), and Rules 6e-2(b)(15) and 6e-3(T)(b)(15) thereunder, if and to
the extent necessary to permit shares of the Fund to be sold to and held by
variable annuity and variable life insurance separate accounts of both
affiliated and unaffiliated life insurance companies, qualified pension and
retirement plans outside of the separate account context, the manager of a Fund
or certain related corporations, and the general account of a life insurance
company, or certain related corporations, whose separate account holds, or will
hold, shares of the Fund (the "Mixed and Shared Funding Exemptive Order"), and
the Fund hereby provides notice to the Company that appropriate prospectus
disclosure regarding potential risks of mixed and shared funding may be
appropriate;
WHEREAS, the Fund is registered as an open-end management investment
company under the 1940 Act and shares of the Portfolios are registered under the
Securities Act of 1933, as amended (the "1933 Act");
WHEREAS, the Adviser, which serves as investment adviser to certain
Portfolios of the Fund, is duly registered as an investment adviser under the
federal Investment Advisers Act of 1940, as amended;
<PAGE>
WHEREAS, the Company has issued or will issue certain variable life
insurance and/or variable annuity contracts supported wholly or partially by an
Account (the "Contracts"), and said Contracts are listed in Schedule A hereto,
as it may be amended from time to time by mutual written agreement;
WHEREAS, each Account is duly established and maintained as a
segregated asset account, duly established by the Company, to set aside and
invest assets attributable to the aforesaid Contracts;
WHEREAS, BISYS Fund Services (the "Underwriter"), which serves as
distributor to the Fund, is registered as a broker-dealer with the SEC under the
Securities Exchange Act of 1934, as amended (the "1934 Act"), and is a member in
good standing of the National Association of Securities Dealers, Inc. (the
"NASD"); and
WHEREAS, to the extent permitted by applicable insurance laws and
regulations, the Company intends to purchase shares in the Portfolios listed in
Schedule A hereto, as it may be amended from time to time by mutual written
agreement (the "Designated Portfolios") on behalf of the Account to fund the
aforesaid Contracts, and the Underwriter is authorized to sell such shares to
the Account at net asset value;
NOW, THEREFORE, in consideration of their mutual promises, the Company,
the Fund and the Adviser agree as follows:
ARTICLE I. Sale of Fund Shares
1.1. The Fund has granted to the Underwriter exclusive authority to
distribute the Fund's shares, and has agreed to instruct, and has so instructed,
the Underwriter to make available to the Company, for purchase on behalf of the
Account, Fund shares of those Designated Portfolios selected by the Adviser.
Pursuant to such authority and instructions, and subject to Article X hereof,
the Underwriter shall make available to the Company for purchase on behalf of
the Account, shares of those Designated Portfolios listed on Schedule A to this
Agreement, such purchases to be effected at net asset value in accordance with
Section 1.3 of this Agreement. Notwithstanding the foregoing, (i) Fund series
(other than those listed on Schedule A) in existence now or that may be
established in the future will be made available to the Company only as the Fund
and the Adviser may so provide, and (ii) the Board of Trustees of the Fund (the
"Board") may suspend or terminate the offering of Fund shares of any Designated
Portfolio or class thereof, if such action is required by law or by regulatory
authorities having jurisdiction or if, in the sole discretion of the Board
acting in good faith and in light of its fiduciary duties under federal and any
applicable state laws, suspension or termination is necessary in the best
interests of the shareholders of such Designated Portfolio.
1.2. The Fund shall redeem, at the Company's request, any full or
fractional Designated Portfolio shares held by the Company on behalf of the
Account, such redemptions to be effected at net asset value in accordance with
Section 1.3 of this Agreement. Notwithstanding the foregoing, (i) the Company
shall not redeem Fund shares attributable to Contract owners except in the
circumstances permitted in Section 10.3 of this Agreement, and (ii) the Fund may
delay redemption of Fund shares of any Designated Portfolio to the extent
permitted by the 1940 Act, and any rules, regulations or orders thereunder.
<PAGE>
1.3. Purchase and Redemption Procedures
(a) The Fund hereby appoints the Company as an agent of the
Fund for the limited purpose of receiving purchase and redemption requests
on behalf of the Account (but not with respect to any Fund shares that may
be held in the general account of the Company) for shares of those
Designated Portfolios made available hereunder, based on allocations of
amounts to the Account or subaccounts thereof under the Contracts and other
transactions relating to the Contracts or the Account. Receipt of any such
request (or relevant transactional information therefor) on any day the New
York Stock Exchange is open for trading and on which a Designated Portfolio
calculates its net asset value pursuant to the rules of the SEC (a
"Business Day") by the Company as such limited agent of the Fund prior to
the time that the Designated Portfolio ordinarily calculates its net asset
value as described from time to time in the Fund's prospectus, shall
constitute receipt by the Fund on that same Business Day, provided that the
Fund receives notice of such request by 9:30 a.m. Eastern Time on the next
following Business Day.
(b) The Company shall pay for shares of each Designated
Portfolio on the same day that it notifies the Fund of a purchase request
for such shares. Payment for Designated Portfolio shares shall be made in
federal funds transmitted to the Fund by wire to be received by the Fund by
noon, Eastern Time, on the day the Fund is notified of the purchase request
for Designated Portfolio shares (unless the Fund determines and so advises
the Company that sufficient proceeds are available from redemption of
shares of other Designated Portfolios effected pursuant to redemption
requests tendered by the Company on behalf of the Account). If federal
funds are not received on time, such funds will be invested, and Designated
Portfolio shares purchased thereby will be issued, as soon as practicable
and the Company shall promptly, upon the Fund's request, reimburse the Fund
for any charges, costs, fees, interest or other expenses incurred by the
Fund in connection with any advances to, or borrowing or overdrafts by, the
Fund, or any similar expenses incurred by the Fund, as a result of
portfolio transactions effected by the Fund based upon such purchase
request. Upon receipt of federal funds so wired, such funds shall cease to
be the responsibility of the Company and shall become the responsibility of
the Fund.
(c) Payment for Designated Portfolio shares redeemed by the
Account or the Company shall be made in federal funds transmitted by wire
to the Company or any other designated person on the next Business Day
after the Fund is properly notified of the redemption order of such shares
(unless redemption proceeds are to be applied to the purchase of shares of
other Designated Portfolios in accordance with Section 1.3(b) of this
Agreement), except that the Fund reserves the right to redeem Designated
Portfolio shares in assets other than cash and to delay payment of
redemption proceeds to the extent permitted under Section 22(e) of the 1940
Act and any Rules thereunder, and in accordance with the procedures and
policies of the Fund as described in the then current prospectus. The Fund
shall not bear any responsibility whatsoever for the proper disbursement or
crediting of redemption proceeds by the Company, the Company alone shall be
responsible for such action.
(d) Any purchase or redemption request for Designated Portfolio
shares held or to be held in the Company's general account shall be
effected at the net asset value per share next determined after the Fund's
receipt of such request, provided that, in the case of a purchase request,
payment for Fund shares so requested is received by the Fund in federal
funds prior to close of business for determination of such value, as
defined from time to time in the Fund Prospectus.
