<PAGE> 1
PACIFICA VARIABLE TRUST
EMERGING GROWTH PORTFOLIO
EQUITY VALUE PORTFOLIO
BALANCED PORTFOLIO
INTERMEDIATE BOND PORTFOLIO
MONEY MARKET PORTFOLIO
SUPPLEMENT DATED SEPTEMBER 3, 1996 TO THE
PROSPECTUS DATED DECEMBER 1, 1995
On April 1, 1996, First Interstate Bancorp was merged with and into Wells
Fargo & Company ("Wells Fargo") and First Interstate Capital Management, Inc.
("FICM"), the Portfolios' investment adviser, became an indirect wholly-owned
subsidiary of Wells Fargo. In connection with this merger, FICM has changed
its name to Wells Fargo Investment Management, Inc. ("WFIM"). Pursuant to an
order of the Securities and Exchange Commission, the Portfolios have entered
into a new investment advisory agreement with WFIM dated April 1, 1996, which
has the same terms and fee rates as the Portfolios' prior investment advisory
agreement with FICM that automatically terminated on that date. The
Portfolios' new investment advisory agreement with WFIM was ratified
and approved by a vote of the Portfolios' shareholders at a meeting held
on July 26, 1996.
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The following "Financial Highlights" are to be inserted on page 6 before
"Investment Limitations."
FINANCIAL HIGHLIGHTS
The financial information shown below is to assist investors in
evaluating the performance of the Portfolios since their commencement of
operation through March 31, 1996. The information should be read in
conjunction with the related financial statements and notes thereto contained
in the Portfolios' Semi-Annual Report to Shareholders, which may be obtained
without charge by calling 1-800-PVA-0628.
For a share outstanding throughout the period * (unaudited)
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Emerging Intermediate
Growth Equity Value Balanced Bond
Portfolio Portfolio Portfolio Portfolio
----------- ----------- ----------- ---------------
Period Ended March 31, 1996
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Net Asset Value, Beginning of Period $10.00 $10.00 $10.00 $10.00
----------- ----------- ----------- -----------
Income from Investment Operations:
Net investment income * * 0.01 0.03 0.05 0.10
Net gain on securities (both realized and unrealized)* * 0.82 0.54 0.28 (0.22)
------------ ------------ ------------ -------------
Total from Investment Operations 0.83 0.57 0.33 (0.12)
------------ ------------ ------------ -------------
Less Distributions:
Dividends from net investment income (0.01) (0.03) (0.05) (0.10)
Distributions from net realized gains 0.00 0.00 0.00 0.00
------------ ------------ ------------ ------------
Total Distributions (0.01) (0.03) (0.05) (0.10)
------------- ------------- ------------ -------------
Net Asset Value, End of Period $10.82 $10.54 $10.28 $9.78
============= ============= ============ =============
Total Return (not reflecting sales load) 8.25% 5.65% 3.26% -1.50%
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands) $6,184 $5,979 $5,538 $5,056
Ratio of Expenses to Average Net Assets * * * 1.20% 1.20% 1.20% 1.10%
Ratio of Net Investment Income to Average Net Assets * * * 0.22% 1.08% 1.95% 4.22%
Effect of Waivers on above Ratios * * * 0.85% 0.84% 0.85% 0.81%
Portfolio Turnover Rate 11.70% 7.32% 7.92% 80.77%
Average Commission Rate * * * * $0.064 $0.059 $0.060 -
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Money
Market
Portfolio
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Period Ended March 31, 1996
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Net Asset Value, Beginning of Period $1.000
-----------
Income from Investment Operations:
Net investment income * * 0.011
Net gain on securities (both realized and unrealized)* * 0.000
-----------
Total from Investment Operations 0.011
-----------
Less Distributions:
Dividends from net investment income (0.011)
Distributions from net realized gains 0.000
-----------
Total Distributions (0.011)
------------
Net Asset Value, End of Period $1.000
============
Total Return (not reflecting sales load) 0.70%
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands) $5,070
Ratio of Expenses to Average Net Assets * * * 1.05%
Ratio of Net Investment Income to Average Net Assets * * * 4.37%
Effect of Waivers on above Ratios * * * 0.78%
Portfolio Turnover Rate -
Average Commission Rate * * * * -
</TABLE>
* The Portfolios commenced operation on January 2, 1996.
* * Per share data based upon average monthly shares outstanding.
* * * Annualized.
* * * * For fiscal years beginning on or after September 1, 1995, a portfolio
is required to disclose its average commission rate per share for
security trades on which commissions are charged. This amount may
vary from period to period and portfolio to portfolio depending on
the mix of trades executed in various markets where trading practices
and commission rate structures may differ.
For the period January 2, 1996 (commencement of operations) through
March 31, 1996, the Adviser waived its entire advisory fee with respect to each
Portfolio.
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Since May of 1996, the individuals listed below have been responsible
for the day-to-day management of the Funds:
Bob Bissell (Equity Value Portfolio and equity portion of the Balanced
Portfolio)
Mr. Bissell joined Wells Fargo at the time of its acquisition of Crocker
National Bank in 1986 and has been with the combined organization for over 22
years. Prior to joining Wells Fargo, he was a vice president and investment
counselor with M.H. Edie Investment Counseling, where he managed institutional
and high-net worth portfolios. Mr. Bissell holds a finance degree from the
University of Virginia. He is a chartered financial analyst and a member of
the Los Angeles Society of Financial Analysts.
Allen Wisniewski (Equity Value Portfolio)
Mr. Wisniewski joined Wells Fargo at the time of its acquisition of Bank of
America's consumer trust services in April 1987, where he was a portfolio
manager. He received his B.A. and M.B.A. in economics and finance from the
University of California at Los Angeles. He is a chartered financial analyst
and a member of the Los Angeles Society of Financial Analysts.
Tamyra Thomas (Fixed-income portion of the Balanced Portfolio)
Ms. Thomas is a senior vice president and the chief fixed income investment
officer of the Investment Management Group of Wells Fargo Bank. She is also
Chair of the Investment Management Group Policy Committee. Ms. Thomas has
managed bond portfolios for over a decade. She currently manages in excess of
$1 billion of long-term taxable bond portfolios for various foundations,
defined benefit plans and other clients. Prior to joining Wells Fargo in early
1988, she held a number of senior investment positions for the Valley Bank &
Trust Company of Utah, including vice president and manager of the investment
department and chairman of the Trust Investment Committee. She holds a B.S.
from the University of Utah and was the past president of the Utah Bond Club.
Ms. Thomas is a chartered financial analyst.
Jon Hickman (Emerging Growth Portfolio)
Mr. Hickman has over sixteen years experience in the investment management
field. He joined Wells Fargo in 1986 managing equity and balanced portfolios
for individuals and employee benefit plans. He is a senior member of Wells
Fargo's Equity Strategy Committee. Mr. Hickman has a B.A. and an M.B.A. in
finance from Brigham Young University.
<PAGE> 4
Sandra Thornton (Emerging Growth Portfolio)
Ms. Thornton manages equity portfolios and is a member of the Wells Fargo
Growth Stock Team. Prior to joining Wells Fargo in 1993, she worked in the
research department of RCM Capital Management. She obtained her CPA from the
State of California while performing tax/financial planning services at Price
Waterhouse. She holds a B.A. from Albertus Magnus College and is a chartered
financial analyst.
Since August 1, 1996, Michael Hughes has been responsible for the
day-to-day management of the Intermediate Bond Portfolio. Mr. Hughes joined
Wells Fargo in connection with its acquisition of First Interstate Bancorp. He
was employed by the First Interstate organization since November 1988.
MISCELLANEOUS
SunAmerica Inc. ("SunAmerica"), the ultimate parent of Anchor National
Life Insurance Company, provided the initial seed capital for each Portfolio on
January 2, 1996, in the amount of $5,000,000 per Portfolio. As of May 31,
1996, SunAmerica owned the following percentages of each Portfolio attributable
to its seed capital investment: Emerging Growth Portfolio (86.9%), Equity
Value Portfolio (87.1%), Balanced Portfolio (92.5%), Intermediate Bond
Portfolio (95.9%), and Money Market Portfolio (99.7%). For purposes of the
Investment Company Act of 1940, any person who owns directly or through one or
more controlled companies more than 25% of the voting securities of a company
is presumed to "control" such company. Accordingly, SunAmerica may be presumed
to control each Portfolio.
<PAGE> 5
PACIFICA VARIABLE TRUST
Statement of Additional Information
for
Emerging Growth Portfolio
Equity Value Portfolio
Balanced Portfolio
Intermediate Bond Portfolio
Money Market Portfolio
December 1, 1995
(as revised September 3, 1996)
TABLE OF CONTENTS
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Page
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THE TRUST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
INVESTMENT OBJECTIVES AND POLICIES . . . . . . . . . . . . . . . . . . . . 1
NET ASSET VALUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION . . . . . . . . . . . . . . 24
DESCRIPTION OF SHARES . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
ADDITIONAL INFORMATION CONCERNING TAXES . . . . . . . . . . . . . . . . . . 26
MANAGEMENT OF THE PORTFOLIOS . . . . . . . . . . . . . . . . . . . . . . . 28
AUDITORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
COUNSEL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
ADDITIONAL INFORMATION ON PERFORMANCE CALCULATIONS . . . . . . . . . . . . 34
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
APPENDIX A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
APPENDIX B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B-1
</TABLE>
This Statement of Additional Information is meant to be read
in conjunction with the Prospectus dated December 1, 1995, as the same may be
revised from time to time, and is incorporated by reference in its entirety
into the related Prospectus. Because this Statement of Additional Information
is not itself a prospectus, no investment in shares of the Portfolios should be
made solely based upon the information contained herein. Copies of the
Portfolios' Prospectus may be obtained by calling 1-800-FIB-1223 or by writing
Furman Selz LLC, 237 Park Avenue, New York, New York 10017, or by contacting
the Participating Insurance Company. Capitalized terms used but not defined
herein have the same meanings as in the Prospectus.
<PAGE> 6
THE TRUST
Pacifica Variable Trust (the "Trust") is a Delaware business
trust which was organized on August 26, 1994 as an open-end management
investment company. The Trust offers shares representing interests in the
following five separate, diversified investment portfolios: Emerging Growth
Portfolio, Equity Value Portfolio, Balanced Portfolio, Intermediate Bond
Portfolio and Money Market Portfolio.
INVESTMENT OBJECTIVES AND POLICIES
The following policies supplement the discussion of the
Portfolios' respective investment objectives and policies as set forth in the
Prospectus.
Portfolio Transactions
Wells Fargo Investment Management, Inc. ("WFIM" or the
"Adviser") serves as the investment adviser to the Portfolios. Subject to the
general supervision of the Trust's Board of Trustees and the provisions of the
Trust's Advisory Agreement relating to the Portfolios, the Adviser is
responsible for making decisions with respect to, and placing orders for, all
purchases and sales of portfolio securities.
The annualized portfolio turnover rate for each Portfolio
(other than the Money Market Portfolio) is calculated by dividing the lesser of
purchases or sales of portfolio securities for the year by the monthly average
value of the portfolio securities. The calculation excludes all securities,
including options, that have maturities or expiration dates at the time of
acquisition of one year or less. Portfolio turnover may vary greatly from year
to year as well as within a particular year, and may be affected by cash
requirements for redemption of shares and by requirements which enable the
Portfolios to receive favorable tax treatment. Portfolio turnover will not be
a limiting factor in making portfolio decisions, and each Portfolio may engage
in short-term trading to achieve its investment objective.
The Money Market Portfolio does not intend to seek profits
from short-term trading. Its annual portfolio turnover rate will be relatively
high, but brokerage commissions are normally not paid on money market
instruments, and portfolio turnover is not expected to have a material effect
on the Portfolio's net income. For regulatory purposes the portfolio turnover
rate for the Portfolio is expected to be zero.
Transactions on U.S. stock exchanges involve the payment of
negotiated brokerage commissions. On exchanges on which commissions are
negotiated, the cost of transactions may
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vary among different brokers. Transactions in the over-the-counter market are
generally principal transactions with dealers and the costs of such
transactions involve dealer spreads rather than brokerage commissions. With
respect to over-the-counter transactions, the Adviser will normally deal
directly with the dealers who make a market in the securities involved, except
in those circumstances where better prices and execution terms are available
elsewhere or as described below. The cost of securities purchased from
underwriters includes an underwriting commission or concession, and the prices
at which securities are purchased from and sold to dealers include a dealer's
mark-up or mark-down.
The Portfolios may participate, if and when practicable, in
bidding for the purchase of portfolio securities directly from an issuer in
order to take advantage of the lower purchase price available to members of a
bidding group. A Portfolio will engage in this practice, however, only when
the Adviser, in its sole discretion, believes such practice to be otherwise in
a Portfolio's interests.
The Advisory Agreement for the Portfolios provide that, in
executing portfolio transactions and selecting brokers or dealers, the Adviser
will seek to obtain the best overall terms available. In assessing the best
overall terms available for any transaction, the Adviser will consider factors
it deems relevant, including the breadth of the market in the security, the
price of the security, the financial condition and execution capability of the
broker or dealer, and the reasonableness of the commission, if any, both for
the specific transaction and on a continuing basis. In addition, the Agreement
authorizes the Adviser to cause any of the Portfolios to pay a broker-dealer
which furnishes brokerage and research services a higher commission than that
which might be charged by another broker-dealer for effecting the same
transaction, provided that they determine in good faith that such commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker-dealer, viewed in terms of either that particular
transaction or the overall responsibilities of the Adviser to the Portfolios.
Such brokerage and research services might consist of reports and statistics of
specific companies or industries, general summaries of groups of stocks or
bonds and their comparative earnings and yields, or broad overviews of the
stock, bond and government securities markets and the economy.
Supplementary research information so received is in addition
to, and not in lieu of, services required to be performed by the Adviser and
does not reduce the advisory fees payable by the Portfolios. The Trustees will
periodically review the commissions paid by the Portfolios to consider whether
the commissions paid over representative periods of time appear to be
reasonable in relation to the benefits inuring to the Portfolios.
