<PAGE>
Wanger Advisors Trust
Supplement dated July 17, 1998 to
Prospectus dated April 30, 1998
[Replace fourth paragraph on first page of the Prospectus with the following]
A Statement of Additional Information ("SAI") dated the date of this prospectus,
and any supplement to the SAI, has been filed with the Securities and Exchange
Commission, and is incorporated herein by reference. The SAI is available free
upon request by calling WAM at 1-800-4-WANGER.
<PAGE>
WANGER ADVISORS TRUST
STATEMENT OF
ADDITIONAL
INFORMATION
April 30, 1998
Supplemented July 17, 1998
227 West Monroe Street
Chicago, Illinois 60606
Telephone: 1-800-4-WANGER
____________________________
WANGER U.S. SMALL CAP
WANGER INTERNATIONAL SMALL CAP
TABLE OF CONTENTS
-----------------
Page
----
INFORMATION ABOUT THE FUNDS....................................................2
INVESTMENT OBJECTIVES AND POLICIES.............................................2
INVESTMENT TECHNIQUES AND RISKS................................................2
INVESTMENT RESTRICTIONS.......................................................17
PERFORMANCE INFORMATION.......................................................20
INVESTMENT ADVISER............................................................22
DISTRIBUTOR...................................................................24
THE TRUST.....................................................................25
TRUSTEES AND OFFICERS; CERTAIN SHAREHOLDERS...................................26
PURCHASING AND REDEEMING SHARES...............................................28
ADDITIONAL TAX INFORMATION....................................................29
PORTFOLIO TRANSACTIONS........................................................30
CUSTODIAN.....................................................................32
INDEPENDENT AUDITORS..........................................................32
APPENDIX.....................................................................A-1
This Statement of Additional Information ("SAI") is not a prospectus but
provides information that should be read in conjunction with the prospectus of
Wanger Advisors Trust dated April 30, 1998 and any supplement thereto, which may
be obtained from the Trust at no charge by writing or telephoning Wanger Asset
Management, L.P., the Trust's investment adviser, at the address or telephone
number shown above.
1
<PAGE>
INFORMATION ABOUT THE FUNDS
Wanger U.S. Small Cap ("U.S. Small Cap") and Wanger International Small Cap
("International Small Cap") (each, a "Fund"; together, the "Funds") are series
of Wanger Advisors Trust (the "Trust"). Both Funds are currently available only
for allocation to certain life insurance company ("Life Company") separate
accounts established for the purpose of funding certain qualified and non-
qualified variable annuity contracts ("Variable Contracts"), and may also be
offered directly to certain types of pension plans and retirement arrangements
and accounts permitting the accumulation of funds on a tax-deferred basis
("Retirement Plans"), as described in the prospectus.
A copy of the Trust's 1997 Annual Report accompanies this SAI. The Annual Report
contains audited financial statements, notes thereto, supplementary information
entitled "Financial Highlights," and a report of independent auditors, all of
which (but no other part of the Annual Report) are incorporated herein by
reference. Additional copies of the Annual Report may be obtained without charge
by writing or telephoning Wanger Asset Management, L.P. at the address or
telephone number shown on the cover page of this SAI.
The discussion below supplements the description in the prospectus of the Funds'
investment objectives, policies, and restrictions.
INVESTMENT OBJECTIVES AND POLICIES
U.S. Small Cap and International Small Cap invest with the objective of long-
term growth of capital. Although income is considered by U.S. Small Cap in the
selection of securities, the Funds are not designed for investors seeking
primarily income rather than capital appreciation. Both Funds are managed by
Wanger Asset Management, L.P. ("WAM").
The Funds use the techniques and invest in the types of securities described
below and in the prospectus.
INVESTMENT TECHNIQUES AND RISKS
Foreign Securities
The Funds invest in foreign securities, which may entail a greater degree of
risk (including risks relating to exchange rate fluctuations, tax provisions, or
expropriation of assets) than does investment in securities of domestic issuers.
Under normal market conditions, International Small Cap invests at least 65% of
its total assets, taken at market value, in foreign securities. U.S. Small Cap
does not have a current intention to invest more than 5% of its net assets in
foreign securities.
The Funds may invest in securities of foreign issuers directly or in the form of
American Depositary Receipts (ADRs), European Depositary Receipts (EDRs), or
other securities
2
<PAGE>
representing underlying shares of foreign issuers. Positions in these securities
are not necessarily denominated in the same currency as the common stocks into
which they may be converted. ADRs are receipts typically issued by an American
bank or trust company evidencing ownership of the underlying securities. EDRs
are European receipts evidencing a similar arrangement. Generally, ADRs, in
registered form, are designed for use in the U.S. securities markets and EDRs,
in bearer form, are designed for use in European securities markets. A Fund may
invest in both "sponsored" and "unsponsored" ADRs. In a sponsored ADR, the
issuer typically pays some or all of the expenses of the depository and agrees
to provide its regular shareholder communications to ADR holders. An unsponsored
ADR is created independently of the issuer of the underlying security. The ADR
holders generally pay the expenses of the depository and do not have an
undertaking from the issuer of the underlying security to furnish shareholder
communications. Neither Fund expects to invest more than 5% of its total assets
in unsponsored ADRs.
A Fund's investment performance is affected by the strength or weakness of the
U.S. dollar against the currencies of the foreign markets in which the Fund's
securities trade or in which they are denominated. For example, if the dollar
falls in value relative to the Japanese yen, the dollar value of a yen-
denominated stock held in the portfolio will rise even though the price of the
stock remains unchanged. Conversely, if the dollar rises in value relative to
the yen, the dollar value of the yen-denominated stock will fall. (See the
discussion of transaction hedging and portfolio hedging under "Currency Exchange
Transactions.")
Investors should understand and consider carefully the risks involved in foreign
investing. Investing in foreign securities, positions in which are generally
denominated in foreign currencies, and utilization of forward foreign currency
exchange contracts involve risks and opportunities not typically associated with
investing in U.S. securities. These considerations include: fluctuations in
exchange rates of foreign currencies; possible imposition of exchange control
regulation or currency restrictions that would prevent cash from being brought
back to the United States; less public information with respect to issuers of
securities; less governmental supervision of stock exchanges, securities
brokers, and issuers of securities; lack of uniform accounting, auditing, and
financial reporting standards; lack of uniform settlement periods and trading
practices; less liquidity and frequently greater price volatility in foreign
markets than in the United States; possible imposition of foreign taxes;
possible investments in securities of companies in developing as well as
developed countries; and sometimes less advantageous legal, operational, and
financial protections applicable to foreign sub-custodial arrangements.
Although the Funds try to invest in companies and governments of countries
having stable political environments, there is the possibility of expropriation
or confiscatory taxation, seizure or nationalization of foreign bank deposits or
other assets, establishment of exchange controls, the adoption of foreign
government restrictions, or other adverse political, social, or diplomatic
developments that could affect investment in these nations.
3
<PAGE>
Currency Exchange Transactions
The Funds may enter into currency exchange transactions. A currency exchange
transaction may be conducted either on a spot (i.e., cash) basis at the spot
rate for purchasing or selling currency prevailing in the foreign exchange
market or through a forward currency exchange contract ("forward contract"). A
forward contract is an agreement to purchase or sell a specified currency at a
specified future date (or within a specified time period) and price set at the
time of the contract. Forward contracts are usually entered into with banks,
foreign exchange dealers or broker-dealers, are not exchange traded, and are
usually for less than one year, but may be renewed.
Forward currency transactions may involve currencies of the different countries
in which the Funds may invest, and serve as hedges against possible variations
in the exchange rate between these currencies. The Funds' currency transactions
are limited to transaction hedging and portfolio hedging involving either
specific transactions or portfolio positions, except to the extent described
below under "Synthetic Foreign Money Market Positions." Transaction hedging is
the purchase or sale of a forward contract with respect to specific payables or
receivables of a Fund accruing in connection with the purchase or sale of
portfolio securities. Portfolio hedging is the use of a forward contract with
respect to a portfolio security position denominated or quoted in a particular
currency. The Funds may engage in portfolio hedging with respect to the currency
of a particular country in amounts approximating actual or anticipated positions
in securities denominated in that currency. When either Fund owns or anticipates
owning securities in countries whose currencies are linked, WAM may aggregate
such positions as to the currency hedged.
If a Fund enters into a forward contract hedging an anticipated purchase of
portfolio securities, liquid assets of that Fund, such as cash, U.S. government
securities, or other liquid high grade debt obligations, having a value equal to
the Fund's commitment under such forward contract will be segregated on the
books of the Fund and held by the custodian while the contract is outstanding.
At the maturity of a forward contract to deliver a particular currency, a Fund
may either sell the portfolio security related to such contract and make
delivery of the currency, or it may retain the security and either acquire the
currency on the spot market or terminate its contractual obligation to deliver
the currency by purchasing an offsetting contract with the same currency trader
obligating it to purchase on the same maturity date the same amount of the
currency.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for a Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of currency that the Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the currency.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency that the Fund is obligated to deliver.
4
<PAGE>
If a Fund retains the portfolio security and engages in an offsetting
transaction, that Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period between a Fund's
entering into a forward contract for the sale of a currency and the date it
enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, a Fund will suffer a loss to the extent the price of the
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell. A default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase or sale of the
currency, if any, at the current market price.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for a Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates. The cost to a Fund of
engaging in currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and prevailing market
conditions. Because currency exchange transactions are usually conducted on a
principal basis, no fees or commissions are involved.