<PAGE>
1.4. The Fund shall use its best efforts to make the net asset
value per share for each Designated Portfolio available to the Company by 6:30
p.m. Eastern Time each Business Day, and in any event, as soon as reasonably
practicable after the net asset value per share for such Designated Portfolio is
calculated, and shall calculate such net asset value in accordance with the
Fund's prospectus. Neither the Fund, any Designated Portfolio, the Underwriter,
nor any of their affiliates shall be liable for any information provided to the
Company pursuant to this Agreement which information is based on incorrect
information supplied by the Company or any other Participating Insurance Company
to the Fund or the Underwriter.
1.5. The Fund shall furnish notice (by wire or telephone followed
by written confirmation) to the Company, as soon as reasonably practicable, of
any income dividends or capital gain distributions payable on any Designated
Portfolio shares. The Company, on its behalf and on behalf of the Account,
hereby elects to receive all such dividends and distributions as are payable on
any Designated Portfolio shares in the form of additional shares of that
Designated Portfolio. The Company reserves the right, on its behalf and on
behalf of the Account, to revoke this election and to receive all such dividends
and capital gain distributions in cash. The Fund shall notify the Company
promptly of the number of Designated Portfolio shares so issued as payment of
such dividends and distributions.
1.6. Issuance and transfer of Fund shares shall be by book entry
only. Share certificates will not be issued to the Company or the Account.
Purchase and redemption orders for Fund shares shall be recorded in an
appropriate ledger for the Account or the appropriate subaccount of the Account.
1.7. (a) The parties hereto acknowledge that the arrangement
contemplated by this Agreement is not exclusive; the Fund's shares may be sold
to other insurance companies (subject to Section 1.8 hereof) and the cash value
of the Contracts may be invested in other investment companies, provided,
however, that until this Agreement is terminated pursuant to Article X, the
Company shall promote the Designated Portfolios on the same basis as other
funding vehicles available under the Contracts. Funding vehicles other than
those listed on Schedule A to this Agreement may be available for the investment
of the cash value of the Contracts, provided, however, (i) any such vehicle or
series thereof, has investment objectives or policies that are substantially
different from the investment objectives and policies of the Designated
Portfolios available hereunder; (ii) the Company gives the Fund and the
Underwriter 45 days written notice of its intention to make such other
investment vehicle available as a funding vehicle for the Contracts; and (iii)
unless such other investment company was available as a Funding vehicle for the
Contracts prior to the date of this Agreement and the Company has so informed
the Fund and the Underwriter prior to the Fund's signing of this Agreement, the
Fund or Adviser consents in writing to the use of such other vehicle, such
consent not to be unreasonably withheld.
(b) The Company shall not, without prior notice to the Adviser
(unless otherwise required by applicable law), take any action to operate
the Account as a management investment company under the 1940 Act.
(c) The Company shall not, without prior notice to the Adviser
(unless otherwise required by applicable law), induce Contract owners to
change or modify the Fund or change the Fund's distributor or investment
adviser.
(d) The Company shall not, without prior notice to the Fund,
induce Contract owners to vote on any matter submitted for consideration by
the shareholders of the Fund in a manner other than as recommended by the
Board of Trustees of the Fund.
1.8. The Fund shall sell Fund shares only to Participating
Insurance Companies and their separate accounts and to persons or plans
("Qualified Persons") that communicate to the Fund (or its designees) that they
qualify to purchase shares of the Fund under Section 817(h) of the Internal
Revenue Code of 1986, as amended (the "Code"), and the regulations thereunder
without impairing the ability of the Account to consider the portfolio
investments of the Fund as constituting investments of the Account for the
purpose of satisfying the diversification requirements of Section 817(h). The
Fund shall not sell Fund shares to any insurance company or separate account
unless an agreement substantially complying with Article VI of this Agreement is
in effect to govern such sales, to the extent required. The Company hereby
represents and warrants that it and the Account are Qualified Persons. The Fund
reserves the right to cease offering shares of any Designated Portfolio in the
discretion of the Fund.
<PAGE>
ARTICLE II. Representations and Warranties
2.1. The Company represents and warrants that the Contracts (a)
are, or prior to issuance will be, registered under the 1933 Act, or (b) are not
registered because they are properly exempt from registration under the 1933 Act
or will be offered exclusively in transactions that are properly exempt from
registration under the 1933 Act. The Company further represents and warrants
that the Contracts will be issued and sold in compliance in all material
respects with all applicable federal securities and state securities and
insurance laws and that the sale of the Contracts shall comply in all material
respects with state insurance suitability requirements. The Company further
represents and warrants that it is an insurance company duly organized and in
good standing under applicable law, that it has legally and validly established
the Account prior to any issuance or sale thereof as a segregated asset account
under Illinois insurance laws, and that it (a) has registered or, prior to any
issuance or sale of the Contracts, will register the Account as a unit
investment trust in accordance with the provisions of the 1940 Act to serve as a
segregated investment account for the Contracts, or alternatively (b) has not
registered the Account in proper reliance upon an exclusion from registration
under the 1940 Act. The Company shall register and qualify the Contracts or
interests therein as securities in accordance with the laws of the various
states only if and to the extent deemed advisable by the Company.
2.2. The Fund represents and warrants that Fund shares sold
pursuant to this Agreement shall be registered under the 1933 Act, duly
authorized for issuance and sold in compliance with applicable state and federal
securities laws and that the Fund is and shall remain registered under the 1940
Act. The Fund shall amend the registration statement for its shares under the
1933 Act and the 1940 Act from time to time as required in order to effect the
continuous offering of its shares. The Fund shall register and qualify the
shares for sale in accordance with the laws of the various states only if and to
the extent deemed advisable by the Fund.
2.3. The Fund may make payments to finance distribution expenses
pursuant to Rule 12b-1 under the 1940 Act. Prior to financing distribution
expenses pursuant to Rule 12b-1, the Fund will have the Board, a majority of
whom are not interested persons of the Fund, formulate and approve a plan
pursuant to Rule 12b-1 under the 1940 Act to finance distribution expenses.
2.4. The Fund makes no representations as to whether any aspect of
its operations, including, but not limited to, investment policies, fees and
expenses, complies with the insurance and other applicable laws of the various
states.
2.5. The Fund represents that it is lawfully organized and validly
existing under the laws of the State of Massachusetts and that it does and will
comply in all material respects with the 1940 Act.
2.6. The Adviser represents and warrants that it is registered as
an investment adviser with the SEC.
2.7. The Fund and the Adviser represent and warrant that all of
their trustees/directors, officers, employees, investment advisers, and other
individuals or entities dealing with the money and/or securities of the Fund are
and shall continue to be at all times covered by a blanket fidelity bond or
similar coverage for the benefit of the Fund in an amount not less than the
minimum coverage as required currently by Rule 17g-1 under the 1940 Act or
related provisions as may be promulgated from time to time. The aforesaid bond
shall include coverage for larceny and embezzlement and shall be issued by a
reputable bonding company.
<PAGE>
2.8. The Company represents and warrants that all of its directors,
officers, employees, and other individuals/entities employed or controlled by
the Company dealing with the money and/or securities of the Account are covered
by a blanket fidelity bond or similar coverage for the benefit of the Account,
in an amount not less than $5 million. The aforesaid bond includes coverage for
larceny and embezzlement and is issued by a reputable bonding company. The
Company agrees to hold for the benefit of the Fund and to pay to the Fund any
amounts lost from larceny, embezzlement or other events covered by the aforesaid
bond to the extent such amounts properly belong to the Fund pursuant to the
terms of this Agreement. The Company agrees to make all reasonable efforts to
see that this bond or another bond containing these provisions is always in
effect, and agrees to notify the Fund and the Adviser in the event that such
coverage no longer applies.