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It is possible that certain of the supplementary research or other services
received will primarily benefit one or more other investment companies or other
accounts for which investment discretion is exercised. Conversely, a Portfolio
may be the primary beneficiary of the research or services received as a result
of portfolio transactions effected for such other account or investment
company.
The Portfolios may from time to time purchase securities
issued by the Trust's regular broker/dealers. Portfolio securities will not,
however, be purchased from or sold to (and savings deposits will not be made in
and repurchase and reverse repurchase agreements will not be entered into with)
the Adviser, Furman Selz LLC, the Participating Insurance Company or an
affiliated person (as such term is defined in the Investment Company Act of
1940 (the "1940 Act")) of any of them acting as principal, except to the extent
permitted by the Securities and Exchange Commission. In addition, the
Portfolios will not purchase securities during the existence of any
underwriting or selling group relating thereto of which Furman Selz LLC, the
Adviser, the Participating Insurance Company or an affiliated person of any of
them, is a member, except to the extent permitted by the Securities and
Exchange Commission.
Investment decisions for each Portfolio are made independently
from those for the other Portfolios and from those made for other investment
companies and accounts advised or managed by the Adviser. Such other
investment companies and accounts may also invest in the same securities as the
Portfolios. When a purchase or sale of the same security is made at
substantially the same time on behalf of a Portfolio and another investment
company or account, those transactions will be averaged as to price, and
available securities will be allocated between the Portfolio and the other
purchaser in a manner which the Adviser believes to be equitable to the
Portfolio and such other investment company or account. In some instances,
this investment procedure may adversely affect the price paid or received by a
Portfolio or the size of the position obtained by the Portfolio. To the extent
permitted by law, the Adviser may aggregate the securities to be sold or
purchased for a Portfolio with those to be sold or purchased for other
investment companies or accounts in executing transactions.
Debt Ratings
The ratings of Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's Corporation ("S&P"), Duff & Phelps Credit Rating Co. ("D&P"),
Fitch Investors Service, Inc. ("Fitch"), Thomson Bank Watch ("Thomson") and
IBCA Inc. ("IBCA") represent their opinions as to the quality of debt
securities. It should be emphasized, however, that ratings are general and are
not absolute standards of quality, and debt securities with
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<PAGE> 9
the same maturity, interest rate and rating may have different yields while
debt securities of the same maturity and interest rate with different ratings
may have the same yield. Subsequent to purchase by a Portfolio, an issue of
debt securities may cease to be rated or its rating may be reduced below the
minimum rating required for purchase by a Portfolio. The Adviser will consider
such an event in determining whether the Portfolio involved should continue to
hold the obligation.
The payment of principal and interest on most securities
purchased by the Portfolios will depend upon the ability of the issuers to meet
their obligations. An issuer's obligations under its debt securities are
subject to the provisions of bankruptcy, insolvency, and other laws affecting
the rights and remedies of creditors, such as the Federal Bankruptcy Code, and
laws, if any, which may be enacted by Federal or state legislatures extending
the time for payment of principal or interest, or both, or imposing other
constraints upon enforcement of such obligations or, in the case of
governmental entities, upon the ability of such entities to levy taxes. The
power or ability of an issuer to meet its obligations for the payment of
interest and principal of its debt securities may be materially adversely
affected by litigation or other conditions.
Options Trading
As stated in the Prospectus, the Emerging Growth, Equity
Value, Balanced and Intermediate Bond Portfolios may purchase put and call
options listed on a national securities exchange and issued by the Options
Clearing Corporation. This is a highly specialized activity which may entail
greater than ordinary investment risks. Regardless of how much the market
price of the underlying security increases or decreases, the option buyer's
risk is limited to the amount of the original investment for the purchase of
the option. However, options may be more volatile than their underlying
securities and, therefore, on a percentage basis, an investment in options may
be subject to greater fluctuation than an investment in their underlying
securities. A listed call option gives the purchaser of the option the right
to buy from a clearing corporation, and a writer has the obligation to sell to
the clearing corporation, the underlying security at the stated exercise price
at any time prior to the expiration of the option, regardless of the market
price of the security. The premium paid to the writer is in consideration for
undertaking the obligations under the option contract. A listed put option
gives the purchaser the right to sell to a clearing corporation the underlying
security at the stated exercise price at any time prior to the expiration date
of the option, regardless of the market price of the security.
The Portfolios will write only "covered" call options on
securities. The option is "covered" if a Portfolio owns the
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security underlying the call or has an absolute and immediate right to acquire
that security without additional cash consideration (or, if additional cash
consideration is required, cash or cash equivalents in such amount as are held
in a segregated account by its custodian) upon conversion or exchange of other
securities held by it. A call option is also covered if a Portfolio holds a
call on the same security as the call written where the exercise price of the
call held is (i) equal to or less than the exercise price of the call written,
or (ii) greater than the exercise price of the call written provided the
difference is maintained by the Portfolio in cash or cash equivalents in a
segregated account with its custodian.
A Portfolio's obligation to sell a security subject to a
covered call option written by it, or to purchase a security subject to a
secured put option written by it, may be terminated prior to the expiration
date of the option by the Portfolio's executing a closing purchase transaction,
which is effected by purchasing on an exchange an option of the same series
(i.e., same underlying security, exercise price and expiration date) as the
option previously written. Such a purchase does not result in the ownership of
an option. A closing purchase transaction will ordinarily be effected to
realize a profit on an outstanding option, to prevent an underlying security
from being called, to permit the sale of the underlying security or to permit
the writing of a new option containing different terms on such underlying
security. The cost of such a liquidation purchase plus transaction costs may
be greater than the premium received upon the original option, in which event
the Portfolio will have incurred a loss in the transaction. An option position
may be closed out only on an exchange which provides a secondary market for an
option of the same series. There is no assurance that a liquid secondary
market on an exchange will exist for any particular option. A covered call
option writer, unable to effect a closing purchase transaction, will not be
able to sell the underlying security until the option expires or the underlying
security is delivered upon exercise with the result that the writer in such
circumstances will be subject to the risk of market decline in the underlying
security during such period. A Portfolio will write an option on a particular
security only if the Adviser believes that a liquid secondary market will exist
on an exchange for options of the same series which will permit the Portfolio
to make a closing purchase transaction in order to close out its position.
When a Portfolio purchases a put or call option, the premium
paid by it is recorded as an asset of the Portfolio. When a Portfolio writes
an option, an amount equal to the net premium (the premium less the commission)
received by the Portfolio is included in the liability section of the
Portfolio's statement of assets and liabilities as a deferred credit. The
amount of this asset or deferred credit will be subsequently
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marked-to-market to reflect the current value of the option purchased or
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 purchased by a Portfolio expires unexercised the Portfolio realizes a
loss equal to the premium paid. If a Portfolio enters into a closing sale
transaction on an option purchased by it, the Portfolio will realize a gain if
the premium received by the Portfolio on the closing transaction is more than
the premium paid to purchase the option, or a loss if it is less. If an option
written by a Portfolio expires on the stipulated expiration date or if a
Portfolio enters into a closing purchase transaction, it will realize a gain
(or 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 written by a Portfolio is exercised,
the proceeds of the sale will be increased by the net premium originally
received and the Portfolio will realize a gain or loss.
As noted previously, there are several risks associated with
transactions in options on securities. For example, there are significant
differences between the securities and options markets which could result in an
imperfect correlation between the markets, causing a given transaction not to
achieve its objectives. In addition, a liquid secondary market for particular
options, whether traded over-the-counter or on a national securities exchange
("Exchange") may be absent for reasons which include the following: there may
be insufficient trading interest in certain options; restrictions may be
imposed by an Exchange on opening transactions, closing transactions or both;
trading halts, suspensions or other restrictions may be imposed with respect to
particular classes or series of options or underlying securities; unusual or
unforeseen circumstances may interrupt normal operations on an Exchange; the
facilities of an Exchange or the Options Clearing Corporation may not at all
times be adequate to handle current trading volume; or one or more Exchanges
could, for economic or other reasons, decide or be compelled at some future
date to discontinue the trading of options (or a particular class or series of
options), in which event the secondary market on that Exchange (or in that
class or series of options) would cease to exist, although outstanding options
that had been issued by the Options Clearing Corporation as a result of trades
on that Exchange would continue to be exercisable in accordance with their
terms. A Portfolio will likely be unable to control losses by closing its
position where a liquid secondary market does not exist. A decision as to
whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
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Futures Contracts and Related Options
The Equity Value and Balanced Portfolios may invest in futures
contracts and options thereon as described in Appendix B to this Statement of
Additional Information.
Warrants
To the extent described in the Prospectus, the Emerging
Growth, Equity Value, Balanced and Intermediate Bond Portfolios may purchase
warrants, 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 a Portfolio 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. A
Portfolio will not invest more than 5% of its total assets, taken at market
value, in warrants, or more than 2% of its total assets, taken at market value,
in warrants not listed on the New York or American Stock Exchanges. Warrants
acquired by a Portfolio in units or attached to other securities are not
subject to this restriction.
Foreign Currency Exchange Transactions
The Equity Value and Balanced Portfolios may enter into
foreign currency exchange transactions to convert United States currency to
foreign currency and foreign currency to United States currency as well as
convert foreign currency to other foreign currencies. Each Portfolio will
either enter into these transactions on a spot (i.e., cash) basis at the spot
rate prevailing in the foreign currency exchange market, or use forward
contracts to purchase or sell foreign currencies.
A forward foreign currency exchange contract is an obligation
by a Portfolio to purchase or sell a specific currency at a specified price and
future date, which may be any fixed number of days from the date of the
contract. Forward foreign currency exchange contracts establish an exchange
rate at a future date. These contracts are transferable in the interbank
market conducted directly between currency traders (usually large commercial
banks) and their customers. A forward foreign currency exchange contract
generally has no deposit requirement, and is traded at a net price without
commission. Neither spot transactions nor forward foreign currency exchange
contracts eliminate fluctuations in the prices of a Portfolio's securities
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or in foreign exchange rates, or prevent loss if the prices of these securities
should decline.
The Equity Value and Balanced Portfolios may enter into
foreign currency hedging transactions in an attempt to protect against changes
in foreign currency exchange rates between the trade and settlement dates of
specific securities transactions or changes in foreign currency exchange rates
that would adversely affect a portfolio position or an anticipated portfolio
position. Since consideration of the prospect for currency parities will be
incorporated into a Portfolio's long-term investment decisions, the Portfolio
will not routinely enter into foreign currency hedging transactions with
respect to portfolio security transactions; however, it is important to have
the flexibility to enter into foreign currency hedging transactions when it is
determined that the transactions would be in a Portfolio's best interest.
Although these transactions tend to minimize the risk of loss due to a decline
in the value of the hedged currency, at the same time they tend to limit any
potential gain that might be realized should the value of the hedged currency
increase. The precise matching of the forward contract amounts and the value
of the securities involved will not generally be possible because the future
value of these securities in foreign currencies will change as a consequence of
market movements in the value of those securities between the date the forward
contract is entered into and the date it matures. The projection of currency
market movements is extremely difficult, and the successful execution of a
hedging strategy is highly uncertain.
Lending Securities
Collateral for securities loans may include cash, securities
of the U.S. Government, its agencies or instrumentalities, or an irrevocable
letter of credit issued by a bank that meets the investment standards for the
Money Market Portfolio, or any combination thereof. When a Portfolio lends its
securities, it continues to receive interest or dividends on the securities
loaned and may simultaneously earn interest on the collateral received from the
borrower or from the investment of cash collateral in readily marketable,
high-quality, short-term obligations. Although voting rights, or rights to
consent, attendant to securities on loan pass to the borrower, such loans may
be called at any time and will be called so that the securities may be voted by
a Portfolio if a material event affecting the investment is to occur.
Repurchase Agreements
The repurchase price under repurchase agreements described in
the Portfolios' Prospectus generally equals the price paid by a Portfolio plus
interest negotiated on the basis of current short-term rates (which may be more
or less than the
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rate on the securities underlying the repurchase agreement). Securities
subject to repurchase agreements are held by the Portfolios' custodian (or a
sub-custodian) or in the Federal Reserve/Treasury book-entry system.
Repurchase agreements are considered to be loans under the 1940 Act.
Bank Obligations
For purposes of each Portfolio's investment policies with
respect to bank obligations, the assets of a bank will be deemed to include the
assets of its domestic and foreign branches. Each Portfolio's investments in
the obligations of foreign branches of U.S. banks and of foreign banks may
subject the Portfolio to investment risks that are different in some respects
from those of investments in obligations of U.S. domestic issuers. Such 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 foreign banks 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. Each Portfolio will acquire securities issued by foreign branches of
U.S. banks or foreign banks only when the Adviser believes that the risks
associated with such instruments are minimal.
Government Obligations
The Portfolios may invest in obligations issued or guaranteed
by the U.S. Government, its agencies and instrumentalities. Examples of the
types of U.S. Government obligations that may be held by the Portfolios include
U.S. Treasury bonds, notes and bills and the obligations of Federal Home Loan
Banks, Federal Farm Credit Banks, Federal Land Banks, the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, Government National Mortgage
Association, Federal National Mortgage Association, General Services
Administration, Student Loan Marketing Association, Central Bank for
Cooperatives, Federal Home Loan Mortgage Corporation, Federal Intermediate
Credit Banks and Maritime Administration. Obligations of certain agencies and
instrumentalities of the U.S. Government, such as those of the Government
National Mortgage Association, are supported by the full faith and credit of
the U.S. Treasury; others, such as the Export-Import Bank of the United States,
are supported by the right of the issuer to borrow from the Treasury; others,
such as those of the Federal National Mortgage Association, are supported by
the discretionary
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authority of the U.S. Government to purchase the agency's obligations; still
others, such as those of the Student Loan Marketing Association, 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
instrumentalities if it is not obligated to do so by law.