Synthetic Foreign Money Market Positions. The Funds may invest in money market
instruments denominated in foreign currencies. In addition to, or in lieu of,
such direct investment, the Funds may construct a synthetic foreign money market
position by (a) purchasing a money market instrument denominated in one
currency, generally U.S. dollars, and (b) concurrently entering into a forward
contract to deliver a corresponding amount of that currency in exchange for a
different currency on a future date and at a specified rate of exchange. For
example, a synthetic money market position in Japanese yen could be constructed
by purchasing a U.S. dollar money market instrument, and entering concurrently
into a forward contract to deliver a corresponding amount of U.S. dollars in
exchange for Japanese yen on a specified date and at a specified rate of
exchange. Because of the availability of a variety of highly liquid short-term
U.S. dollar money market instruments, a synthetic money market position
utilizing such U.S. dollar instruments may offer greater liquidity than direct
investment in foreign money market instruments. The results of a direct
investment in a foreign currency and a concurrent construction of a synthetic
position in such foreign currency, in terms of both income yield and gain or
loss from changes in currency exchange rates, in general should be similar, but
would not be identical because the components of the alternative investments
would not be identical. Except to the extent a synthetic foreign money market
position consists of a money market instrument denominated in a foreign
currency, the synthetic foreign money market position shall not be deemed a
"foreign security" for purposes of the policies that, under normal conditions,
(a) U.S. Small Cap will generally invest at least 65% of its total assets in
domestic securities, and (b) International Small Cap will generally invest at
least 65% of its total assets in foreign securities.
5
<PAGE>
Options and Futures
The Funds may purchase and write both call options and put options on securities
and on indexes, and enter into interest rate and index futures contracts, and
may purchase or sell options on such futures contracts ("futures options") in
order to provide additional revenue, or to hedge against changes in security
prices or interest rates. The Funds may also use other types of options, futures
contracts and futures options currently traded or subsequently developed and
traded, provided the Board of Trustees determines that their use is consistent
with the Funds' investment objective.
Options. An option on a security (or index) is a contract that gives the
purchaser (holder) of the option, in return for a premium, the right to buy from
(call) or sell to (put) the seller (writer) of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option (normally not exceeding nine
months). The writer of an option on an individual security or on a foreign
currency has the obligation upon exercise of the option to deliver the
underlying security or foreign currency upon payment of the exercise price or to
pay the exercise price upon delivery of the underlying security or foreign
currency. Upon exercise, the writer of an option on an index is obligated to pay
the difference between the cash value of the index and the exercise price
multiplied by the specified multiplier for the index option. (An index is
designed to reflect specified facets of a particular financial or securities
market, a specific group of financial instruments or securities, or certain
economic indicators.)
The Funds will write call options and put options only if they are "covered."
For example, in the case of a call option on a security, the option is "covered"
if a Fund owns the 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 are held in a segregated account by its custodian) upon conversion or
exchange of other securities held in its portfolio.
If an option written by a Fund expires, that Fund realizes a capital gain equal
to the premium received at the time the option was written. If an option
purchased by a Fund expires, that Fund realizes a capital loss equal to the
premium paid.
Prior to the earlier of exercise or expiration, an option may be closed out by
an offsetting purchase or sale of an option of the same series (type, exchange,
underlying security or index, exercise price and expiration). There can be no
assurance, however, that a closing purchase or sale transaction can be effected
when a Fund desires.
A Fund will realize a capital gain from a closing purchase transaction if the
cost of the closing option is less than the premium received from writing the
option, or, if it is more, the Fund will realize a capital loss. If the premium
received from a closing sale transaction is more than the premium paid to
purchase the option, the Fund will realize a capital gain or, if it is less, the
Fund will realize a capital loss. The principal factors affecting the market
value of a put or a call option include supply and demand, interest rates, the
current market price of the underlying
6
<PAGE>
security or index in relation to the exercise price of the option, the
volatility of the underlying security or index, and the time remaining until the
expiration date.
A put or call option purchased by a Fund is an asset of that Fund, valued
initially at the premium paid for the option. The premium received for an option
written by a Fund is recorded as a deferred credit. The value of an option
purchased or written is marked-to-market daily and is valued at the closing
price on the exchange on which it is traded or, if not traded on an exchange or
no closing price is available, at the mean between the last bid and asked
prices.
OTC Derivatives. The Funds may buy and sell over-the-counter ("OTC") derivatives
(derivatives not traded on exchange). Unlike exchange-traded derivatives, which
are standardized with respect to the underlying instrument, expiration date,
contract size, and strike price, the terms of OTC derivatives generally are
established through negotiation with the other party to the contract. While this
type of arrangement allows the Funds greater flexibility to tailor an instrument
to their needs, OTC derivatives generally involve greater credit risk than
exchange-traded derivatives, which are guaranteed by the clearing organization
of the exchanges where they are traded. Each Fund will limit its investments so
that no more than 5% of its total assets will be placed at risk in the use of
OTC derivatives. See "Illiquid Securities" below for more information on the
risks associated with investing in OTC derivatives.
Risks Associated with Options. There are several risks associated with
transactions in options. For example, there are significant differences among
the securities markets, the currency markets, and the options markets that could
result in an imperfect correlation among these markets, causing a given
transaction not to achieve its objectives. 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.
There can be no assurance that a liquid market will exist when a Fund seeks to
close out an option position. If a Fund were unable to close out an option that
it had purchased on a security, it would have to exercise the option in order to
realize any profit or the option would expire and become worthless. If a Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security until the option
expired. As the writer of a covered call option on a security, a Fund forgoes,
during the option's life, the opportunity to profit from increases in the market
value of the security covering the call option above the sum of the premium and
the exercise price of the call. As the writer of a covered call option on a
foreign currency, a Fund foregoes, during the option's life, the opportunity to
profit from currency appreciation.
If trading were suspended in an option purchased or written by one of the Funds,
that Fund would not be able to close out the option. If restrictions on exercise
were imposed, the Fund might be unable to exercise an option it had purchased.
Futures Contracts and Options on Futures Contracts. The Funds may use interest
rate futures contracts and index futures contracts. An interest rate or index
futures contract provides for the future sale by one party and purchase by
another party of a specified quantity of a
7
<PAGE>
financial instrument or the cash value of an index/1/ at a specified price and
time. A public market exists in futures contracts covering a number of indexes
(including, but not limited to: the Standard & Poor's 500 Index; the Value Line
Composite Index; the Russell 2000 Index; and the New York Stock Exchange
Composite Index) as well as financial instruments (including, but not limited
to: U.S. Treasury bonds; U.S. Treasury notes; Eurodollar certificates of
deposit; and foreign currencies). Other index and financial instrument futures
contracts are available and it is expected that additional futures contracts
will be developed and traded.
The Funds may purchase and write call and put futures options. Futures options
possess many of the same characteristics as options on securities and indexes
(discussed above). A futures option gives the holder the right, in return for
the premium paid, to assume a long position (call) or short position (put) in a
futures contract at a specified exercise price at any time during the period of
the option. Upon exercise of a call option, the holder acquires a long position
in the futures contract and the writer is assigned the opposite short position.
In the case of a put option, the opposite is true.
To the extent required by regulatory authorities having jurisdiction over the
Funds, the Funds will limit their use of futures contracts and futures options
to hedging transactions. For example, the Funds might use futures contracts to
hedge against fluctuations in the general level of stock prices, anticipated
changes in interest rates, or currency fluctuations that might adversely affect
either the value of a Fund's securities or the price of the securities that a
Fund intends to purchase. The Funds' hedging may include sales of futures
contracts as an offset against the effect of expected declines in stock prices
or currency exchange rates or increases in interest rates and purchases of
futures contracts as an offset against the effect of expected increases in stock
prices or currency exchange rates or declines in interest rates. Although other
techniques could be used to reduce the Funds' exposure to stock price, interest
rate, and currency fluctuations, the Funds may be able to hedge their exposure
more effectively and perhaps at a lower cost by using futures contracts and
futures options.
The success of any hedging technique depends on WAM correctly predicting changes
in the level and direction of stock prices, interest rates, currency exchange
rates, and other factors. Should those predictions be incorrect, a Fund's return
might have been better had hedging not been attempted; however, in the absence
of the ability to hedge, WAM might have taken portfolio actions in anticipation
of the same market movements with similar investment results but, presumably, at
greater transaction costs.
When a purchase or sale of a futures contract is made by a Fund, that Fund is
required to deposit with its custodian (or broker, if legally permitted) a
specified amount of cash or U.S. government
- ---------------
/1/ A futures contract on an index is an agreement pursuant to which two
parties agree to take or make delivery of an amount of cash equal to the
difference between the value of the index at the close of the last trading day
of the contract and the price at which the index contract was originally
written. Although the value of a securities index is a function of the value of
certain specified securities, no physical delivery of those securities is made.
8
<PAGE>
securities or other securities acceptable to the broker ("initial margin"). The
margin required for a futures contract is generally set by the exchange on which
the contract is traded; however, the margin requirement may be modified during
the term of the contract, and the Fund's broker may require margin deposits in
excess of the minimum required by the exchange. The initial margin is in the
nature of a performance bond or good faith deposit on the futures contract,
which is returned to the Fund upon termination of the contract, assuming all
contractual obligations have been satisfied. The Funds expect to earn interest
income on their initial margin deposits. A futures contract held by a Fund is
valued daily at the official settlement price of the exchange on which it is
traded. Each day the Fund pays or receives cash, called "variation margin,"
equal to the daily change in value of the futures contract. This process is
known as "marking-to-market." Variation margin paid or received by a Fund does
not represent a borrowing or loan by the Fund but is instead settlement between
that Fund and the broker of the amount one would owe the other if the futures
contract had expired at the close of the previous day. In computing daily net
asset value, the Funds will mark-to-market their open futures positions.
