PAINEWEBBER PACE SELECT ADVISORS TRUST
51 WEST 52ND STREET
NEW YORK, NEW YORK 10019-6114
STATEMENT OF ADDITIONAL INFORMATION
The following funds are series of PaineWebber PACE Select Advisors Trust
("Trust"), a professionally managed open-end investment company.
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<CAPTION>
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PACE Money Market Investments PACE Large Company Value Equity Investments
PACE Government Securities Fixed Income Investments PACE Large Company Growth Equity Investments
PACE Intermediate Fixed Income Investments PACE Small/Medium Company Value Equity Investments
PACE Strategic Fixed Income Investments PACE Small/Medium Company Growth Equity Investments
PACE Municipal Fixed Income Investments PACE International Equity Investments
PACE Global Fixed Income Investments PACE International Emerging Markets Equity Investments
</TABLE>
PACE Intermediate Fixed Income Investments and PACE Global Fixed Income
Investments are non-diversified series of the Trust. The other funds are
diversified series.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly
owned asset management subsidiary of PaineWebber Incorporated ("PaineWebber"),
serves as the manager and administrator for each fund and also as the investment
adviser for PACE Money Market Investments. Mitchell Hutchins selects and
monitors unaffiliated investment advisers who provide advisory services for the
other funds. As distributor for the funds, Mitchell Hutchins has appointed
PaineWebber to serve as the exclusive dealer for the sale of fund shares.
Portions of the funds' Annual Report to Shareholders are incorporated by
reference into this Statement of Additional Information ("SAI"). The Annual
Report accompanies this SAI. You may obtain additional copies of the funds'
Annual Report by calling toll-free 1-800-647-1568.
This SAI is not a prospectus and should be read only in conjunction with
the funds' current Prospectus, dated December 1, 1999. A copy of the Prospectus
may be obtained by calling any PaineWebber Financial Advisor or by calling
toll-free 1-800-647-1568. The Prospectus contains more complete information
about the funds. You should read it carefully before investing.
This SAI is dated December 1, 1999.
TABLE OF CONTENTS
PAGE
The Funds and Their Investment Policies...................................2
The Funds' Investments, Related Risks and Limitations.....................8
Strategies Using Derivative Instruments..................................33
Organization of Trust; Trustees and Officers; Principal
Holders of Securities....................................................42
Investment Advisory, Administration and Distribution Arrangements........46
Portfolio Transactions...................................................51
Additional Redemption Information; Other Services........................56
Valuation of Shares......................................................57
Performance Information..................................................58
Taxes....................................................................60
Other Information........................................................65
Financial Statements.....................................................66
Appendix................................................................A-1
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THE FUNDS AND THEIR INVESTMENT POLICIES
No fund's investment objective may be changed without shareholder
approval. Except where noted, the other investment policies of each fund may be
changed by the board without shareholder approval. As with other mutual funds,
there is no assurance that a fund will achieve its investment objective.
PACE MONEY MARKET INVESTMENTS has an investment objective of current
income consistent with preservation of capital and liquidity. The fund invests
in high quality money market instruments that have, or are deemed to have,
remaining maturities of 13 months or less. Money market instruments are
short-term debt obligations and similar securities. These instruments include
(1) U.S. and foreign government securities, (2) obligations of U.S. and foreign
banks, (3) commercial paper and other short-term corporate obligations of U.S.
and foreign corporations, partnerships, trusts and similar entities, (4)
repurchase agreements and (5) investment company securities. Money market
instruments also include longer term bonds that have variable interest rates or
other special features that give them the financial characteristics of
short-term debt. The fund may purchase participation interests in any of the
securities in which it is permitted to invest. Participation interests are pro
rata interests in securities held by others. The fund maintains a
dollar-weighted average portfolio maturity of 90 days or less.
PACE Money Market Investments may invest in obligations (including
certificates of deposit, bankers' acceptances, time deposits and similar
obligations) of U.S. and foreign banks only if the institution has total assets
at the time of purchase in excess of $1.5 billion. The fund's investments in
non-negotiable time deposits of these institutions will be considered illiquid
if they have maturities greater than seven days.
PACE Money Market Investments may purchase only those obligations that
Mitchell Hutchins determines, pursuant to procedures adopted by the board,
present minimal credit risks and are "First Tier Securities" as defined in Rule
2a-7 under the Investment Company Act of 1940, as amended ("Investment Company
Act"). A First Tier Security is either (1) rated in the highest short-term
rating category by at least two nationally recognized statistical rating
organizations ("rating agencies"), (2) rated in the highest short-term rating
category by a single rating agency if only that rating agency has assigned the
obligation a short-term rating, (3) issued by an issuer that has received such a
short-term rating with respect to a security that is comparable in priority and
security, (4) subject to a guarantee rated in the highest short-term rating
category or issued by a guarantor that has received the highest short-term
rating for a comparable debt obligation or (5) unrated, but determined by
Mitchell Hutchins to be of comparable quality. If a security in the fund's
portfolio ceases to be a First Tier Security (as defined above) or Mitchell
Hutchins becomes aware that a security has received a rating below the second
highest rating by any rating agency, Mitchell Hutchins and, in certain cases,
the board, will consider whether the fund should continue to hold the
obligation. A First Tier Security rated in the highest short-term category at
the time of purchase that subsequently receives a rating below the highest
rating category from a different rating agency may continue to be considered a
First Tier Security.
PACE Money Market Investments may purchase variable and floating rate
securities with remaining maturities in excess of 13 months issued by U.S.
government agencies or instrumentalities or guaranteed by the U.S. government.
In addition, the fund may purchase variable and floating rate securities of
other issuers with remaining maturities in excess of 13 months. The yields on
these securities are adjusted in relation to changes in specific rates, such as
the prime rate, and different securities may have different adjustment rates.
Certain of these obligations carry a demand feature that gives the fund the
right to tender them back to a specified party, usually the issuer or a
remarketing agent, prior to maturity. The fund's investment in these securities
must comply with conditions established by the Securities and Exchange
Commission ("SEC") under which they may be considered to have remaining
maturities of 13 months or less. The fund will purchase variable and floating
rate securities of non-U.S. government issuers that have remaining maturities of
more than 13 months only if the securities are subject to a demand feature
exercisable within 13 months or less.
Generally, PACE Money Market Investments may exercise demand features (1)
upon a default under the terms of the underlying security, (2) to maintain its
portfolio in accordance with its investment objective and policies or applicable
legal or regulatory requirements or (3) as needed to provide liquidity to the
fund in order to meet redemption requests. The ability of a bank or other
financial institutional to fulfill its obligations under a letter of credit,
guarantee or other liquidity arrangement might be affected by possible financial
difficulties of its borrowers, adverse interest rate or economic conditions,
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regulatory limitations or other factors. The interest rate on floating rate or
variable rate securities ordinarily is readjusted on the basis of the prime rate
of the bank that originated the financing or some other index or published rate,
such as the 90-day U.S. Treasury bill rate, or is otherwise reset to reflect
market rates of interest. Generally, these interest rate adjustments cause the
market value of floating rate and variable rate securities to fluctuate less
than the market value of fixed rate securities.
Variable rate securities include variable amount master demand notes,
which are unsecured redeemable obligations that permit investment of varying
amounts at fluctuating interest rates under a direct agreement between PACE
Money Market Investments and an issuer. The principal amount of these notes may
be increased from time to time by the parties (subject to specified maximums) or
decreased by the fund or the issuer. These notes are payable on demand and may
or may not be rated.
PACE Money Market Investments generally may invest no more than 5% of its
total assets in the securities of a single issuer (other than U.S. government
securities), except that the fund may invest up to 25% of its total assets in
First Tier Securities of a single issuer for a period of up to three business
days. The fund may purchase only U.S.
dollar-denominated obligations of foreign issuers.
PACE Money Market Investments may invest up to 10% of its net assets in
illiquid securities. The fund may purchase securities on a when-issued or
delayed delivery basis. The fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33 1/3% of its
total assets. The fund may borrow from banks and through reverse repurchase
agreements for temporary or emergency purposes, but not in excess of 10% of its
total assets.
PACE GOVERNMENT SECURITIES FIXED INCOME INVESTMENTS has an investment
objective of current income. Pacific Investment Management Company serves as the
fund's investment adviser. The fund invests in U.S. government bonds and other
bonds of varying maturities but normally maintains a dollar-weighted average
portfolio duration of between one and seven years. Under normal circumstances,
the fund invests at least 65% of its total assets in U.S. government bonds,
including those backed by mortgages, and related repurchase agreements. The fund
may invest up to 35% of its total assets in corporate bonds, including mortgage-
and asset-backed securities of private issuers. These investments are limited to
bonds that are rated at least A by Standard & Poor's, a division of The
McGraw-Hill Companies, Inc. ("S&P"), or Moody's Investors Service, Inc.
("Moody's"), except that the fund may not acquire a bond if, as a result, more
than 25% of its total assets would be invested in bonds rated below AAA or if
more than 10% of its total assets would be invested in bonds rated A. The fund
may invest in bonds that are assigned comparable ratings by another rating
agency and unrated bonds that its investment adviser determines are of
comparable quality to rated securities in which the fund may invest.
PACE Government Securities Fixed Income Investments may invest in certain
zero coupon securities that are U.S. Treasury notes and bonds that have been
stripped of their unmatured interest coupon receipts. The SEC staff currently
takes the position that "stripped" U.S. government securities that are not
issued through the U.S. Treasury are not U.S. government securities. As long as
the SEC staff takes this position, the fund will not consider these stripped
U.S. government securities to be U.S. government securities for purposes of its
65% investment requirement. The fund may not invest more than 5% of its net
assets in any combination of interest-only, principal-only and inverse floating
rate securities, including those that are not mortgage- or asset-backed
securities.
PACE Government Securities Fixed Income Investments may invest up to 10%
of its net assets in illiquid securities. The fund may purchase securities on a
when-issued or delayed delivery basis. The fund may lend its portfolio
securities to qualified broker-dealers or institutional investors in an amount
up to 33 1/3% of its total assets. The fund may engage in dollar rolls and
reverse repurchase agreements involving up to an aggregate of not more than 5%
of its total assets for investment purposes to enhance its return. These
transactions are considered borrowings. The fund may also borrow from banks and
through reverse repurchase agreements for temporary or emergency purposes, but
not in excess of 10% of its total assets. The fund may invest in loan
participations and assignments. These investments are generally subject to the
fund's overall limitation on investments in illiquid securities. The fund may
invest in the securities of other investment companies and may sell short
"against the box."
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PACE INTERMEDIATE FIXED INCOME INVESTMENTS has an investment objective of
current income, consistent with reasonable stability of principal. Pacific
Income Advisers, Inc. serves as the fund's investment adviser. The fund invests
in bonds of varying maturities but normally maintains a dollar-weighted average
portfolio duration of between two and four and one-half years. Under normal
circumstances, the fund invests at least 65% of its total assets in U.S.
government and foreign government bonds (including bonds issued by supranational
and quasi-governmental entities and mortgage-backed securities), corporate bonds
(including mortgage- and asset-backed securities of private issuers, Eurodollar
certificates of deposit, Eurodollar bonds and Yankee bonds) and preferred
stocks. The fund limits its investments to investment grade securities. The fund
may invest up to 10% of its total assets in securities denominated in foreign
currencies of developed countries. The fund's investments may include certain
zero coupon securities that are U.S. Treasury notes and bonds that have been
stripped of their unmatured interest coupon receipts. The fund may not invest
more than 5% of its net assets in any combination of interest-only,
principal-only and inverse floating rate securities, including those that are
not mortgage- or asset-backed securities.
PACE Intermediate Fixed Income Investments may invest up to 10% of its net
assets in illiquid securities. The fund may purchase securities on a when-issued
or delayed delivery basis. The fund may lend its portfolio securities to
qualified broker-dealers or institutional investors in an amount up to 33 1/3%
of its total assets. The fund may borrow from banks and through reverse
repurchase agreements for temporary or emergency purposes, but not in excess of
10% of its total assets. The fund may invest in the securities of other
investment companies and may sell short "against the box."
PACE STRATEGIC FIXED INCOME INVESTMENTS has an investment objective of
total return consisting of income and capital appreciation. Pacific Investment
Management Company serves as the fund's investment adviser. The fund invests in
bonds of varying maturities but normally maintains a dollar-weighted average
portfolio duration of between three and eight years. Under normal circumstances,
the fund invests at least 65% of its total assets in U.S. government bonds,
bonds (including convertible bonds) of U.S. and foreign private issuers, foreign
government bonds (including bonds issued by supranational and quasi-governmental
entities), foreign currency exchange-related securities, loan participations and
assignments and money market instruments (including commercial paper and
certificates of deposit). These investments include mortgage- and asset-backed
securities, although the fund's investments in mortgage-backed securities of
private issuers are limited to 35% of its total assets. The fund may not invest
more than 5% of its net assets in any combination of interest-only,
principal-only and inverse floating rate securities, including those that are
not mortgage- or asset-backed securities.
PACE Strategic Fixed Income Investments invests primarily in investment
grade bonds but may invest up to 20% of its total assets in securities,
including convertible securities, that are not investment grade but are rated at
least B by S&P or Moody's, assigned a comparable rating by another rating agency
or, if unrated, determined by its investment adviser to be of comparable
quality. The fund may invest up to 20% of its total assets in a combination of
Yankee bonds, Eurodollar bonds and bonds denominated in foreign currencies,
except that not more than 10% of the fund's total assets may be invested in
bonds denominated in foreign currencies. The fund's investments may include
Brady Bonds. The fund's investments also may include certain zero coupon
securities that are U.S. Treasury notes and bonds that have been stripped of
their unmatured interest coupon receipts, other debt securities sold with a
discount and payment-in-kind securities.
PACE Strategic Fixed Income Investments may invest up to 10% of its net
assets in illiquid securities. The fund may purchase securities on a when-issued
or delayed delivery basis. The fund may lend its portfolio securities to
qualified broker-dealers or institutional investors in an amount up to 33 1/3%
of its total assets. The fund may engage in dollar rolls and reverse repurchase
agreements involving up to an aggregate of not more than 5% of its total assets
for investment purposes to enhance the fund's return. These transactions are
considered borrowings. The fund may also borrow from banks and through reverse
repurchase agreements for temporary or emergency purposes, but not in excess of
10% of its total assets. The fund may invest in loan participations and
assignments. These investments are generally subject to the fund's overall
limitation on investments in illiquid securities. The fund may invest in the
securities of other investment companies and may sell short "against the box."
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PACE MUNICIPAL FIXED INCOME INVESTMENTS has an investment objective of
high current income exempt from federal income tax. Deutsche Asset Management,
Inc. serves as the fund's investment adviser. Under normal conditions, the fund
invests at least 80% of its total assets in municipal bonds, the interest on
which, in the opinion of counsel to the issuers, is exempt from federal income
tax. The fund invests in bonds of varying maturities but normally maintains a
dollar-weighted average portfolio duration of between three and seven years. The
fund invests in municipal bonds rated at the time of purchase at least A, MIG-2
or Prime-2 by Moody's or A, SP-2 or A-2 by S&P or, if unrated, determined to be
of comparable quality by its investment adviser, except that the fund may invest
up to 15% of its total assets in municipal bonds that at the time of purchase
are rated Baa by Moody's, BBB by S&P or, if unrated, are determined to be of
comparable quality by its investment adviser. The fund also may invest without
limit in private activity bonds and other municipal bonds that pay interest that
is an item of tax preference for purposes of the federal alternative minimum tax
("AMT") (sometimes referred to as a "tax preference item"), although the fund
will endeavor to manage its portfolio so that no more than 25% of its interest
income will be a tax preference item.
PACE Municipal Fixed Income Investments may not invest more than 25% of
its total assets in municipal obligations whose issuers are located in the same
state. The fund also may not invest more than 25% of its total assets in
municipal obligations that are secured by revenues from a particular industry,
except that it may invest up to 50% of its total assets in municipal bonds that
are secured by revenues from public housing authorities and state and local
housing finance authorities, including bonds backed by the U.S. Treasury or
other U.S. government-guaranteed securities. The fund may invest without limit
in private activity bonds, including private activity bonds that are
collateralized by letters of credit issued by banks having stockholders' equity
in excess of $100 million as of the date of their most recently published
statement of financial condition. The fund may not invest more than 5% of its
net assets in municipal leases.
PACE Municipal Fixed Income Investments may invest up to 10% of its net
assets in illiquid securities. The fund may purchase securities on a when-issued
or delayed delivery basis. The fund may lend its portfolio securities to
qualified broker-dealers or institutional investors in an amount up to 33 1/3%
of its total assets. The fund may borrow from banks and through reverse
repurchase agreements for temporary or emergency purposes, but not in excess of
10% of its total assets. The fund may invest up to 20% of its total assets in
certain taxable securities to maintain liquidity. The fund may invest in the
securities of other investment companies.
PACE GLOBAL FIXED INCOME INVESTMENTS has an investment objective of high
total return. Rogge Global Partners plc serves as the fund's investment adviser.
The fund invests primarily in high-grade bonds, denominated in foreign
currencies or U.S. dollars, of governmental and private issuers in the United
States and developed foreign countries. The fund invests in bonds of varying
maturities but normally maintains a dollar-weighted average portfolio duration
of between four and eight years. Under normal circumstances, the fund invests at
least 65% of its total assets in U.S. government bonds, foreign government bonds
(including bonds issued by supranational organizations and quasi-governmental
entities) and bonds of U.S. or foreign private issuers. The fund normally
invests in a minimum of four countries, one of which may be the United States.
Debt securities are considered high grade if they are rated A or better by S&P
or Moody's or another rating agency or, if unrated, determined by the fund's
investment adviser to be of comparable quality.
PACE Global Fixed Income Investments may invest up to 10% of its total
assets in bonds issued by companies and governments in emerging market countries
that are rated as low as Ba by Moody's or BB by S&P or, if unrated, determined
by the fund's investment adviser to be of comparable quality. The fund considers
"emerging market countries" to be those countries not included in the Morgan
Stanley Capital International World Index of major world economies. The fund's
investments may include Brady Bonds. The fund's investments also may include
certain zero coupon securities that are U.S. Treasury notes and bonds that have
been stripped of their unmatured interest coupon receipts.
PACE Global Fixed Income Investments may invest up to 15% of its net
assets in illiquid securities. The fund may lend its portfolio securities to
qualified broker-dealers or institutional investors in an amount up to 33 1/3%
of its total assets. The fund may borrow from banks and through reverse
repurchase agreements for temporary or emergency purposes, but not in excess of
10% of its total assets. The fund may invest in structured foreign investments
5
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and loan participations and assignments. These investments are generally subject
to the fund's overall limitation on investments in illiquid securities, and in
no event may the fund's investments in loan participations and assignments
exceed 10% of its total assets. The fund may invest in the securities of other
investment companies and may sell short "against the box."
PACE LARGE COMPANY VALUE EQUITY INVESTMENTS has an investment objective of
capital appreciation and dividend income. Brinson Partners, Inc. serves as the
fund's investment adviser. The fund invests primarily in equity securities of
U.S. companies that are believed to be undervalued. The fund's investments may
include both large and medium capitalization companies. However, under normal
circumstances, the fund invests at least 65% of its total assets in common
stocks of companies with a total market capitalization of $4.0 billion or
greater at the time of purchase. The term "market capitalization" means the
market value of a company's outstanding common stock.
PACE Large Company Value Equity Investments may invest up to 10% of its
total assets in convertible bonds that are not investment grade, but these
securities must be rated at least BB by S&P, Ba by Moody's or, if unrated,
determined to be of comparable quality by its investment adviser. Subject to its
65% investment requirement, the fund may invest in a broad range of equity
securities of U.S. issuers that are traded on major stock exchanges or in the
over-the-counter market. The fund may invest up to 5% of its total assets in
U.S. dollar-denominated foreign securities that are traded on recognized U.S.
exchanges or in the U.S. over-the-counter market. The fund also may invest in
U.S. government bonds and investment grade corporate bonds.
PACE Large Company Value Equity Investments may invest up to 10% of its
net assets in illiquid securities. The fund may purchase securities on a
when-issued or delayed delivery basis. The fund may lend its portfolio
securities to qualified broker-dealers or institutional investors in an amount
up to 33 1/3% of its total assets. The fund may borrow from banks and through
reverse repurchase agreements for temporary or emergency purposes, but not in
excess of 10% of its total assets. The fund may invest in the securities of
other investment companies and may sell short "against the box."
PACE LARGE COMPANY GROWTH EQUITY INVESTMENTS has an investment objective
of capital appreciation. Alliance Capital Management L.P. serves as the fund's
investment adviser. The fund invests primarily in equity securities that are
believed to have faster rates of earnings growth than the average rate of the
companies in the Standard & Poor's 500 Composite Stock Price Index. Dividend
income is an incidental consideration in the investment adviser's selection of
investments for the fund. Although the fund may invest in a broad range of
equity securities, including securities convertible into common stocks, under
normal circumstances it invests at least 65% of its total assets in common
stocks of companies with total market capitalization of $4.0 billion or greater
at the time of purchase. The term "market capitalization" means the market value
of a company's outstanding common stock.
Subject to its 65% investment requirement, PACE Large Company Growth
Equity Investments may invest in a broad range of equity securities of U.S.
issuers. The fund may invest up to 5% of its total assets in U.S.
dollar-denominated foreign securities that are traded on recognized U.S.
exchanges or in the U.S. over-the-counter market. The fund also may invest in
U.S. government bonds and investment grade corporate bonds.
PACE Large Company Growth Equity Investments may invest up to 10% of its
net assets in illiquid securities. The fund may purchase securities on a
when-issued or delayed delivery basis. The fund may lend its portfolio
securities to qualified broker-dealers or institutional investors in an amount
up to 33 1/3% of its total assets. The fund may borrow from banks and through
reverse repurchase agreements for temporary or emergency purposes, but not in
excess of 10% of its total assets. The fund may invest in the securities of
other investment companies and may sell short "against the box."
PACE SMALL/MEDIUM COMPANY VALUE EQUITY INVESTMENTS has an investment
objective of capital appreciation. Ariel Capital Management, Inc. and Brandywine
Asset Management, Inc. serve as the fund's investment advisers. Mitchell
Hutchins allocates the fund's assets between the two investment advisers. The
fund invests primarily in equity securities of companies that are believed to be
undervalued or overlooked in the market place. Although the fund may invest in a
broad range of equity securities, including securities convertible into common
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stocks, under normal market conditions the fund invests at least 65% of its
total assets in common stocks of companies with total market capitalization of
less than $4.0 billion at the time of purchase. The term "market capitalization"
means the market value of a company's outstanding common stock. The fund invests
in equity securities that generally have price-to-earnings ("P/E") ratios that
are below the market average. The fund invests in the equity securities of
companies only if they have common stock that is traded on a major stock
exchange or in the over-the-counter market. Subject to its 65% investment
requirement, the fund may invest in U.S. government bonds and investment grade
corporate bonds.
PACE Small/Medium Company Value Equity Investments may invest up to 15% of
its net assets in illiquid securities. The fund may purchase securities on a
when-issued or delayed delivery basis. The fund may lend its portfolio
securities to qualified broker-dealers or institutional investors in an amount
up to 33 1/3% of its total assets. The fund may borrow from banks and through
reverse repurchase agreements for temporary or emergency purposes, but not in
excess of 10% of its total assets. The fund may invest in the securities of
other investment companies and may sell short "against the box."
PACE SMALL/MEDIUM COMPANY GROWTH EQUITY INVESTMENTS has an investment
objective of capital appreciation. Delaware Management Company, Inc. serves as
the fund's investment adviser. The fund invests primarily in the stocks of
companies that are characterized by above-average earnings growth rates and
total market capitalization of less than $4.0 billion at the time of purchase.
The term "market capitalization" means the market value of a company's
outstanding common stock. Dividend income is an incidental consideration in the
investment adviser's selection of investments for the fund. Although the fund
may invest in a broad range of equity securities, including securities
convertible into common stocks, under normal circumstances it invests at least
65% of its total assets in common stocks of issuers with total market
capitalization of less than $4.0 billion that exhibit the potential for high
future earnings growth relative to the overall market. Subject to its 65%
investment requirement, the fund may invest in U.S. government bonds and
investment grade corporate bonds. The fund may invest up to 5% of its total
assets in U.S. dollar-denominated foreign securities that are traded on
recognized U.S. exchanges or in the U.S. over-the-counter market.
PACE Small/Medium Company Growth Equity Investments may invest up to 10%
of its net assets in illiquid securities. The fund may purchase securities on a
when-issued or delayed delivery basis. The fund may lend its portfolio
securities to qualified broker-dealers or institutional investors in an amount
up to 33 1/3% of its total assets. The fund may borrow from banks and through
reverse repurchase agreements for temporary or emergency purposes, but not in
excess of 10% of its total assets. The fund may invest in the securities of
other investment companies and may sell short "against the box."
PACE INTERNATIONAL EQUITY INVESTMENTS has an investment objective of
capital appreciation. Martin Currie Inc. serves as the fund's investment
adviser. The fund invests primarily in equity securities of companies domiciled
outside the United States, and a large part of its investments are usually
denominated in foreign currencies. Under normal circumstances, the fund invests
at least 65% of its total assets in common stocks, which may or may not pay
dividends, and securities convertible into common stocks, of companies domiciled
outside the United States. "Domiciled," for these purposes, means companies (1)
that are organized under the laws of a country other than the United States, (2)
for which the principal securities trading market is in a country other than the
United States or (3) that derive a significant proportion (at least 50%) of
their revenues or profits from goods produced or sold, investments made or
services performed in the respective country or that have at least 50% of their
assets situated in such a country.
PACE International Equity Investments normally invests in the securities
of issuers from three or more countries outside the United States, and, under
normal market conditions, its investments involve securities principally traded
in at least 10 different countries. The fund's investment adviser gives
particular consideration to investments that are principally traded in Japanese,
European, Pacific and Australian securities markets and to securities of foreign
companies that are traded on U.S. securities markets. The fund may also invest
in the securities of companies in emerging markets, including Asia, Latin
America and other regions where the markets may not yet fully reflect the
potential of the developing economies. The fund considers "emerging market
countries" to be those countries not included in the Morgan Stanley Capital
International World Index of major world economies, except that Malaysia is
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considered an emerging market country for this purpose. The fund invests only in
those markets where the investment adviser considers there to be an acceptable
framework of market regulation and sufficient liquidity. The fund may also
invest in non-investment grade convertible securities. These non-investment
grade convertible securities may not be rated lower than B by S&P or Moody's or,
if unrated, determined by the fund's investment adviser to be of comparable
quality. The fund's investments in emerging market securities and non-investment
grade convertible securities, in the aggregate, may not exceed 10% of its total
assets at the time of purchase. Subject to its 65% investment requirement, the
fund also may invest in U.S. government bonds and investment grade bonds of U.S.
and foreign issuers.
PACE International Equity Investments may invest up to 15% of its net
assets in illiquid securities. The fund may lend its portfolio securities to
qualified broker-dealers or institutional investors in an amount up to 33 1/3%
of its total assets. The fund may borrow from banks and through reverse
repurchase agreements for temporary or emergency purposes, but not in excess of
10% of its total assets. The fund may invest in structured foreign investments.
The fund may invest in the securities of other investment companies, including
closed-end funds that invest in foreign markets, and may sell short "against the
box."