American Depository Receipts ("ADRs") and European Depository Receipts ("EDRs")
The Emerging Growth, Equity Value, Intermediate Bond and
Balanced Portfolios may invest their assets in ADRs, which are receipts issued
by a U.S. bank or trust company evidencing ownership of underlying securities
issued by a foreign issuer, and, except for the Intermediate Bond Portfolio,
EDRs, which are receipts issued by European financial institutions evidencing
ownership of underlying securities issued by a foreign issuer. ADRs may be
listed on a national securities exchange or may trade in the over-the-counter
market. ADR prices are denominated in United States dollars while EDR prices
are generally denominated in foreign currencies. The securities underlying an
ADR or EDR will also normally be denominated in a foreign currency. The
underlying security may be subject to foreign government taxes which could
reduce the yield on such securities.
Foreign Securities
The Portfolios have undertaken to comply with California
Department of Insurance guidelines relating to investments in foreign
securities, which provide as follows: To the extent consistent with its
investment objective, a Portfolio will be invested in a minimum of five
different foreign countries at all times, provided that this minimum is reduced
to four when foreign country investments comprise less than 80% of the
Portfolio's net asset value; to three when less than 60% of the Portfolio's net
asset value; to two when less than 40% of the Portfolio's net asset value; and
to one when less than 20%. In addition, a Portfolio will invest no more than
20% of its net asset value in the securities of issuers located in any one
country, except that a Portfolio may have an additional 15% of its value
invested in securities of issuers in any one of Australia, Canada, France,
Japan, the United Kingdom or West Germany. A Portfolio's investments in United
States issuers are not subject to the above guidelines.
Exchange Rate-Related Securities
The Balanced Fund may invest in securities for which the
principal repayment at maturity, while paid in U.S. dollars, is determined by
reference to the exchange rate between the U.S. dollar and the currency of one
or more foreign countries
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("Exchange Rate-Related Securities"). The interest payable on these securities
is denominated in U.S. dollars and is not subject to foreign currency risk and,
in most cases, is paid at rates higher than most other similarly rated
securities in recognition of the foreign currency risk component of Exchange
Rate-Related Securities.
Investments in Exchange Rate-Related Securities entail certain
risks. There is the possibility of significant changes in rates of exchange
between the U.S. dollar and any foreign currency to which an Exchange
Rate-Related Security is linked. In addition, there is no assurance that
sufficient trading interest to create a liquid secondary market will exist for
a particular Exchange Rate-Related Security due to conditions in the debt and
foreign currency markets. Illiquidity in the forward foreign exchange market
and the high volatility of the foreign exchange market may, from time to time,
combine to make it difficult to sell an Exchange Rate-Related Security prior to
maturity without incurring a significant price loss. The Balanced Fund does
not intend to invest more than 5% of its net assets in Exchange Rate-Related
Securities.
Borrowing
At the time a Portfolio enters into a reverse repurchase
agreement (an agreement under which the Portfolio sells portfolio securities
and agrees to repurchase them at an agreed-upon date and price), it will place
in a segregated custodial account liquid assets such as U.S. Government
securities or other liquid high-grade debt securities having a value equal to
or greater than the repurchase price (including accrued interest) and will
subsequently monitor the account to ensure that such value is maintained.
Reverse repurchase agreements involve the risk that the market value of the
securities sold by a Portfolio may decline below the price at which the
Portfolio it is obligated to repurchase the securities. Reverse repurchase
agreements are considered to be borrowings under the 1940 Act. Each Portfolio
intends to limit its borrowings (including reverse repurchase agreements)
during the current fiscal year to not more than 5% of its net assets.
When-Issued Purchases and Forward Commitments
When a Portfolio agrees to purchase securities on a
when-issued basis or enters into a forward commitment to purchase securities,
its custodian will set aside cash, U.S. government securities or other liquid
high grade debt obligations equal to the amount of the purchase or the
commitment in a separate account. Normally, the custodian will set aside
portfolio securities to meet this requirement. The market value of the
separate account will be monitored and if such market value declines, the
Portfolio will be required to place additional
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assets in the separate account in order to ensure that the value of the account
remains equal to the amount of the Portfolio's commitment. Because a Portfolio
will set aside cash or liquid high grade debt securities in the manner
described, the Portfolio's liquidity and ability to manage its portfolio might
be affected in the event its when-issued purchases or forward commitments ever
exceeded 25% of the value of its assets. In the case of a forward commitment
to sell portfolio securities, the Portfolios' custodian will hold the portfolio
securities themselves in a segregated account while the commitment is
outstanding.
A Portfolio will generally make commitments to purchase
securities on a when-issued basis or to purchase or sell securities on a
forward commitment basis only with the intention of completing the transaction
and actually purchasing or selling the securities. If deemed advisable as a
matter of investment strategy, however, a Portfolio may dispose of or
renegotiate a commitment after it is entered into, and may sell securities it
has committed to purchase before those securities are delivered to the
Portfolio on the settlement date. In these cases the Portfolio may realize a
capital gain or loss.
When a Portfolio engages in when-issued and forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such party to do so may result in the Portfolio's incurring a loss or missing
an opportunity to obtain a price considered to be advantageous.
The value of the securities underlying a when-issued purchase
or a forward commitment to purchase securities, and any subsequent fluctuations
in their value, is taken into account when determining a Portfolio's net asset
value starting on the day the Portfolio agrees to purchase the securities. The
Portfolio does not earn interest on the securities it has committed to purchase
until they are paid for and delivered on the settlement date. When a Portfolio
makes a forward commitment to sell securities it owns, the proceeds to be
received upon settlement are included in the Portfolio's assets, and
fluctuations in the value of the underlying securities are not reflected in the
Portfolio's net asset value as long as the commitment remains in effect.
Convertible Securities
Convertible securities entitle the holder to receive interest
paid or accrued on debt or the dividend paid on preferred stock until the
convertible securities mature or are redeemed, converted or exchanged. Prior
to conversion, convertible securities have characteristics similar to ordinary
debt securities in that they normally provide a stable stream of income with
generally higher yields than those of common stock of
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the same or similar issuers. Convertible securities rank senior to common
stock in a corporation's capital structure and therefore generally entail less
risk than the corporation's common stock, although the extent to which such
risk is reduced depends in large measure upon the degree to which the
convertible security sells above its value as a fixed income security.
In selecting convertible securities for a Portfolio, the
Adviser will consider, among other factors, its evaluation of the
creditworthiness of the issuers of the securities; the interest or dividend
income generated by the securities; the potential for capital appreciation of
the securities and the underlying common stocks; the prices of the securities
relative to other comparable securities and to the underlying common stocks;
whether the securities are entitled to the benefits of sinking funds or other
protective conditions; the diversification of the Portfolio as to issuers; and
whether the securities are rated by a rating agency and, if so, the ratings
assigned.
The value of convertible securities is a function of their
investment value (determined by yield in comparison with the yields of other
securities of comparable maturity and quality that do not have a conversion
privilege) and their conversion value (their worth, at market value, if
converted into the underlying common stock). The investment value of
convertible securities is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as
interest rates decline, and by the credit standing of the issuer and other
factors. The conversion value of convertible securities is determined by the
market price of the underlying common stock. If the conversion value is low
relative to the investment value, the price of the convertible securities is
governed principally by their investment value. To the extent the market price
of the underlying common stock approaches or exceeds the conversion price, the
price of the convertible securities will be increasingly influenced by their
conversion value. In addition, convertible securities generally sell at a
premium over their conversion value determined by the extent to which investors
place value on the right to acquire the underlying common stock while holding
fixed income securities.
Capital appreciation for a Portfolio may result from an
improvement in the credit standing of an issuer whose securities are held in
the Portfolio or from a general lowering of interest rates, or a combination of
both. Conversely, a reduction in the credit standing of an issuer whose
securities are held by a Portfolio or a general increase in interest rates may
be expected to result in capital depreciation to the Portfolio.
In general, investments in non-investment grade convertible
securities are subject to a significant risk of a change in the credit rating
or financial condition of the issuing
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entity. Investments in convertible securities of medium or lower quality are
also likely to be subject to greater market fluctuation and to greater risk of
loss of income and principal due to default than investments in higher rated
fixed-income securities. Such lower-rated securities generally tend to reflect
short-term corporate and market developments to a greater extent than higher
rated securities, which react more to fluctuations in the general level of
interest rates. A Portfolio will generally reduce risk to the investor by
diversification, credit analysis and attention to current developments in
trends of both the economy and financial markets. However, while
diversification reduces the effect on a Portfolio of any single investment, it
does not reduce the overall risk of investing in lower-rated securities.
While any investment carries some risk, certain risks
associated with lower-rated securities are different than those for
investment-grade securities. The risk of loss through default is greater
because lower-rated securities are usually unsecured and are often subordinate
to an issuer's other obligations. Additionally, the issuers of these
securities frequently have high debt levels and are thus more sensitive to
difficult economic conditions, individual corporate developments and rising
interest rates. Consequently, the market price of these securities may be quite
volatile and may result in wider fluctuations of a Portfolio's net asset value
per share.
There remains some uncertainty about the performance level of
the market for lower-rated securities under adverse market and economic
environments. An economic downturn or increase in interest rates could have a
negative impact on both the markets for lower-rated securities (resulting in a
greater number of bond defaults) and the value of lower-rated securities held
in the portfolio of investments.
The economy and interest rates can affect lower-rated
securities differently than other securities. For example, the prices of
lower-rated securities are more sensitive to adverse economic changes or
individual corporate developments than are the prices of higher-rated
investments. In addition, during an economic downturn or period in which
interest rates are rising significantly, highly leveraged issuers may
experience financial difficulties, which, in turn, would adversely affect their
ability to service their principal and interest payment obligations, meet
projected business goals and obtain additional financing.
If an issuer of a security defaults, a Portfolio may incur
additional expenses to seek recovery. In addition, periods of economic
uncertainty would likely result in increased volatility for the market prices
of lower-rated securities as
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well as a Portfolio's net asset value. In general, both the prices and yields
of lower-rated securities will fluctuate.
In certain circumstances it may be difficult to determine a
security's fair value due to a lack of reliable objective information. Such
instances occur where there is not an established secondary market for the
security or the security is lightly traded. As a result, a Portfolio's
valuation of a security and the price it is actually able to obtain when it
sells the security could differ.
Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the value and liquidity of
lower-rated convertible securities held by a Portfolio, especially in a thinly
traded market. Illiquid or restricted securities held by a Portfolio may
involve special registration responsibilities, liabilities and costs, and could
involve other liquidity and valuation difficulties.
Current laws, such as those requiring federally-insured
savings and loan associations to remove investments in lower-rated securities
from their portfolios, as well as other pending proposals, may have a material
impact on the market for lower-rated securities.
The rating assigned by a rating agency evaluates the safety of
a lower-rated security's principal and interest payments, but does not address
market value risk. Because the ratings of the rating agencies may not always
reflect current conditions and events, in addition to using recognized rating
agencies and other sources, the Adviser performs its own analysis of the
issuers whose lower-rated securities a Portfolio holds. Because of this, a
Portfolio's performance may depend more on the Adviser's credit analysis than
is the case of mutual funds investing in higher-rated securities.
Restricted Securities
The purchase of securities which are traded pursuant to Rule
144A, as described in the Portfolios' Prospectus, could have the effect of
increasing the level of illiquidity of a Portfolio during periods when
qualified institutional buyers become uninterested in purchasing restricted
securities.
Variable and Floating Rate Instruments
With respect to the variable and floating rate instruments
that may be acquired by the Portfolios as described in the Prospectus, the
Adviser will consider the earning power, cash flows and other liquidity ratios
of the issuers and guarantors of such instruments and, if the instruments are
subject to demand features, will monitor their financial status
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to meet payment on demand. In determining weighted average portfolio maturity,
an instrument will usually be deemed to have a maturity equal to the longer of
the period remaining until the next interest rate adjustment or the time a
Portfolio can recover payment of principal as specified in the instrument.
Variable rate U.S. Government obligations held by the Portfolios, however, will
be deemed to have maturities equal to the period remaining until the next
interest rate adjustment. Where necessary to ensure that a variable or
floating rate instrument is of the minimum required credit quality for a
Portfolio, the issuer's obligation to pay the principal of the instrument will
be backed by an unconditional bank letter or line of credit, guarantee or
commitment to lend.
Municipal Obligations
Municipal obligations that may be acquired by the Intermediate
Bond Portfolio include debt obligations issued by governmental entities to
obtain funds for various public purposes, including the construction of a wide
range of public facilities, the refunding of outstanding obligations, the
payment of general operating expenses and the extension of loans to public
institutions and facilities.
The two principal classifications of municipal obligations
which may be held by the Intermediate Bond Portfolio are "general obligation"
securities and "revenue" securities. General obligation securities are secured
by the issuer's pledge of its full faith, credit and taxing power for the
payment of principal and interest. Revenue securities are payable only from
the revenues derived from a particular facility or class of facilities or, in
some cases, from the proceeds of a special excise tax or other specific revenue
source such as the issuer of the facility being financed. The Portfolio may
also hold "moral obligation" securities, which are normally issued by special
purpose public authorities. If the issuer of moral obligation securities is
unable to meet its debt service obligations from current revenues, it may draw
on a reserve fund, the restoration of which is a moral commitment but not a
legal obligation of the state or municipality which created the issuer.
Further, the Intermediate Bond Portfolio may purchase
municipal obligations known as "certificates of participation" which represent
undivided proportional interests in lease payments by a governmental or
nonprofit entity. The lease payments and other rights under the lease provide
for and secure the payments on the certificates. Lease obligations may be
limited to applicable municipal charter provisions or the nature of the
appropriation for the lease. In particular, lease obligations may be subject
to periodic appropriation. If the entity does not appropriate funds for future
lease payments, the entity cannot be compelled to make such payments.