The Funds are also required to deposit and maintain margin with respect to put
and call options on futures contracts they write. Such margin deposits will vary
depending on the nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the option, and other
futures positions held by the Funds.
Although some futures contracts call for making or taking delivery of the
underlying securities, usually these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index, and delivery month). If an offsetting
purchase price is less than the original sale price, the Funds realize a capital
gain, or if it is more, the Funds realize a capital loss. Conversely, if an
offsetting sale price is more than the original purchase price, the Fund
engaging in the transaction realizes a capital gain, or if it is less, the Fund
realizes a capital loss. The transaction costs must also be included in these
calculations.
Risks Associated with Futures. There are several risks associated with the use
of futures contracts and futures options as hedging techniques. A purchase or
sale of a futures contract may result in losses in excess of the amount invested
in the futures contract. There can be no guarantee that there will be a
correlation between price movements in the hedging vehicle and in the portfolio
securities being hedged. In addition, there are significant differences between
the securities and futures markets that could result in an imperfect correlation
between the markets, causing a given hedge not to achieve its objectives. The
degree of imperfection of correlation depends on circumstances such as:
variations in speculative market demand for futures, futures options, and the
related securities, including technical influences in futures and futures
options trading and differences between the Funds' investments being hedged and
the securities underlying the standard contracts available for trading. For
example, in the case of index futures contracts, the composition of the index,
including the issuers and the weighting of each issue, may differ from the
composition of a Fund's portfolio, and, in the case of interest rate futures
contracts, the interest rate levels, maturities, and creditworthiness of the
issues underlying the futures contract may differ from the financial instruments
held in a Fund's portfolio. A decision as to whether, when, and how to hedge
involves the exercise of skill and judgment, and even a
9
<PAGE>
well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected stock price or interest rate trends.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses. Stock index
futures contracts are not normally subject to such daily price change
limitations.
There can be no assurance that a liquid market will exist at a time when a Fund
seeks to close out a futures or futures option position. The Fund would be
exposed to possible loss on the position during the interval of inability to
close, and would continue to be required to meet margin requirements until the
position is closed. In addition, many of the contracts discussed above are
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist.
Limitations on Options and Futures. A Fund will not enter into a futures
contract or purchase an option thereon if, immediately thereafter, the initial
margin deposits for futures contracts held by that Fund plus premiums paid by it
for open futures option positions, less the amount by which any such positions
are "in-the-money,"/2/ would exceed 5% of the Fund's total assets.
When purchasing a futures contract or writing a put option on a futures
contract, a Fund must maintain with its custodian (or broker, if legally
permitted) cash or cash equivalents (including any margin) equal to the market
value of such contract. When writing a call option on a futures contract, a Fund
similarly will maintain with its custodian cash or cash equivalents (including
any margin) equal to the amount by which such option is in-the-money until the
option expires or is closed out by the Fund.
A Fund may not maintain open short positions in futures contracts, call options
written on futures contracts, or call options written on indexes if, in the
aggregate, the market value of all such open positions exceeds the current value
of the securities in its portfolio, plus or minus unrealized gains and losses on
the open positions, adjusted for the historical relative volatility of the
relationship between the portfolio and the positions. For this purpose, to the
extent a Fund has
- ---------------------
/2/ A call option is "in-the-money" if the value of the futures contract that
is the subject of the option exceeds the exercise price. A put option is
"in-the-money" if the exercise price exceeds the value of the futures contract
that is the subject of the option.
10
<PAGE>
written call options on specific securities in its portfolio, the value of those
securities will be deducted from the current market value of the securities
portfolio.
In order to comply with Commodity Futures Trading Commission Regulation 4.5 and
thereby avoid being deemed a "commodity pool operator," the "underlying
commodity value" of each long position in a commodity contract in which a Fund
invests will not at any time exceed the sum of:
(1) The value of short-term U.S. debt obligations or other U.S. dollar
denominated high-quality short-term money market instruments and cash
set aside in an identifiable manner, plus any funds deposited as
margin on the contract;
(2) Unrealized appreciation on the contract held by the broker; and
(3) Cash proceeds from existing investments due in not more than 30 days.
"Underlying commodity value" means the size of the contract multiplied by the
daily settlement price of the contract.
Each Fund's options and futures transactions are also subject to certain non-
fundamental investment restrictions set forth under "Investment Restrictions" in
this SAI. Moreover, neither Fund will purchase puts, calls, straddles, spreads,
or any combination thereof if by reason of such purchase more than 10% of that
Fund's total assets would be invested in such securities.
Taxation of Options and Futures. If a Fund exercises a call or put option that
it holds, the premium paid for the option is added to the cost basis of the
security purchased (call) or deducted from the proceeds of the security sold
(put). For cash settlement options and futures options exercised by that Fund,
the difference between the cash received at exercise and the premium paid is a
capital gain or loss.
If a call or put option written by a Fund is exercised, the premium is included
in the proceeds of the sale of the underlying security (call) or reduces the
cost basis of the security purchased (put). For cash settlement options and
futures options written by a Fund, the difference between the cash paid at
exercise and the premium received is a capital gain or loss.
Entry into a closing purchase transaction will result in capital gain or loss.
If an option written by a Fund is in-the-money at the time it was written and
the security covering the option was held for more than the long-term holding
period prior to the writing of the option, any loss realized as a result of a
closing purchase transaction will be long-term. The holding period of the
securities covering an in-the-money option will not include the period of time
the option is outstanding.
11
<PAGE>
If a Fund writes an equity call option/3/ other than a "qualified covered call
option," as defined in the Internal Revenue Code, any loss on such option
transaction, to the extent it does not exceed the unrealized gains on the
securities covering the option, may be subject to deferral until the securities
covering the option have been sold.
A futures contract held until delivery results in capital gain or loss equal to
the difference between the price at which the futures contract was entered into
and the settlement price on the earlier of delivery notice date or expiration
date. If a Fund delivers securities under a futures contract, that Fund also
realizes a capital gain or loss on those securities.
For Federal income tax purposes, a Fund generally is required to recognize for
each taxable year its net unrealized gains and losses as of the end of the year
on futures, futures options and non-equity options positions ("year-end mark-to-
market"). Generally, any gain or loss recognized with respect to such positions
(either by year-end mark-to-market or by actual closing of the positions) is
considered to be 60% long-term and 40% short-term, without regard to the holding
periods of the contracts. However, in the case of positions classified as part
of a "mixed straddle," the recognition of losses on certain positions (including
options, futures and futures options positions, the related securities and
certain successor positions thereto) may be deferred to a later taxable year.
Sale of futures contracts or writing of call options (or futures call options)
or buying put options (or futures put options) that are intended to hedge
against a change in the value of securities held by the Fund may affect the
holding period of the hedged securities.
If a Fund were to enter into a short index future, short index futures option or
short index option position and the Fund's portfolio were deemed to "mimic" the
performance of the index underlying such contract, the option or futures
contract position and the Fund's stock positions may be deemed to be positions
in a mixed straddle, subject to the above-mentioned loss deferral rules.
The Taxpayer Relief Act of 1997 (the "Act") imposed constructive sale treatment
for Federal income tax purposes on certain hedging strategies with respect to
appreciated securities. Under these rules taxpayers will recognize gain, but not
loss, with respect to securities if they enter into short sales of "offsetting
notional principal contracts" (as defined by the Act) with respect to, or
futures or "forward contracts" (as defined by the Act) with respect to, the same
or substantially identical property, or if they enter into such transactions and
then acquire the same or substantially identical property. These changes
generally apply to constructive sales after June 8, 1997. The Secretary of the
Treasury is authorized to promulgate regulations that will treat as constructive
sales certain transactions that have substantially the same effect as short
sales,
_____________________
/3/ An equity option is defined to mean any option to buy or sell stock, and
any other option the value of which is determined by reference to an index
of stocks of the type that is ineligible to be traded on a commodity
futures exchange (e.g., an option contract on a sub-index based on the
price of nine hotel-casino stocks). The definition of equity option
excludes options on broad-based stock indexes (such as the Standard &
Poor's 500 index).
12
<PAGE>
offsetting notional principal contracts, and futures or forward contracts to
deliver the same or substantially similar property.
In order for each Fund to continue to qualify for Federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income; i.e., dividends, interest,
income derived from loans of securities, and gains from the sale of securities
or foreign currencies, or other income (including but not limited to gains from
options, futures, or forward contracts). Any net gain realized from futures (or
futures options) contracts will be considered gain from the sale of securities
and therefore be qualifying income for purposes of the 90% requirement.
The Funds intend to distribute to shareholders annually any capital gains that
have been recognized for Federal income tax purposes (including year-end mark-
to-market gains) on options and futures transactions, together with gains on
other Fund investments, to the extent such gains exceed recognized capital
losses and any net capital loss carryovers of the Funds. Shareholders will be
advised of the nature of such capital gain distributions.
Swap Agreements. A swap agreement is generally individually negotiated and
structured to include exposure to a variety of different types of investments or
market factors. Depending on its structure, a swap agreement may increase or
decrease a Fund's exposure to changes in the value of an index of securities in
which the Fund might invest, the value of a particular security or group of
securities, or foreign currency values. Swap agreements can take many different
forms and are known by a variety of names. A Fund may enter into any form of
swap agreement if WAM determines it is consistent with the Fund's investment
objective and policies, but each Fund will limit its use of swap agreements so
that no more than 5% of its total assets will be placed at risk.
A swap agreement tends to shift the Fund's investment exposure from one type of
investment to another. For example, if the Fund agrees to exchange payments in
dollars at a fixed rate for payments in a foreign currency the amount of which
is determined by movements of a foreign securities index, the swap agreement
would tend to increase the Fund's exposure to foreign stock market movements and
foreign currencies. Depending on how it is used, a swap agreement may increase
or decrease the overall volatility of the Fund's investments and its net asset
value.