ARTICLE III. Prospectuses and Proxy Statements; Voting
3.1. The Fund or its designee shall provide the Company with as
many copies of the Fund's current prospectus (describing only the Designated
Portfolios listed on Schedule A) or, to the extent permitted, the Fund's
profiles as the Company may reasonably request. The Company shall bear the
expense of printing copies of the current prospectus and profiles for the
Contracts that will be distributed to existing Contract owners, and the Company
shall bear the expense of printing copies of the Fund's prospectus and profiles
that are used in connection with offering the Contracts issued by the Company.
If requested by the Company in lieu thereof, the Fund shall provide such
documentation (including a final copy of the new prospectus on diskette at the
Fund's expense) and other assistance as is reasonably necessary in order for the
Company once each year (or more frequently if the prospectus for the Fund is
amended) to have the prospectus for the Contracts and the Fund's prospectus or
profile printed together in one document (such printing to be at the Company's
expense).
3.2. The Fund's prospectus shall state that the current statement
of additional information ("SAI") for the Fund is available, and the Underwriter
(or the Fund), at its expense, shall provide a reasonable number of copies of
such SAI free of charge to the Company for itself and for any owner of a
Contract who requests such SAI.
3.3. The Fund shall provide the Company with information regarding
the Fund's expenses, which information may include a table of fees and related
narrative disclosure. for use in any prospectus or other descriptive document
relating to a Contract. The Company agrees that it will use such information in
the form provided. The Company shall provide prior written notice of any
proposed modification of such information, which notice will describe in detail
the manner in which the Company proposes to modify the information, and agrees
that it may not modify such information in any way without the prior consent of
the Fund.
3.4. The Fund, at its expense, shall provide the Company with
copies of its proxy material, reports to shareholders, and other communications
to shareholders in such quantity as the Company shall reasonably require for
distributing to Contract owners.
<PAGE>
3.5. The Company shall:
(i) solicit voting instructions from Contract owners;
(ii) vote the Fund shares in accordance with instructions
received from Contract owners;
(iii)vote Fund shares for which no instructions have been
received in the same proportion as Fund shares of such
portfolio for which instructions have been received;
and
(iv) vote Fund shares it owns in the same proportion as
those shares for which it has received voting
instructions,
so long as and to the extent that the SEC continues to interpret the 1940 Act to
require pass-through voting privileges for variable contract owners or to the
extent otherwise required by law. The Company will vote Fund shares held in any
segregated asset account in the same proportion as Fund shares of such portfolio
for which voting instructions have been received from Contract owners, to the
extent permitted by law.
3.6. Participating Insurance Companies shall be responsible for
assuring that each of their separate accounts participating in a Designated
Portfolio calculates voting privileges as required by the Mixed and Shared
Funding Exemptive Order and consistent with any reasonable standards that the
Fund may adopt and provide in writing.
ARTICLE IV. Sales Material and Information
4.1. The Company shall furnish, or shall cause to be furnished, to
the Fund or its designee, each piece of sales literature or other promotional
material that the Company develops and in which the Fund (or a Designated
Portfolio thereof) or the Adviser or the Underwriter is named. No such material
shall be used until approved by the Fund or its designee, and the Fund will use
its best efforts for it or its designee to review such sales literature or
promotional material within ten Business Days after receipt of such material.
The Fund or its designee reserves the right to reasonably object to the
continued use of any such sales literature or other promotional material in
which the Fund (or a Designated Portfolio thereof) or the Adviser or the
Underwriter is named, and no such material shall be used if the Fund or its
designee so object.
4.2. The Company shall not give any information or make any
representations or statements on behalf of the Fund or concerning the Fund or
the Adviser or the Underwriter in connection with the sale of the Contracts
other than the information or representations contained in the registration
statement or prospectus or SAI for the Fund shares, as such registration
statement and prospectus or SAI may be amended or supplemented from time to
time, or in reports or proxy statements for the Fund, or in sales literature or
other promotional material approved by the Fund or its designee, except with the
permission of the Fund or its designee.
4.3. The Fund or its designee shall furnish, or cause to be
furnished, to the Company, each piece of sales literature or other promotional
material that it develops and in which the Company, and/or its Account, is
named. No such material shall be used until approved by the Company, and the
Company will use its best efforts to review such sales literature or promotional
material within ten Business Days after receipt of such material. The Company
reserves the right to reasonably object to the continued use of any such sales
literature or other promotional material in which the Company and/or its Account
is named, and no such material shall be used if the Company so objects.
<PAGE>
4.4. The Fund, the Adviser and the Underwriter shall not give any
information or make any representations on behalf of the Company or concerning
the Company, the Account, or the Contracts other than the information or
representations contained in a registration statement, prospectus (which shall
include an offering memorandum, if any, if the Contracts issued by the Company
or interests therein are not registered under the 1933 Act), or SAI for the
Contracts, as such registration statement, prospectus, or SAI may be amended or
supplemented from time to time, or in published reports for the Account which
are in the public domain or approved by the Company for distribution to Contract
owners, or in sales literature or other promotional material approved by the
Company or its designee, except with the permission of the Company.
4.5. The Fund will provide to the Company at least one complete
copy of all registration statements, prospectuses, SAIs, reports, proxy
statements, sales literature and other promotional materials, applications for
exemptions, requests for no-action letters, and all amendments to any of the
above, that relate to the Fund or its shares, promptly after the filing of such
document(s) with the SEC or other regulatory authorities.
4.6. The Company will provide to the Fund at least one complete
copy of all registration statements, prospectuses (which shall include an
offering memorandum, if any, if the Contracts issued by the Company or interests
therein are not registered under the 1933 Act), SAIs, reports, solicitations for
voting instructions, sales literature and other promotional materials,
applications for exemptions, requests for no-action letters, and all amendments
to any of the above, that relate to the Contracts or the Account, promptly after
the filing of such document(s) with the SEC or other regulatory authorities. The
Company shall provide to the Fund or its designee any complaints received from
the Contract owners pertaining to the Fund or the Designated Portfolio.
4.7. The Fund will provide the Company with as much notice as is
reasonably practicable of any proxy solicitation for any Designated Portfolio,
and of any material change in the Fund's registration statement, particularly
any change resulting in a change to the registration statement or prospectus for
any Account. The Fund will work with the Company so as to enable the Company to
solicit proxies from Contract owners, or to make changes to its prospectus or
registration statement, in an orderly manner. The Fund will make reasonable
efforts to attempt to have changes affecting Contract prospectuses become
effective simultaneously with the annual updates for such prospectuses.
4.8. For purposes of this Article IV, the phrase "sales literature
and other promotional materials" includes, but is not limited to, any of the
following that refer to the Fund or any affiliate of the Fund: advertisements
(such as material published, or designed for use in, a newspaper, magazine, or
other periodical, radio, television, telephone or tape recording, videotape
display, signs or billboards, motion pictures, or other public media), sales
literature (i.e., any written communication distributed or made generally
available to customers or the public, including brochures, circulars, reports,
market letters, form letters, seminar texts, reprints or excerpts of any other
advertisement, sales literature, or published article), educational or training
materials or other communications distributed or made generally available to
some or all agents or employees, and registration statements, prospectuses,
SAIs, shareholder reports, proxy materials, and any other communications
distributed or made generally available with regard to the Fund.