Furthermore, a
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lease may or may not provide that the certificate trustee can accelerate lease
obligations upon default. If the trustee could not accelerate lease
obligations upon default, the trustee would only be able to enforce lease
payments as they became due. In the event of a default or failure of
appropriation, it is unlikely that the trustee would be able to obtain an
acceptable substitute source of payment. Certificates of participation are
generally subject to redemption by the issuing municipal entity under specified
circumstances. If a specified event occurs, a certificate is callable at par
either at any interest payment date or, in some cases, at any time. As a
result, certificates of participation are not as liquid or marketable as other
types of municipal obligations and are generally valued at par or less than par
in the open market.
There are, of course, variations in the quality of municipal
obligations both within a particular classification and between
classifications, and the yields on municipal obligations depend upon a variety
of factors, including general money market conditions, the financial condition
of the issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation and the rating of the
issue.
Private activity bonds are issued to obtain funds to provide
privately operated housing facilities, pollution control facilities, convention
or trade show facilities, mass transit, airport, port or parking facilities and
certain local facilities for water supply, gas, electricity or sewage or solid
waste disposal. Private activity bonds are also issued to privately held or
publicly owned corporations in the financing of commercial or industrial
facilities. State and local governments are authorized in most states to issue
private activity bonds for such purposes in order to encourage corporations to
locate within their communities. Private activity bonds are in most cases
revenue securities and are not payable from the unrestricted revenues of the
issuer. The credit quality of such bonds is usually directly related to the
credit standing of the corporate user of the facility involved.
Certain of the municipal obligations held by the Intermediate
Bond Portfolio may be insured as to the timely payment of principal and
interest. The insurance policies will usually be obtained by the issuer of the
municipal obligation at the time of its original issuance. In the event that
the issuer defaults on interest or principal payment, the insurer will be
notified and will be required to make payment to the bondholders. There is,
however, no guarantee that the insurer will meet its obligations. In addition,
such insurance will not protect against market fluctuations caused by changes
in interest rates and other factors.
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Stripped Government Obligations
Within the past several years, the Treasury Department has
facilitated transfers of ownership of zero coupon securities by accounting
separately for the beneficial ownership of particular interest coupon and
principal payments on Treasury securities through the Federal Reserve
book-entry record-keeping system. The Federal Reserve program as established
by the Treasury Department is known as "STRIPS" or "Separate Trading of
Registered Interest and Principal of Securities." The Portfolios may purchase
securities registered in the STRIPS program. Under the STRIPS program, the
Portfolios will be able to have their beneficial ownership of zero coupon
securities recorded directly in the book-entry record-keeping system in lieu of
having to hold certificates or other evidences of ownership of the underlying
U.S. Treasury securities.
In addition, the Portfolios may acquire U.S. Government
obligations and their unmatured interest coupons that have been separated
("stripped") by their holder, typically a custodian bank or investment
brokerage firm. Having separated the interest coupons from the underlying
principal of the U.S. Government obligations, the holder will resell the
stripped securities in custodial receipt programs with a number of different
names, including "Treasury Income Growth Receipts" ("TIGRs") and "Certificate
of Accrual on Treasury Securities" ("CATS"). The stripped coupons are sold
separately from the underlying principal, which is usually sold at a deep
discount because the buyer receives only the right to receive a future fixed
payment on the security and does not receive any rights to periodic interest
(cash) payments. The underlying U.S. Treasury bonds and notes themselves are
held in book-entry form at the Federal Reserve Bank or, in the case of bearer
securities (i.e., unregistered securities which are ostensibly owned by the
bearer or holder), in trust on behalf of the owners. Counsel to the
underwriters of these certificates or other evidences of ownership of U.S.
Treasury securities have stated that, in their opinion, purchasers of the
stripped securities most likely will be deemed the beneficial holders of the
underlying U.S. Government obligations for Federal tax purposes. The Trust is
unaware of any binding legislative, judicial or administrative authority on
this issue. Investments by a Portfolio in these securities will not exceed 5%
of the value of the Portfolio's total assets.
The Prospectus discusses other types of stripped securities
that may be purchased by the Portfolios.
Asset-Backed Securities
To the extent described in the Prospectus, the Portfolios may
purchase asset-backed securities, which are
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securities backed by mortgages, installment contracts, credit card receivables
or other assets. Asset-backed securities represent interests in "pools" of
assets in which payments of both interest and principal on the securities are
made monthly, thus in effect "passing through" monthly payments made by the
individual borrowers on the assets that underlie the securities, net of any
fees paid to the issuer or guarantor of the securities. The average life of
asset-backed securities varies with the maturities of the underlying
instruments, and the average life of a mortgage-backed instrument, in
particular, is likely to be substantially less than the original maturity of
the mortgage pools underlying the securities as a result of mortgage
prepayments. For this and other reasons, an asset-backed security's stated
maturity may be shortened, and the security's total return may be difficult to
predict precisely. Asset-backed securities acquired by the Portfolios may
include collateralized mortgage obligations ("CMOs") issued by private
companies.
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 guaranteed by the 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 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-backed
securities issued by the FNMA include FNMA Guaranteed Mortgage Pass-Through
Certificates (also known as "Fannie Maes") which are solely the obligations of
the FNMA and are not backed by or entitled to the full faith and credit of the
United States, but are supported by the right of the issuer to borrow from the
Treasury. FNMA is a government-sponsored organization owned entirely by
private stockholders. Fannie Maes are guaranteed as to timely payment of the
principal and interest by FNMA. Mortgage-related securities issued by the
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 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 timely payment of interest, which is guaranteed by FHLMC.
FHLMC guarantees either ultimate collection or 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.
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Additional Investment Limitations
In addition to the investment limitations disclosed in the
Prospectus, the Portfolios are subject to the investment limitations enumerated
below which may be changed with respect to a particular Portfolio only by a
vote of a majority of the holders of such Portfolio's outstanding shares (as
defined under "Miscellaneous" below).
No Portfolio may:
1. Purchase or sell real estate, except that each
Portfolio may purchase securities of issuers which deal in real estate and may
purchase securities which are secured by interests in real estate.
2. Purchase securities of companies for the purpose of
exercising control.
3. Acquire any other investment company or investment
company security except in connection with a merger, consolidation,
reorganization or acquisition of assets or where otherwise permitted by the
Investment Company Act of 1940.
4. Act as an underwriter of securities within the
meaning of the Securities Act of 1933 except insofar as a Portfolio might be
deemed to be an underwriter upon disposition of portfolio securities acquired
within the limitation on purchases of restricted securities and except to the
extent that the purchase and sale of obligations in accordance with the
Portfolio's investment objective, policies and limitations may be deemed to be
underwriting.
5. Write or sell put options, call options, straddles,
spreads, or any combination thereof, except for transactions in options on
securities, financial instruments, currencies and indices of securities;
futures contracts and options on futures contracts; and forward currency
exchange contracts.
6. Purchase securities on margin, make short sales of
securities or maintain a short position, except that (a) this investment
limitation shall not apply to a Portfolio's transactions in futures contracts
and related options, and (b) a Portfolio may obtain short-term credit as may be
necessary for the clearance of purchases and sales of portfolio securities.
7. Purchase or sell commodity contracts, or invest in
oil, gas or mineral exploration or development programs, except that the
Portfolio may, to the extent appropriate to its investment objective, purchase
publicly traded securities of companies engaging in whole or in part in such
activities and may enter into futures contracts and related options.
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8. Borrow money (other than pursuant to reverse
repurchase agreements), except (a) as a temporary measure, and then only in
amounts not exceeding 5% of the value of a Portfolio's total assets or (b) from
banks, provided that immediately after any such borrowing all borrowings of the
Portfolio do not exceed one-third of the Portfolio's total assets. The
exceptions in (a) and (b) to this restriction are not for investment leverage
purposes but are solely for extraordinary or emergency purposes or to
facilitate management of a Portfolio by enabling the Portfolio to meet
redemption requests when the liquidation of portfolio instruments is deemed to
be disadvantageous or not possible. If due to market fluctuations or other
reasons the total assets of a Portfolio fall below 300% of its borrowings, the
Trust will reduce the borrowings of such Portfolio in accordance with the 1940
Act. In addition, as a matter of fundamental policy, the Portfolios may not
enter into reverse repurchase agreements exceeding in the aggregate one-third
of their respective total assets.
9. Mortgage, pledge or hypothecate any assets (other
than pursuant to reverse repurchase agreements) except to secure permitted
borrowings.
In order to comply with California Department of Insurance
guidelines, as a non-fundamental investment restriction, a Portfolio may not
borrow money in excess of (i) 10% of its net asset value when borrowing for any
general purpose or (ii) 25% of its net asset value when borrowing as a
temporary measure to facilitate redemptions.
Securities held in escrow or separate accounts in connection
with the Portfolios' investment practices described in this Statement of
Additional Information and in the Prospectus are not deemed to be mortgaged,
pledged or hypothecated for purposes of the foregoing Investment Limitations.
Any restriction which involves a maximum percentage will not
be considered violated unless an excess over the percentage occurs immediately
after, and is caused by, an acquisition or encumbrance of securities or assets
of, or borrowings by, the Portfolio.
In order to permit the sale of the Portfolios' shares in
certain states, the Trust may make commitments with respect to the Portfolios
more restrictive than the investment policies listed above and in the
Prospectus. Should the Trust determine that any commitment made to permit the
sale of a Portfolio's shares in any state is no longer in the best interests of
the Portfolio, it will revoke the commitment by terminating sales of a
Portfolio's shares in the state involved.
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NET ASSET VALUE
The net asset value per share of a Portfolio is calculated by
adding the value of all portfolio securities and other assets belonging to the
Portfolio, subtracting the liabilities charged to the Portfolio, and dividing
the result by the number of shares of the Portfolio outstanding. "Assets
belonging to" a Portfolio consists of the consideration received upon the
issuance of shares of the Portfolio together with all income, earnings, profits
and proceeds derived from the investment thereof, including any proceeds from
the sale, exchange or liquidation of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of the Trust not belonging to a particular investment portfolio that are
allocated to that portfolio by the Trust's Board of Trustees. The Board of
Trustees may allocate such general assets in any manner it deems fair and
equitable. It is anticipated that the general assets will normally be
allocated to particular portfolios based on their relative net asset values at
the time of allocation. Assets belonging to a particular portfolio are charged
with the direct liabilities and expenses of that portfolio and with a share of
the general liabilities and expenses of the Trust which are normally allocated
in proportion to the relative net asset values of all of the Trust's investment
portfolios at the time of allocation. The allocations of general assets and
general liabilities and expenses of the Trust to particular portfolios will be
determined in accordance with generally accepted accounting principles.
Subject to the provisions of the Trust Instrument, determinations by the Board
of Trustees as to the direct and allocable liabilities and the allocable
portion of any general assets with respect to the Portfolio are conclusive.
Emerging Growth, Equity Value, Balanced and Intermediate Bond Portfolios
Securities which are traded on a recognized stock exchange are
valued at the last sale price occurring prior to the close of regular trading
on the securities exchange on which such securities are primarily traded or at
the last sale price occurring prior to the close of regular trading on the
national securities market. Securities traded on only over-the-counter markets
are valued on the basis of closing over-the-counter bid prices. Securities for
which there were no transactions are valued at the average of the current bid
and asked prices. Restricted securities, securities for which market
quotations are not readily available, and other assets are valued at fair value
under the supervision of the Board of Trustees. In computing net asset value,
the current value of a Portfolio's open futures contracts and options will be
"marked to market."
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<PAGE> 28
Money Market Portfolio
The Trust uses the amortized cost method of valuation to value
the Money Market Portfolio's portfolio securities, pursuant to which an
instrument is valued at its cost initially and thereafter a constant
amortization to maturity of any discounts or premium is assumed, regardless of
the impact of fluctuating interest rates on the market value of the instrument.
This method may result in periods during which value, as determined by
amortized cost, is higher or lower than the price the Portfolio would receive
if it sold the instrument. The market value of portfolio securities held by
the Portfolio can be expected to vary inversely with changes in prevailing
interest rates.
The Money Market Portfolio maintains a dollar-weighted average
portfolio maturity appropriate to its policy of maintaining a stable net asset
value per share. In this regard, the Portfolio will neither purchase any
security deemed to have a remaining maturity of more than 13 months (397 days)
within the meaning of the 1940 Act nor maintain a dollar-weighted average
maturity which exceeds 90 days. The Trust's Board of Trustees has also
established procedures that are intended to stabilize the net asset value per
share of the Portfolio for purposes of sales and redemptions at $1.00. These
procedures include the determination, at such intervals as the trustees deem
appropriate, of the extent, if any, to which the net asset value per share of
the Portfolio calculated by using available market quotations deviates from
$1.00 per share. In the event such deviation exceeds one-half of one percent,
the Board will promptly consider what action, if any, should be initiated. If
the Board believes that the extent of any deviation from a $1.00 amortized cost
price per share may result in material dilution or other unfair results to new
or existing investors, it has agreed to take such steps as it considers
appropriate to eliminate or reduce to the extent reasonably practicable any
such dilution or unfair results. These steps may include selling portfolio
instruments prior to maturity; shortening the average portfolio maturity;
withholding or reducing dividends; redeeming shares in kind; reducing the
number of outstanding shares without monetary consideration; or utilizing a net
asset value per share determined by using available market quotations.
Net income of the Money Market Portfolio for dividend purposes
consists of (i) interest accrued and discount earned on the Portfolio's assets,
less (ii) amortization of market premium on such assets, accrued expenses
directly attributable to the Portfolio, and the Portfolio's allocable share of
the general expenses.
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<PAGE> 29
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Shares of the Portfolios are sold on a continuous basis by
Furman Selz LLC ("Furman Selz"). Each purchase is confirmed to the Separate
Account in a written statement of the number of shares purchased and the
aggregate number of shares currently held.
