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"):
o 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.
o HSBC Variable Fixed Income Fund, which seeks high current income
consistent with appreciation of capital by investing primarily in fixed
income securities.
o 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 May 22, 2000.
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TABLE OF CONTENTS
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RISK/RETURN SUMMARIES MANAGEMENT OF THE FUNDS
HSBC VARIABLE GROWTH AND INCOME FUND INVESTMENT ADVISER
HSBC VARIABLE FIXED INCOME FUND PORTFOLIO MANAGERS
HSBC VARIABLE CASH MANAGEMENT FUND ADMINISTRATOR AND DISTRIBUTOR
INVESTMENT OBJECTIVES AND STRATEGIES SERVICING AGENTS
HSBC VARIABLE GROWTH AND INCOME FUND TAXATION
HSBC VARIABLE FIXED INCOME FUND GENERAL INFORMATION
HSBC VARIABLE CASH MANAGEMENT FUND DESCRIPTION OF THE TRUST AND ITS SHARES
RISK CONSIDERATIONS SIMILAR FUND PERFORMANCE INFORMATION
VALUATION OF SHARES MISCELLANEOUS
PURCHASING AND REDEEMING SHARES
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RISK/RETURN SUMMARIES
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:
o 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 greatest 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.
o 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.
o 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.
o 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.
o Security-Specific Risk. An issuer of a portfolio investment may be
unable to achieve its earnings or growth expectations.
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."
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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:
o 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.
o 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 maturities of these types of securities tend
to lengthen, and the value of the securities decreases more
significantly.
o 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.
o 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.
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."
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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:
o 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.
o 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."
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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.
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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.
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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.
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 Fund 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.
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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.
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. 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.
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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 Variable 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 (or other agent)
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 abnormal 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.
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.
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Each Fund may reject or refuse, in whole or in part, any order to purchase its
shares. Each Fund reserves the right to discontinue offering shares at any time,
or to cease investment operations entirely. In such an event, 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, or in another mutual fund.
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 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.
Percentage of
average daily net assets
--------------------------------------------------------------------------------
Variable Growth and Income Fund 0.55%
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Variable Fixed Income Fund 0.55%
--------------------------------------------------------------------------------
Variable Cash Management Fund 0.35%
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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 Variable 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.
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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
Fund's 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.
TAXATION
Each Fund intends to diversify its investments in a manner intended to comply
with tax requirements generally applicable to mutual funds. In addition, each
Fund will 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 single
issuer are treated as one investment and each U.S. Government agency or
instrumentality is treated as a separate issuer. Any security issued,
guaranteed, or insured (to the extent so guaranteed or insured) by the U.S.
Government or an agency or instrumentality of the U.S. Government 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.
Since the shareholders of the Funds will be separate accounts, no discussion is
included here as to the federal income tax consequences at the shareholder
level. For information concerning the federal income tax consequences to
purchasers of the variable life insurance policies and variable annuity
contracts, see the prospectus for the relevant variable insurance contract. See
the Statement of Additional Information for more information on taxes.
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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 Variable Growth and Income Fund, the Variable Fixed Income
Fund, and 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 of the corresponding Fund. However, the portfolio managers of
the Variable Growth and Income Fund and the Variable 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 operating expenses of the Similar
Funds, which are higher than the expenses of the Funds. Performance would have
been higher for each Similar Fund if its corresponding Fund's expenses were
used. 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.
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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 Totals Return for the Similar Funds and for Their Benchmarks for
Periods Ended December 31, 1999
<TABLE>
<S> <C> <C> <C> <C>
Similar Fund/Benchmark 1 Year 3 Years 5 Years 10 Years
---------------------- ------ ------- ------- --------
Growth and Income Fund+ 12.55% 22.11% 23.37% 15.41%
Growth and Income Fund++ 18.48% 24.22% 24.64% 16.00%
S&P 500(R)Composite Index* 21.04% 27.56% 28.54% 18.20%
Since Inception
Similar Fund/Benchmark 1 Year 3 Years 5 Years (January 15, 1993)
---------------------- ------ ------- ------- ------------------
Fixed Income Fund+ -6.55% 3.24% 5.56% 4.92%
Fixed Income Fund++ -1.86% 4.91% 6.60% 5.65%
Lehman Brothers Aggregate Bond Index** -0.83% 5.73% 7.73% 6.42%
Similar Fund/Benchmark 1 Year 3 Years 5 Years 10 Years
---------------------- ------ ------- ------- --------
Cash Management Fund 4.75% 5.03% 5.10% 5.02%
Lipper Money Market Fund*** 4.49% 4.78% 4.95% 4.79%
</TABLE>
-----------------
+ 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 their
distributor. This prospectus does not constitute an offering by the Funds or
their 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 and copy the SAI and other information about the Fund at
the Public Reference Room of the Securities and Exchange Commission. Investors
may call 1-202-942-8090 for more information about the Public Reference Room.