ARTICLE V. Fees and Expenses
5.1. The Fund and the Adviser shall pay no fee or other
compensation to the Company under this Agreement. If the Fund or any Portfolio
adopts and implements a plan pursuant to Rule 12b-1 to finance distribution
expenses, or a plan to finance Contract owner services, then the Fund or
Underwriter may make payments to the Company or to the underwriter for the
Contracts if and in amounts agreed to by the Underwriter in writing.
<PAGE>
5.2. All expenses incident to performance by the Fund under this
Agreement shall be paid by the Fund. The Fund shall see to it that all its
shares are registered and authorized for issuance in accordance with applicable
federal law and, if and to the extent deemed advisable by the Fund, in
accordance with applicable state laws prior to their sale. The Fund shall bear
the expenses for the cost of registration and qualification of the Fund's
shares, preparation and filing of the Fund's prospectus and registration
statement, proxy materials and reports, setting the prospectus in type, setting
in type and printing the proxy materials and reports to shareholders (including
the costs of printing a prospectus that constitutes an annual report), the
preparation of all statements and notices required by any federal or state law,
and all taxes on the issuance or transfer of the Fund's shares.
5.3. The Company shall bear the expenses of distributing the Fund's
prospectus to owners of Contracts issued by the Company and of distributing the
Fund's proxy materials and reports to such Contract owners.
ARTICLE VI. Diversification and Qualification
6.1. The Fund will invest its assets in such a manner as to ensure
that the Contracts will be treated as annuity or life insurance contracts,
whichever is appropriate, under the Code and the regulations issued thereunder
(or any successor provisions). Without limiting the scope of the foregoing, each
Designated Portfolio has complied and will continue to comply with Section
817(h) of the Code and Treasury Regulation ss.1.817-5, and any Treasury
interpretations thereof, relating to the diversification requirements for
variable annuity, endowment, or life insurance contracts, and any amendments or
other modifications or successor provisions to such Section or Regulations. In
the event of a breach of this Article VI by the Fund, it will take all
reasonable steps (a) to notify the Company of such breach and (b) to adequately
diversify the Fund so as to achieve compliance within the grace period afforded
by Regulation 1.817-5.
6.2. The Fund represents that it is or will be qualified as a
Regulated Investment Company under Subchapter M of the Code, and that it will
make every effort to maintain such qualification (under Subchapter M or any
successor or similar provisions) and that it will notify the Company immediately
upon having a reasonable basis for believing that it has ceased to so qualify or
that it might not so qualify in the future.
6.3. The Company represents that the Contracts are currently, and
at the time of issuance shall be, treated as life insurance or annuity insurance
contracts, under applicable provisions of the Code, and that it will make every
effort to maintain such treatment, and that it will notify the Fund, the
Adviser, and the Underwriter immediately upon having a reasonable basis for
believing the Contracts have ceased to be so treated or that they might not be
so treated in the future. The Company agrees that any prospectus offering a
contract that is a "modified endowment contract" as that term is defined in
Section 7702A of the Code (or any successor or similar provision), shall
identify such contract as a modified endowment contract.
ARTICLE VII. Potential Conflicts
The following provisions shall apply only upon the sale of shares
of the Fund to variable life insurance separate accounts, and then only to the
extent required under the 1940 Act.
<PAGE>
7.1. The Board will monitor the Fund for the existence of any
material irreconcilable conflict between the interests of the Contract owners of
all separate accounts investing in the Fund and all other persons investing in
the Fund. A material irreconcilable conflict may arise for a variety of reasons,
including: (a) an action by any state insurance regulatory authority; (b) a
change in applicable federal or state insurance, tax, or securities laws or
regulations, or a public ruling, private letter ruling, no-action or
interpretative letter, or any similar action by insurance, tax, or securities
regulatory authorities; (c) an administrative or judicial decision in any
relevant proceeding; (d) the manner in which the investments of any Portfolio
are being managed; (e) a difference in voting instructions given by variable
annuity contract and variable life insurance contract owners; (f) a decision by
an insurer to disregard the voting instructions of contract owners; or (g) if
applicable, a decision by a qualified pension or retirement plan to disregard
the voting instructions of its participants. The Board shall promptly inform the
Company if it determines that a material irreconcilable conflict exists and the
implications thereof.
7.2. The Company, with a view only to the interests of Contract
owners, will report any potential or existing conflicts of which it is aware to
the Board. The Company, with a view only to the interests of Contract owners,
will assist the Board in carrying out its responsibilities under the Mixed and
Shared Funding Exemptive Order, by providing the Board with all information
reasonably necessary for the Board to consider any issues raised. This includes,
but is not limited to, an obligation by the Company to inform the Board whenever
Contract owner voting instructions are disregarded. No less than annually, the
Company shall submit to the Board such reports, materials, or data as the Board
reasonably requests so that the Board may carry out its obligations under the
Mixed and Shared Funding Exemptive Order. Such reports, materials and data shall
be submitted more frequently if deemed appropriate by the Board.
7.3. If it is determined by a majority of the Board, or a majority
of its disinterested members, that a material irreconcilable conflict exists,
the Company and other Participating Insurance Companies shall, at their expense
and to the extent reasonably practicable (as determined by a majority of the
disinterested Board members), take whatever steps are necessary to remedy or
eliminate the irreconcilable material conflict, up to and including: (1)
withdrawing the assets allocable to some or all of the separate accounts from
the Fund or any Portfolio and reinvesting such assets in a different investment
medium, including (but not limited to) another Portfolio of the Fund, or
submitting the question as to whether such segregation should be implemented to
a vote of all affected contract owners and, as appropriate, segregating the
assets of any appropriate group (i.e., annuity contract owners, life insurance
contract owners, or variable contract owners of one or more Participating
Insurance Companies) that votes in favor of such segregation, or offering to the
affected contract owners the option of making such a change; and (2)
establishing a new registered management investment company or managed separate
account.
7.4. If a material irreconcilable conflict arises because of a
decision by the Company to disregard Contract owner voting instructions and that
decision represents a minority position or would preclude a majority vote, the
Company may be required, at the Fund's election, to withdraw the Account's
investment in the Fund and terminate this Agreement with respect to each Account
(at the Company's expense); provided, however, that such withdrawal and
termination shall be limited to the extent required by the foregoing material
irreconcilable conflict as determined by a majority of the disinterested members
of the Board. Any such withdrawal and termination must take place within six (6)
months after the Fund gives written notice that this provision is being
implemented, and until the end of that six month period the Fund shall continue
to accept and implement orders by the Company for the purchase (and redemption)
of shares of the Fund.
7.5. If a material irreconcilable conflict arises because a
particular state insurance regulator's decision applicable to the Company
conflicts with the majority of other state regulators, then the Company will
withdraw the affected Account's investment in the Fund and terminate this
Agreement with respect to such Account (at the Company's expense) within six
months after the Board informs the Company in writing that it has determined
that such decision has created a material irreconcilable conflict; provided,
however, that such withdrawal and termination shall be limited to the extent
required by the foregoing material irreconcilable conflict as determined by a
majority of the disinterested members of the Board. Until the end of the
foregoing six month period, the Fund shall continue to accept and implement
orders by the Company for the purchase (and redemption) of shares of the Fund.