The Trust may suspend the right of redemption or postpone the
date of payment for shares of any Portfolio for more than seven days during any
period when (a) trading in the markets the Portfolio normally utilizes is
restricted, or an emergency, as defined by the rules and regulations of the
SEC, exists making disposal of the Portfolio's investments or determination of
its net asset value not reasonably practicable; (b) the New York Stock Exchange
is closed (other than customary weekend and holiday closings); or (c) the SEC
has by order permitted such suspension.
DESCRIPTION OF SHARES
The Trust is a Delaware business trust. Under the Trust
Instrument, the beneficial interest in the Trust may be divided into an
unlimited number of full and fractional transferable shares. The Trust
Instrument authorizes the Board of Trustees to classify or reclassify any
unissued shares of the Trust into one or more additional series by setting or
changing in any one or more respects, their respective designations,
preferences, voting powers, rights and privileges. Pursuant to such authority,
the Board of Trustees has authorized the issuance of five series of shares,
each series representing interests in a separate investment portfolio. The
Trustees may similarly classify or reclassify any particular series of shares
into one or more classes.
Each share of the Trust has a par value of $0.0001, represents
an equal proportionate interest in a Portfolio, and is entitled to such
dividends and distributions of the income earned on the Portfolio's assets as
are declared at the discretion of the Trustees. Shares of the Portfolios have
no 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 Prospectus, a Portfolio's shares will be fully paid and non-assessable
by the Trust. In the event of the termination of the Trust or an individual
Portfolio, shareholders of a particular Portfolio would be entitled to receive
the assets available for distribution belonging to such Portfolio.
Shareholders of a Portfolio are entitled to participate in the net
distributable assets of the particular Portfolio involved on termination, based
on the number of shares of the Portfolio that are held by each of them,
respectively.
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<PAGE> 30
Unless the Board of Trustees determines otherwise,
shareholders of the Portfolios, as well as those of the other investment
portfolios offered by the Trust, will vote together in the aggregate and not
separately on a Portfolio-by-Portfolio basis, except as otherwise required by
law or when the Board of Trustees determines that the matter to be voted upon
affects only the interests of the shareholders of a particular Portfolio. 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
Portfolio affected by the matter. A Portfolio is affected by a matter unless
it is clear that the interests of each Portfolio in the matter are
substantially identical or that the matter does not affect any interest of the
Portfolio. Under the Rule, the approval of an investment advisory agreement or
any change in a fundamental investment policy would be effectively acted upon
with respect to a Portfolio only if approved by a majority of the outstanding
shares of such Portfolio. However, the Rule also provides that the
ratification of the appointment 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
particular Portfolios.
There will normally be no meetings of shareholders for the
purpose of electing trustees unless and until such time as less than a majority
of the trustees holding office have been elected by shareholders, at which time
the trustees then in office will call a shareholders meeting for the election
of trustees. Shares of the Trust have noncumulative voting rights and,
accordingly, the holders of more than 50% of the Trust's outstanding shares
(irrespective of class) may elect all of the Trustees. The Board of Trustees
will call meetings of the shareholders of the Trust upon the written request of
shareholders owning at least 10% of the outstanding shares entitled to vote.
Except as set forth above, the Trustees will continue to hold office and may
appoint successor trustees.
The Trust Instrument authorizes the Board of Trustees, without
shareholder approval, to issue shares to a party or parties and for such amount
and type of consideration and on such terms, subject to applicable law, as the
Trustees may deem appropriate. The Board of Trustees may issue fractional
shares and shares held in the treasury. The Board of Trustees has full power
and authority, in their sole discretion, and without obtaining shareholder
approval, to divide or combine the shares or any class or series thereof into a
greater or lesser number, to classify or reclassify any issued shares or any
class or series thereof into one or more classes or series of shares, and
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<PAGE> 31
to take such other action with respect to the Trust's shares as the Board of
Trustees may deem desirable.
The Trust Instrument provides that the Trustees, when acting
in their capacity as such, will not be personally liable to any person other
than the Trust or a beneficial owner for any act, omission or obligation of the
Trust or any Trustee. A Trustee shall not be liable for any act or omission in
his capacity as Trustee, or for any act or omission of any officer or employee
of the Trust or of any other person or party, provided that nothing contained
in the Trust Instrument or in the Delaware Business Trust Act shall protect any
Trustee against any liability to the Trust or to shareholders to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of the
office of Trustee.
ADDITIONAL INFORMATION CONCERNING TAXES
Shares of the Portfolios are offered only to Separate Accounts
that fund variable annuity contracts. See the prospectus for the variable
annuity contracts for a discussion of the special taxation of insurance
companies with respect to the Separate Accounts and the variable annuity
contracts, and the holders thereof.
The following is only a summary of certain tax considerations
generally affecting the Portfolios that are not described in the Portfolios'
Prospectus. No attempt is made to present a detailed explanation of the tax
treatment of the Portfolios, and the discussions here and in the Prospectus are
not intended as a substitute for careful tax planning. This discussion is
based on tax laws and regulations which are in effect on the date hereof; such
laws and regulations may be changed by legislative or administrative action.
Investors are urged to consult their tax advisors with reference to their own
situation.
Federal
Each Portfolio is treated as a separate corporate entity under
the Code and intends to qualify as a regulated investment company. In order to
so qualify, each Portfolio must satisfy certain requirements with respect to
the distribution and sources of its income for a taxable year. At least 90% of
the gross income of each Portfolio must be derived from dividends, interest,
payments with respect to securities loans, gains from the sale or other
disposition of stocks, securities or foreign currencies, and other income
(including, but not limited to, gains from options, futures, or forward
contracts) derived with respect to the Portfolio's business of investing in
such stock, securities or currencies. The Treasury Department may by
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<PAGE> 32
regulation exclude from qualifying income foreign currency gains which are not
directly related to the Portfolio's principal business of investing in stock or
securities, or options and futures with respect to stock or securities. Any
income derived by a Portfolio from a partnership or trust is treated for this
purpose as derived with respect to the Portfolio's business of investing in
stock, securities or currencies only to the extent that such income is
attributable to items of income which would have been qualifying income if
realized by the Portfolio in the same manner as by the partnership or trust.
Qualification as a regulated investment company under the Code
also requires that in each taxable year a Portfolio distribute to its
shareholders an amount equal to at least the sum of 90% of its investment
company taxable income for such year. In general, a Portfolio's investment
company taxable income will be its taxable income, subject to certain
adjustments and excluding the excess of any net long-term capital gain for the
taxable year over the net short-term capital loss, if any, for such year. Each
Portfolio intends to distribute as dividends substantially all of its
investment company taxable income each year.
Another requirement for qualification as a regulated
investment company under the Code is that less than 30% of a Portfolio's gross
income for a taxable year must be derived from gains realized on the sale or
other disposition of the following investments held for less than three months:
(1) stock and securities (as defined in Section 2(a)(36) of the 1940 Act); (2)
options, futures and forward contracts other than those on foreign currencies;
and (3) foreign currencies (and options, futures and forward contracts on
foreign currencies) that are not directly related to a Portfolio's principal
business of investing in stock and securities (and options and futures with
respect to stocks and securities). Interest (including original issue discount
and accrued market discount) received by a Portfolio upon maturity or
disposition of a security held for less than three months will not be treated
as gross income derived from the sale or other disposition of such security
within the meaning of this requirement. However, any other income which is
attributable to realized market appreciation will be treated as gross income
from the sale or other disposition of securities for this purpose. See
Appendix B -- "Accounting and Tax Treatment" - - for a general discussion of
the Federal tax treatment of futures contracts, related options thereon and
other financial instruments, including their treatment under the 30% test.
As noted in the Prospectus, each Portfolio must, and intends
to, comply with the diversification requirements imposed by Section 817(h) of
the Code and the regulations thereunder. For information concerning the
consequences of failure to meet
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<PAGE> 33
the requirements of Section 817(h), see the prospectus for the variable
contracts.
A 4% non-deductible excise tax is imposed on regulated
investment companies that fail to currently distribute an amount equal to
specified percentages of their ordinary taxable income and capital gain net
income (excess of capital gains over capital losses). Each Portfolio intends
to make sufficient distributions or deemed distributions of its ordinary
taxable income and any capital gain net income prior to the end of each
calendar year to avoid liability for this excise tax.
If for any taxable year a Portfolio does not qualify for tax
treatment as a regulated investment company, all of the taxable income of the
Portfolio will be subject to tax at regular corporate rates, without any
deduction for distributions to shareholders, and the Portfolio's distributions
to shareholders will be taxable as ordinary dividends to the extent of the
current and accumulated earnings and profits of the particular Portfolio.
State
Depending upon the extent of the Portfolios' activities in
states and localities in which their offices are maintained, in which their
agents or independent contractors are located or in which they are otherwise
deemed to be conducting business, the Portfolios may be subject to the tax laws
of such states or localities. In addition, in those states and localities
which have income tax laws, the treatment of the Portfolios and their
shareholders under such laws may differ from their treatment under federal
income tax laws.
MANAGEMENT OF THE PORTFOLIOS
Trustees and Officers
The trustees and officers of the Trust, their addresses, ages,
principal occupations during the past five years and other affiliations are as
follows:
<TABLE>
<CAPTION>
=============================================================================================================
POSITION(S) HELD
NAME, ADDRESS, AND AGE WITH THE TRUST PRINCIPAL OCCUPATION(S) DURING THE PAST 5 YEARS
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Dennis W. Draper; School of Trustee Associate Professor of Finance, at University of
Business, Hoffman 701-F, Southern California since 1978; Director of Data
University of Southern Analysis, Inc. (financial services); and Editorial
California, Los Angeles, Board Member of Chicago Board of Trade.
California 90089; 46.
- -------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 34
<TABLE>
<CAPTION>
=============================================================================================================
POSITION(S) HELD
NAME, ADDRESS, AND AGE WITH THE TRUST PRINCIPAL OCCUPATION(S) DURING THE PAST 5 YEARS
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Joseph N. Hankin; Trustee President, Westchester Community College since 1971;
Westchester Community President of Hartford Junior College from 1967 to
College, 75 Grasslands Road, 1971; Adjunct Professor of Columbia University
Valhalla, New York 10595; Teachers College since 1976.
55.
- -------------------------------------------------------------------------------------------------------------
John E. Heilmann; Old Trustee Retired; former Chairman, President and Chief
Norwood Plantation, Route 1, Executive Officer of Distillers Somerset, Inc. and
Box II A, Wingina, Virginia Norwood Enterprises, Inc. from 1987-1992.
24599; 64.
- -------------------------------------------------------------------------------------------------------------
Jack D. Henderson; 1600 Trustee Attorney--sole practitioner; Partner of the law firm
Broadway, Denver, Colorado of Clanahan, Tanner, Downing & Knowlton, P.C. until
80202; 68. November, 1995. He is a Trustee of Westcore Trust (a
mutual fund family).
- -------------------------------------------------------------------------------------------------------------
Richard A. Wedemeyer; 17 Trustee Vice President of Performance Advantage, Inc., since
High Street, Norwalk, 1992; Vice President of Jim Henson Productions from
Connecticut 06851; 59. 1979 to 1992; Author of In Transition (Harper
Collins); co-founder and co-conductor of Harvard
Business School Club of New York Career Seminar;
Trustee of Jim Henson Legacy Trust.
- -------------------------------------------------------------------------------------------------------------
Michael C. Petrycki; 230 President Executive Vice President and Director of Furman Selz
Park Avenue, New York, NY since 1984.
10169; 53.
- -------------------------------------------------------------------------------------------------------------
Steven D. Blecher; 230 Park Executive Vice Executive Vice President and Director of Furman Selz
Avenue, New York, NY 10169; President since 1983; Vice President, Secretary and Treasurer
52. of Furman Selz Capital Management, Inc. since 1984.
- -------------------------------------------------------------------------------------------------------------
John J. Pileggi; 237 Park Vice President Managing Director of Furman Selz, from 1984 to 1992;
Avenue, New York, NY 10017; and Treasurer Senior Managing Director since 1992 and Director of
36. Furman Selz since 1994.
- -------------------------------------------------------------------------------------------------------------
Joan V. Fiore; 237 Park Vice President Managing Director and Counsel of Furman Selz since
Avenue, New York, NY 10017; and Secretary 1991; Staff Attorney at the U.S. Securities and
39. Exchange Commission, Division of Investment
Management, from 1986 to 1991.
- -------------------------------------------------------------------------------------------------------------
Donald E. Brostrom; 237 Park Assistant Director, Fund Services, Furman Selz Incorporated
Avenue, New York, NY 10017; Treasurer since 1986; Managing Director of Furman Selz since
37 1995.
- -------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 35
<TABLE>
<CAPTION>
=============================================================================================================
POSITION(S) HELD
NAME, ADDRESS, AND AGE WITH THE TRUST PRINCIPAL OCCUPATION(S) DURING THE PAST 5 YEARS
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Eric Rubin; Assistant Mr. Rubin joined Furman Selz as a Managing Director
7501 East McCormick Parkway, Secretary in the Mutual Fund Division in June of 1995.
110N Scottsdale, AZ 85258 Previous to that, Mr. Rubin was a Vice President and
Managing Director at Banc One Investment Advisers in
Columbus, Ohio. In that role, he was responsible for
sales, marketing, product development and
administration for Banc One's proprietary Fund
family. From January 1989 to November 1993 Mr. Rubin
was employed by Furman Selz as an Associate Director.
Throughout those years he was responsible for the
administration and fund accounting of several
proprietary bank mutual fund groups. He also served
as an officer or several of those fund complexes.
=============================================================================================================
</TABLE>
Each trustee receives an annual fee of $1000 plus $250 for
each Board meeting attended and reimbursement of expenses incurred in attending
meetings.