The performance of a swap agreement is determined by the change in the specific
currency, market index, security, or other factors that determine the amounts of
payments due to and from the Fund. If a swap agreement calls for payments by the
Fund, the Fund must be prepared to make such payments when due. If the
counterparty's creditworthiness declines, the value of a swap agreement would be
likely to decline, potentially resulting in a loss. The Fund expects to be able
to eliminate its exposure under any swap agreement either by assignment or by
other disposition, or by entering into an offsetting swap agreement with the
same party or a similarly creditworthy party.
The Fund will segregate assets of the Fund to cover its current obligations
under swap agreements. If the Fund enters into a swap agreement on a net basis,
it will segregate assets with a daily value at least equal to the excess, if
any, of the Fund's accumulated obligations under the swap agreement over the
accumulated amount the Fund is entitled to receive under the agreement. If the
Fund
13
<PAGE>
enters into a swap agreement on other than a net basis, it will segregate
assets with a value equal to the full amount of the Fund's accumulated
obligations under the agreement.
Illiquid Securities
A Fund may not invest in illiquid securities, including restricted securities
and OTC derivatives, if as a result they would comprise more than 15% of the
value of the net assets of the Fund.
Restricted securities may be sold only in privately negotiated transactions or
in a public offering with respect to which a registration statement is in effect
under the Securities Act of 1933 (the "1933 Act"). Where registration is
required, a Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, the Fund might obtain a less favorable price than
prevailed when it decided to sell. Restricted securities will be priced at fair
value as determined in good faith by the Board of Trustees. If through the
appreciation of illiquid securities or the depreciation of liquid securities,
either U.S. Small Cap or International Small Cap should be in a position where
more than 15% of the value of its net assets is invested in illiquid assets,
including restricted securities and OTC derivatives, that Fund will take
appropriate steps to protect liquidity.
Notwithstanding the foregoing, a Fund may purchase securities that have been
privately placed but that are eligible for purchase and sale under Rule 144A
under the 1933 Act. That rule permits certain qualified institutional buyers,
such as the Funds, to trade in privately placed securities that have not been
registered for sale under the 1933 Act. WAM, under the supervision of the Board
of Trustees, will consider whether securities purchased under Rule 144A are
illiquid and thus subject to a Fund's restriction of investing no more than 15%
of its assets in illiquid securities. A determination of whether a Rule 144A
security is liquid or not is a question of fact. In making this determination
WAM will consider the trading markets for the specific security taking into
account the unregistered nature of a Rule 144A security. In addition, WAM could
consider the (1) frequency of trades and quotes, (2) number of dealers and
potential purchasers, (3) dealer undertakings to make a market, and (4) nature
of the security and of market place trades (e.g., the time needed to dispose of
the security, the method of soliciting offers and the mechanics of transfer).
The liquidity of Rule 144A securities will be monitored and if, as a result of
changed conditions, it is determined that a Rule 144A security is no longer
liquid, the Funds' holdings of illiquid securities would be reviewed to
determine what, if any, steps are required to assure that a Fund does not invest
more than 15% of its assets in illiquid securities. Investing in Rule 144A
securities could have the effect of increasing the amount of a Fund's assets
invested in illiquid securities if qualified institutional buyers are unwilling
to purchase such securities.
Debt Securities
The Funds may invest in debt securities, including lower-rated securities (i.e.,
securities rated BB or lower by Standard & Poor's Corporation ("S&P") or Ba or
lower by Moody's Investor Services, Inc. ("Moody's"), commonly called "junk
bonds"), and securities that are not rated.
14
<PAGE>
There are no restrictions as to the ratings of debt securities acquired by the
Funds or the portion of a Fund's assets that may be invested in debt securities
in a particular ratings category except that neither Fund will invest more than
20% of its assets in securities rated below investment grade or considered by
WAM to be of comparable credit quality. Neither Fund expects to invest more than
5% of its net assets in such securities during the current fiscal year.
Securities rated BBB or Baa are considered to be medium grade and to have
speculative characteristics. Lower-rated debt securities are predominantly
speculative with respect to the issuer's capacity to pay interest and repay
principal. Investment in medium- or lower-quality debt securities involves
greater investment risk, including the possibility of issuer default or
bankruptcy. An economic downturn could severely disrupt the market for such
securities and adversely affect the value of such securities. In addition,
lower-quality bonds are less sensitive to interest rate changes than higher-
quality instruments and generally are more sensitive to adverse economic changes
or individual corporate developments. During a period of adverse economic
changes, including a period of rising interest rates, the junk bond market may
be severely disrupted, and issuers of such bonds may experience difficulty in
servicing their principal and interest payment obligations.
Medium- and lower-quality debt securities may be less marketable than higher-
quality debt securities because the market for them is less broad. The market
for unrated debt securities is even narrower. During periods of thin trading in
these markets, the spread between bid and asked prices is likely to increase
significantly, and a Fund may have greater difficulty selling its portfolio
securities. See "Net Asset Value." The market value of these securities and
their liquidity may be affected by adverse publicity and investor perceptions. A
more complete description of the characteristics of bonds in each ratings
category is included in the appendix to this SAI.
Repurchase Agreements
Repurchase agreements are transactions in which a Fund purchases a security from
a bank or recognized securities dealer and simultaneously commits to resell that
security to the bank or dealer at an agreed-upon price, date, and market rate of
interest unrelated to the coupon rate or maturity of the purchased security.
Although repurchase agreements carry certain risks not associated with direct
investments in securities, a Fund will enter into repurchase agreements only
with banks and dealers believed by WAM to present minimum credit risks in
accordance with guidelines approved by the board of trustees. WAM will review
and monitor the creditworthiness of such institutions, and will consider the
capitalization of the institution, WAM's prior dealings with the institution,
any rating of the institution's senior long-term debt by independent rating
agencies, and other relevant factors.
A Fund will invest only in repurchase agreements collateralized at all times in
an amount at least equal to the repurchase price plus accrued interest. To the
extent that the proceeds from any sale of such collateral upon a default in the
obligation to repurchase were less than the repurchase price, the Fund would
suffer a loss. If the financial institution which is party to the repurchase
agreement petitions for bankruptcy or otherwise becomes subject to bankruptcy or
other
15
<PAGE>
liquidation proceedings there may be restrictions on a Fund's ability to sell
the collateral and the Fund could suffer a loss. However, with respect to
financial institutions whose bankruptcy or liquidation proceedings are subject
to the U.S. Bankruptcy Code, each Fund intends to comply with provisions under
such Code that would allow it immediately to resell such collateral.
When-Issued and Delayed Delivery Securities
The Funds may purchase securities on a when-issued or delayed delivery basis.
Although the payment and interest terms of these securities are established at
the time the Fund enters into the commitment, the securities may be delivered
and paid for a month or more after the date of purchase, when their value may
have changed. A Fund makes such commitments only with the intention of actually
acquiring the securities, but may sell the securities before the settlement date
if WAM deems it advisable for investment reasons. A Fund may utilize spot and
forward foreign currency exchange transactions to reduce the risk inherent in
fluctuations in the exchange rate between one currency and another when
securities are purchased or sold on a when-issued or delayed delivery basis.
At the time a Fund enters into a binding obligation to purchase securities on a
when-issued or delayed delivery basis, liquid assets of the Fund having a value
at least as great as the purchase price of the securities to be purchased will
be segregated on the books of the Fund and held by the custodian throughout the
period of the obligation. The use of these investment strategies, as well as any
borrowing by a Fund, may increase net asset value fluctuation.
Temporary Strategies
The Funds have the flexibility to respond promptly to changes in market and
economic conditions. In the interest of preserving shareholders' capital, WAM
may employ a temporary defensive investment strategy if it determines such a
strategy to be warranted. Pursuant to such a defensive strategy, a Fund
temporarily may hold cash (U.S. dollars, foreign currencies, multinational
currency units) and/or invest up to 100% of its assets in high quality debt
securities or money market instruments of U.S. or foreign issuers, and most or
all of the Fund's investments may be made in the United States and denominated
in U.S. dollars. It is impossible to predict whether, when, or for how long a
Fund might employ defensive strategies.
In addition, pending investment of proceeds from new sales of Fund shares or to
meet ordinary daily cash needs, a Fund temporarily may hold cash (U.S. dollars,
foreign currencies, or multinational currency units) and may invest any portion
of its assets in money market instruments.
Portfolio Turnover
Although the Funds do not purchase securities with a view to rapid turnover,
there are no limitations on the length of time that portfolio securities must be
held. Portfolio turnover can occur for a number of reasons such as general
conditions in the securities markets, more favorable investment opportunities in
other securities, or other factors relating to the desirability
16
<PAGE>
of holding or changing a portfolio investment. The Funds' anticipated portfolio
turnover rates are less than 100% for each Fund. A high rate of portfolio
turnover, if it should occur, would result in increased transaction expenses
which must be borne by each Fund and realization of capital gains or losses. The
rate of portfolio turnover for U.S. Small Cap for the year ended December 31,
1996 was 46% and for the year ended December 31, 1997 was 34%. The rate of
portfolio turnover for International Small Cap for the year ended December 31,
1996 was 50% and for the year ended December 31, 1997 was 60%.
Line of Credit
The Trust maintains a line of credit with a bank in order to permit borrowing on
a temporary basis to meet share redemption requests in circumstances in which
temporary borrowing may be preferable to liquidation of portfolio securities.
Any borrowings under that line of credit by the Trust would be subject to the
Trust's restrictions on borrowing under "Investment Restrictions," below.