PACE INTERNATIONAL EMERGING MARKETS EQUITY INVESTMENTS has an investment
objective of capital appreciation. Schroder Investment Management North America
Inc. serves as the fund's investment adviser. The fund invests at least 65% of
its total assets in equity securities issued by companies domiciled in emerging
market countries. "Domiciled," for these purposes, means companies (1) that are
organized under the laws of an emerging market country, (2) for which the
principal securities trading market is in an emerging market country or (3) that
derive a significant proportion (at least 50%) of their revenues or profits from
goods produced or sold, investments made or services performed in the respective
country or that have at least 50% of their assets situated in such a country.
The fund considers "emerging market countries" to be those countries not
included in the Morgan Stanley Capital International World Index of major world
economies. The fund normally invests in the securities of issuers from three or
more emerging market countries.
PACE International Emerging Markets Equity Investments may invest up to
35% of its total assets in bonds, including U.S. government bonds, foreign
government bonds and bonds of private U.S. and foreign issuers, including
convertible bonds. The fund's investments may include Brady Bonds. The fund's
investments in bonds of private issuers are rated at the time of purchase at
least A by S&P or Moody's or, if unrated, determined by the investment adviser
to be of comparable quality, except that up to 10% of the fund's total assets
may be invested in lower quality bonds, including convertible bonds. These lower
quality bonds must, at the time of purchase, be rated at least C by S&P or
determined by the investment adviser to be of comparable quality.
PACE International Emerging Markets Equity Investments may invest up to
15% of its net assets in illiquid securities. The fund may lend its portfolio
securities to qualified broker-dealers or institutional investors in an amount
up to 33 1/3% of its total assets. The fund may borrow from banks and through
reverse repurchase agreements for temporary or emergency purposes, but not in
excess of 10% of its total assets. The fund may invest in structured foreign
investments and loan participations and assignments. These investments are
generally subject to the fund's overall limitation on investments in illiquid
securities, and in no event may the fund's investments in loan participations
and assignments exceed 10% of its total assets. The fund may invest in the
securities of other investment companies, including closed-end funds that invest
in foreign markets, and may sell short "against the box."
THE FUNDS' INVESTMENTS, RELATED RISKS AND LIMITATIONS
The following supplements the information contained in the Prospectus and
above concerning the funds' investments, related risks and limitations. Except
as otherwise indicated in the Prospectus or this SAI, the funds have established
no policy limitations on their ability to use the investments or techniques
discussed in these documents.
EQUITY SECURITIES. Equity securities include common stocks, most preferred
stocks and securities that are convertible into them, including common stock
purchase warrants and rights, equity interests in trusts, partnerships, joint
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ventures or similar enterprises and depositary receipts. Common stocks, the most
familiar type, represent an equity (ownership) interest in a corporation.
Preferred stock has certain fixed income features, like a bond, but is
actually equity that is senior to a company's common stock. Convertible bonds
may include debentures and notes that may be converted into or exchanged for a
prescribed amount of common stock of the same or a different issuer within a
particular period of time at a specified price or formula. Preferred stock also
may be converted into or exchanged for common stock. Depositary receipts
typically are issued by banks or trust companies and evidence ownership of
underlying equity securities.
While past performance does not guarantee future results, equity
securities historically have provided the greatest long-term growth potential in
a company. However, the prices of equity securities generally fluctuate more
than other securities and reflect changes in a company's financial condition and
in overall market and economic conditions. Common stocks generally represent the
riskiest investment in a company. It is possible that a fund may experience a
substantial or complete loss on an individual equity investment. While this is
possible with bonds, it is less likely.
BONDS. Bonds are fixed or variable rate debt obligations, including notes,
debentures, money market instruments and similar instruments and securities.
Mortgage- and asset-backed securities are types of bonds, and certain types of
income-producing, non-convertible preferred stocks may be treated as bonds for
investment purposes. Bonds generally are used by corporations, governments and
other issuers to borrow money from investors. The issuer pays the investor a
fixed or variable rate of interest and normally must repay the amount borrowed
on or before maturity. Many preferred stocks and some bonds are "perpetual" in
that they have no maturity date.
Bonds are subject to interest rate risk and credit risk. Interest rate
risk is the risk that interest rates will rise and that, as a result, bond
prices will fall, lowering the value of a fund's investments in bonds. In
general, bonds having longer durations are more sensitive to interest rate
changes than are bonds with shorter durations. Duration is a measure of the
expected life of a bond on a present value basis. Credit risk is the risk that
an issuer may be unable or unwilling to pay interest and/or principal on the
bond, or that a market may become less confident as to the issuer's ability or
willingness to do so. Credit risk can be affected by many factors, including
adverse changes in the issuer's own financial condition or in economic
conditions.
CREDIT RATINGS; NON-INVESTMENT GRADE BONDS. Moody's, S&P and other rating
agencies are private services that provide ratings of the credit quality of
bonds, including municipal bonds, and certain other securities. A description of
the ratings assigned to corporate bonds by Moody's and S&P is included in the
Appendix to this SAI. The process by which Moody's and S&P determine ratings for
mortgage-backed securities includes consideration of the likelihood of the
receipt by security holders of all distributions, the nature of the underlying
assets, the credit quality of the guarantor, if any, and the structural, legal
and tax aspects associated with these securities. Not even the highest such
ratings represent an assessment of the likelihood that principal prepayments
will be made by obligors on the underlying assets or the degree to which such
prepayments may differ from that originally anticipated, nor do such ratings
address the possibility that investors may suffer a lower than anticipated yield
or that investors in such securities may fail to recoup fully their initial
investment due to prepayments.
Credit ratings attempt to evaluate the safety of principal and interest
payments, but they do not evaluate the volatility of a bond's value or its
liquidity and do not guarantee the performance of the issuer. Rating agencies
may fail to make timely changes in credit ratings in response to subsequent
events, so that an issuer's current financial condition may be better or worse
than the rating indicates. There is a risk that rating agencies may downgrade
the rating of a bond. Subsequent to a bond's purchase by a fund, it may cease to
be rated or its rating may be reduced below the minimum rating required for
purchase by the fund. The funds may use these ratings in determining whether to
purchase, sell or hold a security. It should be emphasized, however, that
ratings are general and are not absolute standards of quality. Consequently,
bonds with the same maturity, interest rate and rating may have different market
prices.
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In addition to ratings assigned to individual bond issues, the applicable
investment adviser will analyze interest rate trends and developments that may
affect individual issuers, including factors such as liquidity, profitability
and asset quality. The yields on bonds are dependent on a variety of factors,
including general money market conditions, general conditions in the bond
market, the financial condition of the issuer, the size of the offering, the
maturity of the obligation and its rating. There is a wide variation in the
quality of bonds, both within a particular classification and between
classifications. An issuer's obligations under its bonds are subject to the
provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of bond holders or other creditors of an issuer; litigation or other
conditions may also adversely affect the power or ability of issuers to meet
their obligations for the payment of interest and principal on their bonds.
Investment grade bonds are rated in one of the four highest rating
categories by Moody's or S&P, comparably rated by another rating agency or, if
unrated, determined by the applicable investment adviser to be of comparable
quality. Moody's considers bonds rated Baa (its lowest investment grade rating)
to have speculative characteristics. This means that changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
to make principal and interest payments than is the case for higher rated debt
securities. Bonds rated D by S&P are in payment default or such rating is
assigned upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized. Bonds rated C by Moody's
are in the lowest rated class and can be regarded as having extremely poor
prospects of attaining any real investment standing. References to rated bonds
in the Prospectus or this SAI include bonds that are not rated by a rating
agency but that the applicable investment adviser determines to be of comparable
quality.
Non-investment grade bonds (commonly known as "junk bonds") are rated Ba
or lower by Moody's, BB or lower by S&P, comparably rated by another rating
agency or, if unrated, determined by a fund's investment adviser to be of
comparable quality. A fund's investments in non-investment grade bonds entail
greater risk than its investments in higher rated bonds. Non-investment grade
bonds, which are sometimes referred to as "high yield bonds," are considered
predominantly speculative with respect to the issuer's ability to pay interest
and repay principal and may involve significant risk exposure to adverse
conditions. Non-investment grade bonds generally offer a higher current yield
than that available for investment grade issues; however, they involve greater
risks, in that they are especially sensitive to adverse changes in general
economic conditions and in the industries in which the issuers are engaged, to
changes in the financial condition of the issuers and to price fluctuations in
response to changes in interest rates. During periods of economic downturn or
rising interest rates, highly leveraged issuers may experience financial stress
that could adversely affect their ability to make payments of interest and
principal and increase the possibility of default. In addition, such issuers may
not have more traditional methods of financing available to them and may be
unable to repay debt at maturity by refinancing. The risk of loss due to default
by such issuers is significantly greater because such securities frequently are
unsecured by collateral and will not receive payment until more senior claims
are paid in full.
The market for non-investment grade bonds, especially those of foreign
issuers, has expanded rapidly in recent years, which has been a period of
generally expanding growth and lower inflation. These securities will be
susceptible to greater risk when economic growth slows or reverses and when
inflation increases or deflation occurs. This has been reflected in recent
volatility in emerging market securities. In the past, many lower rated bonds
experienced substantial price declines reflecting an expectation that many
issuers of such securities might experience financial difficulties. As a result,
the yields on lower rated bonds rose dramatically. However, those higher yields
did not reflect the value of the income stream that holders of such securities
expected. Rather, they reflected the risk that holders of such securities could
lose a substantial portion of their value due to the issuers' financial
restructurings or defaults by the issuers. There can be no assurance that those
declines will not recur.
The market for non-investment grade bonds generally is thinner and less
active than that for higher quality securities, which may limit a fund's ability
to sell such securities at fair value in response to changes in the economy or
financial markets. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may also decrease the values and liquidity of
non-investment grade bonds, especially in a thinly traded market.
Opinions relating to the validity of municipal bonds and to the exemption
of interest thereon from federal income tax and (when available) from treatment
as a tax preference item, are rendered by bond counsel to the respective issuing
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authorities at the time of issuance. Neither PACE Municipal Fixed Income
Investments, its investment adviser or Mitchell Hutchins reviews the proceedings
relating to the issuance of municipal bonds or the basis for such opinions. An
issuer's obligations under its municipal bonds are subject to the bankruptcy,
insolvency and other laws affecting the rights and remedies of creditors (such
as the federal bankruptcy laws) and federal, state and local laws that may be
enacted that adversely affect the tax-exempt status of interest on the municipal
bonds held by the fund or the exempt-interest dividends received by its
shareholders, extend the time for payment of principal or interest, or both, or
impose other constraints upon enforcement of such obligations. There is also the
possibility that, as a result of litigation or other conditions, the power or
ability of issuers to meet their obligations for the payment of principal of and
interest on their municipal bonds may be materially and adversely affected.
U.S. GOVERNMENT SECURITIES. U.S. government securities include direct
obligations of the U.S. Treasury (such as Treasury bills, notes or bonds) and
obligations issued or guaranteed as to principal and interest (but not as to
market value) by the U.S. government, its agencies or its instrumentalities.
U.S. government securities include mortgage-backed securities issued or
guaranteed by government agencies or government-sponsored enterprises. Other
U.S. government securities may be backed by the full faith and credit of the
U.S. government or supported primarily or solely by the creditworthiness of the
government-related issuer or, in the case of mortgage-backed securities, by
pools of assets.
U.S. government securities also include separately traded principal and
interest components of securities issued or guaranteed by the U.S. Treasury,
which are traded independently under the Separate Trading of Registered Interest
and Principal of Securities ("STRIPS") program. Under the STRIPS programs, the
principal and interest components are individually numbered and separately
issued by the U.S. Treasury.
Treasury inflation-protected securities ("TIPS") are Treasury bonds on
which the principal value is adjusted daily in accordance with changes in the
Consumer Price Index. Interest on TIPS is payable semi-annually on the adjusted
principal value. The principal value of TIPS would decline during periods of
deflation, but the principal amount payable at maturity would not be less than
the original par amount. If inflation is lower than expected while a fund holds
TIPS, the fund may earn less on the TIPS than it would on conventional Treasury
bonds. Any increase in the principal value of TIPS is taxable in the year the
increase occurs, even though holders do not receive cash representing the
increase at that time.
ASSET-BACKED SECURITIES. Asset-backed securities have structural
characteristics similar to mortgage-backed securities, as discussed in more
detail below. However, the underlying assets are not first lien mortgage loans
or interests therein but include assets such as motor vehicle installment sales
contracts, other installment sales contracts, home equity loans, leases of
various types of real and personal property and receivables from revolving
credit (credit card) agreements. Such assets are securitized through the use of
trusts or special purpose corporations. Payments or distributions of principal
and interest may be guaranteed up to a certain amount and for a certain time
period by a letter of credit or pool insurance policy issued by a financial
institution unaffiliated with the issuer, or other credit enhancements may be
present.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect interests in pools of underlying mortgage loans that are secured by
real property. U.S. government mortgage-backed securities are issued or
guaranteed as to the payment of principal and interest (but not as to market
value) by Ginnie Mae (also known as the Government National Mortgage
Association), Fannie Mae (also known as the Federal National Mortgage
Association), Freddie Mac (also known as the Federal Home Loan Mortgage
Corporation) or other government sponsored enterprises. Other domestic
mortgage-backed securities are sponsored or issued by private entities,
generally originators of and investors in mortgage loans, including savings
associations, mortgage bankers, commercial banks, investment bankers and special
purposes entities (collectively, "Private Mortgage Lenders"). Payments of
principal and interest (but not the market value) of such private
mortgage-backed securities may be supported by pools of mortgage loans or other
mortgage-backed securities that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or they may be
issued without any government guarantee of the underlying mortgage assets but
with some form of non-government credit enhancement. Foreign mortgage-backed
securities may be issued by mortgage banks and other private or governmental
entities outside the United States and are supported by interests in foreign
real estate.
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Mortgage-backed securities may be composed of one or more classes and may
be structured either as pass-through securities or collateralized debt
obligations. Multiple-class mortgage-backed securities are referred to herein as
"CMOs." Some CMOs are directly supported by other CMOs, which in turn are
supported by mortgage pools. Investors typically receive payments out of the
interest and principal on the underlying mortgages. The portions of these
payments that investors receive, as well as the priority of their rights to
receive payments, are determined by the specific terms of the CMO class. CMOs
involve special risk and evaluating them requires special knowledge.
A major difference between mortgage-backed securities and traditional
bonds is that interest and principal payments are made more frequently (usually
monthly) and that principal may be repaid at any time because the underlying
mortgage loans may be prepaid at any time. When interest rates go down and
homeowners refinance their mortgages, mortgage-backed securities may be paid off
more quickly than investors expect. When interest rates rise, mortgage-backed
securities may be paid off more slowly than originally expected. Changes in the
rate or "speed" of these prepayments can cause the value of mortgage-backed
securities to fluctuate rapidly.
Mortgage-backed securities also may decrease in value as a result of
increases in interest rates and, because of prepayments, may benefit less than
other bonds from declining interest rates. Reinvestments of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting a fund's yield. Actual prepayment experience may cause the yield of a
mortgage-backed security to differ from what was assumed when the fund purchased
the security. Prepayments at a slower rate than expected may lengthen the
effective life of a mortgage-backed security. The value of securities with
longer effective lives generally fluctuates more widely in response to changes
in interest rates than the value of securities with shorter effective lives.
CMO classes may be specially structured in a manner that provides any of a
wide variety of investment characteristics, such as yield, effective maturity
and interest rate sensitivity. As market conditions change, however, and
particularly during periods of rapid or unanticipated changes in market interest
rates, the attractiveness of the CMO classes and the ability of the structure to
provide the anticipated investment characteristics may be significantly reduced.
These changes can result in volatility in the market value, and in some
instances reduced liquidity, of the CMO class.
Certain classes of CMOs and other mortgage-backed securities are
structured in a manner that makes them extremely sensitive to changes in
prepayment rates. Interest-only ("IO") and principal-only ("PO") classes are
examples of this. IOs are entitled to receive all or a portion of the interest,
but none (or only a nominal amount) of the principal payments, from the
underlying mortgage assets. If the mortgage assets underlying an IO experience
greater than anticipated principal prepayments, then the total amount of
interest payments allocable to the IO class, and therefore the yield to
investors, generally will be reduced. In some instances, an investor in an IO
may fail to recoup all of his or her initial investment, even if the security is
government issued or guaranteed or is rated AAA or the equivalent. Conversely,
PO classes are entitled to receive all or a portion of the principal payments,
but none of the interest, from the underlying mortgage assets. PO classes are
purchased at substantial discounts from par, and the yield to investors will be
reduced if principal payments are slower than expected. Some IOs and POs, as
well as other CMO classes, are structured to have special protections against
the effects of prepayments. These structural protections, however, normally are
effective only within certain ranges of prepayment rates and thus will not
protect investors in all circumstances. Inverse floating rate CMO classes also
may be extremely volatile. These classes pay interest at a rate that decreases
when a specified index of market rates increases.
The market for privately issued mortgage-backed securities is smaller and
less liquid than the market for U.S. government mortgage-backed securities.
Foreign mortgage-backed securities markets are substantially smaller than U.S.
markets but have been established in several countries, including Germany,
Denmark, Sweden, Canada and Australia, and may be developed elsewhere. Foreign
mortgage-backed securities generally are structured differently than domestic
mortgage-backed securities, but they normally present substantially similar
investment risks as well as the other risks normally associated with foreign
securities.
During 1994, the value and liquidity of many mortgage-backed securities
declined sharply due primarily to increases in interest rates. There can be no
assurance that such declines will not recur. The market value of certain
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mortgage-backed securities, including IO and PO classes of mortgage-backed
securities, can be extremely volatile, and these securities may become illiquid.
A fund's investment adviser seeks to manage its investments in mortgage-backed
securities so that the volatility of its portfolio, taken as a whole, is
consistent with its investment objective. Management of portfolio duration is an
important part of this. However, computing the duration of mortgage-backed
securities is complex. See, "The Funds' Investments, Related Risks and
Limitations -- Duration." If a fund's investment adviser does not compute the
duration of mortgage-backed securities correctly, the value of its portfolio may
be either more or less sensitive to changes in market interest rates than
intended. In addition, if market interest rates or other factors that affect the
volatility of securities held by a fund change in ways that its investment
adviser does not anticipate, the fund's ability to meet its investment objective
may be reduced.
More information concerning these mortgage-backed securities and the
related risks of investments therein is set forth below. New types of
mortgage-backed securities are developed and marketed from time to time and,
consistent with its investment limitations, a fund expects to invest in those
new types of mortgage-backed securities that its investment adviser believes may
assist it in achieving its investment objective. Similarly, a fund may invest in
mortgage-backed securities issued by new or existing governmental or private
issuers other than those identified herein.
GINNIE MAE CERTIFICATES -- Ginnie Mae guarantees certain mortgage
pass-through certificates ("Ginnie Mae certificates") that are issued by Private
Mortgage Lenders and that represent ownership interests in individual pools of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. Timely payment of interest
and principal is backed by the full faith and credit of the U.S. government.
Each mortgagor's monthly payments to his lending institution on his residential
mortgage are "passed through" to certificateholders such as the funds. Mortgage
pools consist of whole mortgage loans or participations in loans. The terms and
characteristics of the mortgage instruments are generally uniform within a pool
but may vary among pools. Lending institutions that originate mortgages for the
pools are subject to certain standards, including credit and other underwriting
criteria for individual mortgages included in the pools.
FANNIE MAE CERTIFICATES -- Fannie Mae facilitates a national secondary
market in residential mortgage loans insured or guaranteed by U.S. government
agencies and in privately insured or uninsured residential mortgage loans
(sometimes referred to as "conventional mortgage loans" or "conventional loans")
through its mortgage purchase and mortgage-backed securities sales activities.
Fannie Mae issues guaranteed mortgage pass-through certificates ("Fannie Mae
certificates"), which represent pro rata shares of all interest and principal
payments made and owed on the underlying pools. Fannie Mae guarantees timely
payment of interest and principal on Fannie Mae certificates. The Fannie Mae
guarantee is not backed by the full faith and credit of the U.S. government.
FREDDIE MAC CERTIFICATES -- Freddie Mac also facilitates a national
secondary market for conventional residential and U.S. government-insured
mortgage loans through its mortgage purchase and mortgage-backed securities
sales activities. Freddie Mac issues two types of mortgage pass-through
securities: mortgage participation certificates ("PCs") and guaranteed mortgage
certificates ("GMCs"). Each PC represents a pro rata share of all interest and
principal payments made and owed on the underlying pool. Freddie Mac generally
guarantees timely monthly payment of interest on PCs and the ultimate payment of
principal, but it also has a PC program under which it guarantees timely payment
of both principal and interest. GMCs also represent a pro rata interest in a
pool of mortgages. These instruments, however, pay interest semi-annually and
return principal once a year in guaranteed minimum payments. The Freddie Mac
guarantee is not backed by the full faith and credit of the U.S. government.
PRIVATE MORTGAGE-BACKED SECURITIES -- Mortgage-backed securities issued by
Private Mortgage Lenders are structured similarly to CMOs issued or guaranteed
by Ginnie Mae, Fannie Mae and Freddie Mac. Such mortgage-backed securities may
be supported by pools of U.S. government or agency insured or guaranteed
mortgage loans or by other mortgage-backed securities issued by a government
agency or instrumentality, but they generally are supported by pools of
conventional (I.E., non-government guaranteed or insured) mortgage loans. Since
such mortgage-backed securities normally are not guaranteed by an entity having
the credit standing of Ginnie Mae, Fannie Mae and Freddie Mac, they normally are
structured with one or more types of credit enhancement. See "The Funds'
Investments, Related Risks and Limitations -- Mortgage-Backed Securities --
TYPES OF CREDIT ENHANCEMEnt." These credit enhancements do not protect investors
from changes in market value.
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COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE PASS-THROUGHS
- -- CMOs are debt obligations that are collateralized by mortgage loans or
mortgage pass-through securities (collectively, "Mortgage Assets"). CMOs may be
issued by Private Mortgage Lenders or by government entities such as Fannie Mae
or Freddie Mac. Multi-class mortgage pass-through securities are interests in
trusts that are comprised of Mortgage Assets and that have multiple classes
similar to those in CMOs. Unless the context indicates otherwise, references
herein to CMOs include multi-class mortgage pass-through securities. Payments of
principal of, and interest on, the Mortgage Assets (and in the case of CMOs, any
reinvestment income thereon) provide the funds to pay the debt service on the
CMOs or to make scheduled distributions on the multi-class mortgage pass-through
securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, also referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrued on all classes of a CMO (other than any
principal-only or "PO" class) on a monthly, quarterly or semi-annual basis. The
principal and interest on the Mortgage Assets may be allocated among the several
classes of a CMO in many ways. In one structure, payments of principal,
including any principal prepayments, on the Mortgage Assets are applied to the
classes of a CMO in the order of their respective stated maturities or final
distribution dates so that no payment of principal will be made on any class of
the CMO until all other classes having an earlier stated maturity or final
distribution date have been paid in full. In some CMO structures, all or a
portion of the interest attributable to one or more of the CMO classes may be
added to the principal amounts attributable to such classes, rather than passed
through to certificateholders on a current basis, until other classes of the CMO
are paid in full.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken into
account in calculating the stated maturity date or final distribution date of
each class, which, as with other CMO structures, must be retired by its stated
maturity date or final distribution date but may be retired earlier.
Some CMO classes are structured to pay interest at rates that are adjusted
in accordance with a formula, such as a multiple or fraction of the change in a
specified interest rate index, so as to pay at a rate that will be attractive in
certain interest rate environments but not in others. For example, an inverse
floating rate CMO class pays interest at a rate that increases as a specified
interest rate index decreases but decreases as that index increases. For other
CMO classes, the yield may move in the same direction as market interest rates
- -- I.e., the yield may increase as rates increase and decrease as rates decrease
- -- but may do so more rapidly or to a greater degree. The market value of such
securities generally is more volatile than that of a fixed rate obligation. Such
interest rate formulas may be combined with other CMO characteristics. For
example, a CMO class may be an inverse IO class, on which the holders are
entitled to receive no payments of principal and are entitled to receive
interest at a rate that will vary inversely with a specified index or a multiple
thereof.
TYPES OF CREDIT ENHANCEMENT -- To lessen the effect of failures by
obligors on Mortgage Assets to make payments, mortgage-backed securities may
contain elements of credit enhancement. Such credit enhancement falls into two
categories: (1) liquidity protection and (2) loss protection. Loss protection
relates to losses resulting after default by an obligor on the underlying assets
and collection of all amounts recoverable directly from the obligor and through
liquidation of the collateral. Liquidity protection refers to the provision of
advances, generally by the entity administering the pool of assets (usually the
bank, savings association or mortgage banker that transferred the underlying
loans to the issuer of the security), to ensure that the receipt of payments on
the underlying pool occurs in a timely fashion. Loss protection ensures ultimate
payment of the obligations on at least a portion of the assets in the pool. Such
protection may be provided through guarantees, insurance policies or letters of
credit obtained by the issuer or sponsor, from third parties, through various
means of structuring the transaction or through a combination of such
approaches. A fund will not pay any additional fees for such credit enhancement,
although the existence of credit enhancement may increase the price of a
security. Credit enhancements do not provide protection against changes in the
market value of the security. Examples of credit enhancement arising out of the
structure of the transaction include "senior-subordinated securities" (multiple
class securities with one or more classes subordinate to other classes as to the
payment of principal thereof and interest thereon, with the result that defaults
on the underlying assets are borne first by the holders of the subordinated
class), creation of "spread accounts" or "reserve funds" (where cash or
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investments, sometimes funded from a portion of the payments on the underlying
assets, are held in reserve against future losses) and "over-collateralization"
(where the scheduled payments on, or the principal amount of, the underlying
assets exceed that required to make payment of the securities and pay any
servicing or other fees). The degree of credit enhancement provided for each
issue generally is based on historical information regarding the level of credit
risk associated with the underlying assets. Delinquency or loss in excess of
that anticipated could adversely affect the return on an investment in such a
security.
SPECIAL CHARACTERISTICS OF MORTGAGE- AND ASSET-BACKED SECURITIES -- The
yield characteristics of mortgage- and asset-backed securities differ from those
of traditiona1 debt securities. Among the major differences are that interest
and principal payments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other obligations generally may be prepaid at any time. Prepayments on a pool of
mortgage loans are influenced by a variety of economic, geographic, social and
other factors, including changes in mortgagors' housing needs, job transfers,
unemployment, mortgagors' net equity in the mortgaged properties and servicing
decisions. Generally, however, prepayments on fixed-rate mortgage loans will
increase during a period of falling interest rates and decrease during a period
of rising interest rates. Similar factors apply to prepayments on asset-backed
securities, but the receivables underlying asset-backed securities generally are
of a shorter maturity and thus are less likely to experience substantial
prepayments. Such securities, however, often provide that for a specified time
period the issuers will replace receivables in the pool that are repaid with
comparable obligations. If the issuer is unable to do so, repayment of principal
on the asset-backed securities may commence at an earlier date. Mortgage- and
asset-backed securities may decrease in value as a result of increases in
interest rates and may benefit less than other fixed-income securities from
declining interest rates because of the risk of prepayment.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to the
annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificateholders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are purchased
or traded in the secondary market at a premium or discount. In addition, there
is normally some delay between the time the issuer receives mortgage payments
from the servicer and the time the issuer makes the payments on the
mortgage-backed securities, and this delay reduces the effective yield to the
holder of such securities.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice was to assume that prepayments on pools of
fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of average
life determined for each pool. In periods of declining interest rates, the rate
of prepayment tends to increase, thereby shortening the actual average life of a
pool of mortgage-related securities. Conversely, in periods of rising interest
rates, the rate of prepayment tends to decrease, thereby lengthening the actual
average life of the pool. However, these effects may not be present, or may
differ in degree, if the mortgage loans in the pools have adjustable interest
rates or other special payment terms, such as a prepayment charge. Actual
prepayment experience may cause the yield of mortgage-backed securities to
differ from the assumed average life yield. Reinvestment of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting a fund's yield.