For the last fiscal year, the Trustees will receive the
following compensation from the Trust and from certain other investment
companies (as indicated) that have the same investment adviser as the Trust or
an investment adviser that is an affiliate person of the Trust's investment
adviser:
<TABLE>
<CAPTION>
====================================================================================================================
PENSION OR
RETIREMENT TOTAL
BENEFITS ESTIMATED COMPENSATION
AGGREGATE ACCRUED AS ANNUAL FROM
COMPENSATION PART OF BENEFITS REGISTRANT
FROM THE TRUST UPON AND FUND
NAME OF TRUSTEE TRUST EXPENSE RETIREMENT COMPLEX
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Dennis W. Draper $2000* $0 $0 $12,500**
- --------------------------------------------------------------------------------------------------------------------
Joseph N. Hankin $2000* $0 $0 $12,500**
- --------------------------------------------------------------------------------------------------------------------
John E. Heilmann $2000* $0 $0 $12,500**
- --------------------------------------------------------------------------------------------------------------------
Jack D. Henderson $2000* $0 $ $11,707**
- --------------------------------------------------------------------------------------------------------------------
Richard A. Wedemeyer $2000* $0 $0 $11,707**
====================================================================================================================
</TABLE>
* Estimated compensation for the Trust's 1996 fiscal year.
** Includes amounts received for service as a member of the Board of
Trustees of Pacific Funds Trust which is also advised by WFIM.
As of the date of this Statement of Additional Information,
the Trust's Trustees and officers as a group own less than 1% of the
outstanding shares of each Portfolio.
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<PAGE> 36
Adviser
WFIM serves as Adviser to the Portfolios. In the Advisory
Agreement, the Adviser has agreed to provide a continuous investment program
for the respective Portfolios and to pay all expenses it incurs in connection
with its advisory activities, other than the cost of securities and other
investments, including brokerage commissions and other transaction charges, if
any, purchased or sold for the Portfolios.
For the period January 2, 1996 (commencement of operations)
through March 31, 1996, the Adviser was entitled to receive advisory fees in
the following amounts: Emerging Growth Portfolio -- $10,077; Equity Value
Portfolio -- $9,873; Balanced Portfolio -- $9,537; Intermediate Bond Portfolio
- -- $7,928; Money Market Portfolio -- $7,332. During such time period, the
Adviser voluntarily waived all of such advisory fees.
The Adviser has agreed that if, in any fiscal year, the
expenses borne by a Portfolio exceed the applicable expense limitations imposed
by the securities regulations of any state in which shares of a Portfolio are
registered or qualified for sale to the public, it will reimburse the Portfolio
for any excess to the extent required by such regulations. To the Trust's
knowledge, as of the date of this Statement of Additional Information the most
restrictive expense limitations for any fiscal year imposed by state securities
regulations which were applicable to the Portfolios were as follows: two and
one-half percent of the first $30 million of a Portfolio's average net assets,
two percent of the next $70 million of average net assets, and one and one-half
percent of a Portfolio's remaining average net assets.
The Advisory Agreement provides that the Adviser shall not be
liable for any error of judgment or mistake of law or for any loss suffered by
the Portfolios in connection with the performance of such agreements, except a
loss resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith or gross negligence on the part of the Adviser in the performance of its
duties or from its reckless disregard of its duties and obligations under the
agreements.
Authority to Act as Adviser
Banking laws and regulations, including the Glass-Steagall Act
as presently interpreted by the Board of Governors of the Federal Reserve
System, presently (a) prohibit a bank holding company registered under the
Federal Bank Holding Company Act of 1956 or any bank or non-bank affiliate
thereof from sponsoring, organizing, controlling or distributing the shares of
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<PAGE> 37
a registered, open-end investment company continuously engaged in the issuance
of its shares, and prohibit banks generally from underwriting securities, but
(b) do not prohibit such a bank holding company or affiliate or banks generally
from acting as investment adviser, transfer agent or custodian to such an
investment company or from purchasing shares of such a company as agent and
upon order of a customer. The Adviser is subject to such banking laws and
regulations.
The Adviser believes that it may perform the services for the
Portfolios contemplated by the Portfolios' Advisory Agreement without
violation of the Glass-Steagall Act or other applicable banking laws or
regulations. It should be noted, however, that future changes in either
Federal or state statutes and regulations relating to permissible activities of
banks or trust companies and their subsidiaries or affiliates, as well as
further judicial or administrative decisions or interpretations of present and
future statutes and regulations, could prevent the Adviser from continuing to
perform such services for the Portfolios. If the Adviser were prohibited from
continuing to perform advisory and sub-advisory services for the Portfolios, it
is expected that the Board of Trustees would recommend that the Portfolios
enter into new agreements or would consider the possible dissolution of the
Portfolios. Any new advisory agreement would be subject to shareholder
approval.
On the other hand, legislation has been proposed in Congress
from time to time, which, if enacted, would permit a bank holding company
subsidiary to organize, sponsor and distribute shares of an investment company
such as the Trust notwithstanding present banking law restrictions. As
described herein, the Portfolios are currently distributed by Furman Selz,
which also provides certain administrative services. If the current
restrictions preventing a bank holding company subsidiary from legally
sponsoring, organizing, controlling and distributing shares of an investment
company were relaxed, the Trust expects that the Adviser or any of its
affiliates would consider the possibility of offering to perform additional
services for the Trust. It is not possible to predict whether or in what form
such legislation might be enacted or the terms upon which the Adviser might
offer to provide such services for consideration by the Trust's Board of
Trustees.
State securities laws on the aforementioned issue may differ
from the interpretations of federal laws expressed herein, and banks and
financial institutions such as the Adviser may be required to register as
dealers pursuant to state law.
Distribution of Shares
The Trust retains Furman Selz to serve as principal
underwriter for the shares of the Portfolios pursuant to a
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<PAGE> 38
Distribution Contract. The Distribution Contract provides that the Furman Selz
will maintain the distribution of the Portfolios' shares to bona fide
investors. Furman Selz is not obligated to sell any specific amount of shares.
Administrative Services
Furman Selz also provides management and administrative
services necessary for the operation of the Portfolios, including among other
things, (i) preparation of shareholder reports and communications, (ii)
regulatory compliance, such as reports to and filings with the Securities and
Exchange Commission ("SEC") and state securities commissions and (iii) general
supervision of the operation of the Portfolios, including coordination of the
services performed by the Portfolios' Adviser, distributor, transfer agent,
custodian, independent accountants, legal counsel and others. In addition,
Furman Selz furnishes office space and facilities required for conducting the
business of the Portfolios and pays the compensation of the Trust's officers
affiliated with Furman Selz. For these services, Furman Selz is entitled to
receive from the Portfolios a fee, payable monthly, at the annual rate of .15%
of each Portfolio's average daily net assets.
For the period January 2, 1996 (commencement of operations)
through March 31, 1996, Furman Selz was entitled to receive administrative fees
in the following amounts: Emerging Growth Portfolio -- $2,016; Equity Value
Portfolio -- $1,974; Balanced Portfolio -- $1,908; Intermediate Bond Portfolio
- -- $1,830; Money Market Portfolio -- $1,833. During such time period, Furman
Selz voluntarily waived its administrative fees in the following amounts:
Emerging Growth Portfolio -- $1,344; Equity Value Portfolio -- $1,316; Balanced
Portfolio -- $1,272; Intermediate Bond Portfolio -- $1,830; Money Market
Portfolio -- $1,833.
The Administrative Services Contract between Furman Selz and
the Trust is terminable with respect to any Portfolio without penalty, at any
time, by vote of a majority of the Trustees who are not "interested persons" of
the Trust and who have no direct or indirect financial interest in the
operation of the Administrative Services Contract upon not more than 60 days
written notice to Furman Selz or by vote of the holders of a majority of the
shares of the Portfolio involved, or, upon 60 days notice, by Furman Selz. The
Administrative Services Contract will terminate automatically in the event of
its assignment.
Custodian and Transfer Agent
Wells Fargo Bank, N.A. (the "Custodian") serves as custodian
of the Portfolios' assets pursuant to the Custody Agreement. Under the Custody
Agreements, the Custodian has
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<PAGE> 39
agreed to (a) maintain a separate account in the name of each Portfolio; (b)
make receipts and disbursements of money on behalf of each Portfolio; (c)
collect and receive all income and other payments and distributions on account
of each Portfolio's portfolio securities; (d) respond to correspondence from
shareholders, security brokers and others relating to its duties; and (e) make
periodic reports to the Trust's Board of Trustees concerning each Portfolio's
operations. The Custodian may, at its own expense, open and maintain a custody
account or accounts on behalf of any Portfolio with other banks or trust
companies, provided that the Custodian shall remain liable for the performance
of all of its duties under the Custody Agreement notwithstanding any
delegation. For its services as custodian, the Custodian is entitled to
receive compensation from each Portfolio based on the aggregate market value of
the portfolio securities of the Portfolio as follows: 0.0210% on the first $5
billion of the average net assets; 0.0175% on the next $5 billion; and 0.0150%
on assets in excess of $10 billion. The minimum annual custody fee payable by
each Portfolio is $500. In addition, the Custodian is entitled to certain
transaction charges at the rate of $20 for each transaction involving a
domestic security, $25 for each transaction involving a foreign security, and
$45 per option (including issuance of an escrow receipt), and to reimbursement
for its out-of-pocket expenses in connection with the above services.
Furman Selz acts as the Trust's transfer agent. The Trust
compensates Furman Selz for providing personnel and facilities to perform
transfer agency related services for the Trust at a rate intended to represent
the cost of providing such services.
AUDITORS
Ernst & Young LLP, 515 South Flower Street, Los Angeles,
California, have been selected to serve as the Portfolios' independent
auditors.
COUNSEL
Drinker Biddle & Reath, Philadelphia National Bank Building,
1345 Chestnut Street, Philadelphia, Pennsylvania 19107-3496, serves as counsel
to the Trust and will pass upon certain legal matters relating to the
Portfolios.
ADDITIONAL INFORMATION ON PERFORMANCE CALCULATIONS
Yield Quotations -- Money Market Portfolio
The standardized annualized seven-day yield for the Money
Market Portfolio is computed by: (1) determining the net change, exclusive of
capital changes, in the value of a
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<PAGE> 40
hypothetical pre-existing account in the Portfolio having a balance of one
share at the beginning of a seven-day period, for which the yield is to be
quoted, (2) dividing the net change in account value by the value of the
account at the beginning of the base period to obtain the base period return,
and (3) annualizing the results (i.e., multiplying the base period return by
(365/7)). The net change in the value of the account in the Portfolio includes
the value of additional shares purchased with dividends from the original share
and dividends declared on both the original share and any such additional
shares, and all fees that are charged by the Portfolio to all shareholder
accounts in proportion to the length of the base period, other than
nonrecurring account and sales charges. For any account fees that vary with
the size of the account, the amount of fees charged is computed with respect to
the Portfolio's mean (or median) account size. The capital changes to be
excluded from the calculation of the net change in account value are realized
gains and losses from the sale of securities and unrealized appreciation and
depreciation. The effective compound yield quotation for the Portfolio is
computed by adding 1 to the unannualized base period return (calculated as
described above), raising the sum to a power equal to 365 divided by 7, and
subtracting 1 from the result.
For the seven-day period ended March 31, 1996, the Money
Market Portfolio had an annualized seven-day yield of 4.29% and an effective
seven-day yield of 4.38%.
Yield and Total Return of the Emerging Growth, Equity Value, Balanced and
Intermediate Bond Portfolios
The 30-day (or one month) standard yield of the Balanced and
Intermediate Bond Portfolios described in the Prospectus is calculated for each
Portfolio in accordance with the method prescribed by the SEC for mutual funds:
a - b
YIELD = 2[( - - - - +1 )6 - 1]
cd
Where: a = dividends and interest earned by a Portfolio during
the period;
b = expenses accrued for the period (net of
reimbursements);
c = average daily number of shares outstanding during the
period, entitled to receive dividends; and
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<PAGE> 41
d = maximum offering price per share on the last day of
the period.
For the purpose of determining net investment income earned during the period
(variable "a" in the formula), dividend income on equity securities held by a
Portfolio is recognized by accruing 1/360 of the stated dividend rate of the
security each day that the security is in the Portfolio. Except as noted
below, interest earned on debt obligations held by a Portfolio is calculated by
computing the yield to maturity of each obligation based on the market value of
the obligation (including actual accrued interest) at the close of business on
the last business day of each month, or, with respect to obligations purchased
during the month, the purchase price (plus actual accrued interest) and
dividing the result by 360 and multiplying the quotient by the market value of
the obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is held by the Portfolio. For purposes of this calculation, it is
assumed that each month contains 30 days. The maturity of an obligation with a
call provision is the next call date on which the obligation reasonably may be
expected to be called or, if none, the maturity date. With respect to debt
obligations purchased at a discount or premium, the formula generally calls for
amortization of the discount or premium. The amortization schedule will be
adjusted monthly to reflect changes in the market value of such debt
obligations. Expenses accrued for the period (variable "b" in the formula)
include all recurring fees charged by a Portfolio to all shareholder accounts
in proportion to the length of the base period and the Portfolio's mean (or
median) account size. Undeclared earned income will be subtracted from the
offering price per share (variable "d" in the formula).
For the one-month period ended March 31, 1996, the Balanced
Portfolio and the Intermediate Bond Portfolio had 30-day yields of 2.23% and
4.90%, respectively.
With respect to mortgage or other receivables-backed
obligations which are expected to be subject to monthly payments of principal
and interest ("pay-downs") (i) gain or loss attributable to actual monthly pay
downs are accounted for as an increase or decrease to interest income during
the period and (ii) each Portfolio may elect either (a) to amortize the
discount and premium on the remaining security, based on the cost of the
security, to the weighted average maturity date, if such information is
available, or to the remaining term of the security, if any, if the weighted
average date is not available or (b) not to amortize discount or premium on the
remaining security.
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<PAGE> 42
Each Portfolio that advertises its "average annual total
return" computes such return by determining the average annual compounded rate
of return during specified periods that equates the initial amount invested to
the ending redeemable value of such investment according to the following
formula:
ERV l/n
T = [(-----) - 1]
P
Where: T = average annual total return;
ERV = ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the
l, 5 or 10 year (or other) periods at the end
of the applicable period (or a fractional
portion thereof);
P = hypothetical initial payment of $1,000; and
n = period covered by the computation, expressed
in years.