INVESTMENT RESTRICTIONS
In pursuing their investment objectives, U.S. Small Cap and International Small
Cap each will not:
1. With respect to 75% of the value of the Fund's total assets, invest
more than 5% of its total assets (valued at the time of investment) in
securities of a single issuer, except securities issued or guaranteed by
the government of the U.S., or any of its agencies or instrumentalities;
2. Acquire securities of any one issuer that at the time of investment
(a) represent more than 10% of the voting securities of the issuer or (b)
have a value greater than 10% of the value of the outstanding securities of
the issuer;
3. Invest more than 25% of its assets (valued at the time of investment)
in securities of companies in any one industry;
4. Make loans, but this restriction shall not prevent the Fund from (a)
buying a part of an issue of bonds, debentures, or other obligations that
are publicly distributed, or from investing up to an aggregate of 15% of
its total assets (taken at market value at the time of each purchase) in
parts of issues of bonds, debentures or other obligations of a type
privately placed with financial institutions, (b) investing in repurchase
agreements, or (c) lending portfolio securities, provided that it may not
lend securities if, as a result, the aggregate value of all securities
loaned would exceed 33% of its total assets (taken at market value at the
time of such loan);/4/
- -------------------------
/4/ The Funds have no present intention of lending their portfolio securities.
17
<PAGE>
5. Borrow money except (a) from banks for temporary or emergency purposes
in amounts not exceeding 33% of the value of the Fund's total assets at the
time of borrowing, and (b) in connection with transactions in options,
futures and options on futures;/5/
6. Underwrite the distribution of securities of other issuers; however,
the Fund may acquire "restricted" securities which, in the event of a
resale, might be required to be registered under the Securities Act of 1933
on the ground that the Fund could be regarded as an underwriter as defined
by that act with respect to such resale; but the Fund will limit its total
investment in restricted securities and in other securities for which there
is no ready market, including repurchase agreements maturing in more than
seven days, to not more than 15% of its net assets at the time of
acquisition;
7. Purchase and sell real estate or interests in real estate, although it
may invest in marketable securities of enterprises which invest in real
estate or interests in real estate;
8. Purchase and sell commodities or commodity contracts, except that it
may enter into (a) futures and options on futures and (b) forward
contracts;
9. Make margin purchases of securities, except for use of such short-term
credits as are needed for clearance of transactions and except in
connection with transactions in options, futures and options on futures;
10. Issue any senior security except to the extent permitted under the
Investment Company Act of 1940.
Restrictions 1 through 10 above are "fundamental," which means that they cannot
be changed without the approval of the lesser of (i) 67% of the Fund's shares
present at a meeting if more than 50% of the shares outstanding are present or
(ii) more than 50% of the Fund's outstanding shares.
In addition, each Fund is subject to a number of restrictions that may be
changed by the Board of Trustees without shareholder approval. Under those non-
fundamental restrictions, each Fund will not:
(a) Invest in companies for the purpose of management or the exercise of
control;
(b) Invest in oil, gas or other mineral leases or exploration or
development programs, although it may invest in marketable securities of
enterprises engaged in oil, gas or mineral exploration;
- -------------------------
/5/ State insurance laws currently restrict a Fund's borrowings to facilitate
redemptions to no more than 25% of the Fund's net assets.
18
<PAGE>
(c) Invest more than 10% of its net assets (valued at the time of
investment) in warrants, valued at the lower of cost or market; provided
that warrants acquired in units or attached to securities shall be deemed
to be without value for purposes of this restriction;
(d) Invest more than 5% of its total assets (valued at time of investment)
in securities of issuers with less than three years' operation (including
predecessors);
(e) Acquire securities of other registered investment companies except in
compliance with the Investment Company Act of 1940 and applicable state
law;
(f) Purchase or retain securities of a company if all of the Trustees,
directors and officers of the Trust and of WAM who individually own
beneficially more than 1/2% of the securities of the company collectively
own beneficially more than 5% of such securities;
(g) Pledge, mortgage or hypothecate its assets, except as may be necessary
in connection with permitted borrowings or in connection with short sales,
options, futures and options on futures;
(h) Purchase a put or call option if the aggregate premiums paid for all
put and call options exceed 20% of its net assets (less the amount by which
any such positions are in-the-money), excluding put and call options
purchased as closing transactions;
(i) Sell securities short or maintain a short position.
Notwithstanding the foregoing investment restrictions, either Fund may purchase
securities pursuant to the exercise of subscription rights, provided that such
purchase will not result in the Fund's ceasing to be a diversified investment
company. Japanese and European corporations frequently issue additional capital
stock by means of subscription rights offerings to existing shareholders at a
price substantially below the market price of the shares. The failure to
exercise such rights would result in a Fund's interest in the issuing company
being diluted. The market for such rights is not well developed in all cases
and, accordingly, the Fund may not always realize full value on the sale of
rights. The exception applies in cases where the limits set forth in the
investment restrictions would otherwise be exceeded by exercising rights or
would have already been exceeded as a result of fluctuations in the market value
of the Fund's portfolio securities with the result that the Fund would be forced
either to sell securities at a time when it might not otherwise have done so, or
to forego exercising the rights.
In addition, pursuant to state insurance laws, each Fund is subject to the
following guidelines, which may also be changed by the Trustees:
(a) Each Fund will be invested in a minimum of five different foreign
countries at all times, except that this minimum is reduced to four when
foreign country investments comprise less than 80% of the value of the
Fund's net assets; to three when less than 60% of such value; to two when
less than 40%; and to one when less than 20%.
19
<PAGE>
(b) Each Fund will have no more than 20% of its net assets invested in
securities of issuers located in any one country; except that a Fund may
have an additional 15% of its net assets invested in securities of issuers
located in any one of the following countries: Australia; Canada; France;
Japan; the United Kingdom; or Germany.
(c) A Fund may not acquire the securities of any issuer if, as a result of
such investment, more than 10% of the Fund's total assets would be invested
in the securities of any one issuer, except that this restriction shall not
apply to U.S. Government securities or foreign government securities; and
the Fund will not invest in a security if, as a result of such investment,
it would hold more than 10% of the outstanding voting securities of any one
issuer.
(d) Each Fund may borrow no more than 10% of the value of its net assets
when borrowing for any general purpose and 25% of net assets when borrowing
as a temporary measure to facilitate redemptions.
PERFORMANCE INFORMATION
From time to time the Funds may quote total return figures. "Total Return" for a
period is the percentage change in value during the period of an investment in
shares of a Fund, including the value of shares acquired through reinvestment of
all dividends and capital gains distributions. "Average Annual Total Return" is
the average annual compounded rate of change in value represented by the Total
Return for the period.
Average Annual Total Return is computed as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
ERV = P(1 +T)/n/
Where: P = the amount of an assumed initial investment in shares of
a Fund
T = average annual total return
n = number of years from initial investment to the end of the
period
ERV = ending redeemable value of shares held at the end of the
period
</TABLE>
For example, as of December 31, 1997 the Total Return and Average Total
Return on a $1,000 investment in the funds for the following periods were:
<TABLE>
<CAPTION>
U.S. Small Cap Average Annual
-------------- Total Return Total Return
------------ --------------
<S> <C> <C>
1 year............................ 29.4.% 29.4.
Life of Fund (inception 5/3/95)... 120.1% 34.4%
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
International Small Cap
----------------------- Average Annual
Total Return Total Return
------------ --------------
<S> <C> <C>
1 year............................. -1.5% -1.5%
Life of Fund (inception 5/3/95).... 75.0% 23.3%
</TABLE>
The Funds impose no sales charges and pay no distribution expenses. Income taxes
are not taken into account. Performance figures quoted by the Funds are not
necessarily indicative of future results. Each Fund's performance is a function
of conditions in the securities markets, portfolio management, and operating
expenses. Although information about past performance is useful in reviewing a
Fund's performance and in providing some basis for comparison with other
investment alternatives, it should not be used for comparison with other
investments using different reinvestment assumptions or time periods. Fund
performance figures do not reflect expenses of the separate accounts of the Life
Companies, expenses imposed under the Variable Contracts, or expenses imposed by
the Retirement Plans.
The Funds may note their mention or recognition, or the mention or recognition
of WAM or its principals, in newsletters, newspapers, magazines, or other media.
In advertising and sales literature, each Fund's performance may be compared
with those of market indexes and other mutual funds. In addition to the
performance information described above, a Fund might use comparative
performance as computed in a ranking or rating determined by Lipper Analytical
Services, Inc., an independent service that monitors the performance of over
1,000 mutual funds, Morningstar, Inc., VARDS, or another service.
The Funds may also use statistics to indicate volatility or risk. The premise of
each of these measures is that greater volatility connotes greater risk
undertaken in achieving performance. One measure of volatility is beta. Beta is
the volatility of a fund's total return relative to the movements of a benchmark
index. A beta greater than one indicates volatility greater than the index, and
a beta of less than one indicates a volatility less than the index. Another
measure of volatility is R-squared. It reflects the percentage of a fund's price
movements that are explained by movements in the benchmark index. An R-squared
of 1.00 indicates that all movements of a fund's price are completely explained
by movements in the index. Generally, a higher R-squared will indicate a more
reliable beta figure. Alpha is a measure used to discuss a fund's relative
performance. Alpha measures the actual return of a fund compared to the expected
return of a fund given its risk (as measured by beta). The expected return of a
fund is based on how historical movements of the benchmark index and historical
performance of a fund compare to the benchmark index. The expected return is
computed by multiplying the advance or decline in a market represented by a
fund's beta. A positive alpha quantifies the value that a fund manager has added
and a negative alpha quantifies the value that a fund manager has lost. Beta and
R-squared are calculated by performing a least squares linear regression using
five years of monthly total return figures for each portfolio and benchmark
combination. Alpha is calculated by taking the difference between the average
monthly portfolio return and the beta-adjusted average monthly benchmark return.