Investors can get text-only copies of information about the Fund:
o For a fee, by writing the Public Reference Section of the Commission,
Washington, D.C. 20549-0102 or by electronic request at [email protected].
o 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
1-888-467-8167
STATEMENT OF ADDITIONAL INFORMATION
May 22, 2000
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:
o HSBC Variable Growth and Income Fund;
o HSBC Variable Fixed Income Fund; and
o 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 May 22, 2000, 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...........................................24
NET ASSET VALUE.......................................................24
Valuation of the Variable 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...........................................29
Portfolio Transactions.......................................30
Federal Banking Law..........................................31
Administrator................................................31
Expenses.....................................................32
Distributor..................................................33
Custodian, Transfer Agent and Fund Accounting Services.......33
Independent Accountants......................................34
Legal Counsel................................................34
Code of Ethics...............................................34
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......................................40
Miscellaneous................................................42
FINANCIAL STATEMENTS..................................................42
APPENDIX ..............................................................i
<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 Management (Americas) Inc. ("HSBC"): the HSBC Variable Growth and Income
Fund (the "Variable Growth and Income Fund") the HSBC Variable Fixed Income Fund
(the "Variable Fixed Income Fund"); and the HSBC Variable Cash Management Fund
(the "Variable 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 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). The Variable 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 Variable 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.
The Variable 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.
<PAGE>
The Variable 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 Variable 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 Variable Growth and Income Fund and the Variable 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 Variable Growth and Income
Fund and the Variable 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 Variable 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 Variable 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 Variable
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 Variable
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.
<PAGE>
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.
The Variable Growth and Income Fund and Variable 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.
<PAGE>
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.
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
Variable 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 Variable Growth and Income Fund and Variable 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 Variable 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 Variable 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 Variable
Growth and Income Fund and Variable 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 Variable Growth
and Income Fund and Variable 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 hedging 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 Variable 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 Variable Growth and Income Fund and Variable 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 Variable Growth and Income Fund and Variable 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 Variable Fixed
Income Fund will engage in options trading principally for hedging purposes.
<PAGE>
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.
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 Variable 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 Variable
Growth and Income Fund and the Variable 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.
<PAGE>
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.
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 Variable Growth and
Income Fund and Variable 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.
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, Variable Growth and Income Fund and Variable Fixed Income Fund may
invest in other asset-backed securities that may be developed in the future.
<PAGE>
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 Variable 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.
<PAGE>
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.
Investments in Municipal Securities. The Variable 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 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 Variable 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 Variable 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 Variable 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 Variable Growth and Income Fund and
Variable 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 Funds 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.
<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," 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.
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 Variable 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;
<PAGE>
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;
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 Variable 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.
<PAGE>
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.
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 Variable Cash Management Fund
The Variable 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:
<TABLE>
<S> <C>
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: 60
Michael Van Buskirk Chief Executive Officer, Ohio Bankers Association
37 West Broad Street (industry trade association).
Suite 1001
Columbus, OH 43215
Age: 53
Walter B. Grimm* Employee of BISYS Fund Services (6/92-present).
3435 Stelzer Road
Columbus, Oh 43219
Age: 54
</TABLE>
--------------------------
* Mr. Grimm is an "interested person" of the Trust as that term is defined in
the 1940 Act.
<PAGE>
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, 1999, the Trust paid the following compensation to the Trustees of
the Trust:
Aggregate Compensation Total Compensation from
Name from Trust* Trust and Fund Complex**
James H. Woodward $4,000 $ 20,750
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 Funds, AmSouth Funds,
HSBC Mutual Funds Trust, HSBC Funds Trust, and Kent Funds.
<PAGE>
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):
<TABLE>
<S> <C> <C>
Name, Address, and Age Position(s) Held Principal Occupation
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: 46 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: 32
Charles L. Booth Vice President and Assistant Employee of BISYS Fund Services (1988 -
Age: 40 Secretary present).
Alaina Metz Secretary Employee of BISYS Fund Services (6/95 -
Age: 33 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).
</TABLE>
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.
<PAGE>
As of April 1, 2000, 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 Variable Growth and Income Fund, Variable
Fixed Income Fund, and Variable 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 Variable Growth and Income Fund, 0.55%
for the Variable Fixed Income Fund, and 0.35% for the Variable 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.
<PAGE>
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.
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.
<PAGE>
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.