<PAGE>
7.6. For purposes of Section 7.3 through 7.6 of this Agreement, a
majority of the disinterested members of the Board shall determine whether any
proposed action adequately remedies any material irreconcilable conflict, but in
no event will the Fund be required to establish a new funding medium for the
Contracts. The Company shall not be required by Section 7.3 to establish a new
funding medium for the Contract if an offer to do so has been declined by vote
of a majority of Contract owners materially and adversely affected by the
material irreconcilable conflict. In the event that the Board determines that
any proposed action does not adequately remedy any material irreconcilable
conflict, then the Company will withdraw the Account's investment in the Fund
and terminate this Agreement within six (6) months after the Board informs the
Company in writing of the foregoing determination; provided, however, that such
withdrawal and termination shall be limited to the extent required by any such
material irreconcilable conflict as determined by a majority of the
disinterested members of the Board.
7.7. If and to the extent the Mixed and Shared Funding Exemptive
Order or any amendment thereto contains terms and conditions different from
Sections 3.5, 3.6, 7.1, 7.2, 7.3, 7.4, and 7.5 of this Agreement, then the Fund
and/or the Participating Insurance Companies, as appropriate, shall take such
steps as may be necessary to comply with the Mixed and Shared Funding Exemptive
Order, and Sections 3.5, 3.6, 7.1, 7.2, 7.3, 7.4 and 7.5 of this Agreement shall
continue in effect only to the extent that terms and conditions substantially
identical to such Sections are contained in the Mixed and Shared Funding
Exemptive Order or any amendment thereto. If and to the extent that Rule 6e-2
and Rule 6e-3(T) are amended, or Rule 6e-3 under the 1940 Act is adopted, to
provide exemptive relief from any provision of the 1940 Act or the rules
promulgated thereunder with respect to mixed or shared funding (as defined in
the Mixed and Shared Funding Exemptive Order) on terms and conditions materially
different from those contained in the Mixed and Shared Funding Exemptive Order,
then (a) the Fund and/or the Participating Insurance Companies, as appropriate,
shall take such steps as may be necessary to comply with Rules 6e-2 and 6e-3(T),
as amended, and Rule 6e-3, as adopted, to the extent such rules are applicable;
and (b) Sections 3.5, 3.6, 7.1., 7.2, 7.3, 7.4, and 7.5 of this Agreement shall
continue in effect only to the extent that terms and conditions substantially
identical to such Sections are contained in such Rule(s) as so amended or
adopted.
ARTICLE VIII. Indemnification
8.1. Indemnification by the Company
8.1(a). The Company agrees to indemnify and hold harmless the
Fund, the Adviser and the Underwriter and the trustees/directors and officers of
each, and each person, if any, who controls the Fund, the Adviser or Underwriter
within the meaning of Section 15 of the 1933 Act or who is under common control
with the Fund, the Adviser or the Underwriter (collectively, the "Indemnified
Parties" for purposes of this Section 8.1) against any and all losses, claims,
damages, liabilities (including amounts paid in settlement with the written
consent of the Company) or litigation (including legal and other expenses), to
which the Indemnified Parties may become subject under any statute or
regulation, at common law or otherwise, insofar as such losses, claims, damages
or liabilities (or actions in respect thereof) or settlements:
(i) arise out of or are based upon any untrue statement or
alleged untrue statements of any material fact
contained in the registration statement, prospectus
(which shall include a written description of a
Contract that is not registered under the 1933 Act), or
SAI for the Contracts or contained in the Contracts or
sales literature for the Contracts (or any amendment or
supplement to any of the foregoing), or arise out of or
are based upon the omission or the alleged omission to
state therein a material fact required to be stated
therein or necessary to make the statements therein not
misleading, provided that this agreement to indemnify
shall not apply as to any Indemnified Party if such
statement or omission or such alleged statement or
omission was made in reliance upon and in conformity
with information furnished to the Company by or on
behalf of the Fund for use in the registration
statement, prospectus or SAI for the Contracts or in
the Contracts or sales literature (or any amendment or
supplement) or otherwise for use in connection with the
sale of the Contracts or Fund shares; or
<PAGE>
(ii) arise out of or as a result of statements or
representations (other than statements or
representations contained in the registration
statement, prospectus, SAI, or sales literature of the
Fund not supplied by the Company or persons under its
control) or wrongful conduct of the Company or its
agents or persons under the Company's authorization or
control, with respect to the sale or distribution of
the Contracts or Fund shares; or
(iii)arise out of any untrue statement or alleged untrue
statement of a material fact contained in a
registration statement, prospectus, SAI, or sales
literature of the Fund or any amendment thereof or
supplement thereto or the omission or alleged omission
to state therein a material fact required to be stated
therein or necessary to make the statements therein not
misleading if such a statement or omission was made in
reliance upon information furnished to the Fund by or
on behalf of the Company; or
(iv) arise as a result of any material failure by the
Company to provide the services and furnish the
materials under the terms of this Agreement (including
a failure, whether unintentional or in good faith or
otherwise, to comply with the qualification
requirements specified in Article VI of this
Agreement); or
(v) arise out of or result from any material breach of any
representation and/or warranty made by the Company in
this Agreement or arise out of or result from any other
material breach of this Agreement by the Company;
as limited by and in accordance with the provisions of Sections 8.1(b) and
8.1(c) hereof.
8.1(b). The Company shall not be liable under this
indemnification provision with respect to any losses, claims, damages,
liabilities or litigation to which an Indemnified Party would otherwise be
subject by reason of such Indemnified Party's willful misfeasance, bad faith, or
gross negligence in the performance of such Indemnified Party's duties or by
reason of such Indemnified Party's reckless disregard of its obligations or
duties under this Agreement.
8.1(c). The Company shall not be liable under this
indemnification provision with respect to any claim made against an Indemnified
Party unless such Indemnified Party shall have notified the Company in writing
within a reasonable time after the summons or other first legal process giving
information of the nature of the claim shall have been served upon such
Indemnified Party (or after such Indemnified Party shall have received notice of
such service on any designated agent), but failure to notify the Company of any
such claim shall not relieve the Company from any liability which it may have to
the Indemnified Party against whom such action is brought otherwise than on
account of this indemnification provision. In case any such action is brought
against an Indemnified Party, the Company shall be entitled to participate, at
its own expense, in the defense of such action. The Company also shall be
entitled to assume the defense thereof, with counsel satisfactory to the party
named in the action. After notice from the Company to such party of the
Company's election to assume the defense thereof, the Indemnified Party shall
bear the fees and expenses of any additional counsel retained by it, and the
Company will not be liable to such party under this Agreement for any legal or
other expenses subsequently incurred by such party independently in connection
with the defense thereof other than reasonable costs of investigation.
<PAGE>
8.1(d). The Indemnified Parties will promptly notify the
Company of the commencement of any litigation or proceedings against them in
connection with the issuance or sale of the Fund shares or the Contracts or the
operation of the Fund.