The result of this calculation is then geometrically annualized.
21
<PAGE>
The following are some benchmark indices utilized by the Funds: Salomon Brothers
Extended Market Index ("EMI"), an index of the bottom 20% of institutionally
investable capital of countries, selected by Salomon, excluding the U.S.; Morgan
Stanley's Europe, Australasia Far East Index ("EAFE"), an index of companies
throughout the world in proportion to world stock market capitalizations,
excluding the U.S. and Canada; the Standard & Poor's 500 Stock Index ("S&P
500"), a broad, market-weighted average of U.S. blue-chip companies; the
Standard & Poor's MidCap 400 ("S&P 400"), also a broad, market-weighted average
of U.S. companies in the next tier down in size from the S&P 500; and the
Russell 2000 Index, an index formed by taking the 3,000 largest U.S. companies
and eliminating the largest 1,000, leaving an unweighted index of 2000 small
companies. All indexes are unmanaged and included reinvested dividends.
As of June 30, 1998, some statistics for the funds are as follows:
<TABLE>
<CAPTION>
R/2/ Beta Alpha
- ---- -----
Wanger U.S. Small Cap
---------------------
<S> <C> <C> <C>
vs. S&P 500 0.29 0.65 1.29%
vs. Russell 2000 0.82 0.90 14.18%
Wanger International Small Cap
------------------------------
vs. EMI Ex U.S. 0.68 0.96 18.20%
vs. EAFE 0.45 0.70 16.78%
</TABLE>
Other measures of volatility and relative performance may be used as
appropriate. All such measures will fluctuate and do not represent future
results.
INVESTMENT ADVISER
The Funds' investment adviser, Wanger Asset Management, L.P. ("WAM"), is a
limited partnership managed by its general partner, Wanger Asset Management,
Ltd. ("WAM Ltd."). WAM serves as the investment adviser for the Funds and for
other institutional accounts. WAM commenced operations in 1992. WAM is a limited
partnership managed by its general partner, Wanger Asset Management, Ltd. ("WAM
Ltd."), whose stockholders are Ralph Wanger, Leah J. Zell, Charles P. McQuaid,
Marcel P. Houtzager, Robert A. Mohn and John H. Park. Ralph Wanger is the
president and Howard L. Kastel is the chief executive officer of WAM Ltd. On
matters submitted to the shareholders of WAM Ltd., each shareholder has one vote
(or a lesser vote in the case of new shareholders). With certain limited
exceptions, decisions are made by majority vote. At March 31, 1998 WAM had more
than $7 billion under management, including the Funds.
WAM furnishes continuing investment advice to the Funds and is responsible for
overall management of the Funds' business affairs. It furnishes office space and
all necessary office facilities, equipment, and personnel to the Funds; it
assumes all other expenses incurred by WAM in connection with managing the
assets of the Funds, including expenses in connection
22
<PAGE>
with placement of securities orders, expenses in determination of daily price
computations, portfolio accounting and related bookkeeping; and assumes the
expenses of printing and distributing the Funds' prospectus and reports to
prospective investors. At its own expense, WAM may contract with any other
person or persons to provide services in connection with daily price
computations, portfolio accounting and related bookkeeping.
For its services to U.S. Small Cap, WAM receives a fee accrued daily and paid
monthly at the annual rate of 1.0% of the net asset value of the Fund up to $100
million, 0.95% of the net asset value in excess of $100 million and up to $250
million, and 0.90% of the net asset value in excess of $250 million. These fees
may be reduced by any amount necessary to cause the Fund's expenses to be within
the limitation described below. The investment advisory fees of the Fund for the
fiscal period from May 3, 1995 to December 31, 1995 were $71,496; for the fiscal
year ended December 31, 1996, the advisory fees were $704,115; and for the
fiscal year ended December 31, 1997, the advisory fees were $1,960,795.
For its services to International Small Cap, WAM receives a fee accrued daily
and paid monthly at the annual rate of 1.30% of the net asset value of the Fund
up to $100 million, 1.20% of the net asset value in excess of $100 million and
up to $250 million, and 1.10% of the net asset value in excess of $250 million.
These fees may be reduced by any amount necessary to cause the Fund's expenses
to be within the limitation described below. The investment advisory fees of the
Fund for the fiscal period from May 3, 1995 to December 31, 1995 were $43,726;
for the fiscal year ended December 31, 1996, the advisory fees were $631,977;
and for the fiscal year ended December 31, 1997, the advisory fees were
$1,528,703.
The Trust pays all charges of depositories, custodians and other agents for the
safekeeping and servicing of the Funds' cash, securities and other property; all
charges of the Funds' transfer agents and registrars, and the Funds' dividend
disbursing and redemption agents, if any; and all charges of independent
auditors and legal counsel. The Trust also pays other expenses such as the cost
of qualifying and maintaining the registration of shares of the Funds and the
cost of compliance with federal and state securities laws; typesetting of the
Funds' prospectus and of printing and mailing copies of the prospectus furnished
to each then-existing shareholder or beneficial owner; printing and mailing
certificates for shares of the Funds; publishing reports and notices to the
Funds' shareholders and to governmental bodies or regulatory agencies; proxy
solicitations of the Funds or of the Board of Trustees of the Trust; shareholder
meetings; fees and taxes payable to federal, state or governmental agencies,
domestic or foreign; insurance premiums required by law or deemed advisable by
the Trust's Board of Trustees; all costs of borrowing money; all expenses of
maintaining the registration of the Trust under the Investment Company Act of
1940, all fees, dues and other expenses related to membership of the Trust in
any trade association or other investment company organization; the fees of
Trustees who are not otherwise affiliated with the Trust or WAM, and all
expenses incurred in connection with their services to the Trust. The Trust also
pays all brokers' commissions and other charges relative to the purchase and
sale of portfolio securities for the Funds.
WAM has voluntarily agreed to reimburse the Fund in the event the fees and
expenses payable by the Fund in any fiscal year (as described above) exceed
1.90% for Wanger International Small
23
<PAGE>
Cap and 1.50% for Wanger U.S. Small Cap of average daily net assets. The
following items are excluded for purposes of calculating the expenses subject to
this limitation: (i) credits, if any, that a Fund may receive that have the
effect of offsetting certain of those expenses; and (ii) the excess custodian
costs attributable to investments in foreign securities compared to the
custodian costs which would have been incurred had the investments been in
domestic securities. Reimbursement of expenses in excess of this limitation will
be made monthly and will be paid to the Fund by reduction of WAM's advisory fee.
The expenses of each Fund have been below the limit at which reimbursement would
be required during 1996 and 1997. WAM may from time to time absorb expenses for
a Fund in addition to the reimbursement of expenses in excess of applicable
limitations.
WAM advanced all of the Trust's organizational expenses, which are being
amortized and reimbursed to WAM over a five year period.
Each Fund's investment advisory agreement with WAM was effective on January 1,
1998 and will continue in effect through December 31, 1999, and thereafter from
year to year so long as its continuance as to each Fund is approved at least
annually by (i) the board of trustees of the Trust or by the holders of a
majority of each Fund's outstanding voting securities as defined by the
Investment Company Act of 1940 and (ii) a majority of the members of the board
of trustees who are not otherwise affiliated with the Trust or WAM, cast in
person at a meeting called for that purpose. Any amendment to each new agreement
must be approved in the same manner. The agreements may be terminated as to a
Fund without penalty by the vote of the board of trustees of the Trust or the
shareholders of a Fund (by a majority as defined in the 1940 Act) on sixty days'
written notice to WAM or by WAM on sixty days' notice to the Fund, and will
terminate automatically in the event of its assignment. The fees payable by a
Fund under each agreement are the obligation only of that Fund and impose no
liability on the other Fund.
DISTRIBUTOR
Shares of each Fund are distributed by WAM Brokerage Services, L.L.C. ("WAM BD")
under a Distribution Agreement as described in the prospectus dated April 30,
1998, which is incorporated herein by reference. The Distribution Agreement
continues in effect from year to year, provided such continuance is approved
annually (i) by a majority of the trustees or by a majority of the outstanding
voting securities of the Trust, and (ii) by a majority of the trustees who are
not parties to the Agreement or interested persons of any such party. Shares of
the Funds are offered for sale through WAM BD on a best efforts basis without
any sales commission or charges to the Funds or Life Companies or Retirement
Plans purchasing Fund shares. However, each Variable Contract imposes its own
charges and fees on owners of Variable Contracts and Retirement Plans and may
impose such charges on participants in a Retirement Plan.
The Trust has agreed to pay all expenses in connection with registration of its
shares with the Securities and Exchange Commission and in compliance with state
securities laws. WAM bears
24
<PAGE>
all sales and promotional expenses, other than those borne by a Life Company or
Retirement Plan. WAM BD is located at 227 West Monroe Street, Suite 3000,
Chicago, Illinois 60606.
THE TRUST
The Trust is a Massachusetts business trust organized under an Agreement and
Declaration of Trust dated August 30, 1994. The Agreement and Declaration of
Trust may be amended by a vote of either the Trust's shareholders or its
Trustees. The Trust may issue an unlimited number of shares, in one or more
series as the Board of Trustees may authorize. Any such series of shares may be
further divided, without shareholder approval, into two or more classes of
shares having such preferences or special or relative rights or privileges as
the Trustees may determine. The shares of the Funds are not currently divided
into classes. U.S. Small Cap and International Small Cap are the only series of
the Trust currently being offered. The Board of Trustees may authorize the
issuance of additional series if deemed advisable, each with its own investment
objective, policies, and restrictions. All shares issued will be fully paid and
non-assessable and will have no preemptive or conversion rights.