ADJUSTABLE RATE MORTGAGE AND FLOATING RATE MORTGAGE-BACKED SECURITIES --
Adjustable rate mortgage ("ARM") securities are mortgage-backed securities
(sometimes referred to as "ARMs") that represent a right to receive interest
payments at a rate that is adjusted to reflect the interest earned on a pool of
mortgage loans bearing variable or adjustable rates of interest. Floating rate
mortgage-backed securities are classes of mortgage-backed securities that have
been structured to represent the right to receive interest payments at rates
that fluctuate in accordance with an index but that generally are supported by
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pools comprised of fixed-rate mortgage loans. Because the interest rates on ARM
and floating rate mortgage-backed securities are reset in response to changes in
a specified market index, the values of such securities tend to be less
sensitive to interest rate fluctuations than the values of fixed-rate
securities. As a result, during periods of rising interest rates, ARMs generally
do not decrease in value as much as fixed rate securities. Conversely, during
periods of declining rates, ARMs generally do not increase in value as much as
fixed rate securities. ARMs represent a right to receive interest payments at a
rate that is adjusted to reflect the interest earned on a pool of ARM loans.
These mortgage loans generally specify that the borrower's mortgage interest
rate may not be adjusted above a specified lifetime maximum rate or, in some
cases, below a minimum lifetime rate. In addition, certain ARM loans specify
limitations on the maximum amount by which the mortgage interest rate may adjust
for any single adjustment period. These mortgage loans also may limit changes in
the maximum amount by which the borrower's monthly payment may adjust for any
single adjustment period. If a monthly payment is not sufficient to pay the
interest accruing on the ARM, any such excess interest is added to the mortgage
loan ("negative amortization"), which is repaid through future payments. If the
monthly payment exceeds the sum of the interest accrued at the applicable
mortgage interest rate and the principal payment that would have been necessary
to amortize the outstanding principal balance over the remaining term of the
loan, the excess reduces the principal balance of the ARM loan. Borrowers under
these mortgage loans experiencing negative amortization may take longer to build
up their equity in the underlying property and may be more likely to default.
ARM loans also may be subject to a greater rate of prepayments in a
declining interest rate environment. For example, during a period of declining
interest rates, prepayments on these mortgage loans could increase because the
availability of fixed mortgage loans at competitive interest rates may encourage
mortgagors to "lock-in" at a lower interest rate. Conversely, during a period of
rising interest rates, prepayments on ARM loans might decrease. The rate of
prepayments with respect to ARM loans has fluctuated in recent years.
The rates of interest payable on certain ARM loans, and therefore on
certain ARM securities, are based on indices, such as the one-year constant
maturity Treasury rate, that reflect changes in market interest rates. Others
are based on indices, such as the 11th District Federal Home Loan Bank Cost of
Funds Index ("COFI"), that tend to lag behind changes in market interest rates.
The values of ARM securities supported by ARM loans that adjust based on lagging
indices tend to be somewhat more sensitive to interest rate fluctuations than
those reflecting current interest rate levels, although the values of such ARM
securities still tend to be less sensitive to interest rate fluctuations than
fixed-rate securities.
Floating rate mortgage-backed securities are classes of mortgage-backed
securities that have been structured to represent the right to receive interest
payments at rates that fluctuate in accordance with an index but that generally
are supported by pools comprised of fixed-rate mortgage loans. As with ARM
securities, interest rate adjustments on floating rate mortgage-backed
securities may be based on indices that lag behind market interest rates.
Interest rates on floating rate mortgage-backed securities generally are
adjusted monthly. Floating rate mortgage-backed securities are subject to
lifetime interest rate caps, but they generally are not subject to limitations
on monthly or other periodic changes in interest rates or monthly payments.
INVESTING IN FOREIGN SECURITIES. Investing in foreign securities may
involve more risks than investing in U.S. securities. The value of foreign
securities is subject to economic and political developments in the countries
where the issuers operate and to changes in foreign currency values. Investments
in foreign securities involve risks relating to political, social and economic
developments abroad, as well as risks resulting from the differences between the
regulations to which U.S. and foreign issuers and markets are subject. These
risks may include expropriation, confiscatory taxation, withholding taxes on
interest and/or dividends, limitations on the use of or transfer of fund assets
and political or social instability or diplomatic developments. Moreover,
individual foreign economies may differ favorably or unfavorably from the U.S.
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position. In those European countries that have begun using the Euro as a common
currency unit, individual national economies may be adversely affected by the
inability of national governments to use monetary policy to address their own
economic or political concerns.
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Securities of foreign issuers may not be registered with the SEC, and the
issuers thereof may not be subject to its reporting requirements. Accordingly,
there may be less publicly available information concerning foreign issuers of
securities held by the funds than is available concerning U.S. companies.
Foreign companies are not generally subject to uniform accounting, auditing and
financial reporting standards or to other regulatory requirements comparable to
those applicable to U.S. companies.
Securities of many foreign companies may be less liquid and their prices
more volatile than securities of comparable U.S. companies. From time to time
foreign securities may be difficult to liquidate rapidly without significantly
depressing the price of such securities. Transactions in foreign securities may
be subject to less efficient settlement practices. Foreign securities trading
practices, including those involving securities settlement where fund assets may
be released prior to receipt of payment, may expose a fund to increased risk in
the event of a failed trade or the insolvency of a foreign broker-dealer. Legal
remedies for defaults and disputes may have to be pursued in foreign courts,
whose procedures differ substantially from those of U.S. courts.
The costs of investing outside the United States frequently are higher
than those attributable to investing in the United States. This is particularly
true with respect to emerging capital markets. For example, the cost of
maintaining custody of foreign securities exceeds custodian costs for domestic
securities, and transaction and settlement costs of foreign investing frequently
are higher than those attributable to domestic investing. Costs associated with
the exchange of currencies also make foreign investing more expensive than
domestic investing.
A fund may invest in foreign securities by purchasing depositary receipts,
including American Depositary Receipts ("ADRs"), European Depositary Receipts
("EDRs") and Global Depositary Receipts ("GDRs"), or other securities
convertible into securities of issuers based in foreign countries. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. ADRs are receipts typically issued
by a U.S. bank or trust company evidencing ownership of the underlying
securities. They generally are in registered form, are denominated in U.S.
dollars and are designed for use in the U.S. securities markets. EDRs are
European receipts evidencing a similar arrangement, may be denominated in other
currencies and are designed for use in European securities markets. GDRs are
similar to EDRs and are designed for use in several international financial
markets. For purposes of each fund's investment policies, depositary receipts
generally are deemed to have the same classification as the underlying
securities they represent. Thus, a depositary receipt representing ownership of
common stock will be treated as common stock.
ADRs are publicly traded on exchanges or over-the-counter in the United
States and are issued through "sponsored" or "unsponsored" arrangements. In a
sponsored ADR arrangement, the foreign issuer assumes the obligation to pay some
or all of the depositary's transaction fees, whereas under an unsponsored
arrangement, the foreign issuer assumes no obligations and the depositary's
transaction fees are paid directly by the ADR holders. In addition, less
information is available in the United States about an unsponsored ADR than
about a sponsored ADR.
Eurodollar bonds and Yankee bonds are types of U.S. dollar-denominated
foreign securities. Eurodollar bonds are U.S. dollar-denominated bonds that are
held outside the United States, primarily in Europe. Yankee bonds are U.S.
dollar-denominated bonds of foreign issuers that are sold primarily in the
United States.
The funds that invest outside the United States anticipate that their
brokerage transactions involving foreign securities of companies headquartered
in countries other than the United States will be conducted primarily on the
principal exchanges of such countries. Although each fund will endeavor to
achieve the best net results in effecting its portfolio transactions,
transactions on foreign exchanges are usually subject to fixed commissions that
are generally higher than negotiated commissions on U.S. transactions. There is
generally less government supervision and regulation of exchanges and brokers in
foreign countries than in the United States.
Foreign markets have different clearance and settlement procedures, and in
certain markets there have been times when settlements have failed to keep pace
with the volume of securities transactions, making it difficult to conduct such
transactions. Delays in settlement could result in temporary periods when assets
of a fund are uninvested and no return is earned thereon. The inability of a
fund to make intended security purchases due to settlement problems could cause
the fund to miss attractive investment opportunities. Inability to dispose of a
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portfolio security due to settlement problems could result either in losses to
the fund due to subsequent declines in the value of such portfolio security or,
if the fund has entered into a contract to sell the security, could result in
possible liability to the purchaser.
Investment income and gains on certain foreign securities in which the
funds may invest may be subject to foreign withholding or other taxes that could
reduce the return on these securities. Tax treaties between the United States
and certain foreign countries, however, may reduce or eliminate the amount of
foreign taxes to which the funds would be subject. In addition, substantial
limitations may exist in certain countries with respect to the funds' ability to
repatriate investment capital or the proceeds of sales of securities.
FOREIGN CURRENCY RISKS. Currency risk is the risk that changes in foreign
exchange rates may reduce the U.S. dollar value of a fund's foreign investments.
If the value of a foreign currency rises against the value of the U.S. dollar,
the value of a fund's investments that are denominated in, or linked to, that
currency will increase. Conversely, if the value of a foreign currency declines
against the value of the U.S. dollar, the value of those fund investments will
decrease. These changes may have a significant impact on the value of fund
shares. In some instances, a fund may use derivative strategies to hedge against
changes in foreign currency value. (See "Strategies Using Derivative
Instruments," below.) However, opportunities to hedge against currency risk may
not exist in certain markets, particularly with respect to emerging market
currencies, and even when appropriate hedging opportunities are available, a
fund may choose not to hedge against currency risk.
Generally, currency exchange rates are determined by supply and demand in
the foreign exchange markets and the relative merits of investments in different
countries. In the case of those European countries that use the Euro as a common
currency unit, the relative merits of investments in the common market in which
they participate, rather than the merits of investments in the individual
country, will be a determinant of currency exchange rates. Currency exchange
rates also can be affected by the intervention of the U.S. and foreign
governments or central banks, the imposition of currency controls, speculation,
devaluation or other political or economic developments inside and outside the
United States.
Each fund that invests in foreign-currency denominated securities values
its assets daily in U.S. dollars and does not intend to convert its holdings of
foreign currencies to U.S. dollars on a daily basis. From time to time a fund's
foreign currencies may be held as "foreign currency call accounts" at foreign
branches of foreign or domestic banks. These accounts bear interest at
negotiated rates and are payable upon relatively short demand periods. If a bank
became insolvent, a fund could suffer a loss of some or all of the amounts
deposited. A fund may convert foreign currency to U.S. dollars from time to
time.
The value of the assets of a fund as measured in U.S. dollars may be
affected favorably or unfavorably by fluctuations in currency rates and exchange
control regulations. Further, a fund may incur costs in connection with
conversions between various currencies. Currency exchange dealers realize a
profit based on the difference between the prices at which they are buying and
selling various currencies. Thus, a dealer normally will offer to sell a foreign
currency to a fund at one rate, while offering a lesser rate of exchange should
a fund desire immediately to resell that currency to the dealer. A fund conducts
its currency exchange transactions either on a spot (I.E., cash) basis at the
spot rate prevailing in the foreign currency exchange market, or through
entering into forward, futures or options contracts to purchase or sell foreign
currencies.
SPECIAL CHARACTERISTICS OF EMERGING MARKET SECURITIES AND SOVEREIGN DEBT
EMERGING MARKET INVESTMENTS. The special risks of investing in foreign
securities are heightened when emerging markets are involved. For example, many
emerging market currencies recently have experienced significant devaluations
relative to the U.S. dollar. Emerging market countries typically have economic
and political systems that are less fully developed and can be expected to be
less stable than those of developed countries. Emerging market countries may
have policies that restrict investment by foreigners, and there is a higher risk
of government expropriation or nationalization of private property. The
possibility of low or nonexistent trading volume in the securities of companies
in emerging markets also may result in a lack of liquidity and in price
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volatility. Issuers in emerging markets typically are subject to a greater
degree of change in earnings and business prospects than are companies in
developed markets.
INVESTMENT AND REPATRIATION RESTRICTIONS -- Foreign investment in the
securities markets of several emerging market countries is restricted or
controlled to varying degrees. These restrictions may limit a fund's investment
in these countries and may increase its expenses. For example, certain countries
may require governmental approval prior to investments by foreign persons in a
particular company or industry sector or limit investment by foreign persons to
only a specific class of securities of a company, which may have less
advantageous terms (including price) than securities of the company available
for purchase by nationals. Certain countries may restrict or prohibit investment
opportunities in issuers or industries deemed important to national interests.
In addition, the repatriation of both investment income and capital from some
emerging market countries is subject to restrictions, such as the need for
certain government consents. Even where there is no outright restriction on
repatriation of capital, the mechanics of repatriation may affect certain
aspects of a fund's operations. These restrictions may in the future make it
undesirable to invest in the countries to which they apply. In addition, if
there is a deterioration in a country's balance of payments or for other
reasons, a country may impose restrictions on foreign capital remittances
abroad. A fund could be adversely affected by delays in, or a refusal to grant,
any required governmental approval for repatriation, as well as by the
application to it of other restrictions on investments.
If, because of restrictions on repatriation or conversion, a fund were
unable to distribute substantially all of its net investment income and capital
gains within applicable time periods, the fund would be subject to federal
income and/or excise taxes that would not otherwise be incurred and could cease
to qualify for the favorable tax treatment afforded to regulated investment
companies under the Internal Revenue Code. In that case, it would become subject
to federal income tax on all of its net income and gains.
SOCIAL, POLITICAL AND ECONOMIC FACTORS -- Many emerging market countries
may be subject to a greater degree of social, political and economic instability
than is the case in the United States. Any change in the leadership or policies
of these countries may halt the expansion of or reverse any liberalization of
foreign investment policies now occurring. Such instability may result from,
among other things, the following: (1) authoritarian governments or military
involvement in political and economic decision making, and changes in government
through extra-constitutional means; (2) popular unrest associated with demands
for improved political, economic and social conditions; (3) internal
insurgencies; (4) hostile relations with neighboring countries; and (5) ethnic,
religious and racial disaffection. Such social, political and economic
instability could significantly disrupt the financial markets in those countries
and elsewhere and could adversely affect the value of a fund's assets. In
addition, there may be the possibility of asset expropriations or future
confiscatory levels of taxation affecting a fund.
The economies of many emerging markets are heavily dependent upon
international trade and are accordingly affected by protective trade barriers
and the economic conditions of their trading partners, principally the United
States, Japan, China and the European Union. The enactment by the United States
or other principal trading partners of protectionist trade legislation,
reduction of foreign investment in the local economies and general declines in
the international securities markets could have a significant adverse effect
upon the securities markets of these countries. In addition, the economies of
some countries are vulnerable to weakness in world prices for their commodity
exports, including crude oil.
FINANCIAL INFORMATION AND LEGAL STANDARDS -- Issuers in emerging market
countries generally are subject to accounting, auditing and financial standards
and requirements that differ, in some cases significantly, from those applicable
to U.S. issuers. In particular, the assets and profits appearing on the
financial statements of an emerging market issuer may not reflect its financial
position or results of operations in the way they would be reflected had the
financial statements been prepared in accordance with U.S. generally accepted
accounting principles. In addition, for an issuer that keeps accounting records
in local currency, inflation accounting rules may require, for both tax and
accounting purposes, that certain assets and liabilities be restated on the
issuer's balance sheet in order to express items in terms of currency of
constant purchasing power. Inflation accounting may indirectly generate losses
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or profits. Consequently, financial data may be materially affected by
restatements for inflation and may not accurately reflect the real condition of
those issuers and securities markets.
In addition, existing laws and regulations are often inconsistently
applied. As legal systems in some of the emerging market countries develop,
foreign investors may be adversely affected by new laws and regulations, changes
to existing laws and regulations and preemption of local laws and regulations by
national laws. In circumstances where adequate laws exist, it may not be
possible to obtain swift and equitable enforcement of the law.
FOREIGN SOVEREIGN DEBT. Sovereign debt includes bonds that are issued by
foreign governments or their agencies, instrumentalities or political
subdivisions or by foreign central banks. Sovereign debt also may be issued by
quasi-governmental entities that are owned by foreign governments but are not
backed by their full faith and credit or general taxing powers. Investment in
sovereign debt involves special risks. The issuer of the debt or the
governmental authorities that control the repayment of the debt may be unable or
unwilling to repay principal and/or interest when due in accordance with the
terms of such debt, and the funds may have limited legal recourse in the event
of a default.
Sovereign debt differs from debt obligations issued by private entities in
that, generally, remedies for defaults must be pursued in the courts of the
defaulting party. Legal recourse is therefore somewhat diminished. Political
conditions, especially a sovereign entity's willingness to meet the terms of its
debt obligations, are of considerable significance. Also, there can be no
assurance that the holders of commercial bank debt issued by the same sovereign
entity may not contest payments to the holders of sovereign debt in the event of
default under commercial bank loan agreements.
A sovereign debtor's willingness or ability to repay principal and
interest due in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's policy
toward principal international lenders and the political constraints to which a
sovereign debtor may be subject. A country whose exports are concentrated in a
few commodities could be vulnerable to a decline in the international price of
such commodities. Increased protectionism on the part of a country's trading
partners, or political changes in those countries, could also adversely affect
its exports. Such events could diminish a country's trade account surplus, if
any, or the credit standing of a particular local government or agency. Another
factor bearing on the ability of a country to repay sovereign debt is the level
of the country's international reserves. Fluctuations in the level of these
reserves can affect the amount of foreign exchange readily available for
external debt payments and, thus, could have a bearing on the capacity of the
country to make payments on its sovereign debt.
The occurrence of political, social or diplomatic changes in one or more
of the countries issuing sovereign debt could adversely affect the funds'
investments. Political changes or a deterioration of a country's domestic
economy or balance of trade may affect the willingness of countries to service
their sovereign debt.
With respect to sovereign debt of emerging market issuers, investors
should be aware that certain emerging market countries are among the largest
debtors to commercial banks and foreign governments. Some emerging market
countries have from time to time declared moratoria on the payment of principal
and interest on external debt.
Some emerging market countries have experienced difficulty in servicing
their sovereign debt on a timely basis which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements
or converting outstanding principal and unpaid interest to Brady Bonds
(discussed below), and obtaining new credit to finance interest payments.
Holders of sovereign debt, including the funds, may be requested to participate
in the rescheduling of such debt and to extend further loans to sovereign
debtors. The interests of holders of sovereign debt could be adversely affected
in the course of restructuring arrangements or by certain other factors referred
to below. Furthermore, some of the participants in the secondary market for
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sovereign debt may also be directly involved in negotiating the terms of these
arrangements and may, therefore, have access to information not available to
other market participants. Obligations arising from past restructuring
agreements may affect the economic performance and political and social
stability of certain issuers of sovereign debt. There is no bankruptcy
proceeding by which sovereign debt on which a sovereign has defaulted may be
collected in whole or in part.
Foreign investment in certain sovereign debt is restricted or controlled
to varying degrees. These restrictions or controls may at times limit or
preclude foreign investment in such sovereign debt and increase the costs and
expenses of a fund. Certain countries in which a fund may invest require
governmental approval prior to investments by foreign persons, limit the amount
of investment by foreign persons in a particular issuer, limit the investment by
foreign persons only to a specific class of securities of an issuer that may
have less advantageous rights than the classes available for purchase by
domiciliaries of the countries or impose additional taxes on foreign investors.
Certain issuers may require governmental approval for the repatriation of
investment income, capital or the proceeds of sales of securities by foreign
investors. In addition, if a deterioration occurs in a country's balance of
payments the country could impose temporary restrictions on foreign capital
remittances. A fund could be adversely affected by delays in, or a refusal to
grant, any required governmental approval for repatriation of capital, as well
as by the application to the fund of any restrictions on investments. Investing
in local markets may require a fund to adopt special procedures, seek local
government approvals or take other actions, each of which may involve additional
costs to the fund.
BRADY BONDS -- Brady Bonds are sovereign bonds issued under the framework
of the Brady Plan, an initiative announced by former U.S. Treasury Secretary
Nicholas F. Brady in 1989 as a mechanism for debtor nations to restructure their
outstanding external commercial bank indebtedness. In restructuring its external
debt under the Brady Plan framework, a debtor nation negotiates with its
existing bank lenders as well as multilateral institutions such as the
International Monetary Fund ("IMF"). The Brady Plan framework, as it has
developed, contemplates the exchange of commercial bank debt for newly issued
Brady Bonds. Brady Bonds may also be issued in respect of new money being
advanced by existing lenders in connection with the debt restructuring. The
World Bank and the IMF support the restructuring by providing funds pursuant to
loan agreements or other arrangements which enable the debtor nation to
collateralize the new Brady Bonds or to repurchase outstanding bank debt at a
discount.
Brady Bonds have been issued only in recent years, and accordingly do not
have a long payment history. Agreements implemented under the Brady Plan to date
are designed to achieve debt and debt-service reduction through specific options
negotiated by a debtor nation with its creditors. As a result, the financial
packages offered by each country differ. The types of options have included the
exchange of outstanding commercial bank debt for bonds issued at 100% of face
value of such debt, which carry a below-market stated rate of interest
(generally known as par bonds), bonds issued at a discount from the face value
of such debt (generally known as discount bonds), bonds bearing an interest rate
which increases over time and bonds issued in exchange for the advancement of
new money by existing lenders. Regardless of the stated face amount and stated
interest rate of the various types of Brady Bonds, a fund will purchase Brady
Bonds in which the price and yield to the investor reflect market conditions at
the time of purchase.
Certain Brady Bonds have been collateralized as to principal due at
maturity by U.S. Treasury zero coupon bonds with maturities equal to the final
maturity of such Brady Bonds. Collateral purchases are financed by the IMF, the
World Bank and the debtor nations' reserves. In the event of a default with
respect to collateralized Brady Bonds as a result of which the payment
obligations of the issuer are accelerated, the U.S. Treasury zero coupon
obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent until the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments that would have then been due on the Brady Bonds in the
normal course. Interest payments on Brady Bonds may be wholly uncollateralized
or may be collateralized by cash or high grade securities in amounts that
typically represent between 12 and 18 months of interest accruals on these
instruments, with the balance of the interest accruals being uncollateralized.
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Brady Bonds are often viewed as having several valuation components: (1)
the collateralized repayment of principal, if any, at final maturity, (2) the
collateralized interest payments, if any, (3) the uncollateralized interest
payments and (4) any uncollateralized repayment of principal at maturity (these
uncollateralized amounts constitute the "residual risk"). In light of the
residual risk of Brady Bonds and, among other factors, the history of defaults
with respect to commercial bank loans by public and private entities of
countries issuing Brady Bonds, investments in Brady Bonds are to be viewed as
speculative. A fund may purchase Brady Bonds with no or limited
collateralization and will be relying for payment of interest and (except in the
case of principal collateralized Brady Bonds) repayment of principal primarily
on the willingness and ability of the foreign government to make payment in
accordance with the terms of the Brady Bonds.
STRUCTURED FOREIGN INVESTMENTS. This term refers to interests in U.S. and
foreign entities organized and operated solely for the purpose of securitizing
or restructuring the investment characteristics of foreign securities. This type
of securitization or restructuring involves the deposit with or purchase by a
U.S. or foreign entity, such as a corporation or trust, of specified instruments
(such as commercial bank loans or Brady Bonds) and the issuance by that entity
of one or more classes of securities backed by, or representing interests in,
the underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued structured foreign investments to create
securities with different investment characteristics such as varying maturities,
payment priorities and interest rate provisions, and the extent of the payments
made with respect to structured foreign investments is dependent on the extent
of the cash flow on the underlying instruments.
Structured foreign investments frequently involve no credit enhancement.
Accordingly, their credit risk generally will be equivalent to that of the
underlying instruments. In addition, classes of structured foreign investments
may be subordinated to the right of payment of another class. Subordinated
structured foreign investments typically have higher yields and present greater
risks that unsubordinated structured foreign investments. Structured foreign
investments are typically sold in private placement transactions, and there
currently is no active trading market for structured foreign investments.
CURRENCY-LINKED INVESTMENTS. The principal amount of securities that are
indexed to specific foreign currency exchange rates may be adjusted up or down
(but not below zero) at maturity to reflect changes in the exchange rate between
two currencies. A fund may experience loss of principal due to these
adjustments.
ZERO COUPON, OTHER OID AND PIK SECURITIES. Zero coupon securities are
securities on which no periodic interest payments are made but instead are sold
at a deep discount from their face value. The buyer of these securities receives
a rate of return by the gradual appreciation of the security, which results from
the fact that it will be paid at face value on a specified maturity date. There
are many types of zero coupon securities. Some are issued in zero coupon form,
including Treasury bills, notes and bonds that have been stripped of (separated
from) their unmatured interest coupons (unmatured interest payments) and
receipts or certificates representing interests in such stripped debt
obligations and coupons. Others are created by brokerage firms that strip the
coupons from interest-paying bonds and sell the principal and the coupons
separately.
Other securities that are sold with original issue discount ("OID") (I.E.,
the difference between the issue price and the value at maturity) may provide
for some interest to be paid prior to maturity. In addition, payment-in-kind
("PIK") securities pay interest in additional securities, not in cash. OID and
PIK securities usually trade at a discount from their face value.
Zero coupon securities are generally more sensitive to changes in interest
rates than debt obligations of comparable maturities that make current interest
payments. This means that when interest rates fall, the value of zero coupon
securities rises more rapidly than securities paying interest on a current
basis. However, when interest rates rise, their value falls more dramatically.
Other OID securities and PIK securities also are subject to greater fluctuations
in market value in response to changing interest rates than bonds of comparable
maturities that make current distributions of interest in cash.
Federal tax law requires that a fund that holds a zero coupon or other OID
security include in gross income each year the OID that accrues on the security
for the year, even though the fund receives no interest payment on the security
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during the year. Similarly, while PIK securities may pay interest in the form of
additional securities rather than cash, that interest must be included in a
fund's current income. These distributions would have to be made from the fund's
cash assets or, if necessary, from the proceeds of sales of portfolio
securities. A fund would not be able to purchase additional securities with cash
used to make such distributions and its current income and the value of its
shares would ultimately be reduced as a result.
Certain zero coupon securities are U.S. Treasury notes and bonds that have
been stripped of their unmatured interest coupon receipts or interests in such
U.S. Treasury securities or coupons. The staff of the SEC currently takes the
position that "stripped" U.S. government securities that are not issued through
the U.S. Treasury are not U.S. government securities. This technique is
frequently used with U.S. Treasury bonds to create CATS (Certificate of Accrual
Treasury Securities), TIGRs (Treasury Income Growth Receipts) and similar
securities.