Each Portfolio that advertises its "aggregate total return"
computes such returns by determining the aggregate compounded rates of return
during specified periods that likewise equate the initial amount invested to
the ending redeemable value of such investment. The formula for calculating
aggregate total return is as follows:
ERV
Aggregate Total Return = [(-----) - l]
P
The calculations are made assuming that (1) all dividends and
capital gain distributions are reinvested on the reinvestment dates at the
price per share existing on the reinvestment date, (2) all recurring fees
charged to all shareholder accounts are included, and (3) for any account fees
that vary with the size of the account, a mean (or median) account size in the
Portfolio during the periods is reflected. The ending redeemable value
(variable "ERV" in the formula) is determined by assuming complete redemption
of the hypothetical investment after deduction of all nonrecurring charges at
the end of the measuring period.
For the period from January 2, 1996 (commencement of
operations) through March 31, 1996, the total returns for the Portfolios were
as follows:
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<PAGE> 43
<TABLE>
<CAPTION>
=============================================================
FUND TOTAL RETURN
-------------------------------------------------------------
<S> <C>
Emerging Growth Portfolio 8.25%
-------------------------------------------------------------
Equity Value Portfolio 5.65%
-------------------------------------------------------------
Balanced Portfolio 3.26%
-------------------------------------------------------------
Intermediate Bond Portfolio -1.50%
=============================================================
</TABLE>
FINANCIAL STATEMENTS
The Financial Statements included in the Portfolios' March 31,
1996 Semi-Annual Report to Shareholders are incorporated by reference into this
SAI. Copies of the Financial Statements may be obtained upon request and
without charge by calling 1-800-PVA-0628 or by writing Furman Selz, 237 Park
Avenue, New York, New York 10017, or by contacting the Participating Insurance
Company.
MISCELLANEOUS
As used in this Statement of Additional Information and the
Portfolios' Prospectus, a "majority of the outstanding shares" of a Portfolio
or a series of shares, with respect to the approval of an investment advisory
agreement or a change in a fundamental investment policy, means the lesser of
(1) 67% of the shares of the particular Portfolio or series represented at a
meeting at which the holders of more than 50% of the outstanding shares of such
Portfolio or series are present in person or by proxy, or (2) more than 50% of
the outstanding shares of such Portfolio or series.
SunAmerica Inc. ("SunAmerica"), the ultimate parent of Anchor
National Life Insurance Company ("Anchor"), provided the initial seed capital
for each Portfolio on January 2, 1996, in the amount of $5,000,000 per
Portfolio. SunAmerica's principal business address is 1 SunAmerica Center, Los
Angeles, California 90067-6022. As of May 31, 1996, no person or "group" (as
such term is defined in the Securities Exchange Act of 1934, as amended, and
the rules thereunder) was known to Pacifica to have allocated contributions
under annuity contracts such that, upon pass-through of voting rights by
Anchor, the person or group would have the right to give voting instructions
with respect to more than 5% of the outstanding shares of a Portfolio. As of
May 31, 1996, SunAmerica owned the following percentages of each Portfolio
attributable to its seed capital investment in Pacifica: Emerging Growth
Portfolio (86.9%), Equity Value Portfolio (87.1%), Balanced Portfolio (92.5%),
Intermediate Bond Portfolio (95.9%), and Money Market Portfolio (99.7%).
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<PAGE> 44
APPENDIX A
DESCRIPTION OF SECURITIES RATINGS
Commercial Paper Ratings
A Standard & Poor's commercial paper rating is a current
assessment of the likelihood of timely payment of debt considered short-term in
the relevant market. The following summarizes the rating categories used by
Standard and Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is
strong. Those issues determined to possess extremely strong safety
characteristics are denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory.
However, the relative degree of safety is not as high as for issues designated
"A-1."
"A-3" - Issue has an adequate capacity for timely payment. It
is, however, somewhat more vulnerable to the adverse effects of changes in
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely
payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability
of issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are
considered to have a superior capacity for repayment of short-term promissory
obligations. Prime-1 repayment capacity will normally be evidenced by the
following characteristics: leading market positions in well established
industries; high rates of return on funds employed; conservative capitalization
structures with moderate reliance on debt and ample asset protection; broad
margins in earning coverage of fixed financial charges and high internal cash
generation; and well established access to a range of financial markets and
assured sources of alternate liquidity.
A-1
<PAGE> 45
"Prime-2" - Issuer or related supporting institutions are
considered to have a strong capacity for repayment of short-term promissory
obligations. This will normally be evidenced by many of the characteristics
cited above but to a lesser degree. Earnings trends and coverage ratios, while
sound, will be more subject to variation. Capitalization characteristics,
while still appropriate, may be more affected by external conditions. Ample
alternative liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime
rating categories.
The three rating categories of Duff & Phelps for investment
grade commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff &
Phelps employs three designations, "D-1+," "D-1" and "D-1-," within the highest
rating category. The following summarizes the rating categories used by Duff &
Phelps for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment.
Short-term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment.
Liquidity factors are strong and supported by good fundamental protection
factors. Risk factors are very small.
"D-2" - Debt possesses good certainty of timely payment.
Liquidity factors and company fundamentals are sound. Although ongoing funding
needs may enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
"D-3" - Debt possesses satisfactory liquidity, and other
protection factors qualify issue as investment grade. Risk
A-2
<PAGE> 46
factors are larger and subject to more variation. Nevertheless, timely payment
is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or
interest payments.
Fitch short-term ratings apply to debt obligations that are
payable on demand or have original maturities of generally up to three years.
The following summarizes the rating categories used by Fitch for short-term
obligations:
"F-1+" - Securities possess exceptionally strong credit
quality. Issues assigned this rating are regarded as having the strongest
degree of assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues
assigned this rating have a satisfactory degree of assurance for timely
payment, but the margin of safety is not as great as the "F-1+" and "F-1"
categories.
"F-3" - Securities possess fair credit quality. Issues
assigned this rating have characteristics suggesting that the degree of
assurance for timely payment is adequate; however, near-term adverse changes
could cause these securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues
assigned this rating have characteristics suggesting a minimal degree of
assurance for timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term
ratings to indicate that the rating is based upon a letter of credit issued by
a commercial bank.
Thomson BankWatch short-term ratings assess the likelihood of
an untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one
A-3
<PAGE> 47
year or less which are issued by United States commercial banks, thrifts and
non-bank banks; non-United States banks; and broker-dealers. The following
summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's
highest rating category and indicates a very high degree of likelihood that
principal and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of
safety regarding timely payment of principal and interest is strong, the
relative degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment
grade category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded
as non-investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1+" - Obligations supported by the highest capacity for
timely repayment.
"A1" - Obligations are supported by the highest capacity for
timely repayment.
"A2" - Obligations are supported by a satisfactory capacity
for timely repayment.
"A3" - Obligations are supported by a satisfactory capacity
for timely repayment.
"B" - Obligations for which there is an uncertainty as to the
capacity to ensure timely repayment.
"C" - Obligations for which there is an inadequate capacity to
ensure timely repayment.
"D" - Obligations for which there is a high risk of default or
which are currently in default.
A-4
<PAGE> 48
Corporate and Municipal Long-Term Debt Ratings
The following summarizes the ratings used by Standard & Poor's
for corporate and municipal debt:
"AAA" - This designation represents the highest rating
assigned by Standard & Poor's to a debt obligation and indicates an extremely
strong capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to
pay interest and repay principal and differs from AAA issues only in small
degree.
"A" - Debt is considered to have a strong capacity to pay
interest and repay principal although such issues are somewhat more susceptible
to the adverse effects of changes in circumstances and economic conditions than
debt in higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay interest and repay
principal for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance,
as predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payments. The
"BB" rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal repayments.
Adverse business, financial or economic conditions will likely impair capacity
or willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE> 49
"CCC" - Debt has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The "CCC"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated
to senior debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to
senior debt which is assigned an actual or implied "CCC-" debt rating. The "C"
rating may be used to cover a situation where a bankruptcy petition has been
filed, but debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no
interest is being paid.
"D" - Debt is in payment default. This rating is used when
interest payments or principal payments are not made on the date due, even if
the applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. "D" rating is also used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC"
may be modified by the addition of a plus or minus sign to show relative
standing within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid,
and certain other obligations that S & P believes may experience high
volatility or high variability in expected returns due to non-credit risks.
Examples of such obligations are: securities whose principal or interest return
is indexed to equities, commodities, or currencies; certain swaps and options;
and interest only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
A-6
<PAGE> 50
"Aa" - Bonds are judged to be of high quality by all
standards. Together with the "Aaa" group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in "Aaa" securities or fluctuation
of protective elements may be of greater amplitude or there may be other
elements present which make the long-term risks appear somewhat larger than in
"Aaa" securities.
"A" - Bonds possess many favorable investment attributes and
are to be considered as upper medium-grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they
are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of
these ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be
in default.
Con. (---) - Bonds for which the security depends upon the
completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed, or (d) payments to which
some other limiting condition attaches. Parenthetical rating denotes probable
credit stature upon completion of construction or elimination of basis of
condition.
(P)... - When applied to forward delivery bonds, indicates
that the rating is provisional pending delivery of the bonds. The rating may
be revised prior to delivery if changes occur in the legal documents or the
underlying credit quality of the bonds.
A-7
<PAGE> 51
The following summarizes the long-term debt ratings used by
Duff & Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit
quality. The risk factors are negligible, being only slightly more than for
risk-free U.S. Treasury debt.
"AA" - Debt is considered of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from time to time
because of economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but
such protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of
these ratings is considered to be below investment grade. Although below
investment grade, debt rated "BB" is deemed likely to meet obligations when
due. Debt rated "B" possesses the risk that obligations will not be met when
due. Debt rated "CCC" is well below investment grade and has considerable
uncertainty as to timely payment of principal, interest or preferred dividends.
Debt rated "DD" is a defaulted debt obligation, and the rating "DP" represents
preferred stock with dividend arrearages.
To provide more detailed indications of credit quality, the
"AA," "A," "BBB," "BB" and "B" ratings may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within these major
categories.
The following summarizes the highest four ratings used by
Fitch for corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
"AA" - Bonds considered to be investment grade and of very
high credit quality. The obligor's ability to pay interest and repay principal
is very strong, although not quite as strong as bonds rated "AAA." Because
bonds rated in the "AAA" and "AA" categories are not significantly vulnerable
to foreseeable future developments, short-term debt of these issuers is
generally rated "F-1+."
A-8
<PAGE> 52
"A" - Bonds considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings
of these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" - Bonds that
possess one of these ratings are considered by Fitch to be speculative
investments. The ratings "BB" to "C" represent Fitch's assessment of the
likelihood of timely payment of principal and interest in accordance with the
terms of obligation for bond issues not in default. For defaulted bonds, the
rating "DDD" to "D" is an assessment of the ultimate recovery value through
reorganization or liquidation.
To provide more detailed indications of credit quality, the
Fitch ratings from and including "AA" to "C" may be modified by the addition of
a plus (+) or minus (-) sign to show relative standing within these major
rating categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation
of investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation
of investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
strong, although adverse changes in business,
A-9
<PAGE> 53
economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low
expectation of investment risk. Capacity for timely repayment of principal and
interest is adequate, although adverse changes in business, economic or
financial conditions are more likely to lead to increased investment risk than
for obligations in other categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one
of these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree
of speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating
to denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely
repayment of principal or interest over the term to maturity of long term debt
and preferred stock which are issued by United States commercial banks, thrifts
and non-bank banks; non-United States banks; and broker-dealers. The following
summarizes the rating categories used by Thomson BankWatch for long-term debt
ratings:
"AAA" - This designation represents the highest category
assigned by Thomson BankWatch to long-term debt and indicates that the ability
to repay principal and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to
repay principal and interest on a timely basis with limited incremental risk
compared to issues rated in the highest category.
"A" - This designation indicates that the ability to repay
principal and interest is strong. Issues rated "A" could be more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
A-10
<PAGE> 54
"BB," "B," "CCC," and "CC," - These designations are assigned
by Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of principal and interest. "BB" indicates the lowest degree of
speculation and "CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC"
may include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
Municipal Note Ratings
A Standard and Poor's rating reflects the liquidity concerns
and market access risks unique to notes due in three years or less. The
following summarizes the ratings used by Standard & Poor's Ratings Group for
municipal notes:
"SP-1" - The issuers of these municipal notes exhibit very
strong or strong capacity to pay principal and interest. Those issues
determined to possess overwhelming safety characteristics are given a plus (+)
designation.
"SP-2" - The issuers of these municipal notes exhibit
satisfactory capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit
speculative capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other
short-term loans are designated Moody's Investment Grade ("MIG") and variable
rate demand obligations are designated Variable Moody's Investment Grade
("VMIG"). Such ratings recognize the differences between short-term credit
risk and long-term risk. The following summarizes the ratings by Moody's
Investors Service, Inc. for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the
best quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high
quality, with margins of protection ample although not so large as in the
preceding group.
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"MIG-3"/"VMIG-3" - Loans bearing this designation are of
favorable quality, with all security elements accounted for but lacking the
undeniable strength of the preceding grades. Liquidity and cash flow
protection may be narrow and market access for refinancing is likely to be less
well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of
adequate quality, carrying specific risk but having protection commonly
regarded as required of an investment security and not distinctly or
predominantly speculative.
"SG" - Loans bearing this designation are of speculative
quality and lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described
under Commercial Paper Ratings for municipal notes.
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APPENDIX B
As stated in the Prospectus, the Equity Value and Balanced
Portfolios may enter into futures contracts and options for hedging purposes.
Such transactions are described in this Appendix.