On any matter submitted to a vote of shareholders, shares are voted in the
aggregate and not by individual series except that shares are voted by
individual series when required by the Investment Company Act of 1940 or other
applicable law, or when the Board of Trustees determines that the matter affects
only the interests of one series, in which case shareholders of the unaffected
series are not entitled to vote on such matters. All shares of the Trust are
voted together in the election of Trustees. Shares do not have cumulative voting
rights; accordingly, shareholders controlling voting interests of more than 50%
of shares of the Funds voting for the election of Trustees could elect all of
the Trustees if they chose to do so, and in such event, shareholders controlling
voting interests of the remaining shares would not be able to elect any
Trustees.
Shareholder rights regarding voting are described in the prospectus. These
voting rights are based on applicable federal and state laws. To the extent that
changes in such laws or regulations thereunder or interpretations thereof
eliminate the necessity to submit any such matters to a shareholder vote, or
otherwise restrict or limit such voting rights, the Trust reserves the right to
act in any manner permitted by such changes.
The Trust's Declaration of Trust disclaims liability of the shareholders,
trustees, and officers of the Trust for acts or obligations of the Trust and
requires that notice of such disclaimer be given in each agreement, obligation,
or contract entered into or executed by the Trust or the board of trustees. The
Declaration of Trust provides for indemnification out of the Trust's assets for
all losses or expenses of any shareholder held personally liable for the
obligations of the Trust. Thus, although shareholders of a business trust may,
under certain circumstances, be held personally liable under Massachusetts law
for the obligations of the trust, the risk of a shareholder incurring financial
loss on account of shareholder liability is believed to be remote because it is
limited to circumstances in which the disclaimer is inoperative and the Trust
itself is
25
<PAGE>
unable to meet its obligations. The risk to any one series of sustaining a loss
on account of liabilities incurred by another series is also believed to be
remote.
TRUSTEES AND OFFICERS; CERTAIN SHAREHOLDERS
The Trustees and officers of the Trust (including their dates of birth and their
principal business activities during the past five years are) are listed below
in alphabetical order:
Fred D. Hasselbring, trustee (8/14/1941)
1338 N. Bell Avenue, Chicago, Illinois 60622; owner, Fred D. Hasselbring
and Associates (retail industry computer systems consulting and sales);
director and executive administrator, The Malachi Corp., Inc. (a non-profit
corporation).
Marcel P. Houtzager, vice president (10/26/1960)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; principal,
analyst and portfolio manager, Wanger Asset Management, L.P. since April
1992.
Kenneth A. Kalina, assistant treasurer (8/4/1959)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60603; Fund
controller, Wanger Asset Management, L.P., since September 1995; prior
thereto, treasurer of the Stein Roe Mutual Funds; assistant treasurer,
Acorn Investment Trust.
Merrillyn J. Kosier, senior vice president and secretary (12/10/1959)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; director of
marketing and shareholder services, Wanger Asset Management, L.P., since
September 1993; prior thereto, vice president of marketing, Kemper
Financial Services, Inc.; senior vice president and secretary, Acorn
Investment Trust.
Bruce H. Lauer, vice president and treasurer (7/22/1957)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; chief
administrative officer, Wanger Asset Management, L.P., since April 1995;
vice president and treasurer, Acorn Investment Trust; director Wanger
Investment Company PLC; prior thereto, first vice president, investment
accounting, Kemper Financial Services, Inc.
Charles P. McQuaid, trustee and senior vice president* (8/27/1953)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; principal,
Wanger Asset Management, L.P. since July 1992; trustee and senior vice
president, Acorn Investment Trust.
Robert A. Mohn, vice president (9/13/1961)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; principal,
analyst and portfolio manager, Wanger Asset Management, L.P. since August
1992.
John H. Park, vice president (5/30/1967)
26
<PAGE>
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; principal and
analyst, Wanger Asset Management, L.P. since July 1993; prior thereto,
analyst, Ariel Capital Management.
P. Michael Phelps, trustee (9/19/1933)
222 East Chestnut Street, Chicago, Illinois 60611; retired since January
31, 1998; prior thereto, vice president and corporate secretary, Morton
International, Inc.
James A. Star, trustee (2/27/1961)
222 N. LaSalle Street, Suite 2000, Chicago, Illinois 60601; vice president,
Henry Crown and Company, a diversified private holding company, since
October 1994; portfolio manager and investment analyst, Harris Associates
L.P., June 1991 to October 1994; attorney, Kirkland and Ellis, prior to
June 1991.
Ralph Wanger, trustee and president* (6/21/1934)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; principal,
Wanger Asset Management, L.P. since July 1992; trustee and president, Acorn
Investment Trust.
Leah J. Zell, vice president (5/23/1949)
227 West Monroe Street, Suite 3000, Chicago, Illinois 60606; principal,
analyst, and portfolio manager, Wanger Asset Management, L.P., since July
1992; vice president, Acorn Investment Trust.
*Messrs. McQuaid and Wanger are Trustees who are "interested persons" of the
Trust as defined in the Investment Company Act of 1940, and of WAM. Messrs.
McQuaid, Phelps and Wanger are members of the Executive Committee, which has
authority during intervals between meetings of the Board of Trustees to exercise
the powers of the board, with certain exceptions. Messrs. Hasselbring, Phelps,
and Star are members of the Audit Committee, which has the authority to make
recommendations to the Board of Trustees regarding the selection of independent
auditors for the Trust and to confer with the independent auditors regarding the
scope and results of each audit.
At March 31, 1998, the trustees and officers as a group owned beneficially less
than 1% of the outstanding shares of each of U.S. Small Cap and International
Small Cap. At that date, Phoenix Home Life Mutual Insurance Company (and its
affiliates), One American Row, Hartford, Connecticut 06115, was the record
holder of 6,949,254.017 shares (approximately 96.8% of the outstanding shares)
of International Small Cap, and 13,716,365.170 shares (approximately 97.4% of
the outstanding shares) of U.S. Small Cap, all of which are beneficially owned
by Variable Contract owners.
The following table shows compensation paid by the Trust during the fiscal year
ended December 31, 1997 to each Trustee of the Trust who is not an "interested
person" of the Trust or of WAM. The Trust does not pay compensation to its
officers or to Trustees who are "interested persons." The Trust does not offer
any pension or retirement benefits to its trustees.
27
<PAGE>
<TABLE>
<CAPTION>
===========================================================================================
Name of Person, Aggregate Compensation Aggregate Compensation Total
Position From Wanger U.S. From Wanger International Compensation
Small Cap Advisor Small Cap Advisor From Fund Complex
===========================================================================================
<S> <C> <C> <C>
Fred D. Hasselbring $5,800 $5,800 $11,600
Trustee
P. Michael Phelps $6,550 $6,550 $13,100
Trustee
James A. Star $5,800 $5,800 $11,600
Trustee
</TABLE>
PURCHASING AND REDEEMING SHARES
Shares of U.S. Small Cap and International Small Cap may not be purchased or
redeemed directly by individual Variable Contract owners or individual
Retirement Plan participants. Purchases and redemptions are discussed in the
prospectus. That information is incorporated herein by reference.
For purposes of computing the net asset value of a share of either Fund, a
security traded on a securities exchange, or in an over-the-counter market in
which transaction prices are reported, is generally valued at the last sale
price at the time of valuation. A security for which there is no reported sale
on the valuation date is generally valued at the mean of the latest bid and ask
quotations or, if there is no ask quotation, at the most recent bid quotation.
Securities for which quotations are not readily available, or for which the
market quotation is determined not to represent a fair value, and any other
assets are valued at a fair value as determined in good faith by the Board of
Trustees. Money market instruments having a maturity of 60 days or less from the
valuation date are valued on an amortized cost basis. All assets and liabilities
initially expressed in foreign currencies are converted into U.S. dollars at the
mean of the bid and offer prices of such currencies against U.S. dollars quoted
by any major bank or dealer. If such quotations are not readily available, the
rate of exchange will be determined in accordance with policies established in
good faith by the board of trustees.
The Funds' net asset values are determined only on days on which the New York
Stock Exchange ("NYSE") is open for trading. The NYSE is regularly closed on
Saturdays and Sundays and on New Year's Day, the third Monday in January, the
third Monday in February, Good Friday, the last Monday in May, Independence Day,
Labor Day, Thanksgiving, and Christmas. If one of these holidays falls on a
Saturday or Sunday, the NYSE will be closed on the preceding Friday or the
following Monday, respectively.
Trading in the portfolio securities of the Funds, particularly International
Small Cap, may take place in various foreign markets at certain times on certain
days (such as Saturday) when the NYSE is not open for business and the Funds do
not calculate their net asset values. Conversely,
28
<PAGE>
trading in the Funds' portfolio securities may not occur on days when the NYSE
is open. Because of the differences in the days and times at which trading
occurs in various markets, the calculation of net asset value does not take
place contemporaneously with the determinations of the prices of many of the
Funds' portfolio securities. The last sale price included in the calculation of
a Fund's net asset value may be several hours old at the time when it is
included in that calculation, which may have a significant effect on a Fund's
net asset value.
Computation of net asset value (and the sale and redemption of Fund shares) may
be suspended or postponed during any period when (a) trading on the NYSE is
restricted, as determined by the Securities and Exchange Commission, or that
exchange is closed for other than customary weekend and holiday closings, (b)
the Commission has by order permitted such suspension, or (c) an emergency, as
determined by the Commission, exists making disposal of portfolio securities or
valuation of the net assets of the Funds not reasonably practicable.