8.2. Indemnification by the Fund
8.2(a). The Fund shall indemnify and hold harmless the Company
and each of its directors and officers and each person, if any, who controls the
Company within the meaning of Section 15 of the 1933 Act (collectively, the
"Indemnified Parties" for purposes of this Section 8.2) against any and all
losses, claims, damages, liabilities (including amounts paid in settlement with
the written consent of the Fund) or litigation (including legal and other
expenses) to which the Indemnified Parties may become subject under any statute
or regulation, at common law or otherwise, insofar as such losses, claims,
damages or liabilities (or actions in respect thereof) or settlements are
related to the operations of the Fund and:
(i) arise out of or are based upon any untrue statement or
alleged untrue statement of any material fact contained
in the registration statement or prospectus or SAI or
sales literature of the Fund (or any amendment or
supplement to any of the foregoing), or arise out of or
are based upon the omission or the alleged omission to
state therein a material fact required to be stated
therein or necessary to make the statements therein not
misleading, provided that this agreement to indemnify
shall not apply as to any Indemnified Party if such
statement or omission or such alleged statement or
omission was made in reliance upon and in conformity
with information furnished to the Fund or its designee
by or on behalf of the Company for use in the
registration statement, prospectus or SAI for the Fund
or in sales literature (or any amendment or supplement)
or otherwise for use in connection with the sale of the
Contracts or Fund shares; or
(ii) arise out of or as a result of statements or
representations (other than statements or
representations contained in the registration
statement, prospectus, SAI or sales literature for the
Contracts not supplied by the Fund or its designees) or
wrongful conduct of the Fund or its designees, with
respect to the sale or distribution of the Contracts or
Fund shares; or
(iii)arise out of any untrue statement or alleged untrue
statement of a material fact contained in a
registration statement, prospectus, SAI or sales
literature covering the Contracts, or any amendment
thereof or supplement thereto, or the omission or
alleged omission to state therein a material fact
required to be stated therein or necessary to make the
statement or statements therein not misleading, if such
statement or omission was made in reliance upon
information furnished to the Company by or on behalf of
the Fund; or
(iv) arise as a result of any failure by the Fund or its
designees to provide the services and furnish the
materials under the terms of this Agreement (including
a failure of the Fund, whether unintentional or in good
faith or otherwise, to comply with the diversification
and other qualification requirements specified in
Article VI of this Agreement); or
<PAGE>
(v) arise out of or result from any material breach of any
representation and/or warranty made by the Fund in this
Agreement or arise out of or result from any other
material breach of this Agreement by the Fund;
as limited by and in accordance with the provisions of Sections 8.2(b) and
8.2(c) hereof.
8.2(b). The Fund shall not be liable under this
indemnification provision with respect to any losses, claims, damages,
liabilities or litigation to which an Indemnified Party would otherwise be
subject by reason of such Indemnified Party's willful misfeasance, bad faith, or
gross negligence in the performance or such Indemnified Party's duties or by
reason of such Indemnified Party's reckless disregard of obligations and duties
under this Agreement or to the Company or the Account, whichever is applicable.
8.2(c). The Fund shall not be liable under this
indemnification provision with respect to any claim made against an Indemnified
Party unless such Indemnified Party shall have notified the Fund in writing
within a reasonable time after the summons or other first legal process giving
information of the nature of the claim shall have been served upon such
Indemnified Party (or after such Indemnified Party shall have received notice of
such service on any designated agent), but failure to notify the Fund of any
such claim shall not relieve the Fund from any liability which it may have to
the Indemnified Party against whom such action is brought otherwise than on
account of this indemnification provision. In case any such action is brought
against an Indemnified Party, the Fund will be entitled to participate, at its
own expense, in the defense thereof. The Fund also shall be entitled to assume
the defense thereof, with counsel satisfactory to the party named in the action.
After notice from the Fund to such party of the Fund's election to assume the
defense thereof, the Indemnified Party shall bear the fees and expenses of any
additional counsel retained by it, and the Fund will not be liable to such party
under this Agreement for any legal or other expenses subsequently incurred by
such party independently in connection with the defense thereof other than
reasonable costs of investigation.
8.2(d). The Indemnified Parties will promptly notify the Fund
or its designees of the commencement of any litigation or proceedings against it
or any of its officers or directors in connection with the issuance or sale of
the Contracts or the operation of the Account.
8.3. Indemnification By the Adviser
8.3(a). The Adviser agrees to indemnify and hold harmless the
Company and each of its directors and officers and each person, if any, who
controls the Company within the meaning of Section 15 of the 1933 Act
(collectively, the "Indemnified Parties" for purposes of this Section 8.3)
against any and all losses, claims, damages, liabilities (including amounts paid
in settlement with the written consent of the Adviser) or litigation (including
legal and other expenses) to which the Indemnified Parties may be required to
pay or may become subject under any statute or regulation, at common law or
otherwise, insofar as such losses, claims, damages or liabilities (or actions in
respect thereof) or settlements:
(i) arise as a result of any failure by the Adviser to
provide the services and furnish the materials under
the terms of this Agreement (including a failure,
whether unintentional or in good faith or otherwise, to
comply with the diversification and other qualification
requirements specified in Article VI of this
Agreement); or
(ii) arise out of or result from any material breach of any
representation and/or warranty made by the Adviser in
this Agreement or arise out of or result from any other
material breach of this Agreement by the Adviser;
as limited by and in accordance with the provisions of Sections 8.3(b) and
8.3(c) hereof.
8.3(b). The Adviser shall not be liable under this
indemnification provision with respect to any losses, claims, damages,
liabilities or litigation to which an Indemnified Party would otherwise be
subject by reason of such Indemnified Party's willful misfeasance, bad faith, or
gross negligence in the performance of such Indemnified Party's duties or by
reason of such Indemnified Party's reckless disregard of obligations and duties
under this Agreement or to the Company, the Fund, the Adviser or the Account,
whichever is applicable.
8.3(c). The Adviser shall not be liable under this
indemnification provision with respect to any claim made against an Indemnified
Party unless such Indemnified Party shall have notified the Adviser in writing
within a reasonable time after the summons or other first legal process giving
information of the nature of the claim shall have been served upon such
Indemnified Party (or after such Indemnified Party shall have received notice of
such service on any designated agent), but failure to notify the Adviser of any
such claim shall not relieve the Adviser from any liability which it may have to
the Indemnified Party against whom such action is brought otherwise than on
account of this indemnification provision. In case any such action is brought
against the Indemnified Parties, the Adviser will be entitled to participate, at
its own expense, in the defense thereof. The Adviser also shall be entitled to
assume the defense thereof, with counsel satisfactory to the party named in the
action. After notice from the Adviser to such party of the Adviser's election to
assume the defense thereof, the Indemnified Party shall bear the fees and
expenses of any additional counsel retained by it, and the Adviser will not be
liable to such party under this Agreement for any legal or other expenses
subsequently incurred by such party independently in connection with the defense
thereof other than reasonable costs of investigation.
8.3(d). The Company and the Fund shall promptly notify the
Adviser of the commencement of any litigation or proceeding against it or any of
its respective officers or directors in connection with the Agreement, the
issuance or sale of the Contracts, the operation of the Account, or the sale or
acquisition of shares of the Fund.
ARTICLE IX. Applicable Law
9.1. This Agreement shall be construed and the provisions hereof
interpreted under and in accordance with the laws of the State of New York.
9.2. This Agreement shall be subject to the provisions of the 1933,
1934 and 1940 Acts, and the rules and regulations and rulings thereunder,
including such exemptions from those statutes, rules and regulations as the SEC
may grant (including, but not limited to, the Mixed and Shared Funding Exemptive
Order) and the terms hereof shall be interpreted and construed in accordance
therewith. If, in the future, the Mixed and Shared Funding Exemptive Order
should no longer be necessary under applicable law, then Article VII shall no
longer apply.