CONVERTIBLE SECURITIES. A convertible security is a bond, preferred stock
or other security that may be converted into or exchanged for a prescribed
amount of common stock of the same or a different issuer within a particular
period of time at a specified price or formula. A convertible security entitles
the holder to receive interest or dividends until the convertible security
matures or is redeemed, converted or exchanged. Convertible securities have
unique investment characteristics in that they generally (1) have higher yields
than common stocks, but lower yields than comparable non-convertible securities,
(2) are less subject to fluctuation in value than the underlying stock because
they have fixed income characteristics and (3) provide the potential for capital
appreciation if the market price of the underlying common stock increases. While
no securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock. However,
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed income
security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by a fund is called for redemption,
the fund will be required to permit the issuer to redeem the security, convert
it into underlying common stock or sell it to a third party.
WARRANTS. Warrants are securities permitting, but not obligating, holders
to subscribe for other securities. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments. In addition, the value of a warrant does not
necessarily change with the value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to its expiration date.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Investments in secured or unsecured
fixed or floating rate loans ("Loans") arranged through private negotiations
between a borrowing corporation, government or other entity and one or more
financial institutions ("Lenders") may be in the form of participations
("Participations") in Loans or assignments ("Assignments") of all or a portion
of Loans from third parties. Participations typically result in the fund's
having a contractual relationship only with the Lender, not with the borrower. A
fund has the right to receive payments of principal, interest and any fees to
which it is entitled only from the Lender selling the Participation and only
upon receipt by the Lender of the payments from the borrower. In connection with
purchasing Participations, a fund generally has no direct right to enforce
compliance by the borrower with the terms of the loan agreement relating to the
Loan, nor any rights of set-off against the borrower, and a fund may not
directly benefit from any collateral supporting the Loan in which it has
purchased the Participation. As a result, a fund assumes the credit risk of both
the borrower and the Lender that is selling the Participation. In the event of
the insolvency of the selling Lender, the fund may be treated as a general
creditor of that Lender and may not benefit from any set-off between the Lender
and the borrower. A fund will acquire Participations only if its investment
adviser determines that the selling Lender is creditworthy.
When a fund purchases Assignments from Lenders, it acquires direct rights
against the borrower on the Loan. In an Assignment, the fund is entitled to
receive payments directly from the borrower and, therefore, does not depend on
the selling bank to pass these payments onto the fund. However, because
Assignments are arranged through private negotiations between potential
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assignees and assignors, the rights and obligations acquired by the fund as the
purchaser of an Assignment may differ from, and be more limited than, those held
by the assigning Lender.
Assignments and Participations are generally not registered under the
Securities Act of 1933, as amended ("Securities Act"), and thus may be subject
to a fund's limitation on investment in illiquid securities. Because there may
be no liquid market for such securities, such securities may be sold only to a
limited number of institutional investors. The lack of a liquid secondary market
could have an adverse impact on the value of such securities and on a fund's
ability to dispose of particular Assignments or Participations when necessary to
meet the fund's liquidity needs or in response to a specific economic event,
such as a deterioration in the creditworthiness of the borrower.
TEMPORARY AND DEFENSIVE INVESTMENTS; MONEY MARKET INVESTMENTS. Each fund
may invest in money market investments for temporary or defensive purposes or as
part of its normal investment program. Such investments include, among other
things, (1) securities issued or guaranteed by the U.S. government or one of its
agencies or instrumentalities, (2) debt obligations of banks, savings and loan
institutions, insurance companies and mortgage bankers, (3) commercial paper and
notes, including those with variable and floating rates of interest, (4) debt
obligations of foreign branches of U.S. banks, U.S. branches of foreign banks,
and foreign branches of foreign banks, (5) debt obligations issued or guaranteed
by one or more foreign governments or any of their foreign political
subdivisions, agencies or instrumentalities, including obligations of
supranational entities, (6) bonds issued by foreign issuers, (7) repurchase
agreements and (8) securities of other investment companies that invest
exclusively in money market instruments. Only those funds that may trade outside
the United States may invest in money market instruments that are denominated in
foreign currencies.
INVESTMENTS IN OTHER INVESTMENT COMPANIES. Each fund may invest in
securities of other investment companies, subject to Investment Company Act
limitations. Among other things, these limitations currently restrict a fund's
aggregate investments in other registered investment companies to no more than
10% of its total assets. The shares of other investment companies are subject to
the management fees and other expenses of those companies, and the purchase of
shares of some investment companies requires the payment of sales loads and (in
the case of closed-end investment companies) sometimes substantial premiums
above the value of such companies' portfolio securities. At the same time, a
fund would continue to pay its own management fees and expenses with respect to
all its investments, including shares of other investment companies. Each fund
may invest in the shares of other investment companies when, in the judgment of
its investment adviser, the potential benefits of the investment outweigh the
payment of any management fees and expenses and, where applicable, premium or
sales load. From time to time, investments in other investment companies may be
the most effective available means for a fund to invest a portion of its assets.
In some cases, investment in another investment company (often a closed-end
investment company) may be the only practical way for a fund to invest in
securities of issuers in certain countries. A fund's investment in another
investment company is subject to the risks of that investment company's
underlying portfolio securities. Shares of closed-end investment companies also
can trade at substantial discounts below the value of the companies' portfolio
securities. A fund that invests in a closed-end investment company is also
subject to the risk that the shares of the closed-end investment company might
trade at a discount to their net asset value.
PACE Money Market Investments may invest in the securities of other money
market funds when Mitchell Hutchins believes that (1) the amounts to be invested
are too small or are available too late in the day to be effectively invested in
money market instruments, (2) shares of other money market funds otherwise would
provide a better return than direct investment in money market instruments or
(3) such investments would enhance the fund's liquidity. The other funds may
invest in the securities of money market funds for similar reasons.
ILLIQUID SECURITIES. The term "illiquid securities" means securities that
cannot be disposed of within seven days in the ordinary course of business at
approximately the amount at which a fund has valued the securities and includes,
among other things, purchased over-the-counter options, repurchase agreements
maturing in more than seven days and restricted securities other than those its
investment adviser has determined are liquid pursuant to guidelines established
by the board. The assets used as cover for over-the-counter options written by a
fund will be considered illiquid unless the over-the-counter options are sold to
qualified dealers who agree that the fund may repurchase any over-the-counter
options they write at a maximum price to be calculated by a formula set forth in
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the option agreements. The cover for an over-the-counter option written subject
to this procedure would be considered illiquid only to the extent that the
maximum repurchase price under the formula exceeds the intrinsic value of the
option. Under current SEC guidelines, interest-only and principal-only classes
of mortgage-backed securities generally are considered illiquid. However,
interest-only and principal-only classes of fixed-rate mortgage-backed
securities issued by the U.S. government or one of its agencies or
instrumentalities will not be considered illiquid if the fund's investment
adviser has determined that they are liquid pursuant to guidelines established
by the board. A fund may not be able readily to liquidate illiquid securities
and may have to sell other investments if necessary to raise cash to meet its
obligations. The lack of a liquid secondary market for illiquid securities may
make it more difficult for a fund to assign a value to those securities for
purposes of valuing its portfolio and calculating its net asset value.
Restricted securities are not registered under the Securities Act and may
be sold only in privately negotiated or other exempted transactions or after a
Securities Act registration statement has become effective. 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 a fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, a fund might obtain a less favorable price than
prevailed when it decided to sell.
However, not all restricted securities are illiquid. For funds that are
authorized to trade outside the United States, foreign securities are freely
tradeable in the country in which they are principally traded generally are not
considered illiquid, even if they are restricted in the United States. A large
institutional market has developed for many U.S. and foreign securities that are
not registered under the Securities Act. Institutional investors generally will
not seek to sell these instruments to the general public but instead will often
depend either on an efficient institutional market in which such unregistered
securities can be readily resold or on an issuer's ability to honor a demand for
repayment. Therefore, the fact that there are contractual or legal restrictions
on resale to the general public or certain institutions is not dispositive of
the liquidity of such investments.
Institutional markets for restricted securities also have developed as a
result of Rule 144A under the Securities Act, which establishes a "safe harbor"
from the registration requirements of that Act for resales of certain securities
to qualified institutional buyers. Such markets include automated systems for
the trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National Association
of Securities Dealers, Inc. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held by
a fund, however, could affect adversely the marketability of such portfolio
securities, and the fund might be unable to dispose of such securities promptly
or at favorable prices.
The board has delegated the function of making day-to-day determinations
of liquidity to each fund's investment adviser pursuant to guidelines approved
by the board. An investment adviser takes into account a number of factors in
reaching liquidity decisions, including (1) the frequency of trades for the
security, (2) the number of dealers that make quotes for the security, (3) the
number of dealers that have undertaken to make a market in the security, (4) the
number of other potential purchasers, (5) the nature of the security and how
trading is effected (E.G., the time needed to sell the security, how bids are
solicited and the mechanics of transfer) and (6) the existence of demand
features or similar liquidity enhancements. A fund's investment adviser monitors
the liquidity of restricted securities in its portfolio and reports periodically
on such decisions to the board.
In making determinations as to the liquidity of municipal lease
obligations purchased by PACE Municipal Fixed Income Investments, the investment
adviser distinguishes between direct investments in municipal lease obligations
(or participations therein) and investments in securities that may be supported
by municipal lease obligations or certificates of participation therein. Since
these municipal lease obligation-backed securities are based on a
well-established means of securitization, the investment adviser does not
believe that investing in such securities presents the same liquidity issues as
direct investments in municipal lease obligations.
Mitchell Hutchins and (where applicable) the fund's investment adviser
monitor each fund's overall holdings of illiquid securities. If a fund's
holdings of illiquid securities comes to exceed its limitation on investments in
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illiquid securities for any reason, such as a security ceasing to qualify as
liquid, changes in relative market values of portfolio securities or shareholder
redemptions, Mitchell Hutchins will consider what action would be in the best
interest of the fund and its shareholders.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a
fund purchases securities or other obligations from a bank or securities dealer
(or its affiliate) and simultaneously commits to resell them to the counterparty
at an agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased obligations.
A fund maintains custody of the underlying obligations prior to their
repurchase, either through its regular custodian or through a special
"tri-party" custodian or sub-custodian that maintains separate accounts for both
the fund and its counterparty. Thus, the obligation of the counterparty to pay
the repurchase price on the date agreed to or upon demand is, in effect, secured
by such obligations.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including a possible decline in the market value of
the underlying obligations. If their value becomes less than the repurchase
price, plus any agreed-upon additional amount, the counterparty must provide
additional collateral so that at all times the collateral is at least equal to
the repurchase price plus any agreed-upon additional amount. The difference
between the total amount to be received upon repurchase of the obligations and
the price that was paid by a fund upon acquisition is accrued as interest and
included in its net investment income. Repurchase agreements involving
obligations other than U.S. government securities (such as commercial paper and
corporate bonds) may be subject to special risks and may not have the benefit of
certain protections in the event of the counterparty's insolvency. If the seller
or guarantor becomes insolvent, the fund may suffer delays, costs and possible
losses in connection with the disposition of collateral. Each fund intends to
enter into repurchase agreements only with counterparties in transactions
believed by Mitchell Hutchins to present minimum credit risks.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements involve the
sale of securities held by a fund subject to its agreement to repurchase the
securities at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest and are subject to the fund's limitation on borrowings.
While a reverse repurchase agreement is outstanding, a fund will maintain, in a
segregated account with its custodian, cash or liquid securities, marked to
market daily, in an amount at least equal to its obligations under the reverse
repurchase agreement. See "The Funds' Investments, Related Risks and Limitations
- -- Segregated Accounts."
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by a fund might be unable to deliver them when that fund seeks
to repurchase. If the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, such buyer or trustee or receiver may
receive an extension of time to determine whether to enforce that fund's
obligation to repurchase the securities, and the fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
decision.
DOLLAR ROLLS. In a dollar roll, a fund sells mortgage-backed or other
securities for delivery on the next regular settlement date for those securities
and, simultaneously, contracts to purchase substantially similar securities for
delivery on a later settlement date. Dollar rolls also are subject to a fund's
limitation on borrowings.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each fund may purchase
securities on a "when-issued" basis or may purchase or sell securities for
delayed delivery, I.E., for issuance or delivery to the fund later than the
normal settlement date for such securities at a stated price and yield.
When-issued securities include TBA ("to be assigned") securities. TBA
securities, which are usually mortgage-backed securities, are purchased on a
forward commitment basis with an approximate principal amount and no defined
maturity date. The actual principal amount and maturity date are determined upon
settlement when the specific mortgage pools are assigned. A fund generally would
not pay for such securities or start earning interest on them until they are
received. However, when a fund undertakes a when-issued or delayed-delivery
obligation, it immediately assumes the risks of ownership, including the risks
of price fluctuation. Failure of the issuer to deliver a security purchased by a
fund on a when-issued or delayed-delivery basis may result in the fund's
incurring or missing an opportunity to make an alternative investment. Depending
on market conditions, a fund's when-issued and delayed-delivery purchase
commitments could cause its net asset value per share to be more volatile,
because such securities may increase the amount by which the fund's total
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assets, including the value of when-issued and delayed-delivery securities held
by that fund, exceeds its net assets.
A security purchased on a when-issued or delayed delivery basis is
recorded as an asset on the commitment date and is subject to changes in market
value, generally based upon changes in the level of interest rates. Thus,
fluctuation in the value of the security from the time of the commitment date
will affect a fund's net asset value. When a fund commits to purchase securities
on a when-issued or delayed delivery basis, its custodian segregates assets to
cover the amount of the commitment. See "The Funds' Investments, Related Risks
and Limitations -- Segregated Accounts." A fund may sell the right to acquire
the security prior to delivery if its investment adviser deems it advantageous
to do so, which may result in a gain or loss to the fund.
PACE MUNICIPAL FIXED INCOME INVESTMENTS -- TYPES OF MUNICIPAL BONDs. The
fund may invest in a variety of municipal bonds, as described below:
MUNICIPAL BOND -- Municipal bonds are obligations that are issued by
states, municipalities, public authorities or other issuers and that pay
interest that is exempt from federal income tax in the opinion of issuer's
counsel. The two principal classifications of municipal bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable only from the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise tax or other specific revenue source such as from
the user of the facility being financed. Municipal bonds also include "moral
obligation" bonds, which are normally issued by special purpose authorities. For
these bonds, a government unit is regarded as morally obligated to support
payment of the debt service, which is usually subject to annual budget
appropriations. Various types of municipal bonds are described in the following
sections.
MUNICIPAL LEASE OBLIGATIONS -- Municipal bonds include municipal lease
obligations, such as leases, installment purchase contracts and conditional
sales contracts, and certificates of participation therein. Municipal lease
obligations are issued by state and local governments and authorities to
purchase land or various types of equipment or facilities and may be subject to
annual budget appropriations. The fund generally invests in municipal lease
obligations through certificates of participation.
Although municipal lease obligations do not constitute general obligations
of the municipality for which its taxing power is pledged, they ordinarily are
backed by the municipality's covenant to budget for, appropriate and make the
payments due under the lease obligation. The leases underlying certain municipal
lease obligations, however, provide that lease payments are subject to partial
or full abatement if, because of material damage or destruction of the leased
property, there is substantial interference with the lessee's use or occupancy
of such property. This "abatement risk" may be reduced by the existence of
insurance covering the leased property, the maintenance by the lessee of reserve
funds or the provision of credit enhancements such as letters of credit.
Certain municipal lease obligations contain "non-appropriation" clauses,
which provide that the municipality has no obligation to make lease or
installment purchase payments in future years unless money is appropriated for
such purpose on a yearly basis. Some municipal lease obligations of this type
are insured as to timely payment of principal and interest, even in the event of
a failure by the municipality to appropriate sufficient funds to make payments
under the lease. However, in the case of an uninsured municipal lease
obligation, the fund's ability to recover under the lease in the event of a
non-appropriation or default will be limited solely to the repossession of
leased property without recourse to the general credit of the lessee, and
disposition of the property in the event of foreclosure might prove difficult.
INDUSTRIAL DEVELOPMENT BONDS ("IDBS") AND PRIVATE ACTIVITY BONDS ("PABS")
- -- IDBs and PABs are issued by or on behalf of public authorities to finance
various privately operated facilities, such as airport or pollution control
facilities. These obligations are considered municipal bonds if the interest
paid thereon is exempt from federal income tax in the opinion of the bond
issuer's counsel. IDBs and PABs are in most cases revenue bonds and thus are not
payable from the unrestricted revenues of the issuer. The credit quality of IDBs
and PABs is usually directly related to the credit standing of the user of the
facilities being financed. IDBs issued after August 15, 1986 generally are
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considered PABs, and to the extent the fund invests in such PABs, shareholders
generally will be required to include a portion of their exempt-interest
dividends from that fund in calculating their liability for the AMT. See "Taxes"
below. The fund may invest more than 25% of its net assets in IDBs and PABs.
FLOATING RATE AND VARIABLE RATE OBLIGATIONS -- Floating rate and variable
rate obligations are municipal bonds that bear interest at rates that are not
fixed but that vary with changes in specified market rates or indices. The
interest rate on floating rate or variable rate securities ordinarily is
readjusted on the basis of the prime rate of the bank that originated the
financing or some other index or published rate, such as the 90-day U.S.
Treasury bill rate, or is otherwise reset to reflect market rates of interest.
Generally, these interest rate adjustments cause the market value of floating
rate and variable rate municipal securities to fluctuate less than the market
value of fixed rate obligations. Accordingly, as interest rates decrease or
increase, the potential for capital appreciation or capital depreciation is less
than for fixed rate obligations. Floating rate or variable rate obligations
typically permit the holder to demand payment of principal from the issuer or
remarketing agent at par value prior to maturity and may permit the issuer to
prepay principal, plus accrued interest, at its discretion after a specified
notice period. Frequently, floating rate or variable rate obligations and/or the
demand features thereon are secured by letters of credit or other credit support
arrangements provided by banks or other financial institutions, the credit
standing of which affects the credit quality of the obligations. Changes in the
credit quality of these institutions could cause losses to the fund and
adversely affect its share price.
A demand feature gives the fund the right to sell the securities to a
specified party, usually a remarketing agent, on a specified date. A demand
feature is often backed by a letter of credit from a bank or a guarantee or
other liquidity support arrangement from a bank or other financial institution.
As discussed under "Participation Interests," to the extent that payment of an
obligation is backed by a letter of credit, guarantee or other liquidity support
that may be drawn upon demand, such payment may be subject to that institution's
ability to satisfy that commitment.
PARTICIPATION INTERESTS -- Participation interests are interests in
municipal bonds, including IDBs, PABs and floating and variable rate
obligations, that are owned by banks. These interests carry a demand feature
permitting the holder to tender them back to the bank, which demand feature
generally is backed by an irrevocable letter of credit or guarantee of the bank.
The credit standing of such bank affects the credit quality of the participation
interests.
A participation interest gives the fund an undivided interest in a
municipal bond owned by a bank. The fund has the right to sell the instruments
back to the bank. Such right generally is backed by the bank's irrevocable
letter of credit or guarantee and permits the fund to draw on the letter of
credit on demand, after specified notice, for all or any part of the principal
amount of the fund's participation interest plus accrued interest. Generally,
the fund expects to exercise the demand under the letters of credit or other
guarantees (1) upon a default under the terms of the underlying bond, (2) to
maintain the fund's portfolio in accordance with its investment objective and
policies or (3) as needed to provide liquidity to the fund in order to meet
redemption requests. The ability of a bank to fulfill its obligations under a
letter of credit or guarantee might be affected by possible financial
difficulties of its borrowers, adverse interest rate or economic conditions,
regulatory limitations or other factors. The fund's investment adviser will
monitor the pricing, quality and liquidity of the participation interests held
by the fund, and the credit standing of banks issuing letters of credit or
guarantees supporting such participation interests on the basis of published
financial information reports of rating services and bank analytical services.
TENDER OPTION BONDS -- Tender option bonds are long-term municipal bonds
sold by a bank subject to a "tender option" that gives the purchaser the right
to tender them to the bank at par plus accrued interest at designated times (the
"tender option"). The tender option may be exercisable at intervals ranging from
bi-weekly to semi-annually, and the interest rate on the bonds is typically
reset at the end of the applicable interval in an attempt to cause the bonds to
have a market value that approximates their par value. The tender option
generally would not be exercisable in the event of a default on, or significant
downgrading of, the underlying municipal bonds. Therefore, the fund's ability to
exercise the tender option will be affected by the credit standing of both the
bank involved and the issuer of the underlying securities.
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PUT BONDS -- A put bond is a municipal bond that gives the holder the
unconditional right to sell the bond back to the issuer or a remarketing agent
at a specified price and exercise date, which is typically well in advance of
the bond's maturity date. The obligation to purchase the bond on the exercise
date may be supported by a letter of credit or other credit support arrangement
from a bank, insurance company or other financial institution, the credit
standing of which affects the credit quality of the obligation.
If the put is a "one time only" put, the fund ordinarily will either sell
the bond or put the bond, depending upon the more favorable price. If the bond
has a series of puts after the first put, the bond will be held as long as, in
the judgment of its investment adviser, it is in the best interest of the fund
to do so. There is no assurance that the issuer of a put bond acquired by a fund
will be able to repurchase the bond upon the exercise date, if the fund chooses
to exercise its right to put the bond back to the issuer.
TAX-EXEMPT COMMERCIAL PAPER AND SHORT-TERM MUNICIPAL NOTES -- Municipal
bonds include tax-exempt commercial paper and short-term municipal notes, such
as tax anticipation notes, bond anticipation notes, revenue anticipation notes
and other forms of short-term loans. Such notes are issued with a short-term
maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements and other revenues.
INVERSE FLOATERS -- The fund may invest in municipal bonds on which the
rate of interest varies inversely with interest rates on other municipal bonds
or an index. Such obligations include components of securities on which interest
is paid in two separate parts - an auction component, which pays interest at a
market rate that is set periodically through an auction process or other method,
and a residual component, or "inverse floater," which pays interest at a rate
equal to the difference between the rate that the issuer would have paid on a
fixed-rate obligation at the time of issuance and the rate paid on the auction
component. The market value of an inverse floater will be more volatile than
that of a fixed-rate obligation and, like most debt obligations, will vary
inversely with changes in interest rates.
Because the interest rate paid to holders of inverse floaters is generally
determined by subtracting the interest rate paid to holders of auction
components from a fixed amount, the interest rate paid to holders of inverse
floaters will decrease as market rates increase and increase as market rates
decrease. Moreover, the extent of the increases and decreases in the market
value of inverse floaters may be larger than comparable changes in the market
value of an equal principal amount of a fixed rate municipal bond having similar
credit quality, redemption provisions and maturity. In a declining interest rate
environment, inverse floaters can provide the fund with a means of increasing or
maintaining the level of tax-exempt interest paid to shareholders.
MORTGAGE SUBSIDY BONDS -- The fund also may purchase mortgage subsidy
bonds that are normally issued by special purpose public authorities. In some
cases the repayment of such bonds depends upon annual legislative
appropriations; in other cases repayment is a legal obligation of the issuer,
and, if the issuer is unable to meet its obligations, repayment becomes a moral
commitment of a related government unit (subject, however, to such
appropriations). The types of municipal bonds identified above and in the
Prospectus may include obligations of issuers whose revenues are primarily
derived from mortgage loans on housing projects for moderate to low income
families.
STANDBY COMMITMENTS -- The fund may acquire standby commitments pursuant
to which a bank or other municipal bond dealer agrees to purchase securities
that are held in the fund's portfolio or that are being purchased by the fund at
a price equal to (1) the acquisition cost (excluding any accrued interest paid
on acquisition), less any amortized market premium or plus any accrued market or
original issue discount, plus (2) all interest accrued on the securities since
the last interest payment date or the date the securities were purchased by the
fund, whichever is later. Although the fund does not currently intend to acquire
standby commitments with respect to municipal bonds held in its portfolio, the
fund may acquire such commitments under unusual market conditions to facilitate
portfolio liquidity.
The fund would enter into standby commitments only with those banks or
other dealers that, in the opinion of its investment adviser, present minimal
credit risk. The fund's right to exercise standby commitments would be
unconditional and unqualified. A standby commitment would not be transferable by
the fund, although it could sell the underlying securities to a third party at
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any time. The fund may pay for standby commitments either separately in cash or
by paying a higher price for the securities that are acquired subject to such a
commitment (thus reducing the yield to maturity otherwise available for the same
securities). The acquisition of a standby commitment would not ordinarily affect
the valuation or maturity of the underlying municipal bonds. Standby commitments
acquired by the fund would be valued at zero in determining net asset value.
Whether the fund paid directly or indirectly for a standby commitment, its cost
would be treated as unrealized depreciation and would be amortized over the
period the commitment is held by the fund.
DURATION. Duration is a measure of the expected life of a debt security on
a present value basis. Duration incorporates the debt security's yield, coupon
interest payments, final maturity and call features into one measure and is one
of the fundamental tools used by the applicable investment adviser in portfolio
selection and yield curve positioning a fund's investments in bonds. Duration
was developed as a more precise alternative to the concept "term to maturity."
Traditionally, a bond's "term to maturity" has been used as a proxy for the
sensitivity of the security's price to changes in interest rates (which is the
"interest rate risk" or "volatility" of the security). However, "term to
maturity" measures only the time until a bond provides for a final payment,
taking no account of the pattern of the security's payments prior to maturity.
Duration takes the length of the time intervals between the present time
and the time that the interest and principal payments are scheduled or, in the
case of a callable debt security, expected to be made, and weights them by the
present values of the cash to be received at each future point in time. For any
debt security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. For example, depending on its
coupon and the level of market yields, a Treasury note with a remaining maturity
of five years might have a duration of 4.5 years. For mortgage-backed and other
securities that are subject to prepayments, put or call features or adjustable
coupons, the difference between the remaining stated maturity and the duration
is likely to be much greater.
Duration allows an investment adviser to make certain predictions as to
the effect that changes in the level of interest rates will have on the value of
a fund's portfolio of debt securities. For example, when the level of interest
rates increases by 1%, a debt security having a positive duration of three years
generally will decrease by approximately 3%. Thus, if an investment adviser
calculates the duration of a fund's portfolio of bonds as three years, it
normally would expect the portfolio to change in value by approximately 3% for
every 1% change in the level of interest rates. However, various factors, such
as changes in anticipated prepayment rates, qualitative considerations and
market supply and demand, can cause particular securities to respond somewhat
differently to changes in interest rates than indicated in the above example.
Moreover, in the case of mortgage-backed and other complex securities, duration
calculations are estimates and are not precise. This is particularly true during
periods of market volatility. Accordingly, the net asset value of a fund's
portfolio of bonds may vary in relation to interest rates by a greater or lesser
percentage than indicated by the above example.
Futures, options and options on futures have durations that, in general,
are closely related to the duration of the securities that underlie them.
Holding long futures or call option positions will lengthen portfolio duration
by approximately the same amount as would holding an equivalent amount of the
underlying securities. Short futures or put options have durations roughly equal
to the negative duration of the securities that underlie these positions, and
have the effect of reducing portfolio duration by approximately the same amount
as would selling an equivalent amount of the underlying securities.
There are some situations in which the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by the standard duration calculation is the case of mortgage-backed
securities. The stated final maturity of such securities is generally 30 years,
but current prepayment rates are critical in determining the securities'
interest rate exposure. In these and other similar situations, an investment
adviser will use more sophisticated analytical techniques that incorporate the
economic life of a security into the determination of its duration and,
therefore, its interest rate exposure.