The Trust has elected to be governed by Rule 18f-1 under the Investment Company
Act of 1940 pursuant to which it is obligated to redeem shares solely in cash up
to the lesser of $250,000 or 1% of the net asset value of a Fund during any 90-
day period for any one shareholder. Redemptions in excess of the above amounts
will normally be paid in cash, but may be paid wholly or partly by a
distribution in-kind of securities. If a redemption is made in kind, the
redeeming shareholder would bear any transaction costs incurred in selling the
securities received. The Agreement and Declaration of Trust also authorizes the
Trust to redeem shares under certain other circumstances as may be specified by
the Board of Trustees.
ADDITIONAL TAX INFORMATION
Shares of the Funds are offered to separate accounts of Life Companies that fund
Variable Contracts and may be offered to certain Retirement Plans, which are
pension plans and retirement arrangements and accounts permitting the
accumulation of funds on a tax-deferred basis. See the disclosure documents for
the Variable Contracts or the plan documents (including the summary plan
description) for the Retirement Plans for a discussion of the special taxation
of insurance companies with respect to the separate accounts and the Variable
Contracts, and the holders thereof, or the special taxation of Retirement Plans
and the participants therein.
Each Fund intends to continue to qualify for treatment as a regulated investment
company ("RIC") under the Internal Revenue Code of 1986, as amended (the
"Code"). In order to qualify for that treatment, the Fund must distribute to
shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income, net short-term
capital gain, and net gains from certain foreign currency transactions)
("Distribution Requirement") and must meet several additional requirements.
These requirements include the following: (1) the Fund must derive at least 90%
of its gross income each taxable year from dividends, interest, payments with
respect to securities loans, and gains from the sale or other disposition of
securities or foreign currencies, or other income (including gains from options,
futures or forward contracts) derived with respect to its business of investing
in securities or currencies ("Income Requirement"); (2) at the close of each
quarter of the Fund's taxable year, at
29
<PAGE>
least 50% of the value of its total assets must be represented by cash or cash
items, U.S. Government securities, securities of other RICs, and other
securities that, with respect to any one issuer, do not exceed 5% of the value
of the Fund's total assets and that do not represent more than 10% of the
outstanding voting securities of the issuer; and (3) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. Government securities or
the securities of other RICs) of any one issuer.
As noted in the prospectus, each Fund 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 the requirements of Section 817(h), see the prospectus for the Variable
Contracts.
The Funds will not be subject to the 4% federal excise tax imposed on RICs that
do not distribute substantially all their income and gains each calendar year
because that tax does not apply to a RIC whose only shareholders are segregated
asset accounts of life insurance companies held in connection with variable
annuity contracts and/or variable life insurance policies or Retirement Plans.
The foregoing is only a general summary of some of the important federal income
tax considerations generally affecting the Funds and their shareholders. No
attempt is made to present a complete explanation of the federal tax treatment
of the Funds' activities, and this discussion and the discussion in the
prospectuses and/or statements of additional information for variable contracts
are not intended as a substitute for careful tax planning. Accordingly,
potential investors are urged to consult their own tax advisers for more
detailed information and for information regarding any state, local or foreign
taxes applicable to the variable contracts and the holders thereof.
PORTFOLIO TRANSACTIONS
Portfolio transactions of the Funds are placed with those securities brokers and
dealers that WAM believes will provide the best value in transaction and
research services for each Fund, either in a particular transaction or over a
period of time. Although some transactions involve only brokerage services, many
involve research services as well.
In valuing brokerage services, WAM makes a judgment as to which brokers are
capable of providing the most favorable net price (not necessarily the lowest
commission) and the best execution in a particular transaction. Best execution
connotes not only general competence and reliability of a broker, but specific
expertise and effort of a broker in overcoming the anticipated difficulties in
fulfilling the requirements of particular transactions, because the problems of
execution and the required skills and effort vary greatly among transactions.
In valuing research services, WAM makes a judgment of the usefulness of research
and other information provided to WAM by a broker in managing each Fund's
investment portfolio. In some cases, the information, e.g., data or
recommendations concerning particular securities,
30
<PAGE>
relates to the specific transaction placed with the broker, but for the greater
part the research consists of a wide variety of information concerning
companies, industries, investment strategy, and economic, financial, and
political conditions and prospects, useful to WAM in advising that Fund.
The reasonableness of brokerage commissions paid by the Funds in relation to
transaction and research services received is evaluated by WAM's staff on an
ongoing basis. The general level of brokerage charges and other aspects of each
Fund's portfolio transactions are reviewed periodically by the Board of
Trustees.
WAM is the principal source of information and advice to the Funds, and is
responsible for making and initiating the execution of investment decisions by
the Funds. However, the Board of Trustees recognizes that it is important for
WAM, in performing its responsibilities to the Funds, to continue to receive and
evaluate the broad spectrum of economic and financial information that many
securities brokers have customarily furnished in connection with brokerage
transactions, and that in compensating brokers for their services, it is in the
interest of the Funds to take into account the value of the information received
for use in advising the Funds. The extent, if any, to which the obtaining of
such information may reduce WAM's expenses in providing management services to
the Funds is not determinable. In addition, the Board of Trustees understands
that other clients of WAM might benefit from the information obtained for the
Funds, in the same manner that the Funds might benefit from information obtained
by WAM in performing services to others.
Transactions of the Funds in the over-the-counter market and the third market
are executed with primary market makers acting as principal except where it is
believed that better prices and execution may be obtained otherwise.
Brokerage commissions incurred by U.S. Small Cap for the fiscal period from May
3, 1995 to December 31, 1995 were $59,273; for the fiscal year ended December
31, 1996 the brokerage commissions were $243,598; for the fiscal year ended
December 31, 1997 the brokerage commissions were $249,054. Brokerage commissions
incurred by International Small Cap during the same time periods were $49,559,
$422,414 and $647,529, respectively.
The Trust and WAM have adopted codes of ethics that, among other things,
regulate the personal transactions in securities of certain officers, directors,
trustees, partners and employees of the Trust and WAM. Although investment
decisions for the Funds are made independently from those for other investment
advisory clients of WAM, it may develop that the same investment decision is
made for one or both of the Funds and one or more other advisory clients. If one
or both of the Funds and other clients purchase or sell the same class of
securities on the same day, the transactions will be allocated as to amount and
price in a manner considered equitable to each.
31
<PAGE>
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 8502, Boston, Massachusetts 02266-
8502, is the custodian for the Funds. It is responsible for holding all
securities and cash of the Funds, receiving and paying for securities purchased,
delivering against payment securities sold, receiving and collecting income from
investments, making all payments covering expenses of the Funds, and performing
other administrative duties, all as directed by authorized persons of the Funds.
The custodian does not exercise any supervisory function in such matters as
purchase and sale of portfolio securities, payment of dividends, or payment of
expenses of the Funds. The Funds have authorized the custodian to deposit
certain portfolio securities of the Funds in central depository systems as
permitted under federal law. The Funds may invest in obligations of the
custodian and may purchase or sell securities from or to the custodian. The
custodian may employ one or more sub-custodians located in the United States
upon approval by the Board of Trustees of the Trust; and is authorized to employ
sub-custodians for the Funds' assets maintained outside the United States.
INDEPENDENT AUDITORS
Ernst & Young LLP, Sears Tower, 233 South Wacker Drive, Chicago, Illinois 60606
audits and reports on the Funds' annual financial statements, reviews certain
regulatory reports and the Funds' federal income tax return, and performs other
professional accounting, auditing, tax, and advisory services when engaged to do
so by the Funds.
32
<PAGE>
APPENDIX
Description of Bond Ratings
A rating of a rating service represents the service's opinion as to the credit
quality of the security being rated. However, the ratings are general and are
not absolute standards of quality or guarantees as to the creditworthiness of an
issuer. Consequently, WAM believes that the quality of debt securities in which
the Funds invest should be continuously reviewed. A rating is not a
recommendation to purchase, sell or hold a security, because it does not take
into account market value or suitability for a particular investor. When a
security has received a rating from more than one service, each rating should be
evaluated independently. Ratings are based on current information furnished by
the issuer or obtained by the ratings services from other sources which they
consider reliable. Ratings may be changed, suspended or withdrawn as a result of
changes in or unavailability of such information, or for other reasons.
The following is a description of the characteristics of ratings used by Moody's
Investors Service, Inc. ("Moody's") and Standard & Poor's Corporation ("S&P").
Moody's Ratings
Aaa--Bonds rated Aaa are judged to be the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt-edge."
Interest payments are protected by a large or by an exceptionally stable margin
and principal is secure. Although 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 bonds.
Aa--Bonds rated Aa are judged to be 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 bonds or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which make the long
term risk appear somewhat larger than in Aaa bonds.
A--Bonds rated A 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 rated Baa are considered as 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.
A-1
<PAGE>
Ba--Bonds rated Ba are judged to have speculative elements; their future
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B--Bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa--Bonds rated Caa are of poor standing. Such bonds may be in default or
there may be present elements of danger with respect to principal or interest.
Ca--Bonds rated Ca represent obligations which are speculative in a high
degree. Such bonds are often in default or have other marked shortcomings.
S&P Ratings
AAA--Bonds rated AAA have the highest rating. Capacity to pay principal and
interest is extremely strong.
AA--Bonds rated AA have a very strong capacity to pay principal and
interest and differ from AAA bonds only in small degree.
A--Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than bonds in higher rated categories.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay principal and interest for bonds in this capacity
than for bonds in higher rated categories.
BB--B--CCC--CC--Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation among such bonds and CC the highest degree of
speculation. Although such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
A-2