Federal Banking Law
The Gramm-Leach-Bliley Act of 1999 repealed certain provisions of the
Glass-Steagall Act that had previously restricted the ability of banks and their
affiliates to engage in certain mutual fund activities. Nevertheless, HSBC's
activities remain subject to, and may be limited by, applicable federal banking
law and regulations. 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. If future changes in these laws and regulations were to limit the
ability of HSBC to perform these services, the Board of Trustees would review
the Trust's relationship with HSBC and consider taking all action necessary in
the circumstances, which could include recommending to Shareholders the
selection of another qualified advisor or, if that course of action appeared
impractical, that the Funds be liquidated.
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.
<PAGE>
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 $17,985, of which $13,549 was waived or
reimbursed by BISYS. For the fiscal years ended December 31, 1998 and December
31, 1999, the Trust incurred administration fees equal to $105,793 and $157,948
of which $77,410 and $107,516, respectively 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.
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.
<PAGE>
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 Variable Fixed Income Fund; determines the daily net asset
value per share, net investment income and dividend rate for the Variable 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.
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.
<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 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.
Independent Accountants
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.
Code of Ethics
The Trust, HSBC and BISYS each have adopted a code of ethics, as required by
applicable law, which is designed to prevent affiliated persons of the Trust,
HSBC and BISYS from engaging in deceptive, manipulative, or fraudulent
activities in connection with securities held or to be acquired by the Funds
(which may also be held by persons subject to a code). There can be no assurance
that the codes will be effective in preventing such activities.
<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 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.
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.
<PAGE>
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.
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.
<PAGE>
Additional Tax Information
The following discussion summarizes certain U.S. federal tax considerations
incidental to an investment in a Fund. This discussion does not purport to be
complete or to deal with all aspects of federal income taxation that may be
relevant. This discussion is based upon present provisions of the Internal
Revenue Code of 1986, as amended (the "Code"), the regulations promulgated
thereunder, and judicial and administrative ruling authorities, all of which are
subject to change, which change may be retroactive. Prospective investors should
consult their own tax advisors with regard to the federal, state, local and
foreign tax aspects of an investment in a Fund.
Each Fund intends to qualify annually and to elect to be treated as a regulated
investment company under the Subchapter M of 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.
As a regulated investment company, each 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,
each 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.
<PAGE>
Each Fund also intends to comply with the separate diversification requirements
imposed by Section 817(h) of the Code and the regulations thereunder on certain
insurance company separate accounts. These requirements, which are in addition
to the diversification requirements imposed on a Fund by the 1940 Act and
Subchapter M of the Code, place certain limitations on assets of each insurance
company separate account used to fund variable contracts. Because Section 817(h)
and those regulations treat the assets of a Fund as assets of the related
separate account, these regulations are imposed on the assets of the Fund.
Specifically, the regulations provide that, after a one year start-up period or
except as permitted by the "safe harbor" described below, as of the end of each
calendar quarter or within 30 days thereafter no more than 55% of the total
assets of a Fund may be represented by any one investment, no more than 70% by
any two investments, no more than 80% by any three investments and no more than
90% by any four investments. For this purpose, all securities of the same issuer
are considered a single investment, and each U.S. Government agency and
instrumentality is considered a separate issuer. Section 817(h) provides, as a
safe harbor, that a separate account will be treated as being adequately
diversified if the diversification requirements under Subchapter M are satisfied
and no more than 55% of the value of the account's total assets is attributable
to cash and cash items (including receivables), U.S. Government securities and
securities of other regulated investment companies. Failure by a Fund to both
qualify as a regulated investment company and satisfy the Section 817(h)
requirements would generally cause the variable contracts to lose their
favorable tax status and require a contract holder to include in ordinary income
any income accrued under the contracts for the current and all prior taxable
years. Under certain circumstances described in the applicable Treasury
regulations, inadvertent failure to satisfy the applicable diversification
requirements may be corrected, but such a correction would require a payment to
the Internal Revenue Service based on the tax contract holders would have
incurred if they were treated as receiving the income on the contract for the
period during which the diversification requirements were not satisfied. Any
such failure may also result in adverse tax consequences for the insurance
company issuing the contracts. Failure by a Fund to qualify as a regulated
investment company would also subject the Fund to federal and state income
taxation on all of its taxable income and gain, whether or not distributed to
shareholders.
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.
<PAGE>
In the event that rules or regulations are adopted, there can be no assurance
that a given 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 a 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 passive 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. A 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.
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 each 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.
<PAGE>
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 Variable Growth and Income Fund and Variable 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.
The standardized seven-day yield for the Variable 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 Variable 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 Variable 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.
<PAGE>
The 30-day yield and effective yield for the Variable 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.
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.
<PAGE>
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.
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.
S&P applies indicators "+," no character, and "-" to its rating
categories. The indicators show relative standing within the major rating
categories.
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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.
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 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.