<PAGE>
ARTICLE X. Termination
10.1. This Agreement shall continue in full force and effect until
the first to occur of:
(a) termination by any party, for any reason with respect to
some or all Designated Portfolios, by three (3) months
advance written notice delivered to the other parties; or
(b) termination by the Company by written notice to the Fund,
Adviser and the Underwriter based upon the Company's
determination that shares of the Fund are not reasonably
available to meet the requirements of the Contracts; or
(c) termination by the Company by written notice to the Fund,
Adviser and the Underwriter in the event any of the
Designated Portfolio's shares are not registered, issued or
sold in accordance with applicable state and/or federal law
or such law precludes the use of such shares as the
underlying investment media of the Contracts issued or to be
issued by the Company; or
(d) termination by the Fund or Adviser in the event that formal
administrative proceedings are instituted against the
Company by the NASD, the SEC, the Insurance Commissioner or
like official of any state or any other regulatory body
regarding the Company's duties under this Agreement or
related to the sale of the Contracts, the operation of any
Account, or the purchase of the Fund's shares; provided,
however, that the Fund or Adviser determines in its sole
judgment exercised in good faith, that any such
administrative proceedings will have a material adverse
effect upon the ability of the Company to perform its
obligations under this Agreement; or
(e) termination by the Company in the event that formal
administrative proceedings are instituted against the Fund
or Adviser by the NASD, the SEC, or any state securities or
insurance department or any other regulatory body; provided,
however, that the Company determines in its sole judgment
exercised in good faith, that any such administrative
proceedings will have a material adverse effect upon the
ability of the Fund or Adviser to perform its obligations
under this Agreement; or
(f) termination by the Company by written notice to the Fund,
the Adviser and the Underwriter with respect to any
Designated Portfolio in the event that such Portfolio ceases
to qualify as a Regulated Investment Company under
Subchapter M or fails to comply with the Section 817(h)
diversification requirements specified in Article VI hereof,
or if the Company reasonably believes that such Portfolio
may fail to so qualify or comply; or
(g) termination by the Fund or Adviser by written notice to the
Company in the event that the Contracts fail to meet the
qualifications specified in Article VI hereof; or
(h) termination by either the Fund or the Adviser by written
notice to the Company, if either one or both of the Fund or
the Adviser respectively, shall determine, in their sole
judgment exercised in good faith, that the Company has
suffered a material adverse change in its business,
operations, financial condition, or prospects since the date
of this Agreement or is the subject of material adverse
publicity; or
<PAGE>
(i) termination by the Company by written notice to the Fund,
Adviser and the Underwriter, if the Company shall determine,
in its sole judgment exercised in good faith, that the Fund,
Adviser or the Underwriter has suffered a material adverse
change in its business, operations, financial condition or
prospects since the date of this Agreement or is the subject
of material adverse publicity; or
(j) termination by the Fund by written notice to the Company, if
the Company gives the Fund and the Underwriter the written
notice specified in Section 1.7(a)(ii) hereof and at the
time such notice was given there was no notice of
termination outstanding under any other provision of this
Agreement; provided, however, any termination under this
Section 10.1(j) shall be effective 45 days after the notice
specified in Section 1.7(a)(ii) was given; or
(k) termination by the Company upon any substitution of the
shares of another investment company or series thereof for
shares of a Designated Portfolio of the Fund in accordance
with the terms of the Contracts, provided that the Company
has given at least 45 days prior written notice to the Fund,
Adviser and Underwriter of the date of substitution; or
(l) termination by any party in the event that the Board
determines that a material irreconcilable conflict exists as
provided in Article VII.
10.2. Notwithstanding any termination of this Agreement, the Fund
and the Underwriter shall, at the option of the Company, continue to make
available additional shares of the Fund pursuant to the terms and conditions of
this Agreement, for all Contracts in effect on the effective date of termination
of this Agreement (hereinafter referred to as "Existing Contracts"), unless the
Fund or its designee requests that the Company seek an order pursuant to Section
26(b) of the 1940 Act to permit the substitution of other securities for the
shares of the Designated Portfolios. The Fund and/or the Adviser shall split the
cost of seeking such an order, and the Company agrees that it shall reasonably
cooperate with the Fund and seek such an order upon request. Specifically, the
owners of the Existing Contracts may be permitted to reallocate investments in
the Fund, redeem investments in the Fund and/or invest in the Fund upon the
making of additional purchase payments under the Existing Contracts (subject to
any such election by the Fund). The parties agree that this Section 10.2 shall
not apply to any terminations under Article VII and the effect of such Article
VII terminations shall be governed by Article VII of this Agreement. The parties
further agree that this Section 10.2 shall not apply to any terminations under
Section 10.1(g) of this Agreement.
10.3. The Company shall not redeem Fund shares attributable to the
Contracts (as opposed to Fund shares attributable to the Company's assets held
in the Account) except (i) as necessary to implement Contract owner initiated or
approved transactions, (ii) as required by state and/or federal laws or
regulations or judicial or other legal precedent of general application
(hereinafter referred to as a "Legally Required Redemption"), (iii) upon 45 days
prior written notice to the Fund, Adviser and Underwriter, as permitted by an
order of the SEC pursuant to Section 26(b) of the 1940 Act, but only if a
substitution of other securities for the shares of the Designated Portfolios is
consistent with the terms of the Contracts, or (iv) as permitted under the terms
of the Contract. Upon request, the Company will promptly furnish to the Fund,
Adviser and Underwriter reasonable assurance that any redemption pursuant to
clause (ii) above is a Legally Required Redemption. Furthermore, except in cases
where permitted under the terms of the Contracts, the Company shall not prevent
Contract owners from allocating payments to a Portfolio that was otherwise
available under the Contracts without first giving the Fund, Adviser or the
Underwriter 90 days notice of its intention to do so.
<PAGE>
10.4. Notwithstanding any termination of this Agreement, each
party's obligation under Article VIII to indemnify the other parties shall
survive.
ARTICLE XI. Notices
Any notice shall be sufficiently given when sent by registered or
certified mail to the other party at the address of such party set forth below
or at such other address as such party may from time to time specify in writing
to the other party.
If to the Fund: Variable Insurance Funds
3435 Stelzer Road
Columbus, Ohio 43219-3035
If to the Company: Allstate Life Insurance Company
3100 Sanders Road
Northbrook, Illinois 60062
If to the Adviser: HSBC Asset Management (Americas) Inc.
140 Broadway
New York, New York 10005
If to the Underwriter: BISYS Fund Services
3435 Stelzer Road
Columbus, Ohio 43219-3035
ARTICLE XII. Miscellaneous
12.1. All persons dealing with the Fund must look solely to the
property of the respective Designated Portfolios listed on Schedule A hereto as
though each such Designated Portfolio had separately contracted with the Company
and the Adviser for the enforcement of any claims against the Fund. The parties
agree that neither the Board, officers, agents or shareholders of the Fund
assume any personal liability or responsibility for obligations entered into by
or on behalf of the Fund.
12.2. Subject to the requirements of legal process and regulatory
authority, each party hereto shall treat as confidential the names and addresses
of the owners of the Contracts and all information reasonably identified as
confidential in writing by any other party hereto and, except as permitted by
this Agreement, shall not disclose, disseminate or utilize such names and
addresses and other confidential information without the express written consent
of the affected party until such time as such information has come into the
public domain.
12.3. The captions in this Agreement are included for convenience
of reference only and in no way define or delineate any of the provisions hereof
or otherwise affect their construction or effect.
12.4. This Agreement may be executed simultaneously in two or more
counterparts, each of which taken together shall constitute one and the same
instrument.
<PAGE>
12.5. If any provision of this Agreement shall be held or made
invalid by a court decision, statute, rule or otherwise, the remainder of the
Agreement shall not be affected thereby.