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LENDING OF PORTFOLIO SECURITIES. Each fund is authorized to lend its
portfolio securities to broker-dealers or institutional investors that Mitchell
Hutchins deems qualified. Lending securities enables a fund to earn additional
income but could result in a loss or delay in recovering these securities. The
borrower of a fund's portfolio securities must maintain acceptable collateral
with that fund's custodian in an amount, marked to market daily, at least equal
to the market value of the securities loaned, plus accrued interest and
dividends. Acceptable collateral is limited to cash, U.S. government securities
and irrevocable letters of credit that meet certain guidelines established by
Mitchell Hutchins. Each fund may reinvest any cash collateral in money market
investments or other short-term liquid investments. In determining whether to
lend securities to a particular broker-dealer or institutional investor,
Mitchell Hutchins will consider, and during the period of the loan will monitor,
all relevant facts and circumstances, including the creditworthiness of the
borrower. Each fund will retain authority to terminate any of its loans at any
time. Each fund may pay reasonable fees in connection with a loan and may pay
the borrower or placing broker a negotiated portion of the interest earned on
the reinvestment of cash held as collateral. A fund will receive amounts
equivalent to any dividends, interest or other distributions on the securities
loaned. Each fund will regain record ownership of loaned securities to exercise
beneficial rights, such as voting and subscription rights, when regaining such
rights is considered to be in the fund's interest.
Pursuant to procedures adopted by the board governing each fund's
securities lending program, PaineWebber has been retained to serve as lending
agent for each fund. The board also has authorized the payment of fees
(including fees calculated as a percentage of invested cash collateral) to
PaineWebber for these services. The board periodically reviews all portfolio
securities loan transactions for which PaineWebber acted as lending agent.
PaineWebber also has been approved as a borrower under each fund's securities
lending program.
SHORT SALES "AGAINST THE BOX." Each fund (other than PACE Money Market
Investments and PACE Municipal Fixed Income Investments) may engage in short
sales of securities it owns or has the right to acquire at no added cost through
conversion or exchange of other securities it owns (short sales "against the
box"). To make delivery to the purchaser in a short sale, the executing broker
borrows the securities being sold short on behalf of a fund, and that fund is
obligated to replace the securities borrowed at a date in the future. When a
fund sells short, it establishes a margin account with the broker effecting the
short sale and deposits collateral with the broker. In addition, the fund
maintains, in a segregated account with its custodian, the securities that could
be used to cover the short sale. Each fund incurs transaction costs, including
interest expense, in connection with opening, maintaining and closing short
sales "against the box."
A fund might make a short sale "against the box" to hedge against market
risks when its investment adviser believes that the price of a security may
decline, thereby causing a decline in the value of a security owned by the fund
or a security convertible into or exchangeable for a security owned by the fund.
In such case, any loss in the fund's long position after the short sale should
be reduced by a corresponding gain in the short position. Conversely, any gain
in the long position after the short sale should be reduced by a corresponding
loss in the short position. The extent to which gains or losses in the long
position are reduced will depend upon the amount of the securities sold short
relative to the amount of the securities a fund owns, either directly or
indirectly, and in the case where the fund owns convertible securities, changes
in the investment values or conversion premiums of such securities.
SEGREGATED ACCOUNTS. When a fund enters into certain transactions that
involve obligations to make future payments to third parties, including the
purchase of securities on a when-issued or delayed delivery basis, or reverse
repurchase agreements, it will maintain with an approved custodian in a
segregated account cash or liquid securities, marked to market daily, in an
amount at least equal to the fund's obligation or commitment under such
transactions. As described below under "Strategies Using Derivative
Instruments," segregated accounts may also be required in connection with
certain transactions involving options, futures or forward currency contracts
and swaps.
INVESTMENT LIMITATIONS OF THE FUNDS
FUNDAMENTAL LIMITATIONS. The following fundamental investment limitations
cannot be changed for a fund without the affirmative vote of the lesser of (a)
more than 50% of the outstanding shares of the fund or (b) 67% or more of the
shares of the fund present at a shareholders' meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy. If a
percentage restriction is adhered to at the time of an investment or
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transaction, later changes in percentage resulting from a change in values of
portfolio securities or amount of total assets will not be considered a
violation of any of the following limitations, except that with regard to the
borrowings limitation in investment restriction number 4, the funds will comply
with the applicable restrictions of Section 18 of the Investment Company Act.
Under the investment restrictions adopted by the funds:
(1) A fund, other than PACE Intermediate Fixed Income Investments and PACE
Global Fixed Income Investments, may not purchase securities (other than U.S.
government securities) of any issuer if, as a result of the purchase, more than
5% of the value of the fund's total assets would be invested in such issuer,
except that up to 25% of the value of the fund's total assets may be invested
without regard to this 5% limitation.
(2) A fund will not purchase more than 10% of the outstanding voting
securities of any one issuer, except that this limitation is not applicable to
the fund's investments in U.S. government securities and up to 25% of the fund's
assets may be invested without regard to these limitations.
(3) A fund, other than PACE Municipal Fixed Income Investments, will
invest no more than 25% of the value of its total assets in securities of
issuers in any one industry, the term industry being deemed to include the
government of a particular country other than the United States. This limitation
is not applicable to a fund's investments in U.S. government securities.
(4) A fund will not issue senior securities (including borrowing money
from banks and other entities and through reverse repurchase agreements and
mortgage dollar rolls) in excess of 33 1/3% of its total assets (including the
amount of senior securities issued, but reduced by any liabilities and
indebtedness not constituting senior securities), except that a fund may borrow
up to an additional 5% of its total assets (not including the amount borrowed)
for extraordinary or emergency purposes.
(5) A fund will not pledge, hypothecate, mortgage, or otherwise encumber
its assets, except to secure permitted borrowings or in connection with its use
of forward contracts, futures contracts, options, swaps, caps, collars and
floors.
(6) A fund will not lend any funds or other assets, except through
purchasing debt obligations, lending portfolio securities and entering into
repurchase agreements consistent with the fund's investment objective and
policies.
(7) A fund will not purchase securities on margin, except that a fund may
obtain any short-term credits necessary for the clearance of purchases and sales
of securities. For purposes of this restriction, the deposit or payment of
initial or variation margin in connection with futures contracts or options on
futures contracts will not be deemed to be a purchase of securities on margin.
(8) A fund will not make short sales of securities or maintain a short
position, unless at all times when a short position is open it owns an equal
amount of the securities or securities convertible into or exchangeable for,
without payment of any further consideration, securities of the same issue as,
and equal in amount to, the securities sold short ("short sales against the
box"), and unless not more than 10% of the fund's net assets (taken at market
value) is held as collateral for such sales at any one time.
(9) A fund will not purchase or sell real estate or real estate limited
partnership interests, except that it may purchase and sell mortgage related
securities and securities of companies that deal in real estate or interests
therein.
(10) A fund will not purchase or sell commodities or commodity contracts
(except currencies, forward currency contracts, futures contracts and options
and other similar contracts).
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(11) A fund will not act as an underwriter of securities, except that a
fund may acquire restricted securities under circumstances in which, if the
securities were sold, the fund might be deemed to be an underwriter for purposes
of the Securities Act.
NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions are
non-fundamental and may be changed by the vote of the board without shareholder
approval. If a percentage restriction is adhered to at the time of an investment
or transaction, later changes in percentage resulting from a change in values of
portfolio securities or amount of total assets will not be considered a
violation of any of the following limitations.
(1) A fund may not purchase securities of other investment companies,
except to the extent permitted by the Investment Company Act in the open market
at no more than customary brokerage commission rates. This limitation does not
apply to securities received or acquired as dividends, through offers of
exchange or as a result of reorganization, consolidation or merger.
(2) A fund will not purchase portfolio securities while borrowings in
excess of 5% of its total assets are outstanding.
STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Each fund other than PACE
Money Market Investments is authorized to use a variety of financial instruments
("Derivative Instruments"), including certain options, futures contracts
(sometimes referred to as "futures"), options on futures contracts and swap
transactions. For funds that are permitted to trade outside the United States,
the applicable investment adviser also may use forward currency contracts,
foreign currency options and futures and options on foreign currency futures. A
fund may enter into transactions involving one or more types of Derivative
Instruments under which the full value of its portfolio is at risk. Under normal
circumstances, however, each fund's use of these instruments will place at risk
a much smaller portion of its assets. The particular Derivative Instruments used
by the funds are described below.
A fund might not use any derivative instruments or strategies, and there
can be no assurance that using any strategy will succeed. If an investment
adviser is incorrect in its judgment on market values, interest rates or other
economic factors in using a derivative instrument or strategy, a fund may have
lower net income and a net loss on the investment.
OPTIONS ON SECURITIES AND FOREIGN CURRENCIES -- A call option is a
short-term contract pursuant to which the purchaser of the option, in return for
a premium, has the right to buy the security or currency underlying the option
at a specified price at any time during the term of the option or at specified
times or at the expiration of the option, depending on the type of option
involved. The writer of the call option, who receives the premium, has the
obligation, upon exercise of the option during the option term, to deliver the
underlying security or currency against payment of the exercise price. A put
option is a similar contract that gives its purchaser, in return for a premium,
the right to sell the underlying security or currency at a specified price
during the option term or at specified times or at the expiration of the option,
depending on the type of option involved. The writer of the put option, who
receives the premium, has the obligation, upon exercise of the option during the
option term, to buy the underlying security or currency at the exercise price.
OPTIONS ON SECURITIES INDICES -- A securities index assigns relative
values to the securities included in the index and fluctuates with changes in
the market values of those securities. A securities index option operates in the
same way as a more traditional securities option, except that exercise of a
securities index option is effected with cash payment and does not involve
delivery of securities. Thus, upon exercise of a securities index option, the
purchaser will realize, and the writer will pay, an amount based on the
difference between the exercise price and the closing price of the securities
index.
SECURITIES INDEX FUTURES CONTRACTS -- A securities index futures contract
is a bilateral agreement pursuant to which one party agrees to accept, and the
other party agrees to make, delivery of an amount of cash equal to a specified
dollar amount times the difference between the securities index value at the
close of trading of the contract and the price at which the futures contract is
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originally struck. No physical delivery of the securities comprising the index
is made. Generally, contracts are closed out prior to the expiration date of the
contract.
INTEREST RATE AND FOREIGN CURRENCY FUTURES CONTRACTS -- Interest rate and
foreign currency futures contracts are bilateral agreements pursuant to which
one party agrees to make, and the other party agrees to accept, delivery of a
specified type of debt security or currency at a specified future time and at a
specified price. Although such futures contracts by their terms call for actual
delivery or acceptance of bonds or currency, in most cases the contracts are
closed out before the settlement date without the making or taking of delivery.
OPTIONS ON FUTURES CONTRACTS -- Options on futures contracts are similar
to options on securities or currency, except that an option on a futures
contract gives the purchaser the right, in return for the premium, to assume a
position in a futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase or sell a
security or currency, at a specified price at any time during the option term.
Upon exercise of the option, the delivery of the futures position to the holder
of the option will be accompanied by delivery of the accumulated balance that
represents the amount by which the market price of the futures contract exceeds,
in the case of a call, or is less than, in the case of a put, the exercise price
of the option on the future. The writer of an option, upon exercise, will assume
a short position in the case of a call and a long position in the case of a put.
FORWARD CURRENCY CONTRACTS -- A forward currency contract involves an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by the
parties, at a price set at the time the contract is entered into.
GENERAL DESCRIPTION OF STRATEGIES USING DERIVATIVE INSTRUMENTS. A fund may
use Derivative Instruments to attempt to hedge its portfolio and also to attempt
to enhance income or return or realize gains and to manage the duration of its
bond portfolio. In addition, a fund may use Derivative Instruments to adjust its
exposure to different asset classes or to maintain exposure to stocks or bonds
while maintaining a cash balance for fund management purposes (such as to
provide liquidity to meet anticipated shareholder sales of fund shares and for
fund operating expenses).
Hedging strategies can be broadly categorized as "short hedges" and "long
hedges." A short hedge is a purchase or sale of a Derivative Instrument intended
partially or fully to offset potential declines in the value of one or more
investments held in a fund's portfolio. Thus, in a short hedge a fund takes a
position in a Derivative Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged. For example, a
fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, a fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying security declines, a fund might be
able to close out the put option and realize a gain to offset the decline in the
value of the security.
Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that a fund intends to acquire. Thus, in a long
hedge, a fund takes a position in a Derivative Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, a fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, a fund could exercise the call and thus limit its acquisition
cost to the exercise price plus the premium paid and transactions costs.
Alternatively, a fund might be able to offset the price increase by closing out
an appreciated call option and realizing a gain.
A fund may purchase and write (sell) straddles on securities or indices of
securities. A long straddle is a combination of a call and a put option
purchased on the same security or on the same futures contract, where the
exercise price of the put is equal to the exercise price of the call. A fund
might enter into a long straddle when its investment adviser believes it likely
that the prices of the securities will be more volatile during the term of the
option than the option pricing implies. A short straddle is a combination of a
call and a put written on the same security where the exercise price of the put
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is equal to the exercise price of the call. A fund might enter into a short
straddle when its investment adviser believes it unlikely that the prices of the
securities will be as volatile during the term of the option as the option
pricing implies.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that a fund owns
or intends to acquire. Derivative Instruments on stock indices, in contrast,
generally are used to hedge against price movements in broad equity market
sectors in which a fund has invested or expects to invest. Derivative
Instruments on bonds may be used to hedge either individual securities or broad
fixed income market sectors.
Income strategies using Derivative Instruments may include the writing of
covered options to obtain the related option premiums. Return or gain strategies
may include using Derivative Instruments to increase or decrease a fund's
exposure to different asset classes without buying or selling the underlying
instruments. A fund also may use derivatives to simulate full investment by the
fund while maintaining a cash balance for fund management purposes (such as to
provide liquidity to meet anticipated shareholder sales of fund shares and for
fund operating expenses).
The use of Derivative Instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they are traded
and the Commodity Futures Trading Commission ("CFTC"). In addition, a fund's
ability to use Derivative Instruments may be limited by tax considerations. See
"Taxes."
In addition to the products, strategies and risks described below and in
the Prospectus, a fund's investment adviser may discover additional
opportunities in connection with Derivative Instruments and with hedging,
income, return and gain strategies. These new opportunities may become available
as regulatory authorities broaden the range of permitted transactions and as new
Derivative Instruments and techniques are developed. The applicable investment
adviser may use these opportunities for a fund to the extent that they are
consistent with the fund's investment objective and permitted by its investment
limitations and applicable regulatory authorities. The funds' Prospectus or this
SAI will be supplemented to the extent that new products or techniques involve
materially different risks than those described below or in the Prospectus.
SPECIAL RISKS OF STRATEGIES USING DERIVATIVE INSTRUMENTS. The use of
Derivative Instruments involves special considerations and risks, as described
below. Risks pertaining to particular Derivative Instruments are described in
the sections that follow.
(1) Successful use of most Derivative Instruments depends upon the ability
of a fund's investment adviser to predict movements of the overall securities,
interest rate or currency exchange markets, which requires different skills than
predicting changes in the prices of individual securities. While the applicable
investment advisers are experienced in the use of Derivative Instruments, there
can be no assurance that any particular strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Derivative Instrument and price movements of the
investments that are being hedged. For example, if the value of a Derivative
Instrument used in a short hedge increased by less than the decline in value of
the hedged investment, the hedge would not be fully successful. Such a lack of
correlation might occur due to factors affecting the markets in which Derivative
Instruments are traded, rather than the value of the investments being hedged.
The effectiveness of hedges using Derivative Instruments on indices will depend
on the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements in
the investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if a fund entered into a short
hedge because the applicable investment adviser projected a decline in the price
of a security in that fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the Derivative Instrument. Moreover, if the price of the
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Derivative Instrument declined by more than the increase in the price of the
security, the fund could suffer a loss. In either such case, the fund would have
been in a better position had it not hedged at all.
(4) As described below, a fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Derivative Instruments involving obligations to third parties
(I.E., Derivative Instruments other than purchased options). If the fund was
unable to close out its positions in such Derivative Instruments, it might be
required to continue to maintain such assets or accounts or make such payments
until the positions expired or matured. These requirements might impair a fund's
ability to sell a portfolio security or make an investment at a time when it
would otherwise be favorable to do so, or require that the fund sell a portfolio
security at a disadvantageous time. A fund's ability to close out a position in
a Derivative Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of a counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any hedging position can be
closed out at a time and price that is favorable to a fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the funds to an
obligation to another party. A fund will not enter into any such transactions
unless it owns either (1) an offsetting ("covered") position in securities,
currencies or other options or futures contracts or (2) cash or liquid
securities, with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. Each fund will
comply with SEC guidelines regarding cover for such transactions and will, if
the guidelines so require, set aside cash or liquid securities in a segregated
account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Derivative Instrument is open, unless they are
replaced with similar assets. As a result, committing a large portion of a
fund's assets to cover positions or to segregated accounts could impede
portfolio management or the fund's ability to meet redemption requests or other
current obligations.
OPTIONS. The funds may purchase put and call options, and write (sell)
covered put or call options on securities in which they invest and related
indices. Funds that may invest outside the United States also may purchase put
and call options and write covered options on foreign currencies. The purchase
of call options may serve as a long hedge, and the purchase of put options may
serve as a short hedge. In addition, a fund may also use options to attempt to
enhance return or realize gains by increasing or reducing its exposure to an
asset class without purchasing or selling the underlying securities. Writing
covered put or call options can enable a fund to enhance income by reason of the
premiums paid by the purchasers of such options. Writing covered call options
serves as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing the
option. However, if the security appreciates to a price higher than the exercise
price of the call option, it can be expected that the option will be exercised
and the affected fund will be obligated to sell the security at less than its
market value. Writing covered put options serves as a limited long hedge because
increases in the value of the hedged investment would be offset to the extent of
the premium received for writing the option. However, if the security
depreciates to a price lower than the exercise price of the put option, it can
be expected that the put option will be exercised and the fund will be obligated
to purchase the security at more than its market value. The securities or other
assets used as cover for over-the-counter options written by a fund would be
considered illiquid to the extent described under "The Funds' Investment
Policies, Related Risks and Restrictions -- Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration dates
of up to nine months. Generally, over-the-counter options on bonds are
European-style options. This means that the option can only be exercised
immediately prior to its expiration. This is in contrast to American-style
options that may be exercised at any time. There are also other types of options
that may be exercised on certain specified dates before expiration. Options that
expire unexercised have no value.
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A fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, a fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, a fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit a fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
The funds may purchase and write both exchange-traded and over-the-counter
options. Currently, many options on equity securities are exchange-traded.
Exchange markets for options on bonds and foreign currencies exist but are
relatively new, and these instruments are primarily traded on the
over-the-counter market. Exchange-traded options in the United States are issued
by a clearing organization affiliated with the exchange on which the option is
listed that, in effect, guarantees completion of every exchange-traded option
transaction. In contrast, over-the-counter options are contracts between a fund
and its counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when a fund purchases or writes an
over-the-counter option, it relies on the counterparty to make or take delivery
of the underlying investment upon exercise of the option. Failure by the
counterparty to do so would result in the loss of any premium paid by the fund
as well as the loss of any expected benefit of the transaction.
The funds' ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The funds intend to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
over-the-counter options only by negotiating directly with the counterparty, or
by a transaction in the secondary market if any such market exists. Although the
funds will enter into over-the-counter options only with counterparties that are
expected to be capable of entering into closing transactions with the funds,
there is no assurance that a fund will in fact be able to close out an
over-the-counter option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, a fund might be unable to close out
an over-the-counter option position at any time prior to its expiration.
If a fund were unable to effect a closing transaction for an option it had
purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered put or call
option written by the fund could cause material losses because the fund would be
unable to sell the investment used as cover for the written option until the
option expires or is exercised.
A fund may purchase and write put and call options on indices in much the
same manner as the more traditional options discussed above, except the index
options may serve as a hedge against overall fluctuations in a securities market
(or market sector) rather than anticipated increases or decreases in the value
of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. The funds' use of options is governed
by the following guidelines, which can be changed by the board without
shareholder vote:
(1) A fund may purchase a put or call option, including any straddle or
spread, only if the value of its premium, when aggregated with the premiums on
all other options held by the fund, does not exceed 5% of its total assets.
(2) The aggregate value of securities underlying put options written by a
fund, determined as of the date the put options are written, will not exceed 50%
of its net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock or bond indices and options on futures
contracts) purchased by a fund that are held at any time will not exceed 20% of
the fund's net assets.
FUTURES. The funds may purchase and sell securities index futures
contracts, interest rate futures contracts, debt security index futures
contracts and (for those funds that invest outside the United States) foreign
37
<PAGE>
currency futures contracts. A fund may also purchase put and call options, and
write covered put and call options, on futures in which it is allowed to invest.
The purchase of futures or call options thereon can serve as a long hedge, and
the sale of futures or the purchase of put options thereon can serve as a short
hedge. Writing covered call options on futures contracts can serve as a limited
short hedge, and writing covered put options on futures contracts can serve as a
limited long hedge, using a strategy similar to that used for writing covered
options on securities or indices. In addition, a fund may purchase or sell
futures contracts or purchase options thereon to increase or reduce its exposure
to an asset class without purchasing or selling the underlying securities,
either as a hedge or to enhance return or realize gains.
Futures strategies also can be used to manage the average duration of a
fund's bond portfolio. If a fund's investment adviser wishes to shorten the
average duration of its portfolio, the fund may sell a futures contract or a
call option thereon, or purchase a put option on that futures contract. If a
fund's investment adviser wishes to lengthen the average duration of its bond
portfolio, the fund may buy a futures contract or a call option thereon, or sell
a put option thereon.
A fund may also write put options on futures contracts while at the same
time purchasing call options on the same futures contracts in order
synthetically to create a long futures contract position. Such options would
have the same strike prices and expiration dates. A fund will engage in this
strategy only when it is more advantageous to a fund than is purchasing the
futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract a fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, obligations of
the United States or obligations fully guaranteed as to principal and interest
by the United States, in an amount generally equal to 10% or less of the
contract value. Margin must also be deposited when writing a call option on a
futures contract, in accordance with applicable exchange rules. Unlike margin in
securities transactions, initial margin on futures contracts does not represent
a borrowing, but rather is in the nature of a performance bond or good-faith
deposit that is returned to a fund at the termination of the transaction if all
contractual obligations have been satisfied. Under certain circumstances, such
as periods of high volatility, a fund may be required by an exchange to increase
the level of its initial margin payment, and initial margin requirements might
be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of each fund's obligations to or from a futures
broker. When a fund purchases an option on a futures contract, the premium paid
plus transaction costs is all that is at risk. In contrast, when a fund
purchases or sells a futures contract or writes a call option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If a fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Holders and writers of futures contracts and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The funds intend to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
38
<PAGE>
If a fund were unable to liquidate a futures or related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. A fund would continue to be subject
to market risk with respect to the position. In addition, except in the case of
purchased options, a fund would continue to be required to make daily variation
margin payments and might be required to maintain the position being hedged by
the future or option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options markets
are subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price distortions.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The funds' use of
futures and related options is governed by the following guidelines, which can
be changed by the board without shareholder vote:
(1) The aggregate initial margin and premiums on futures contracts,
options on futures contracts and options on foreign currencies traded on a
CFTC-regulated exchange that are not for bona fide hedging purposes (as defined
by the CFTC), excluding the amount by which options are "in-the-money," may not
exceed 5% of a fund's net assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock or bond indices and options on futures
contracts) purchased by a fund that are held at any time will not exceed 20% of
the fund's net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by a fund will not exceed 5% of the fund's total
assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. Each fund
that may invest outside the United States may use options and futures on foreign
currencies, as described above, and forward currency contracts, as described
below, to hedge against movements in the values of the foreign currencies in
which the fund's securities are denominated. Such currency hedges can protect
against price movements in a security a fund owns or intends to acquire that are
attributable to changes in the value of the currency in which it is denominated.
Such hedges do not, however, protect against price movements in the securities
that are attributable to other causes.
A fund might seek to hedge against changes in the value of a particular
currency when no Derivative Instruments on that currency are available or such
Derivative Instruments are considered expensive. In such cases, the fund may
hedge against price movements in that currency by entering into transactions
using Derivative Instruments on another currency or a basket of currencies, the
value of which its investment adviser believes will have a positive correlation
to the value of the currency being hedged. In addition, a fund may use forward
currency contracts to shift exposure to foreign currency fluctuations from one
country to another. For example, if a fund owned securities denominated in a
foreign currency and its investment adviser believed that currency would decline
relative to another currency, it might enter into a forward contract to sell an
appropriate amount of the first foreign currency, with payment to be made in the
second foreign currency. Transactions that use two foreign currencies are
sometimes referred to as "cross hedging." Use of a different foreign currency
magnifies the risk that movements in the price of the Derivative Instrument will
not correlate or will correlate unfavorably with the foreign currency being
hedged.
39
<PAGE>
The value of Derivative Instruments on foreign currencies depends on the
value of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Derivative
Instruments, a fund could be disadvantaged by having to deal in the odd-lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Derivative Instruments until they reopen.
Settlement of Derivative Instruments involving foreign currencies might be
required to take place within the country issuing the underlying currency. Thus,
a fund might be required to accept or make delivery of the underlying foreign
currency in accordance with any U.S. or foreign regulations regarding the
maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
FORWARD CURRENCY CONTRACTS. Each fund that invests outside the United
States may enter into forward currency contracts to purchase or sell foreign
currencies for a fixed amount of U.S. dollars or another foreign currency. Such
transactions may serve as long hedges--for example, a fund may purchase a
forward currency contract to lock in the U.S. dollar price of a security
denominated in a foreign currency that the fund intends to acquire. Forward
currency contract transactions may also serve as short hedges--for example, a
fund may sell a forward currency contract to lock in the U.S. dollar equivalent
of the proceeds from the anticipated sale of a security denominated in a foreign
currency.
The cost to a fund of engaging in forward currency contracts varies with
factors such as the currency involved, the length of the contract period and the
market conditions then prevailing. Because forward currency contracts are
usually entered into on a principal basis, no fees or commissions are involved.
When a fund enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency at the maturity
of the contract. Failure by the counterparty to do so would result in the loss
of any expected benefit of the transaction.
As is the case with futures contracts, parties to forward currency
contracts can enter into offsetting closing transactions, similar to closing
transactions on futures, by entering into an instrument identical to the
instrument purchased or sold, but in the opposite direction. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the counterparty. Thus, there can be no assurance
that a fund will in fact be able to close out a forward currency contract at a
favorable price prior to maturity. In addition, in the event of insolvency of
the counterparty, a fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the fund would continue
to be subject to market risk with respect to the position and would continue to
be required to maintain a position in the securities or currencies that are the
subject of the hedge or to maintain cash or securities in a segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the foreign
currency contract has been established. Thus, a fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward contracts. The projection of short-term
currency market movements is extremely difficult, and the successful execution
of a short-term hedging strategy is highly uncertain.
40
<PAGE>
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS. A fund that may
invest outside the United States may enter into forward currency contracts or
maintain a net exposure to such contracts only if (1) the consummation of the
contracts would not obligate the fund to deliver an amount of foreign currency
in excess of the value of the position being hedged by such contracts or (2) the
fund segregates with its custodian cash or liquid securities in an amount not
less than the value of its total assets committed to the consummation of the
contract and not covered as provided in (1) above, as marked to market daily.