I. Stock Index Futures Contracts.
General. A stock index assigns relative values to the stocks
included in the index and the index fluctuates with changes in the market
values of the stocks included. A stock index futures contract is a bilateral
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to a specified dollar amount times the difference between
the stock index value (which assigns relative values to the common stocks
included in the index) at the close of the last trading day of the contract and
the price at which the futures contract is originally struck. No physical
delivery of the underlying stocks in the index is made. Some stock index
futures contracts are based on broad market indexes, such as the Standard &
Poor's 500 or the New York Stock Exchange Composite Index. In contrast,
certain exchanges offer futures contracts on narrower market indexes, such as
the Standard & Poor's 100 or indexes based on an industry or market segment,
such as oil and gas stocks. Futures contracts are traded on organized
exchanges regulated by the Commodity Futures Trading Commission. Transactions
on such exchanges are cleared through a clearing corporation, which guarantees
the performance of the parties to each contract. The price of a single futures
contract is determined by multiplying the relevant index's value by $500. For
example, if the value of an index were 125, one contract would be worth $62,500
(125 x $500). If the value of such index increased to 130, the value of one
contract would increase by $2,500 (5 x $500) to $65,000. Conversely, if the
value of such index dropped to 115, the value of one contract bought at the
original value of 125 would fall by $5,000 (10 x $500) to $57,500.
Examples of Stock Index Futures Transactions. The following
are examples of transactions in stock index futures (net of commissions and
premiums, if any).
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures at 125
in Equity Securities Value of Futures =
$62,500/Contract
-Day Hedge is Lifted-
Buy Equity Securities with Actual Cost = Sell 1 Index Futures at 130
$65,000 Increase in Value of Futures =
Purchase Price = $65,000/Contract
$2,500 Gain on Futures = $2,500
</TABLE>
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors:
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index = 1.0
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
in Equity Securities Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Securities-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value on Futures = $960,000
Loss in Portfolio Value = Gain on Futures = $40,000
$40,000
</TABLE>
If, however, the market moved in the opposite direction, that
is, market value decreased and the Portfolio had entered into an anticipatory
purchase hedge, or market value increased and the Portfolio had hedged its
stock portfolio, the results of the Portfolio's transactions in stock index
futures would be as set forth below.
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures
in Equity Securities at 125
Value of Futures =
$62,500/Contract
-Day Hedge is Lifted-
Buy Equity Securities Sell 1 Index Futures at 120
Actual Cost = $60,000 Value of Futures =
Decrease in Purchase Price = $60,000/Contract
$2,500 Loss on Futures = $2,500
</TABLE>
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors:
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index = 1.0
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
in Equity Securities Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Securities-Own Buy 16 Index Futures at 130
Stock with Value = Value on Futures = $1,040,000
$1,040,000 Loss on Futures = $40,000
Gain in Portfolio =
$40,000
</TABLE>
II. Margin Payments.
Unlike when a Portfolio purchases or sells a security, no
price is paid or received by a Portfolio upon the purchase or sale of a futures
contract. Initially, a Portfolio will be required to deposit with the broker
or in a segregated account with the Portfolio's custodian an amount of cash or
cash equivalents, the value of which may vary but is generally equal
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to 10% or less of the value of the contract. This amount is known as initial
margin. The nature of initial margin in futures transactions is different from
that of margin in security transactions in that futures contract margin does
not involve the borrowing of funds by the customer to finance the transactions.
Rather, the initial margin is in the nature of a performance bond or good faith
deposit on the contract which is returned to the Portfolio upon termination of
the futures contract assuming all contractual obligations have been satisfied.
Subsequent payments, called variation margin, to and from the broker, will be
made on a daily basis as the price of the underlying instrument fluctuates
making the long and short positions in the futures contract more or less
valuable, a process known as "marking-to-market." For example, when a
Portfolio has purchased a futures contract and the price of the contract has
risen in response to a rise in the underlying instruments, that position will
have increased in value and the Portfolio will be entitled to receive from the
broker a variation margin payment equal to that increase in value. Conversely,
where a Portfolio has purchased a futures contract and the price of the futures
contract has declined in response to a decrease in the underlying instruments,
the position would be less valuable and the Portfolio would be required to make
a variation margin payment to the broker. At any time prior to expiration of
the futures contract, the Adviser may elect to close the position by taking an
opposite position, subject to the availability of a secondary market, which
will operate to terminate the Portfolio's position in the futures contract. A
final determination of variation margin is then made, additional cash is
required to be paid by or released to the Portfolio, and the Portfolio realizes
a loss or gain.
III. Risks of Transactions in Futures Contracts.
There are several risks in connection with the use of futures
by a Portfolio as a hedging device. One risk arises because of the imperfect
correlation between movements in the price of the future and movements in the
price of the securities which are the subject of the hedge. The price of the
future may move more than or less than the price of the securities being
hedged. If the price of the future moves less than the price of the securities
which are the subject of the hedge, the hedge will not be fully effective but,
if the price of the securities being hedged has moved in an unfavorable
direction, the Portfolio would be in a better position than if it had not
hedged at all. If the price of the securities being hedged has moved in a
favorable direction, this advantage will be partially offset by the loss on the
future. If the price of the future moves more than the price of the hedged
securities, the Portfolio involved will experience either a loss or gain on the
future which will not be completely offset by movements in the price of the
securities which are the subject of the hedge. To compensate for the imperfect
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correlation of movements in the price of securities being hedged and movements
in the price of futures contracts, a Portfolio may buy or sell futures
contracts in a greater dollar amount than the dollar amount of securities being
hedged if the volatility over a particular time period of the prices of such
securities has been greater than the volatility over such time period of the
future, or if otherwise deemed to be appropriate by the Adviser. Conversely, a
Portfolio may buy or sell fewer futures contracts if the volatility over a
particular time period of the prices of the securities being hedged is less
than the volatility over such time period of the futures contract being used,
or if otherwise deemed to be appropriate by the Adviser. It is also possible
that, where a Portfolio has sold futures to hedge its portfolio against a
decline in the market, the market may advance and the value of securities held
by the Portfolio may decline. If this occurred, the Portfolio would lose money
on the future and also experience a decline in value in its portfolio
securities.
Where futures are purchased to hedge against a possible
increase in the price of securities before a Portfolio is able to invest its
cash (or cash equivalents) in securities (or options) in an orderly fashion, it
is possible that the market may decline instead; if the Portfolio then
concludes not to invest in securities or options at that time because of
concern as to possible further market decline or for other reasons, the
Portfolio will realize a loss on the futures contract that is not offset by a
reduction in the price of securities purchased.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. Rather than
meeting additional margin deposit requirements, investors may close futures
contracts through off-setting transactions which could distort the normal
relationship between the cash and futures markets. Second, with respect to
financial futures contracts, the liquidity of the futures market depends on
participants entering into off-setting transactions rather than making or
taking delivery. To the extent participants decide to make or take delivery,
liquidity in the futures market could be reduced thus producing distortions.
Third, from the point of view of speculators, the deposit requirements in the
futures market are less onerous than margin requirements in the securities
market. Therefore, increased participation by speculators in the futures
market may also cause temporary price distortions. Due to the possibility of
price distortion in the futures market, and because of the imperfect
correlation between the movements in the cash market and movements in the price
of futures, a correct forecast of general market trends or interest rate
movements by the Adviser may still not result in a successful hedging
transaction over a short time frame.
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Positions in futures may be closed out only on an exchange or
board of trade which provides a secondary market for such futures. Although
the Equity Value and Balance Portfolios intend to purchase or sell futures only
on exchanges or boards of trade where there appear to be active secondary
markets, there is no assurance that a liquid secondary market on any exchange
or board of trade will exist for any particular contract or at any particular
time. In such event, it may not be possible to close a futures investment
position, and in the event of adverse price movements, the Portfolios would
continue to be required to make daily cash payments of variation margin.
However, in the event futures contracts have been used to hedge portfolio
securities, such securities will not be sold until the futures contract can be
terminated. In such circumstances, an increase in the price of the securities,
if any, may partially or completely offset losses on the futures contract.
However, as described above, there is no guarantee that the price of the
securities will in fact correlate with the price movements in the futures
contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary
market in a futures contract may be adversely affected by "daily price
fluctuation limits" established by commodity exchanges which limit the amount
of fluctuation in a futures contract price during a single trading day. Once
the daily limit has been reached in the contract, no trades may be entered into
at a price beyond the limit, thus preventing the liquidation of open futures
positions. The trading of futures contracts is also subject to the risk of
trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of a brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Successful use of futures by a Portfolio is also subject to
the ability of the Adviser to predict correctly movements in the direction of
the market. For example, if a Portfolio has hedged against the possibility of
a decline in the market adversely affecting securities held in its portfolio
and securities prices increase instead, the Portfolio will lose part or all of
the benefit to the increased value of its securities which it has hedged
because it will have offsetting losses in its futures positions. In addition,
in such situations, if a Portfolio has insufficient cash, it may have to sell
securities to meet daily variation margin requirements. Such sales of
securities may be, but will not necessarily be, at increased prices which
reflect the rising market. A Portfolio may have to sell securities at a time
when it may be disadvantageous to do so.
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IV. Put Options on Stock Index Futures Contracts.
The Equity Value and Balanced Portfolios may purchase put
options on stock index futures contracts that would give the Portfolio, in
return for the premium paid, the right to sell (put) to the writer of the
option a stock index futures contract at a specified price at any time during
the period of the option. Upon exercise, the writer of the option is obligated
to pay the difference between the cash value of the futures contract and the
exercise price. Like the buyer of a futures contract, the holder of a put
option has the right to terminate its position prior to the scheduled
expiration of the option by selling an option of the same series, at which time
the person entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same
considerations that are involved in connection with investments in futures
contracts (for example, the existence of a liquid secondary market). The
purchase of an option also entails the risk that changes in the value of the
underlying futures contract will not be fully reflected in the value of the
option purchased. Depending on the pricing of the option compared to either
the futures contract upon which it is based, or upon the price of the
securities being hedged, an option may or may not be less risky than ownership
of the futures contract or such securities. In general, the market prices of
options can be expected to be more volatile than the market prices on the
underlying futures contract. Compared to the sale of futures contracts,
however, the purchase of put options on futures contracts may frequently
involve less potential risk to a Portfolio because the maximum amount at risk
is the premium paid for the options (plus transaction costs).
V. Other Hedging Transactions.
The Equity Value and Balanced Portfolios may use stock index
futures contracts (and related options) in connection with their hedging
activities. The Portfolios also are authorized to enter into hedging
transactions in any other futures or options contracts which are currently
traded or which may subsequently become available for trading. Such
instruments may be employed in connection with the Portfolios' hedging
strategies if, in the judgment of the Adviser, transactions therein are
necessary or advisable.
VI. Accounting and Tax Treatment.
Accounting for futures contracts and options will be in
accordance with generally accepted accounting principles.
Generally, futures contracts held by a Portfolio at the close
of the Portfolio's taxable year will be treated for federal
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income tax purposes as sold for their fair market value on the last business
day of such year, a process known as "marking-to-market." Forty percent of any
gain or loss resulting from such constructive sale will be treated as
short-term capital gain or loss and 60% of such gain or loss will be treated as
long-term capital gain or loss without regard to the length of time the
Portfolio holds the futures contract ("the 40-60 rule"). The amount of any
capital gain or loss actually realized by a Portfolio in a subsequent sale or
other disposition of those futures contracts will be adjusted to reflect any
capital gain or loss taken into account by the Portfolio in a prior year as a
result of the constructive sale of the contracts. With respect to futures
contracts to sell, which will be regarded as parts of a "mixed straddle"
because their values fluctuate inversely to the values of specific securities
held by the Portfolio, losses as to such contracts to sell will be subject to
certain loss deferral rules which limit the amount of loss currently deductible
on either part of the straddle to the amount thereof which exceeds the
unrecognized gain (if any) with respect to the other part of the straddle, and
to certain wash sales regulations. Under short sales rules, which will also be
applicable, the holding period of the securities forming part of the straddle
will (if they have not been held for the long-term holding period) be deemed
not to begin prior to termination of the straddle. With respect to certain
futures contracts, deductions for interest and carrying charges will not be
allowed. Notwithstanding the rules described above, with respect to futures
contracts to sell which are properly identified as such, a Portfolio may make
an election which will exempt (in whole or in part) those identified futures
contracts from being treated for federal income tax purposes as sold on the
last business day of the Portfolio's taxable year, but gains and losses will be
subject to such short sales, wash sales, loss deferral rules and the
requirement to capitalize interest and carrying charges. Under temporary
regulations, a Portfolio would be allowed (in lieu of the foregoing) to elect
either (1) to offset gains or losses from portions which are part of a mixed
straddle by separately identifying each mixed straddle to which such treatment
applies, or (2) to establish a mixed straddle account for which gains and
losses would be recognized and offset on a periodic basis during the taxable
year. Under either election, the 40-60 rule will apply to the net gain or loss
attributable to the futures contracts, but in the case of a mixed straddle
account election, not more than 50% of any net gain may be treated as long-term
and no more than 40% of any net loss may be treated as short-term. Options on
futures contracts generally receive federal tax treatment similar to that
described above.
Under the federal income tax provisions applicable to
regulated investment companies, less than 30% of a company's gross income must
be derived from gains realized on the sale or other disposition of securities
held for less than three months.
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With respect to futures contracts and other financial instruments subject to
the "marking-to-market" rules, the Internal Revenue Service has ruled in
private letter rulings that a gain realized from such a futures contract or
financial instrument will be treated as being derived from a security held for
three months or more (regardless of the actual period for which the contract or
instrument is held) if the gain arises as a result of a constructive sale under
the "marking-to-market" rules, and will be treated as being derived from a
security held for less than three months only if the contract or instrument is
terminated (or transferred) during the taxable year (other than by reason of
marking-to-market) and less than three months have elapsed between the date the
contract or instrument is acquired and the termination date. In determining
whether the 30% test is met for a taxable year, increases and decreases in the
value of a Portfolio's futures contracts and other investments that qualify as
part of a "designated hedge," as defined in the Code, may be netted.
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