12.6. Each party hereto shall cooperate with each other party and
all appropriate governmental authorities (including without limitation the SEC,
the NASD, and state insurance regulators) and shall permit such authorities
reasonable access to its books and records in connection with any investigation
or inquiry relating to this Agreement or the transactions contemplated hereby.
Notwithstanding the generality of the foregoing, each party hereto further
agrees to furnish the Illinois Insurance Commissioner with any information or
reports in connection with services provided under this Agreement which such
Commissioner may request in order to ascertain whether the variable annuity
operations of the Company are being conducted in a manner consistent with the
Illinois insurance laws and regulations and any other applicable law or
regulations.
12.7. The rights, remedies and obligations contained in this
Agreement are cumulative and are in addition to any and all rights, remedies,
and obligations, at law or in equity, which the parties hereto are entitled to
under state and federal laws.
12.8. This Agreement or any of the rights and obligations hereunder
may not be assigned by any party without the prior written consent of all
parties hereto.
12.9. The Company shall furnish, or shall cause to be furnished, to
the Fund or its designee copies of the following reports:
(a) the Company's annual statement (prepared under statutory
accounting principles) and annual report (prepared under
generally accepted accounting principles ("GAAP")) filed
with any state or federal regulatory body or otherwise made
available to the public, as soon as practicable and in any
event within 90 days after the end of each fiscal year;
(b) the Company's quarterly statements (statutory) (and GAAP, if
any), as soon as practical and in any event within 45 days
after the end of each quarterly period;
(c) any financial statement, proxy statement, notice or report
of the Company sent to stockholders and/or policyholders, as
soon as practical after the delivery thereof to stockholders
and/or policy holders;
(d) any registration statement (without exhibits) and financial
reports of the Company filed with the Securities and
Exchange Commission or any state insurance regulatory body,
as soon as practicable after the filing thereof; and
(e) any other report submitted to the Company by independent
accountants in connection with any annual, interim or
special audit made by them of the books of the Company, as
soon as practical after the receipt thereof.
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this
Agreement to be executed in its name and on its behalf by its duly authorized
representative and its seal to be hereunder affixed hereto as of the date
specified below.
ALLSTATE LIFE INSURANCE COMPANY
By its authorized officer
By:
Title:
Date:
VARIABLE INSURANCE FUNDS
By its authorized officer
By:
Title:
Date:
HSBC ASSET MANAGEMENT (AMERICAS) INC.
By its authorized officer
By:
Title:
Date:
<PAGE>
Schedule A
Contract Account Designated Portfolio(s)
1. ____ ____ HSBC Variable Growth and Income Fund
2. ____ ____ HSBC Variable Fixed Income Fund
3. ____ ____ HSBC Variable Cash Management Fund
Date: __________________
Consent of Independent Accountants
We hereby consent to the incorporation by reference in this Post-Effective
Amendment No. 8 to the Registration Statement on Form N-1A (File No. 33-81800)
of our report dated February 11, 1999 on our audits of the financial statements
and financial highlights of the BB&T Growth and Income Fund and the AmSouth
Equity Income Fund, which reports are included in the Annual Report to
Shareholders for the year ended December 31, 1998, which is incorporated by
reference in the statement of additional information in this Post-Effective
Amendment to the Registration Statement. We also consent to the reference to our
Firm under the caption "Auditors" in the Statement of Additional Information in
this Post-Effective Amendment No. 8 to the Registration Statement on Form N-1A
(File No. 33-81800) of the Variable Insurance Funds.
/s/PricewaterhouseCoopers LLP
Columbus, Ohio
September 29, 1999
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000927290
<NAME> VARIABLE INSURANCE FUNDS
<SERIES>
<NUMBER> 001
<NAME> BB&T GROWTH AND INCOME FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<INVESTMENTS-AT-COST> 42521088
<INVESTMENTS-AT-VALUE> 49192120
<RECEIVABLES> 77778
<ASSETS-OTHER> 6244
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 49276142
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 214535
<TOTAL-LIABILITIES> 214535
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 42451526
<SHARES-COMMON-STOCK> 3688258
<SHARES-COMMON-PRIOR> 2426943
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 1048
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 59903
<ACCUM-APPREC-OR-DEPREC> 6671032
<NET-ASSETS> 49061607
<DIVIDEND-INCOME> 800985
<INTEREST-INCOME> 81175
<OTHER-INCOME> 0
<EXPENSES-NET> 351516
<NET-INVESTMENT-INCOME> 530644
<REALIZED-GAINS-CURRENT> (36048)
<APPREC-INCREASE-CURRENT> 4670681
<NET-CHANGE-FROM-OPS> 5165277
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 514713
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1227333
<NUMBER-OF-SHARES-REDEEMED> 8596
<SHARES-REINVESTED> 42578
<NET-CHANGE-IN-ASSETS> 20232673
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 16979
<OVERDIST-NET-GAINS-PRIOR> 23855
<GROSS-ADVISORY-FEES> 285972
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 480478
<AVERAGE-NET-ASSETS> 38644909
<PER-SHARE-NAV-BEGIN> 11.88
<PER-SHARE-NII> 0.16
<PER-SHARE-GAIN-APPREC> 1.42
<PER-SHARE-DIVIDEND> 0.16
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 13.30
<EXPENSE-RATIO> 0.91
[AVG-DEBT-OUTSTANDING] 0
[AVG-DEBT-PER-SHARE] 0
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000927290
<NAME> VARIABLE INSURANCE FUNDS
<SERIES>
<NUMBER> 002
<NAME> AMSOUTH EQUITY INCOME FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> DEC-31-1997
<PERIOD-END> DEC-31-1998
<INVESTMENTS-AT-COST> 20345596
<INVESTMENTS-AT-VALUE> 22885652
<RECEIVABLES> 602865
<ASSETS-OTHER> 8158
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 23496674
<PAYABLE-FOR-SECURITIES> 918568
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 35370
<TOTAL-LIABILITIES> 953938
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 21533905
<SHARES-COMMON-STOCK> 2001942
<SHARES-COMMON-PRIOR> 1462856
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 8707
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 1281202
<ACCUM-APPREC-OR-DEPREC> 2298740
<NET-ASSETS> 22542736
<DIVIDEND-INCOME> 402033
<INTEREST-INCOME> 64349
<OTHER-INCOME> 0
<EXPENSES-NET> 162661
<NET-INVESTMENT-INCOME> 303721
<REALIZED-GAINS-CURRENT> (1278675)
<APPREC-INCREASE-CURRENT> 2263855
<NET-CHANGE-FROM-OPS> 1288901
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 304238
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1874103
<NUMBER-OF-SHARES-REDEEMED> 134871
<SHARES-REINVESTED> 29521
<NET-CHANGE-IN-ASSETS> 20156070
<ACCUMULATED-NII-PRIOR> 517
<ACCUMULATED-GAINS-PRIOR> (2073)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 85510
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 217780
<AVERAGE-NET-ASSETS> 14251619
<PER-SHARE-NAV-BEGIN> 10.23
<PER-SHARE-NII> 0.22
<PER-SHARE-GAIN-APPREC> 1.03
<PER-SHARE-DIVIDEND> 0.22
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.26
<EXPENSE-RATIO> 1.14
[AVG-DEBT-OUTSTANDING] 0
[AVG-DEBT-PER-SHARE] 0
</TABLE>