SWAP TRANSACTIONS. A fund may enter into swap transactions, which include
swaps, caps, floors and collars relating to interest rates, currencies,
securities or other instruments. Interest rate swaps involve an agreement
between two parties to exchange payments that are based, for example, on
variable and fixed rates of interest and that are calculated on the basis of a
specified amount of principal (the "notional principal amount") for a specified
period of time. Interest rate cap and floor transactions involve an agreement
between two parties in which the first party agrees to make payments to the
counterparty when a designated market interest rate goes above (in the case of a
cap) or below (in the case of a floor) a designated level on predetermined dates
or during a specified time period. Interest rate collar transactions involve an
agreement between two parties in which payments are made when a designated
market interest rate either goes above a designated ceiling level or goes below
a designated floor level on predetermined dates or during a specified time
period. Currency swaps, caps, floors and collars are similar to interest rate
swaps, caps, floors and collars, but they are based on currency exchange rates
than interest rates. Equity swaps or other swaps relating to securities or other
instruments are also similar, but they are based on changes in the value of the
underlying securities or instruments. For example, an equity swap might involve
an exchange of the value of a particular security or securities index in a
certain notional amount for the value of another security or index or for the
value of interest on that notional amount at a specified fixed or variable rate.
A fund may enter into interest rate swap transactions to preserve a return
or spread on a particular investment or portion of its portfolio or to protect
against any increase in the price of securities it anticipates purchasing at a
later date. A fund may use interest rate swaps, caps, floors and collars as a
hedge on either an asset-based or liability-based basis, depending on whether it
is hedging its assets or its liabilities. Interest rate swap transactions are
subject to risks comparable to those described above with respect to other
hedging strategies.
A fund will usually enter into swaps on a net basis, I.E., the two payment
streams are netted out, with the fund receiving or paying, as the case may be,
only the net amount of the two payments. Because segregated accounts will be
established with respect to these transactions, Mitchell Hutchins and the
investment advisers believe these obligations do not constitute senior
securities and, accordingly, will not treat them as being subject to a fund's
borrowing restrictions. The net amount of the excess, if any, of a fund's
obligations over its entitlements with respect to each rate swap will be accrued
on a daily basis, and appropriate fund assets having an aggregate net asset
value at least equal to the accrued excess will be maintained in a segregated
account as described above in "Investment Policies and Restrictions--Segregated
Accounts." A fund also will establish and maintain such segregated accounts with
respect to its total obligations under any swaps that are not entered into on a
net basis.
A fund will enter into swap transactions only with banks and recognized
securities dealers believed by its investment adviser to present minimal credit
risk in accordance with guidelines established by the board. If there is a
default by the other party to such a transaction, a fund will have to rely on
its contractual remedies (which may be limited by bankruptcy, insolvency or
similar laws) pursuant to the agreements related to the transaction.
41
<PAGE>
ORGANIZATION OF TRUST; TRUSTEES AND OFFICERS;
PRINCIPAL HOLDERS OF SECURITIES
The Trust was formed on September 9, 1994 as a business trust under the
laws of the State of Delaware and has twelve operating series. The Trust is
governed by a board of trustees, which is authorized to establish additional
series and to issue an unlimited number of shares of beneficial interest of each
existing or future series, par value $0.001 per share. The board oversees each
fund's operations.
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
Name and Address; Age Position With Trust Business Experience; Other Directorships
--------------------- ------------------- ----------------------------------------
<S> <C> <C>
Margo N. Alexander*+; 52 Trustee and President Mrs. Alexander is Chairman (since March 1999), chief executive
officer and a director of Mitchell Hutchins (since January 1995)
and an executive vice president and director of PaineWebber (since
March 1984). Mrs. Alexander is president and a director or trustee
of 32 investment companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as investment
adviser.
David J. Beaubien; 65 Trustee Mr. Beaubien is chairman of Yankee Environmental Systems, Inc., a
101 Industrial Road manufacturer of meteorological measuring systems. Prior to January
Turners Falls, MA 01376 1991, he was senior vice president of EG&G, Inc., a company which
makes and provides a variety of scientific and technically
oriented products and services. He is also a director of IEC,
Inc., a manufacturer of electronic assemblies, and Onix Systems
Inc., a manufacturer of process instrumentation. From 1985 to
January 1995, Mr. Beaubien served as a director or trustee on the
boards of the Kidder, Peabody & Co. Incorporated mutual funds. Mr.
Beaubien is a trustee of one investment company for which Mitchell
Hutchins, PaineWebber or one of their affiliates serves as
investment adviser.
E. Garrett Bewkes, Jr.** +; 73 Trustee Mr. Bewkes is a director of Paine Webber Group Inc. ("PW Group")
(holding company of PaineWebber and Mitchell Hutchins). Prior to
December 1995, he was a consultant to PW Group. Prior to 1988, he
was chairman of the board, president and chief executive officer
of American Bakeries Company. Mr. Bewkes is a director of
Interstate Bakeries Corporation and a director or trustee of 35
investment companies for which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as investment adviser.
Bruce A. Bursey**+; 50 Trustee Mr. Bursey is a senior vice president of PaineWebber and a
director of Investment Consulting Services. He is also a director
of PaineWebber Trust Company. Mr. Bursey is a trustee of one
investment company for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment adviser.
42
<PAGE>
Name and Address; Age Position With Trust Business Experience; Other Directorships
--------------------- ------------------- ----------------------------------------
William W. Hewitt, Jr.; 71 Trustee Mr. Hewitt is retired. Since 1988, he has served as a director or
P.O. Box 2359 trustee on the boards of the Guardian Life Insurance Company
Princeton, NJ 08543-2359 mutual funds. From 1990 to January 1995, Mr. Hewitt served as a
director or trustee on the boards of the Kidder, Peabody & Co.
Incorporated mutual funds. From 1986-1988, he was an executive
vice president and director of mutual funds, insurance and trust
services of Shearson Lehman Brothers Inc. From 1976-1986, he was
president of Merrill Lynch Funds Distributor, Inc. Mr. Hewitt is a
trustee of one investment company for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as investment
adviser.
Morton L. Janklow; 69 Trustee Mr. Janklow is senior partner of Janklow & Nesbit Associates, an
598 Madison Avenue international literary agency representing leading authors in
New York, NY 10022 their relationships with publishers and motion picture, television
and multi-media companies, and of counsel to the law firm of
Janklow, Newborn & Ashley. Mr. Janklow is a director of Revlon,
Inc. Mr. Janklow is a trustee of one investment company for which
Mitchell Hutchins, PaineWebber or one of their affiliates serves
as investment adviser.
J. Richard Sipes**+; 53 Trustee Mr. Sipes is director of Products and Trading in Private Client
1200 Harbor Boulevard Group for PaineWebber. Mr. Sipes is also a director of PaineWebber
Weehawken, NJ 07087 Trust Company, PaineWebber Futures Management Corp., PaineWebber
Properties Inc., and a family of investment companies organized in
Puerto Rico. Mr. Sipes is a trustee of one investment company for
which Mitchell Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
William D. White; 65 Trustee Mr. White is retired. From February 1989 through March 1994, he
P.O. Box 199 was president of the National League of Professional Baseball
Upper Black Eddy, PA Clubs. Prior to 1989, he was a television sportscaster for
WPIX-TV, New York. Mr. White served on the Board of Directors of
Centel from 1989 to 1993. Presently, Mr. White is on the board of
directors of Jefferson Banks Incorporated, Philadelphia, PA. Mr.
White is a trustee of one investment company for which Mitchell
Hutchins, PaineWebber or one of their affiliates serves as
investment adviser.
M. Cabell Woodward, Jr.; 70 Trustee Mr. Woodward is retired. From July 1985 until his retirement in
February 1993, Mr. Woodward was vice chairman and chief financial
officer of ITT Corporation. Mr. Woodward is also a director of
Black & Decker Corporation. Mr. Woodward is a trustee of one
investment company for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment adviser.
Joanne M. Kilkeary**; 31 Vice President and Ms. Kilkeary is an assistant vice president and a manager of the
Assistant Treasurer mutual fund finance department of Mitchell Hutchins. Ms. Kilkeary
is a vice president and assistant treasurer of one investment
company for which Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
43
<PAGE>
Name and Address; Age Position With Trust Business Experience; Other Directorships
--------------------- ------------------- ----------------------------------------
John J. Lee**; 31 Vice President and Mr. Lee is a vice president and a manager of the mutual fund
Assistant Treasurer finance department of Mitchell Hutchins. Prior to September 1997,
he was an audit manager in the financial services practice of
Ernst & Young LLP. Mr. Lee is a vice president and assistant
treasurer of 32 investment companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as investment
adviser.
Ann E. Moran**; 42 Vice President and Ms. Moran is a vice president and a manager of the mutual fund
Assistant Treasurer finance department of Mitchell Hutchins. Ms. Moran is a vice
president and assistant treasurer of 32 other investment companies
for which Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Andrew S. Novak**; 31 Vice President and Mr. Novak is a vice president and assistant general counsel of
Assistant Secretary Mitchell Hutchins. Prior to September 1997, he was an attorney
in private practice. Mr. Novak is a vice president and
assistant secretary of one investment company for which
Mitchell Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Dianne E. O'Donnell**; 47 Vice President and Ms. O'Donnell is a senior vice president and deputy general
Assistant Secretary counsel of Mitchell Hutchins. Ms. O'Donnell is a vice president
and secretary of 31 investment companies and a vice president and
assistant secretary of one investment company for which Mitchell
Hutchins, PaineWebber or one of their affiliates serves as
investment adviser.
Emil Polito*; 39 Vice President Mr. Polito is a senior vice president and director of
operations and control for Mitchell Hutchins. Mr. Polito is
senior vice president of 32 investment companies, for which
Mitchell Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Victoria E. Schonfeld**; 48 Vice President and Ms. Schonfeld is a managing director and general counsel of
Secretary Mitchell Hutchins (since May 1994) and a senior vice president
of PaineWebber Incorporated (since July 1995). Ms. Schonfeld
is a vice president of 31 investment companies and a vice
president and secretary of one investment company for which
Mitchell Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Paul H. Schubert**; 36 Vice President and Mr. Schubert is a senior vice president and the director of the
Treasurer mutual fund finance department of Mitchell Hutchins. Mr. Schubert
is a vice president and treasurer of 32 other investment companies
for which Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Barney A. Taglialatela**; 38 Vice President and Mr. Taglialatela is a vice president and a manager of the mutual
Assistant Treasurer fund finance division of Mitchell Hutchins. Prior to February
1995, he was a manager of the mutual fund finance division of
Kidder Peabody Asset Management, Inc. Mr. Taglialatela is a vice
president and assistant treasurer of 32 investment companies for
which Mitchell Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
</TABLE>
44
<PAGE>
- -------------
* The business address of this person is 51 West 52nd Street, New York, New
York 10019-6114.
** The business address of this person is 1285 Avenue of the Americas, New York,
New York 10019.
+ Messrs. Bewkes, Bursey and Sipes and Mrs. Alexander are "interested persons"
of the Trust as defined in the Investment Company Act by virtue of their
positions with PaineWebber, PW Group and/or Mitchell Hutchins.
The Trust pays each board member who is not an "interested person" of the
Trust $35,000 annually and $5,000 per meeting of the board or any committee
thereof. Trustees are reimbursed for any expenses incurred in attending
meetings. Trustees of the Trust who are "interested persons" of the Trust as
defined in the Investment Company Act receive no compensation from the Trust.
Because Mitchell Hutchins, the investment advisers and PaineWebber perform
substantially all of the services necessary for the operation of the Trust and
the funds, the Trust requires no employees. No officer, director or employee of
Mitchell Hutchins, an investment adviser or PaineWebber presently receives any
compensation from the Trust for acting as a trustee or officer.
The table below includes certain information relating to the compensation
of the current members of the Trust's board who held office with the Trust
during the fiscal year ended July 31, 1999, and the compensation of those
trustees from all PaineWebber funds during that year.
COMPENSATION TABLE
TOTAL COMPENSATION FROM
NAME OF PERSON, POSITION AGGREGATE COMPENSATION THE TRUST AND THE
------------------------ FROM THE TRUST* PAINEWEBBER FUND COMPLEX+
--------------- -------------------------
David J. Beaubien,
Trustee.................... $60,000 $60,000
William W. Hewitt,
Trustee.................... 75,000 75,000
Morton L. Janklow,
Trustee.................... 60,000 60,000
William D. White,
Trustee................... 60,000 60,000
M. Cabell Woodward, Jr.,
Trustee................... 55,000 55,000
- --------------------
Only independent board members are compensated by the PaineWebber funds and
identified above; trustees who are "interested persons", as defined in the
Investment Company Act, do not receive compensation.
* During the fiscal year ended July 31, 1999, Mitchell Hutchins waived a
portion of its management fee and subsidized certain operating expenses,
including the payment of trustees' fees, with respect to some funds in order
to lower the overall expenses of those funds to certain designated levels.
+ No fund within the complex has a bonus, pension, profit sharing or retirement
plan.
PRINCIPAL HOLDERS AND MANAGEMENT OWNERSHIP OF SECURITIES
Trustees and officers of the Trust own in the aggregate less than 1% of
the shares of each fund. The following shareholders are shown in the Trust's
records as owning more than 5% of a fund's shares:
45
<PAGE>
<TABLE>
<CAPTION>
PERCENTAGE
OF SHARES BENEFICIALLY OWNED
SHAREHOLDER NAME AND ADDRESS* AS OF OCTOBER 31, 1999
---------------------------- ----------------------
<S> <C>
PACE INTERMEDIATE FIXED INCOME INVESTMENTS
Chesapeake Hospital Authority Int. Bond Fund
Chesapeake General Hospital 6.03%
PACE STRATEGIC FIXED INCOME INVESTMENTS
CHA Foundation
Chesapeake General Hospital 7.25%
Mercantile-Safe Deposit
c/o Trustee Chesapeake General
Hospital Retirement Account 5.83%
OBICI Foundation 9.61%
</TABLE>
* The shareholders listed may be contacted c/o Mitchell Hutchins Asset
Management Inc., 51 West 52nd Street, New York, NY 10019-6114.
INVESTMENT ADVISORY, ADMINISTRATION AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY AND ADMINISTRATION ARRANGEMENTS. Mitchell Hutchins
acts as the investment manager and administrator to the Trust pursuant to an
Investment Management and Administration Agreement with the Trust ("Management
Agreement") dated June 15, 1995. Pursuant to the Management Agreement, Mitchell
Hutchins, subject to the supervision of the Trust's board and in conformity with
the stated policies of the Trust, manages both the investment operations of the
Trust and the composition of the funds, including the purchase, retention,
disposition and lending of securities. Mitchell Hutchins is authorized to enter
into advisory agreements for investment advisory services ("Advisory
Agreements") in connection with the management of the funds. Mitchell Hutchins
is responsible for monitoring the investment advisory services furnished
pursuant to the Advisory Agreements. Mitchell Hutchins reviews the performance
of all investment advisers and makes recommendations to the board with respect
to the retention and renewal of Advisory Agreements. In connection therewith,
Mitchell Hutchins keeps certain books and records of the Trust. Mitchell
Hutchins also administers the Trust's business affairs and, in connection
therewith, furnishes the Trust with office facilities, together with those
ordinary clerical and bookkeeping services that are not furnished by the Trust's
custodian and its transfer and dividend disbursing agent. The management
services of Mitchell Hutchins under the Management Agreement are not exclusive
to the Trust, and Mitchell Hutchins is free to, and does, render management
services to others.
The following table shows the fees earned (or accrued) by Mitchell
Hutchins under the Management Agreement and the portions of those fees waived by
Mitchell Hutchins for the periods indicated.
<TABLE>
<CAPTION>
ADVISORY AND ADMINISTRATION FEES EARNED ADVISORY AND ADMINISTRATION FEES
(OR ACCRUED) WAIVED BY
BY MITCHELL HUTCHINS MITCHELL HUTCHINS
FOR FISCAL YEARS ENDED JULY 31, FOR FISCAL YEARS ENDED JULY 31,
------------------------------- -------------------------------
PORTFOLIO 1999 1998 1997 1999 1998 1997
- --------- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
PACE Money Market Investments............ $114,410 $76,176 $46,463 $114,410 $76,176 $46,463
PACE Government Securities Fixed
Income Investments....................... 1,277,768 916,670 555,050 102,428 135,366 107,156
46
<PAGE>
ADVISORY AND ADMINISTRATION FEES EARNED ADVISORY AND ADMINISTRATION FEES
(OR ACCRUED) WAIVED BY
BY MITCHELL HUTCHINS MITCHELL HUTCHINS
FOR FISCAL YEARS ENDED JULY 31, FOR FISCAL YEARS ENDED JULY 31,
------------------------------- -------------------------------
PORTFOLIO 1999 1998 1997 1999 1998 1997
- --------- ---- ---- ---- ---- ---- ----
PACE Intermediate Fixed Income
Investments.............................. 740,117 504,134 318,727 1,460 5,372 76,200
PACE Strategic Fixed Income
Investments.............................. 1,302,736 697,639 409,105 70,795 91,847 143,533
PACE Municipal Fixed Income
Investments.............................. 337,795 259,431 143,239 24,086 35,977 131,476
PACE Global Fixed Income
Investments.............................. 805,390 599,606 389,067 220,842 209,982 167,565
PACE Large Company Value Equity
Investments.............................. 2,581,440 1,786,641 1,004,307 1,732 -- 82,199
PACE Large Company Growth Equity
Investments.............................. 2,593,183 1,672,807 875,877 3,823 45,136 50,644
PACE Small/Medium Company Value
Equity Investments....................... 1,458,785 1,384,807 765,902 25,179 11,273 126,324
PACE Small/Medium Company Growth
Equity Investments....................... 1,704,803 1,328,874 719,564 15,569 43,813 71,349
PACE International Equity
Investments.............................. 1,615,444 1,163,135 632,415 834 -- 1,629
PACE International Emerging Markets
Equity Investments....................... 751,091 623,343 417,803 195,575 161,872 225,031
</TABLE>
In connection with its management of the business affairs of the Trust,
Mitchell Hutchins bears the following expenses:
(1) the salaries and expenses of all of its and the Trust's personnel
except the fees and expenses of trustees who are not affiliated persons of
Mitchell Hutchins or the Trust's investment advisers;
(2) all expenses incurred, by Mitchell Hutchins or by the Trust in
connection with managing the ordinary course of the Trust's business, other than
those assumed by the Trust as described below; and
(3) the fees payable to each investment adviser (other than Mitchell
Hutchins) pursuant to the Advisory Agreements.
Under the terms of the Management Agreement, each fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell Hutchins
or the fund's investment adviser. General expenses of the Trust not readily
identifiable as belonging to a fund or to the Trust's other series are allocated
among series by or under the direction of the board in such manner as the board
deems to be fair and equitable. Expenses borne by each fund include the
following (or a fund's share of the following): (1) the cost (including
brokerage commissions) of securities purchased or sold by a fund and any losses
incurred in connection therewith, (2) fees payable to and expenses incurred on
behalf of a fund by Mitchell Hutchins, (3) organizational expenses, (4) filing
fees and expenses relating to the registration and qualification of a fund's
shares and the Trust under federal and state securities laws and maintenance of
such registration and qualifications, (5) fees and salaries payable to trustees
who are not interested persons (as defined in the Investment Company Act) of the
Trust, Mitchell Hutchins or the investment advisers, (6) all expenses incurred
in connection with trustees' services, including travel expenses, (7) taxes
(including any income or franchise taxes) and governmental fees, (8) costs of
any liability, uncollectible items of deposit and other insurance or fidelity
bonds, (9) any costs, expenses or losses arising out of a liability of or claim
47
<PAGE>
for damages or other relief asserted against the Trust or a fund for violation
of any law, (10) legal, accounting and auditing expenses, including legal fees
of special counsel for the independent trustees, (11) charges of custodians,
transfer agents and other agents, (12) costs of preparing share certificates,
(13) expenses of setting in type and printing prospectuses and supplements
thereto, statements of additional information and supplements thereto, reports
and proxy materials for existing shareholders, and costs of mailing such
materials to existing shareholders, (14) any extraordinary expenses (including
fees and disbursements of counsel) incurred by the Trust or a fund, (15) fees,
voluntary assessments and other expenses incurred in connection with membership
in investment company organizations, (16) costs of mailing and tabulating
proxies and costs of meetings of shareholders, the board and any committees
thereof, (17) the cost of investment company literature and other publications
provided to trustees and officers and (18) costs of mailing, stationery and
communications equipment.
Under the Management Agreement, Mitchell Hutchins will not be liable for
any error of judgment or mistake of law or for any loss suffered by a fund in
connection with the performance of the contract, except a loss resulting from
willful misfeasance, bad faith or gross negligence on the part of Mitchell
Hutchins in the performance of its duties or from reckless disregard of its
duties and obligations thereunder. The Management Agreement terminates
automatically upon its assignment and is terminable at any time without penalty
by the board or by vote of the holders of a majority of a fund's outstanding
voting securities, on 60 days' written notice to Mitchell Hutchins or by
Mitchell Hutchins on 60 days' written notice to the fund.
The following table shows the approximate net assets as of October 31,
1999, sorted by category of investment objective, of the investment companies as
to which Mitchell Hutchins serves as adviser or sub-adviser. An investment
company may fall into more than one of the categories below:
INVESTMENT CATEGORY NET ASSETS
- ------------------- ----------
($MIL)
------
Domestic (excluding Money Market)........................... $ 7,873.90
Global...................................................... 4,651.40
Equity/Balanced............................................. 7,822.00
Fixed Income (excluding Money Market)....................... 4,703.30
Taxable Fixed Income................................... 3,233.70
Tax-Free Fixed Income.................................. 1,469.60
Money Market Funds.......................................... 36,069.20
INVESTMENT ADVISORY ARRANGEMENTS. As noted in the Prospectus, subject to
the monitoring of the Manager and, ultimately, the board, each investment
adviser manages the securities held by the fund it serves in accordance with the
fund's stated investment objective and policies, makes investment decisions for
the fund and places orders to purchase and sell securities on behalf of the
fund.
Each Advisory Agreement provides that it will terminate in the event of
its assignment (as defined in the Investment Company Act) or upon the
termination of the Management Agreement. Each Advisory Agreement may be
terminated by the Trust upon not more than 60 days' written notice. Each
Advisory Agreement may be terminated by Mitchell Hutchins or the investment
adviser upon not more than 120 days' written notice. Each Advisory Agreement
provides that it will continue in effect for a period of more than two years
from its execution only so long as such continuance is specifically approved at
least annually in accordance with the requirements of the Investment Company
Act.
Under the Advisory Agreements, the investment advisers will not be liable
for any error or judgment or mistake of law or for any loss suffered by a fund
in connection with the performance of the contract, except a loss resulting from
willful misfeasance, bad faith, or gross negligence on the part of the
investment advisers in the performance of their duties or from reckless
disregard of their duties and obligations thereunder. Each investment adviser
has agreed to its fees as described in the Prospectus and which are generally
lower than the fees it charges to institutional accounts for which it serves as
investment adviser and performs all administrative functions associated with
48
<PAGE>
serving in that capacity in recognition of the reduced administrative
responsibilities it has undertaken with respect to the fund. By virtue of the
management, monitoring and administrative functions performed by Mitchell
Hutchins, and the fact that investment advisers are not required to make
decisions regarding the allocation of assets among the major sectors of the
securities markets, each investment adviser serves in a subadvisory capacity to
the fund. Subject to the monitoring by the Manager and, ultimately, the board,
each investment adviser's responsibilities are limited to managing the
securities held by the fund it serves in accordance with the fund's stated
investment objective and policies, making investment decisions for the fund and
placing orders to purchase and sell securities on behalf of the fund.
Under the Advisory Agreements with Pacific Investment Management Company
for PACE GOVERNMENT FIXED INCOME INVESTMENTS and PACE STRATEGIC FIXED INCOME
INVESTMENTS, Mitchell Hutchins (not the fund) pays PIMCO for its services a fee
in the annual amount of 0.25% of the average daily net assets of each fund. For
the fiscal years ended July 31, 1999, July 31, 1998 and July 31, 1997, Mitchell
Hutchins paid or accrued investment advisory fees to PIMCO of $456,345, $327,708
and $198,232, respectively for PACE Government Fixed Income Investments and
$465,263, $249,156 and $146,108, respectively for PACE Strategic Fixed Income
Investments. PIMCO, a Delaware general partnership, is a registered investment
adviser and a subsidiary partnership of PIMCO Advisors L.P. ("PIMCO Advisors").
The general partners of PIMCO Advisors are PIMCO Advisors Holding L.P. ("PAH"),
a publicly traded company listed on the New York Stock Exchange under the symbol
"PA", and PIMCO Partners, G.P., a general partnership between Pacific Life
Insurance Company and PIMCO Partners, LLC, a limited liability company
controlled by the PIMCO managing directors. PIMCO is one of the largest fixed
income management firms in the nation. Included among PIMCO's institutional
clients are many "Fortune 500" companies. On October 31 1999, PIMCO Advisors,
PAH and Allianz AG ("Allianz") announced that they had reached a definitive
agreement pursuant to which Allianz will acquire majority ownership of PIMCO
Advisors and its subsidiaries, including PIMCO (the "Allianz Transaction").
Under the terms of the transaction, Allianz will acquire all of PAH, the
publicly traded general partner of PIMCO Advisors. Pacific Life Insurance
Company will retain an approximate 30% interest in PIMCO Advisors. The Allianz
Transaction is currently expected to be completed by the end of the first
quarter of 2000.
Under the Advisory Agreement with Pacific Income Advisors, Inc. for PACE
INTERMEDIATE FIXED INCOME INVESTMENTS, Mitchell Hutchins (not the fund) pays
Pacific Income Advisors a fee in the annual amount of 0.20% of the fund's
average daily net assets. For the fiscal years ended July 31, 1999, July 31,
1998 and July 31, 1997, Mitchell Hutchins paid or accrued investment advisory
fees to Pacific Income Advisors of $246,706, $168,045 and $106,137,
respectively. Lloyd McAdams and Heather U. Baines, who serve as chairman and
chief investment officer and president and chief executive officer,
respectively, are each a controlling person of Pacific Income Advisors because
each owns more than 25% of Pacific Income Advisors' voting securities.
Under the Advisory Agreement with Deutsche Asset Management, Inc.
(formerly known as Morgan Grenfell Capital Management, Incorporated) for PACE
MUNICIPAL FIXED INCOME INVESTMENTS, Mitchell Hutchins (not the fund) pays
Deutsche Asset Management a fee in the annual amount of 0.20% of the fund's
average daily net assets. For the fiscal years ended July 31, 1999, July 31,
1998 and July 31, 1997, Mitchell Hutchins paid or accrued investment advisory
fees to Deutsche Asset Management of $112,598, $86,574 and $47,400,
respectively. All of the outstanding voting stock of Deutsche Asset Management
is owned by an indirect wholly owned subsidiary of Deutsche Bank AG, an
international commercial and investment banking group.
Under the current Advisory Agreement with Rogge Global Partners plc for
PACE GLOBAL FIXED INCOME INVESTMENTS, Mitchell Hutchins (not the fund) pays
Rogge Global Partners a fee in the annual amount of 0.35% of the fund's average
daily net assets. For the fiscal years ended July 31, 1999, July 31, 1998 and
July 31, 1997, Mitchell Hutchins paid or accrued investment advisory fees to
Rogge Global Partners under the current Advisory Agreement and a substantially
similar prior agreement of $352,679, $262,596 and $170,772, respectively. Rogge
Global Partners is a wholly owned subsidiary of United Asset Management
Corporation ("UAM"), a New York Stock Exchange listed company. UAM is
principally engaged through affiliated firms in the United States and abroad in
providing institutional investment management services and acquiring
institutional management firms like Rogge Global.
49
<PAGE>
Under the current Advisory Agreement with Brinson Partners, Inc. for PACE
LARGE COMPANY VALUE EQUITY INVESTMENTS, Mitchell Hutchins (not the fund) pays
Brinson Partners a fee in the annual amount of 0.30% of the fund's average daily
net assets. For the fiscal years ended July 31, 1999, July 31, 1998 and July 31,
1997, Mitchell Hutchins paid or accrued investment advisory fees to Brinson
Partners of $968,040, $670,717 and $377,030, respectively. Brinson Partners is
an indirect subsidiary wholly owned by UBS AG. UBS AG, with headquarters in
Zurich, Switzerland, is an internationally diversified organization with
operations in many aspects of the financial services industry.
Under the current Advisory Agreement with Alliance Capital Management L.P.
("Alliance") for PACE LARGE COMPANY GROWTH EQUITY INVESTMENTS, Mitchell Hutchins
(not the fund) pays Alliance for its services under the Advisory Agreement a fee
in the annual amount of 0.30% of the fund's average daily net assets. Prior to
November 10, 1997, Chancellor LGT Asset Management, Inc. was the fund's
investment adviser. For the fiscal years ended July 31, 1999, July 31, 1998 and
July 31, 1997, Mitchell Hutchins paid or accrued investment advisory fees to
Alliance and the prior investment adviser, of $972,444, $628,243 and $328,454,
respectively. Alliance Capital Management Corporation ("ACMC") is a general
partner of Alliance and a wholly owned subsidiary of The Equitable Life
Assurance Society of the United States ("Equitable"). As of November 1, 1999,
Equitable and its subsidiaries were the beneficial owners of an approximately
55.38% partnership interest in Alliance, and Alliance Capital Management Holding
L.P. ("Alliance Holding") owned an approximately 41.87% partnership interest in
Alliance. Equity interests in Alliance Holding are traded on the New York Stock
Exchange in the form of units. Approximately 98% of Alliance Holding's units are
owned by the public and management or employees of Alliance and approximately 2%
are owned by Equitable. The general partner of Alliance Holding is ACMC.
Equitable, a New York life insurance company, had total assets as at June 30,
1999 of approximately US$93.9 billion and is a wholly owned subsidiary of AXA
Financial, Inc. ("AXA Financial"), a Delaware corporation whose shares are
traded on the New York Stock Exchange. As of June 30, 1999, AXA, a French
insurance holding company, owned approximately 58.2% of the issued and
outstanding shares of the common stock of AXA Financial.
Under the current Advisory Agreements with Brandywine Asset Management,
Inc. and Ariel Capital Management, Inc. for PACE SMALL/MEDIUM COMPANY VALUE
INVESTMENTS, Mitchell Hutchins (not the fund) pays each of these investment
advisers a fee in the annual amount of 0.30% of the portion of the fund's
average daily net assets that it manages. For the fiscal years ended July 31,
1999, July 31, 1998 and July 31, 1997, Mitchell Hutchins paid or accrued
investment advisory fees to Brandywine (the fund's sole investment adviser prior
to October 4, 1999) of $547,044, $519,732 and $287,096, respectively. Brandywine
is a wholly owned subsidiary of Legg Mason, Inc. Legg Mason, based in Baltimore,
Maryland, is a holding company that provides securities brokerage, investment
management and investment banking services through its wholly owned
subsidiaries. Ariel is an independent subchapter S corporation with a majority
of ownership held by its employees.
Under the current Advisory Agreement with Delaware Management Company,
Inc. for PACE SMALL/MEDIUM COMPANY GROWTH EQUITY INVESTMENTS, Mitchell Hutchins
(not the fund) pays Delaware Management a fee in the annual amount of 0.40% of
the fund's average daily net assets. Prior to December 16, 1998, Westfield
Capital Management Company, Inc. was the fund's investment adviser. For the
fiscal years ended July 31, 1999, July 31, 1998 and July 31, 1997, Mitchell
Hutchins paid or accrued investment advisory fees to Delaware Management and to
the prior investment adviser, of $852,402, $664,437 and $279,883, respectively.
Delaware Management is a member of Delaware Investments, a subsidiary of Lincoln
National Corporation ("Lincoln National"). Lincoln National, with headquarters
in Fort Wayne, Indiana, is a diversified organization with operations in many
aspects of the financial services industry, including insurance and investment
management.
Under the current Advisory Agreement with Martin Currie Inc. for PACE
INTERNATIONAL EQUITY INVESTMENTS, Mitchell Hutchins (not the fund) pays Martin
Currie Inc. a fee in the annual amount of 0.40% of the fund's average daily net
assets. For the fiscal years ended July 31, 1999, July 31, 1998 and July 31,
1997, Mitchell Hutchins paid or accrued investment advisory fees to Martin
Currie Inc. of $717,975, $517,629 and $281,074, respectively. Martin Currie Inc.
is a wholly owned subsidiary of Martin Currie Limited, a holding company.
50
<PAGE>
Under the current Advisory Agreement with Schroder Investment Management
North America Inc. for PACE INTERNATIONAL EMERGING MARKETS EQUITY INVESTMENTS,
Mitchell Hutchins (not the fund) pays Schroder Investment a fee in the annual
amount of 0.50% of the fund's average daily net assets. Schroder Investment is a
wholly owned subsidiary of Schroder U.S. Holdings Inc. and was the surviving
company in a merger with Schroder Capital Management International Inc. (the
fund's investment adviser prior to July 1, 1999 and another wholly owned
subsidiary of Schroder U.S. Holdings Inc.). For the fiscal years ended July 31,
1999, July 31, 1998 and July 31, 1997, Mitchell Hutchins paid or accrued
investment advisory fees to Schroder Investment and its predecessor of $341,405,
$283,338 and $189,911, respectively. Schroder Holdings Inc. is a wholly owned
subsidiary of Schroders plc., which is listed on the London Stock Exchange and
is the holding parent of a large worldwide group of banks and financial services
companies (referred to as the "Schroder Group") with associated companies and
branch and representative offices located in 24 countries worldwide.
SECURITIES LENDING. For the fiscal year ended July 31, 1999, PaineWebber,
acting as the funds' lending agent, received compensation from the funds as
follows:
FUND COMPENSATION
---- ------------
PACE Money Market Investments................................ $ 0
PACE Government Securities Fixed Income Investments.......... 1,509
PACE Intermediate Fixed Income Investments................... 53,171
PACE Strategic Fixed Income Investments...................... 360
PACE Municipal Fixed Income Investments...................... 0
PACE Global Fixed Income Investments......................... 18,241
PACE Large Company Value Equity Investments.................. 14,730
PACE Large Company Growth Equity Investments................. 11,998
PACE Small/Medium Company Value Equity Investments........... 11,326
PACE Small/Medium Company Growth Equity Investments.......... 28,352
PACE International Equity Investments........................ 18,210
PACE International Emerging Markets Equity Investments....... 7,978
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
the shares of each fund under a distribution contract with the Trust dated June
15, 1995 ("Distribution Contract") that requires Mitchell Hutchins to use its
best efforts, consistent with its other businesses, to sell shares of the funds.
Shares of the funds are offered continuously. Under a dealer agreement between
Mitchell Hutchins and PaineWebber dated June 15, 1995 ("Dealer Agreement"),
PaineWebber sells the funds' shares. PaineWebber and Mitchell Hutchins receive
no compensation under these contracts for their services. Mitchell Hutchins is
located at 51 West 52nd Street, New York, New York 10019-6114 and PaineWebber is
located at 1285 Avenue of the Americas, New York, New York 10019.
PORTFOLIO TRANSACTIONS
Decisions to buy and sell securities for a fund other than PACE Money
Market Investments are made by the fund's investment adviser, subject to the
overall review of Mitchell Hutchins and the board of trustees. Decisions to buy
and sell securities for PACE Money Market Investments are made by Mitchell
Hutchins as that fund's investment adviser, subject to the overall review of the
board of trustees. Although investment decisions for a fund are made
independently from those of the other accounts managed by its investment
adviser, investments of the type that the fund may make also may be made by
those other accounts. When a fund and one or more other accounts managed by its
investment adviser are prepared to invest in, or desire to dispose of, the same
security, available investments or opportunities for sales will be allocated in
a manner believed by the investment adviser to be equitable to each. In some
cases, this procedure may adversely affect the price paid or received by a fund
or the size of the position obtained or disposed of by a fund.
Transactions on U.S. stock exchanges and some foreign stock exchanges
involve the payment of negotiated brokerage commissions. On exchanges on which
commissions are negotiated, the cost of transactions may vary among different
brokers. On most foreign exchanges, commissions are generally fixed. No stated
51
<PAGE>
commission is generally applicable to securities traded in U.S. over-the-counter
markets, but the prices of those securities include undisclosed commissions or
mark-ups. The cost of securities purchased from underwriters include an
underwriting commission or concession and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or mark-down. U.S.
government securities generally are purchased from underwriters or dealers,
although certain newly issued U.S. government securities may be purchased
directly from the U.S.
Treasury or from the issuing agency or instrumentality.
For the periods indicated, the funds paid the brokerage commissions set
forth below:
<TABLE>
<CAPTION>
TOTAL BROKERAGE COMMISSIONS
---------------------------
FISCAL YEAR ENDED JULY 31,
--------------------------
FUND 1999 1998 1997
- ---- ---- ---- ----
<S> <C> <C> <C>
PACE Money Market $ 0 $ 0 $ 0
Investments................................................
PACE Government Securities Fixed Income Investments ....... 0 0 0
PACE Intermediate Fixed Income Investments................. 0 0 0
PACE Strategic Fixed Income Investments.................... 4,297 17,292 169
PACE Municipal Fixed Income Investments.................... 0 0 0
PACE Global Fixed Income Investments....................... 0 0 0
PACE Large Company Value Equity Investments................ 336,042 191,304 164,051
PACE Large Company Growth Equity Investments............... 289,045 422,526 153,087
PACE Small/Medium Company Value Equity Investments......... 715,933 491,524 302,226
PACE Small/Medium Company Growth Equity Investments........ 296,609 303,695 414,380
PACE International Equity Investments...................... 722,215 441,600 288,930
PACE International Emerging Markets Equity Investments..... 361,372 286,220 201,775
</TABLE>
The funds have no obligation to deal with any broker or group of brokers
in the execution of portfolio transactions. The funds contemplate that,
consistent with the policy of obtaining the best net results, brokerage
transactions may be conducted through Mitchell Hutchins or its affiliates,
including PaineWebber. The board has adopted procedures in conformity with Rule
17e-1 under the Investment Company Act to ensure that all brokerage commissions
paid to PaineWebber are reasonable and fair. Specific provisions in the
Management Agreement and Advisory Agreements authorize Mitchell Hutchins and any
of its affiliates that is a member of a national securities exchange to effect
portfolio transactions for the funds on such exchange and to retain compensation
in connection with such transactions. Any such transactions will be effected and
related compensation paid only in accordance with applicable SEC regulations.
For the last three fiscal years, none of the funds paid any brokerage
commissions to PaineWebber, except as follows: during the fiscal year ended July
31, 1999, PACE Large Company Growth Equity Investments paid $215 in brokerage
commissions to PaineWebber, which represented less than 1% of the total
commissions paid by that fund and less than 1% of the aggregate dollar amount of
the fund's transactions involving commission payments.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs") who receive brokerage commissions for their services. The
funds' procedures in selecting FCMs to execute transactions in futures
contracts, including procedures permitting the use of an affiliated FCM,
including PaineWebber and its affiliates, are similar to those in effect with
respect to brokerage transactions in securities.
In selecting brokers for a fund, its investment adviser will consider the
full range and quality of a broker's services. Consistent with the interests of
the funds and subject to the review of the board, Mitchell Hutchins or the
applicable investment adviser may cause a fund to purchase and sell portfolio
securities through brokers who provide Mitchell Hutchins or the investment
adviser with brokerage or research services. The funds may pay those brokers a
higher commission than may be charged by other brokers, provided that Mitchell
52
<PAGE>
Hutchins or the investment adviser, as applicable, determines in good faith that
the commission is reasonable in terms either of that particular transaction or
of the overall responsibility of Mitchell Hutchins or the investment adviser to
that fund and its other clients.
Research services obtained from brokers may include written reports,
pricing and appraisal services, analysis of issues raised in proxy statements,
educational seminars, subscriptions, portfolio attribution and monitoring
services, and computer hardware, software and access charges which are directly
related to investment research. Research services may be received in the form of
written reports, online services, telephone contacts and personal meetings with
securities analysts, economists, corporate and industry spokespersons and
government representatives.
For the fiscal year ended July 31, 1999, the funds directed portfolio
transactions to brokers chosen because they provide research and analysis as
indicated below, for which the funds paid the following in brokerage
commissions:
<TABLE>
<CAPTION>
AMOUNT OF PORTFOLIO BROKERAGE
FUND TRANSACTIONS COMMISSIONS PAID
- ---- ------------ ----------------
<S> <C> <C>
PACE Money Market Investments............................. $ 0 $ 0
PACE Government Securities Fixed Income Investments....... 998,750 39
PACE Intermediate Fixed Income Investments................ 1,373,461 0
PACE Strategic Fixed Income Investments................... 0 0
PACE Municipal Fixed Income Investments................... 0 0
PACE Global Fixed Income Investments...................... 0 0
PACE Large Company Value Equity Investments............... 47,446,582 58,346
PACE Large Company Growth Equity Investments.............. 261,881,403 26,043
PACE Small/Medium Company Value Equity Investments........ 12,073,117 63,394
PACE Small/Medium Company Growth Equity Investments....... 44,250 3,647
PACE International Equity Investments..................... 0 0
PACE International Emerging Markets Equity Investments.... 292,020,674 5,369
</TABLE>
For purchases or sales with broker-dealer firms that act as principal,
Mitchell Hutchins or a fund's investment adviser seeks best execution. Although
Mitchell Hutchins or a fund's investment adviser may receive certain research or
execution services in connection with the transactions, it will not purchase
securities at a higher price or sell securities at a lower price than would
otherwise be paid if no weight was attributed to the services provided by the
executing dealer. Mitchell Hutchins or a fund's investment adviser may engage in
agency transactions in over-the-counter equity and debt securities in return for
research and execution services. These transactions are entered into only
pursuant to procedures that are designed to ensure that the transaction
(including commissions) is at least as favorable as it would have been if
effected directly with a market-maker that did not provide research or execution
services.
Research services and information received from brokers or dealers are
supplemental to the research efforts of Mitchell Hutchins and a fund's
investment adviser and, when utilized, are subject to internal analysis before
being incorporated into their investment processes. Information and research
services furnished by brokers or dealers through which or with which a fund
effects securities transactions may be used by Mitchell Hutchins or the fund's
investment adviser in advising other funds or accounts and, conversely, research
services furnished to Mitchell Hutchins or a fund's investment adviser by
brokers or dealers in connection with other funds or accounts that either of
them advises may be used in advising a fund.
Investment decisions for a fund and for other investment accounts managed
by Mitchell Hutchins or the applicable investment adviser are made independently
of each other in light of differing considerations for the various accounts.
53
<PAGE>
However, the same investment decision may occasionally be made for a fund and
one or more accounts. In those cases, simultaneous transactions are inevitable.
Purchases or sales are then averaged as to price and allocated between that fund
and the other account(s) as to amount according to a formula deemed equitable to
the fund and the other account(s). While in some cases this practice could have
a detrimental effect upon the price or value of the security as far as a fund is
concerned, or upon its ability to complete its entire order, in other cases it
is believed that simultaneous transactions and the ability to participate in
volume transactions will benefit the fund.
The funds will not purchase securities that are offered in underwritings
in which PaineWebber is a member of the underwriting or selling group, except
pursuant to procedures adopted by the board pursuant to Rule 10f-3 under the
Investment Company Act. Among other things, these procedures require that the
spread or commission paid in connection with such a purchase be reasonable and
fair, the purchase be at not more than the public offering price prior to the
end of the first business day after the date of the public offering and that
PaineWebber or any affiliate thereof not participate in or benefit from the sale
to the fund.
As of July 31, 1999, the funds owned securities issued by their regular
broker-dealers (as defined in Rule 10b-1 under the Investment Company Act) as
follows:
PACE Money Market Investments: Short-term corporate obligations of Goldman
Sachs Group L.P. ($200,286).
PACE Government Securities Fixed Income Investments: Repurchase agreements
with State Street Bank and Trust Company ($459,000 and $71,000).
PACE Intermediate Fixed Income Investments: Repurchase agreement with
State Street Bank and Trust Company ($395,000).
PACE Strategic Fixed Income Investments: Corporate obligations of Goldman
Sachs Group L.P. ($3,251,521) and Morgan Stanley Dean Witter ($4,488,476);
repurchase agreement with State Street Bank and Trust Company
($1,943,000).
PACE Municipal Fixed Income Investments: None
PACE Global Fixed Income Investments: None
PACE Large Company Value Equity Investments: Repurchase agreement with
State Street Bank and Trust Company ($14,629,000).
PACE Large Company Growth Equity Investments: Common stock of Morgan
Stanley Dean Witter Discover & Co. ($7,985,075) and repurchase agreement
with State Street Bank and Trust Company ($9,814,000).
PACE Small/Medium Company Value Equity Investments: Repurchase agreement
with State Street Bank and Trust Company ($5,676,000).
PACE Small/Medium Company Growth Equity Investments: Repurchase agreement
with State Street Bank and Trust Company ($19,111,000).
PACE International Equity Investments: Repurchase agreement with State
Street Bank and Trust Company ($10,088,000).
PACE International Emerging Markets Equity Investments: Repurchase
agreement with State Street Bank and Trust Company ($1,509,000).
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PORTFOLIO TURNOVER. PACE Money Market Investments may attempt to increase
yields by trading to take advantage of short-term market variations, which
results in high portfolio turnover. Because purchases and sales of money market
instruments are usually effected as principal transactions, this policy does not
result in high brokerage commissions to the fund. The other funds do not intend
to seek profits through short-term trading. Nevertheless, the funds will not
consider portfolio turnover rate as a limiting factor in making investment
decisions.
A fund's turnover rate is calculated by dividing the lesser of purchases
or sales of its portfolio securities for the year by the monthly average value
of the portfolio securities. Securities or options with remaining maturities of
one year or less on the date of acquisition are excluded from the calculation.
Under certain market conditions, a fund authorized to engage in transactions in
options may experience increased portfolio turnover as a result of its
investment strategies. For instance, the exercise of a substantial number of
options written by a fund (due to appreciation of the underlying security in the
case of call options or depreciation of the underlying security in the case of
put options) could result in a turnover rate in excess of 100%. A portfolio
turnover rate of 100% would occur if all of a fund's securities that are
included in the computation of turnover were replaced once during a period of
one year.
Certain other practices that may be employed by a fund also could result
in high portfolio turnover. For example, portfolio securities may be sold in
anticipation of a rise in interest rates (market decline) or purchased in
anticipation of a decline in interest rates (market rise) and later sold. In
addition, a security may be sold and another of comparable quality purchased at
approximately the same time to take advantage of what an investment adviser
believes to be a temporary disparity in the normal yield relationship between
the two securities. These yield disparities may occur for reasons not directly
related to the investment quality of particular issues or the general movement
of interest rates, such as changes in the overall demand for, or supply of,
various types of securities.
Portfolio turnover rates may vary greatly from year to year as well as
within a particular year and may be affected by cash requirements for
redemptions of a fund's shares as well as by requirements that enable the fund
to receive favorable tax treatment.
The following table sets forth the portfolio turnover rates for each fund
for the periods indicated:
<TABLE>
<CAPTION>
PORTFOLIO TURNOVER RATES
FISCAL YEAR FISCAL YEAR
----------------- ------------------
ENDED ENDED
FUND JULY 31, 1999 JULY 31, 1998
- ---- ------------- -------------
<S> <C> <C>
ACE Money Market Investments.............................. N/A N/A
PACE Government Securities Fixed Income Investments....... 418% 353%
PACE Intermediate Fixed Income Investments................ 89% 111%
PACE Strategic Fixed Income Investments................... 202% 234%
PACE Municipal Fixed Income Investments................... 11% 34%
PACE Global Fixed Income Investments...................... 226% 125%
PACE Large Company Value Equity Investments............... 40% 34%
PACE Large Company Growth Equity Investments.............. 43% 102%
PACE Small/Medium Company Value Equity Investments........ 57% 42%
PACE Small/Medium Company Growth Equity Investments....... 102% 131%
PACE International Equity Investments..................... 89% 56%
PACE International Emerging Markets Equity Investments.... 66% 51%
</TABLE>
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ADDITIONAL REDEMPTION INFORMATION; OTHER SERVICES
ADDITIONAL REDEMPTION INFORMATION. If conditions exist that make cash
payments undesirable, each fund reserves the right to honor any request for
redemption by making payment in whole or in part in securities chosen by the
fund and valued in the same way as they would be valued for purposes of
computing the fund's net asset value. If payment is made in securities, a
shareholder may incur brokerage expenses in converting these securities into
cash. The Trust has elected, however, to be governed by Rule 18f-1 under the
Investment Company Act, under which a fund is obligated to redeem shares solely
in cash up to the lesser of $250,000 or 1% of the net asset value of the fund
during any 90-day period for one shareholder. This election is irrevocable
unless the SEC permits its withdrawal. The funds may suspend redemption
privileges or postpone the date of payment during any period (1) when the New
York Stock Exchange is closed or trading on the New York Stock Exchange is
restricted as determined by the SEC, (2) when an emergency exists, as defined by
the SEC, that makes it not reasonably practicable for a fund to dispose of
securities owned by it or fairly to determine the value of its assets or (3) as
the SEC may otherwise permit. The redemption price may be more or less than the
shareholder's cost, depending on the market value of a fund's portfolio at the
time.
AUTOMATIC INVESTMENT PLAN. Certain shareholders may purchase shares of a
fund through an automatic investment plan, under which shareholders may
authorize PaineWebber to place a purchase order each month or quarter for fund
shares in an amount not less than $500 per month or quarter. The purchase price
is paid automatically from cash held in the shareholder's PaineWebber brokerage
account through the automatic redemption of the shareholder's shares of a
PaineWebber money market fund or through the liquidation of other securities
held in the investor's PaineWebber brokerage account. If the PACE Program assets
are held in a PaineWebber Resource Management Account(R) ("RMA(R)") account, the
shareholder may arrange for preauthorized automatic fund transfer on a regular
basis, from the shareholder's bank account to the shareholder's RMA account.
Shareholders may utilize this service in conjunction with the automatic
investment plan to facilitate regular PACE investments. This automatic fund
transfer service, however, is not available for retirement plan shareholders.
For participants in the PACE(R) Multi Advisor Program, amounts invested through
the automatic investment plan will be invested in accordance with the
participant's benchmark allocation. If sufficient funds are not available in the
participant's account on the trade date to purchase the full amount specified by
the participant, no purchase will be made.
In addition to providing a convenient and disciplined manner of investing,
participation in the automatic investment plan enables an investor to use the
technique of "dollar cost averaging." When a shareholder invests the same amount
each month, the shareholder will purchase more shares when a fund's net asset
value per share is low and fewer shares when the net asset value per share is
high. Using this technique, a shareholder's average purchase price per share
over any given period will usually be lower than if the shareholder purchased a
fixed number of shares on a monthly basis during the period. Of course,
investing through the automatic investment plan does not assure a profit or
protect against loss in declining markets. Additionally, since the automatic
investment plan involves continuous investing regardless of price levels, an
investor should consider his or her financial ability to continue purchases
through periods of low price levels.
For further information about the automatic investment plan, the RMA
account or the automatic funds transfer service, shareholders should contact
their PaineWebber Financial Advisor.
AUTOMATIC REDEMPTION PLAN. Shareholders may have PaineWebber redeem a
portion of their shares in the PACE Program (or the PACE(R) Multi Advisor
Program) monthly or quarterly under the automatic redemption plan. Quarterly
redemptions are made in March, June, September and December. The amount to be
redeemed must be at least $500 per month or quarter. Purchases of additional
shares of a fund concurrent with redemption are ordinarily disadvantageous to
shareholders because of tax liabilities. For retirement plan shareholders,
special limitations apply. For further information regarding the automatic
redemption plan, shareholders should contact their PaineWebber Financial
Advisors.
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INDIVIDUAL RETIREMENT ACCOUNTS. A Self-Directed IRA is available through
PaineWebber under which investments may be made in the funds as well as in other
investments available through PaineWebber. The minimum initial investment in an
IRA is $10,000. Investors considering establishing an IRA should review
applicable tax laws and should consult their tax advisers.
VALUATION OF SHARES
Each fund normally determines its net asset value per share as of the
close of regular trading (usually 4:00 p.m., Eastern time) on the New York Stock
Exchange on each Monday through Friday when the New York Stock Exchange is open.
Prices will be calculated earlier when the New York Stock Exchange closes early
because trading has been halted for the day. Currently the New York Stock
Exchange is closed on the observance of the following holidays: New Year's Day,
Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Securities that are listed on U.S. and foreign stock exchanges normally
are valued at the last sale price on the day the securities are valued or,
lacking any sales on that day, at the last available bid price. In cases where
securities are traded on more than one exchange, the securities are generally
valued on the exchange considered by a fund's investment adviser as the primary
market. Securities traded in the over-the-counter market and listed on the
Nasdaq Stock Market ("Nasdaq") normally are valued at the last available sale
price on Nasdaq prior to valuation; other over-the-counter securities are valued
at the last bid price available prior to valuation, other than short-term
investments that mature in 60 days or less.
Where market quotations are readily available, bonds held by the funds
(other than PACE Money Market Investments) are valued based upon market
quotations, provided those quotations adequately reflect, in the judgment of a
fund's investment adviser, the fair value of the securities. Where those market
quotations are not readily available, bonds are valued based upon appraisals
received from a pricing service using a computerized matrix system or based upon
appraisals derived from information concerning the security or similar
securities received from recognized dealers in those securities. The amortized
cost method of valuation generally is used to value debt obligations with 60
days or less remaining until maturity, unless the board determines that this
does not represent fair value. All other securities and assets are valued at
fair value as determined in good faith by or under the direction of the board.
It should be recognized that judgment often plays a greater role in
valuing thinly traded securities and lower rated bonds than is the case with
respect to securities for which a broader range of dealer quotations and
last-sale information is available.
All investments quoted in foreign currency will be valued daily in U.S.
dollars on the basis of the foreign currency exchange rate prevailing at the
time such valuation is determined by a fund's custodian. Foreign currency
exchange rates are generally determined prior to the close of regular trading on
the NYSE. Occasionally events affecting the value of foreign investments and
such exchange rates occur between the time at which they are determined and the
close of trading on the New York Stock Exchange, which events would not be
reflected in the computation of a fund's net asset value on that day. If events
materially affecting the value of such investments or currency exchange rates
occur during such time period, the investments will be valued at their fair
value as determined in good faith by or under the direction of the board. The
foreign currency exchange transactions of the funds conducted on a spot (that
is, cash) basis are valued at the spot rate for purchasing or selling currency
prevailing on the foreign exchange market. Under normal market conditions this
rate differs from the prevailing exchange rate by less than one-tenth of one
percent due to the costs of converting from one currency to another.
PACE MONEY MARKET INVESTMENTS. PACE Money Market Investments values its
portfolio securities in accordance with the amortized cost method of valuation
under Rule 2a-7 under the Investment Company Act. To use amortized cost to value
its portfolio securities, the fund must adhere to certain conditions under that
Rule relating to its investments. Amortized cost is an approximation of market
value, whereby the difference between acquisition cost and value at maturity is
amortized on a straight-line basis over the remaining life of the instrument.
The effect of changes in the market value of a security as a result of
fluctuating interest rates is not taken into account and thus the amortized cost
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<PAGE>
method of valuation may result in the value of a security being higher or lower
than its actual market value. In the event that a large number of redemptions
takes place at a time when interest rates have increased, the fund might have to
sell portfolio securities prior to maturity and at a price that might not be as
desirable as the value at maturity.
The board has established procedures for the purpose of maintaining a
constant net asset value of $1.00 per share for PACE Money Market Investments,
which include a review of the extent of any deviation of net asset value per
share, based on available market quotations, from the $1.00 amortized cost per
share. Should that deviation exceed 1/2 of 1%, the trustees will promptly
consider whether any action should be initiated to eliminate or reduce material
dilution or other unfair results to shareholders. Such action may include
redeeming shares in kind, selling portfolio securities prior to maturity,
reducing or withholding dividends and utilizing a net asset value per share as
determined by using available market quotations. PACE Money Market Investments
will maintain a dollar weighted average portfolio maturity of 90 days or less
and will not purchase any instrument with a remaining maturity greater than 13
months (as calculated under Rule 2a-7) and except that securities subject to
repurchase agreements may have maturities in excess of 13 months. PACE Money
Market Investments will limit portfolio investments, including repurchase
agreements, to those U.S. dollar-denominated instruments that are of high
quality and that the trustees determine present minimal credit risks as advised
by Mitchell Hutchins and will comply with certain reporting and recordkeeping
procedures. There is no assurance that constant net asset value per share will
be maintained. In the event amortized cost ceases to represent fair value, the
board will take appropriate action.
In determining the approximate market value of portfolio instruments, the
Trust may employ outside organizations, which may use a matrix or formula method
that takes into consideration market indices, matrices, yield curves and other
specific adjustments. This may result in the securities being valued at a price
different from the price that would have been determined had the matrix or
formula method not been used. All cash, receivables and current payables are
carried at their face value. Other assets, if any, are valued at fair value as
determined in good faith by or under the direction of the board.
PERFORMANCE INFORMATION
Each fund's performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represent past performance and are not
intended to indicate future performance. The investment return and principal
value of an investment will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes
("Standardized Return") used in a fund's Performance Advertisements are
calculated according to the following formula:
P(1 + T)n = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares
of a fund
T = average annual total return of shares of that fund n =
number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at
the beginning of that period.
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the Performance
Advertisements for publication. Total return, or "T" in the formula above, is
computed by finding the average annual change in the value of an initial $1,000
investment over the period. All dividends and other distributions are assumed to
have been reinvested at net asset value.
Each fund also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ("Non-Standardized Return"). A fund calculates Non-Standardized Return for
specified periods of time by assuming an investment of $1,000 in fund shares and
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<PAGE>
assuming the reinvestment of all dividends and other distributions. The rate of
return is determined by subtracting the initial value of the investment from the
ending value and by dividing the remainder by the initial value.
YIELD. Yields used in a fund's Performance Advertisements, except for
those given for PACE Money Market Investments, are calculated by dividing the
fund's interest and dividend income attributable to the fund's shares for a
30-day period ("Period"), net of expenses attributable to such fund, by the
average number of shares of such fund entitled to receive dividends during the
Period and expressing the result as an annualized percentage (assuming
semi-annual compounding) of the net asset value per share at the end of the
Period. Yield quotations are calculated according to the following formula:
YIELD = 2 [( a-b/cd +1 )6 - 1 ]
where: a = interest earned during the Period attributable to a fund
= expenses accrued for the Period attributable to a fund (net
b of reimbursements)
c = the average daily number of shares of a fund outstanding
during the Period that
were entitled to receive dividends
d = the net asset value per share on the last day of the Period
Except as noted below, in determining interest and dividend income earned
during the Period (a variable in the above formula), a fund calculates interest
earned on each debt obligation held by it during the Period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the Period or,
if the obligation was purchased during the Period, the purchase price plus
accrued interest and (2) dividing the yield to maturity by 360, and multiplying
the resulting quotient by the market value of the obligation (including actual
accrued interest) to determine the interest income on the obligation for each
day of the period that the obligation is in the fund. Once interest earned is
calculated in this fashion for each debt obligation held by the fund, interest
earned during the Period is then determined by totaling the interest earned on
all debt obligations. For purposes of these calculations, the maturity of an
obligation with one or more call provisions is assumed to be the next date on
which the obligation reasonably can be expected to be called or, if none, the
maturity date.
Tax exempt-yield for PACE Municipal Fixed Income Investments is calculated
according to the same formula except the variable "a" equals interest exempt
from federal income tax earned during the Period. This tax-exempt yield may then
be translated into tax-equivalent yield according to the following formula:
TAX EQUIVALENT YIELD = ( E ) + t
-------
1 - p
E = tax-exempt yield of the fund
p = stated income tax rate
t = taxable yield of the fund
The tax-equivalent yield of PACE Municipal Fixed Income Investments
assumes a 39.6% effective federal tax rate.
PACE Money Market Investments computes its yield and effective yield
quotations using standardized methods required by the SEC. The fund from time to
time advertises (1) its current yield based on a recently ended seven-day
period, computed by determining the net change, exclusive of capital changes, in
the value of a hypothetical pre-existing account having a balance of one share
at the beginning of the period, subtracting a hypothetical charge reflecting
deductions from that shareholder account, dividing the difference by the value
of the account at the beginning of the base period to obtain the base period
return, and then multiplying the base period return by (365/7), with the
resulting yield figure carried to at least the nearest hundredth of one percent,
and (2) its effective yield based on the same seven-day period by compounding
the base period return by adding 1, raising the sum to a power equal to (365/7),
and subtracting 1 from the result, according to the following formula:
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EFFECTIVE YIELD = [(BASE PERIOD RETURN + 1) 365/7[SUPERSCRIPT]] - 1
Yield may fluctuate daily and does not provide a basis for determining
future yields. Because the yield of each fund fluctuates, it cannot be compared
with yields on savings accounts or other investment alternatives that provide an
agreed to or guaranteed fixed yield for a stated period of time. However, yield
information may be useful to an investor considering temporary investments in
money market instruments. In comparing the yield of one money market fund to
another, consideration should be given to each fund's investment policies,
including the types of investments made, the average maturity of the portfolio
securities and whether there are any special account charges that may reduce the
yield.
OTHER INFORMATION. In Performance Advertisement, each fund may compare its
Standardized Return and/or Non-Standardized Return with data published by Lipper
Analytical Services, Inc. ("Lipper"), CDA Investment Technologies, Inc. ("CDA"),
Wiesenberger Investment Companies Services ("Wiesenberger"), Investment Company
Data, Inc. ("ICD"), or Morningstar Mutual Funds ("Morningstar") or with the
performance of appropriate recognized stock and other indices, including the
Standard & Poor's 500 Composite Stock Price Index, the Dow Jones Industrial
Average, the Wilshire 5000 Index, other Wilshire Associates equities indices,
Frank Russell Company equity indices, the Morgan Stanley Capital International
Perspective Indices, the Salomon Smith Barney World Government bond indices, the
Lehman Brothers Bond indices, Municipal Bond Buyers Indices, 90 day Treasury
Bills, 30-year and 10-year U.S. Treasury Bonds and changes in the Consumer Price
Index as published by the U.S. Department of Commerce. The fund also may refer
in such materials to mutual fund performance rankings and other data, such as
comparative asset, expense and fee levels, published by Lipper, CDA,
Wiesenberger, ICD or Morningstar. Performance Advertisements also may refer to
discussions of a fund and comparative mutual fund data and ratings reported in
independent periodicals, including THE WALL STREET JOURNAL, MONEY MAGAZINE,
FORBES, BUSINESS WEEK, FINANCIAL WORLD, BARRON'S, FORTUNE, THE NEW YORK TIMES,
THE CHICAGO TRIBUNE, THE WASHINGTON POST AND THE KIPLINGER LETTERS. Ratings may
include criteria relating to portfolio characteristics in addition to
performance information. In connection with a ranking, a fund may also provide
additional information with respect to the ranking, such as the particular
category to which it relates, the number of funds in the category, the criteria
on which the ranking is based, and the effect of sales charges, fee waivers
and/or expense reimbursements. Each fund may include discussions or
illustrations of the effects of compounding in Performance Advertisements.
"Compounding" refers to the fact that, if dividends or other distributions on a
fund investment are reinvested by being paid in additional fund shares, any
future income or capital appreciation of the fund would increase the value, not
only of the original fund investment, but also of the additional fund shares
received through reinvestment. As a result, the value of the fund investment
would increase more quickly than if dividends or other distributions had been
paid in cash.
TAXES
BACKUP WITHHOLDING. Each fund is required to withhold 31% of all taxable
dividends, capital gain distributions and redemption proceeds payable to
individuals and certain other non-corporate shareholders who do not provide the
fund or PaineWebber with a correct taxpayer identification number. Withholding
at that rate also is required from taxable dividends and capital gain
distributions payable to those shareholders who otherwise are subject to backup
withholding.
SALE OR EXCHANGE OF FUND SHARES. A shareholder's sale (redemption) of fund
shares may result in a taxable gain or loss, depending on whether the
shareholder receives more or less than his or her adjusted basis for the shares.
In addition, if a fund's shares are bought within 30 days before or after
selling other shares of the fund at a loss, all or a portion of that loss will
not be deductible and will increase the basis of the newly purchased shares.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY. To continue to qualify
for treatment as a regulated investment company ("RIC") under the Internal
Revenue Code, a fund meet the conditions described below. A fund must distribute
to its shareholders for each taxable year at least 90% of its investment company
income (consisting generally of net investment income, net short-term capital
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gain and, for some funds, net gain from certain foreign currency transactions).
(PACE Municipal Fixed Income Investments must distribute to its shareholders for
each taxable year at least 90% of the sum of its investment company taxable
income (consisting generally of taxable net investment income and net short-term
capital gain) and its net interest income excludable from gross income under
section 103(a) of the Internal Revenue Code.) In addition to this "Distribution
Requirement," a fund must meet several additional requirements. For each fund,
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 currency contracts) derived with respect to its business of
investing in securities or those currencies ("Income Requirement"); (2) at the
close of each quarter of the fund's taxable year, at least 50% of the value of
its total assets must be represented by cash and cash items, U.S. government
securities, securities of other RICs and other securities that are limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value of
the fund's total assets and that does not represent more than 10% of the
issuer's outstanding voting securities; 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. If a fund failed to qualify for
treatment as a RIC for any taxable year, (a) it would be taxed as an ordinary
corporation on its taxable income for that year without being able to deduct the
distributions it makes to its shareholders and (b) the shareholders would treat
all those distributions, including distributions that otherwise would be
"exempt-interest dividends" as described below under "Taxes -- Information about
PACE Municipal Fixed Income Investments" and distributions of net capital gain
(the excess of net long-term capital gain over net short-term capital loss), as
taxable dividends (that is, ordinary income) to the extent of the fund's
earnings and profits. In addition, the fund could be required to recognize
unrealized gains, pay substantial taxes and interest and make substantial
distributions before requalifying for RIC treatment.
OTHER INFORMATION. Dividends and other distributions declared by a fund in
October, November or December of any year and payable to shareholders of record
on a date in any of those months will be deemed to have been paid by the fund
and received by the shareholders on December 31 of that year if the
distributions are paid by the fund during the following January. Accordingly,
those distributions will be taxed to shareholders for the year in which that
December 31 falls.
A portion of the dividends (whether paid in cash or in additional fund
shares) from the investment company taxable income of funds that invest in
equity securities of corporations may be eligible for the dividends-received
deduction allowed to corporations. The eligible portion for a fund may not
exceed the aggregate dividends received by the fund from U.S. corporations.
However, dividends received by a corporate shareholder and deducted by it
pursuant to the dividends-received deduction are subject indirectly to the
federal alternative minimum tax.
If fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received thereon. Investors also
should be aware that if shares are purchased shortly before the record date for
a taxable dividend or capital gain distribution, the shareholder will pay full
price for the shares and receive some portion of the price back as a taxable
distribution.
Each fund will be subject to a nondeductible 4% excise tax ("Excise Tax")
to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for the calendar year and capital gain
net income for the one-year period ending on October 31 of that year, plus
certain other amounts.
Dividends and interest received, and gains realized, by a fund on foreign
securities may be subject to income, withholding or other taxes imposed by
foreign countries and U.S. possessions (collectively "foreign taxes") that would
reduce the return on its securities. Tax conventions between certain countries
and the United States, however, may reduce or eliminate foreign taxes, and many
foreign countries do not impose taxes on capital gains in respect of investments
by foreign investors. If more than 50% of the value of a fund's total assets at
the close of its taxable year consists of securities of foreign corporations, it
will be eligible to, and may, file an election with the Internal Revenue Service
that will enable its shareholders, in effect, to receive the benefit of the
foreign tax credit with respect to any foreign taxes paid by it. Pursuant to the
election, the fund would treat those taxes as dividends paid to its shareholders
and each shareholder (1) would be required to include in gross income, and treat
as paid by him or her, his or her proportionate share of those taxes, (2) would
be required to treat his or her share of those taxes and of any dividend paid by
the fund that represents income from foreign or U.S. possessions sources as his
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<PAGE>
or her own income from those sources and (3) could either deduct the foreign
taxes deemed paid by him or her in computing his or her taxable income or,
alternatively, use the foregoing information in calculating the foreign tax
credit against his or her federal income tax. A fund will report to its
shareholders shortly after each taxable year their respective shares of foreign
taxes paid to, and the income from sources within, foreign countries and U.S.
possessions if it makes this election. Individuals who have no more than $300
($600 for married persons filing jointly) of creditable foreign taxes included
on Forms 1099 and all of whose foreign source income is "qualified passive
income" may elect each year to be exempt from the extremely complicated foreign
tax credit limitation, in which event they would be able to claim a foreign tax
credit without having to file the detailed Form 1116 that otherwise is required.
Each fund may invest in the stock of "passive foreign investment
companies" ("PFICs") if that stock is a permissible investment. A PFIC is any
foreign corporation (with certain exceptions) that, in general, meets either of
the following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, a fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock of a PFIC or of any gain from disposition of that stock (collectively
"PFIC income"), plus interest thereon, even if the fund distributes the PFIC
income as a taxable dividend to its shareholders. The balance of the PFIC income
will be included in the fund's investment company taxable income and,
accordingly, will not be taxable to it to the extent it distributes that income
to its shareholders.
If a fund invests in a PFIC and elects to treat the PFIC as a "qualified
electing fund" ("QEF"), then in lieu of the foregoing tax and interest
obligation, the fund will be required to include in income each year its pro
rata share of the QEF's annual ordinary earnings and net capital gain (which it
may have to distribute to satisfy the Distribution Requirement and avoid
imposition of the Excise Tax) even if the QEF does not distribute those earnings
and gain to the fund. In most instances it will be very difficult, if not
impossible, to make this election because of certain of its requirements.
Each fund may elect to "mark to market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of a PFIC's stock over
a fund's adjusted basis therein as of the end of that year. Pursuant to the
election, a fund also would be allowed to deduct (as an ordinary, not capital,
loss) the excess, if any, of its adjusted basis in PFIC stock over the fair
market value thereof as of the taxable year-end, but only to the extent of any
net mark-to-market gains with respect to that stock included by the fund for
prior taxable years under the election (and under regulations proposed in 1992
that provided a similar election with respect to the stock of certain PFICs). A
fund's adjusted basis in each PFIC's stock with respect to which it has made
this election will be adjusted to reflect the amounts of income included and
deductions taken thereunder.
The use of hedging strategies, such as writing (selling) and purchasing
options and futures contracts and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the amount,
character and timing of recognition of the gains and losses a fund realizes in
connection therewith. Gains from the disposition of foreign currencies (except
certain gains that may be excluded by future regulations), and gains from
options, futures and forward currency contracts derived by a fund with respect
to its business of investing in securities or foreign currencies, will be
treated as qualifying income under the Income Requirement.
Certain futures and foreign currency contracts in which a fund may invest
may be subject to section 1256 of the Code ("section 1256 contracts"). Any
section 1256 contracts a fund holds at the end of each taxable year generally
must be "marked-to-market" (that is, treated as having been sold at that time
for their fair market value) for federal income tax purposes, with the result
that unrealized gains or losses will be treated as though they were realized.
Sixty percent of any net gain or loss recognized on these deemed sales, and 60%
of any net realized gain or loss from any actual sales of section 1256
contracts, will be treated as long-term capital gain or loss, and the balance
will be treated as short-term capital gain or loss. These rules may operate to
increase the amount that a fund must distribute to satisfy the Distribution
Requirement (I.E., with respect to the portion treated as short-term capital
gain), which will be taxable to the shareholders as ordinary income, and to
increase the net capital gain a fund recognizes, without in either case
increasing the cash available to the fund. A fund may elect not to have the
foregoing rules apply to any "mixed straddle" (that is, a straddle, clearly
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identified by the fund in accordance with the regulations, at least one (but not
all) of the positions of which are section 1256 contracts), although doing so
may have the effect of increasing the relative proportion of net short-term
capital gain (taxable as ordinary income) and thus increasing the amount of
dividends that must be distributed.
Gains or losses (1) from the disposition of foreign currencies, including
forward currency contracts, (2) on the disposition of each
foreign-currency-denominated debt security that are attributable to fluctuations
in the value of the foreign currency between the dates of acquisition and
disposition of the security and (3) that are attributable to exchange rate
fluctuations between the time a fund accrues interest, dividends or other
receivables, or expenses or other liabilities, denominated in a foreign currency
and the time the fund actually collects the receivables or pays the liabilities,
generally will be treated as ordinary income or loss. These gains, referred to
under the Code as "section 988" gains or losses, will increase or decrease the
amount of a fund's investment company taxable income available to be distributed
to its shareholders as ordinary income, rather than increasing or decreasing the
amount of its net capital gain. If section 988 losses exceed other investment
company taxable income during a taxable year, a fund would not be able to
distribute any dividends, and any distributions made during that year before the
losses were realized would be recharacterized as a return of capital to
shareholders, rather than as a dividend, thereby reducing each shareholder's
basis in his or her fund shares.
Offsetting positions in any actively traded security, option, futures or
forward contract entered into or held by a fund may constitute a "straddle" for
federal income tax purposes. Straddles are subject to certain rules that may
affect the amount, character and timing of a fund's gains and losses with
respect to positions of the straddle by requiring, among other things, that (1)
loss realized on disposition of one position of a straddle be deferred to the
extent of any unrealized gain in an offsetting position until the latter
position is disposed of, (2) the fund's holding period in certain straddle
positions not begin until the straddle is terminated (possibly resulting in gain
being treated as short-term rather than long-term capital gain) and (3) losses
recognized with respect to certain straddle positions, that otherwise would
constitute short-term capital losses, be treated as long-term capital losses.
Applicable regulations also provide certain "wash sale" rules, which apply to
transactions where a position is sold at a loss and a new offsetting position is
acquired within a prescribed period, and "short sale" rules applicable to
straddles. Different elections are available to the funds, which may mitigate
the effects of the straddle rules, particularly with respect to "mixed
straddles" (I.E., a straddle of which at least one, but not all, positions are
section 1256 contracts).
When a covered call option written (sold) by a fund expires, it will
realize a short-term capital gain equal to the amount of the premium it received
for writing the option. When a fund terminates its obligations under such an
option by entering into a closing transaction, it will realize a short-term
capital gain (or loss), depending on whether the cost of the closing transaction
is less (or more) than the premium it received when it wrote the option. When a
covered call option written by a fund is exercised, the fund will be treated as
having sold the underlying security, producing long-term or short-term capital
gain or loss, depending on the holding period of the underlying security and
whether the sum of the option price received on the exercise plus the premium
received when it wrote the option is more or less than the basis of the
underlying security.
If a fund has an "appreciated financial position"-- generally, an interest
(including an interest through an option, futures or forward currency contract
or short sale) with respect to any stock, debt instrument (other than "straight
debt") or partnership interest the fair market value of which exceeds its
adjusted basis--and enters into a "constructive sale" of the position, the fund
will be treated as having made an actual sale thereof, with the result that gain
will be recognized at that time. A constructive sale generally consists of a
short sale, an offsetting notional principal contract or a futures or forward
currency contract entered into by a fund or a related person with respect to the
same or substantially identical property. In addition, if the appreciated
financial position is itself a short sale or such a contract, acquisition of the
underlying property or substantially identical property will be deemed a
constructive sale. The foregoing will not apply, however, to a fund's
transaction during any taxable year that otherwise would be treated as a
constructive sale if the transaction is closed within 30 days after the end of
that year and the fund holds the appreciated financial position unhedged for 60
days after that closing (I.E., at no time during that 60-day period is the
fund's risk of loss regarding that position reduced by reason of certain
specified transactions with respect to substantially identical or related
property, such as having an option to sell, being contractually obligated to
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sell, making a short sale or granting an option to buy substantially identical
stock or securities).
A fund that acquires zero coupon or other securities issued with original
issue discount ("OID") and/or Treasury inflation-protected securities ("TIPS"),
on which principal is adjusted based on changes in the Consumer Price Index,
must include in its gross income the OID that accrues on those securities, and
the amount of any principal increases on TIPS, during the taxable year, even if
the fund receives no corresponding payment on them during the year. Similarly, a
fund that invests in payment-in-kind ("PIK") securities must include in its
gross income securities it receives as "interest" on those securities. Each fund
has elected similar treatment with respect to securities purchased at a discount
from their face value ("market discount"). Because a fund annually must
distribute substantially all of its investment company taxable income, including
any accrued OID, market discount and other non-cash income, to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax, it may be
required in a particular year to distribute as a dividend an amount that is
greater than the total amount of cash it actually receives. Those distributions
would have to be made from the fund's cash assets or from the proceeds of sales
of portfolio securities, if necessary. The fund might realize capital gains or
losses from those sales, which would increase or decrease its investment company
taxable income and/or net capital gain.
INFORMATION ABOUT PACE MUNICIPAL FIXED INCOME INVESTMENTS. Dividends paid
by PACE Municipal Fixed Income Investments will qualify as "exempt-interest
dividends," and thus will be excludable from gross income for federal income tax
purposes by its shareholders, if the fund satisfies the requirement that, at the
close of each quarter of its taxable year, at least 50% of the value of its
total assets consists of securities the interest on which is excludable from
gross income under section 103(a); the fund intends to continue to satisfy this
requirement. The aggregate dividends designated as exempt-interest dividends for
any year by the fund may not exceed its net tax-exempt income for the year.
Shareholders' treatment of dividends from the fund under state and local income
tax laws may differ from the treatment thereof under the Internal Revenue Code.
Investors should consult their tax advisers concerning this matter.
Entities or persons who are "substantial users" (or persons related to
"substantial users") of facilities financed by IDBs or PABs should consult their
tax advisers before purchasing fund shares because, for users of certain of
these facilities, the interest on those bonds is not exempt from federal income
tax. For these purposes, "substantial user" is defined to include a "non-exempt
person" who regularly uses in a trade or business a part of a facility financed
from the proceeds of IDBs or PABs.
Up to 85% of social security and railroad retirement benefits may be
included in taxable income for recipients whose adjusted gross income (including
income from tax-exempt sources such as the fund) plus 50% of their benefits
exceeds certain base amounts. Exempt-interest dividends from the fund still
would be tax-exempt to the extent described above; they would only be included
in the calculation of whether a recipient's income exceeded the established
amounts.
If fund shares are sold at a loss after being held for six months or less,
the loss will be disallowed to the extent of any exempt-interest dividends
received on those shares, and any loss not disallowed will be treated as
long-term, instead of short-term, capital loss to the extent of any capital gain
distributions received thereon. Investors also should be aware that if shares
are purchased shortly before the record date for a capital gain distribution,
the shareholder will pay full price for the shares and receive some portion of
the price back as a taxable distribution.
If the fund invests in instruments that generate taxable interest income,
under the circumstances described in the Prospectus and in the discussion of
municipal market discount bonds below, the portion of any fund dividend
attributable to the interest earned thereon will be taxable to the fund's
shareholders as ordinary income to the extent of its earnings and profits, and
only the remaining portion will qualify as an exempt-interest dividend. The
respective portions will be determined by the "actual earned" method, under
which the portion of any dividend that qualifies as an exempt-interest dividend
may vary, depending on the relative proportions of tax-exempt and taxable
interest earned during the dividend period. Moreover, if the fund realizes
capital gain as a result of market transactions, any distributions of the gain
will be taxable to its shareholders.
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The fund may invest in municipal bonds that are purchased, generally not
on their original issue, with market discount (that is, at a price less than the
principal amount of the bond or, in the case of a bond that was issued with
original issue discount, a price less than the amount of the issue price plus
accrued original issue discount) ("municipal market discount bonds"). If a
bond's market discount is less that the product of (1) 0.25% of the redemption
price at maturity times (2) the number of complete years to maturity after the
fund acquired the bond, then no market discount is considered to exist. Gain on
the disposition of a municipal market discount bond purchased by the fund after
April 30, 1993 (other than a bond with a fixed maturity date within one year
from its issuance), generally is treated as ordinary (taxable) income, rather
than capital gain, to the extent of the bond's accrued market discount at the
time of disposition. Market discount on such a bond generally is accrued
ratably, on a daily basis, over the period from the acquisition date to the date
of maturity. In lieu of treating the disposition gain as above, the fund may
elect to include market discount in its gross income currently, for each taxable
year to which it is attributable.
OTHER INFORMATION
DELAWARE BUSINESS TRUST. The Trust is an entity of the type commonly known
as a Delaware business trust. Although Delaware law statutorily limits the
potential liabilities of a Delaware business trust's shareholders to the same
extent as it limits the potential liabilities of a Delaware corporation,
shareholders of a fund could, under certain conflicts of laws jurisprudence in
various states, be held personally liable for the obligations of the Trust or a
fund. However, the trust instrument of the Trust disclaims shareholder liability
for acts or obligations of the Trust or its series (the funds) and requires that
notice of such disclaimer be given in each written obligation made or issued by
the trustees or by any officers or officer by or on behalf of the Trust, a
series, the trustees or any of them in connection with the Trust. The trust
instrument provides for indemnification from a fund's property for all losses
and expenses of any fund shareholder held personally liable for the obligations
of the fund. Thus, the risk of a shareholder's incurring financial loss on
account of shareholder liability is limited to circumstances in which a fund
itself would be unable to meet its obligations, a possibility that Mitchell
Hutchins believes is remote and not material. Upon payment of any liability
incurred by a shareholder solely by reason of being or having been a shareholder
of a fund, the shareholder paying such liability will be entitled to
reimbursement from the general assets of the fund. The trustees intend to
conduct the operations of the funds in such a way as to avoid, as far as
possible, ultimate liability of the shareholders for liabilities of the funds.
In the event any of the initial shares of a fund are redeemed during the
five-year amortization period, the redemption proceeds will be reduced by a pro
rata portion of any unamortized deferred organizational expenses in the same
proportion as the number of initial shares being redeemed bears to the number of
initial shares outstanding at the time of redemption.
VOTING RIGHTS. Shareholders of each fund are entitled to one vote for each
full share held and fractional votes for fractional shares held. Voting rights
are not cumulative and, as a result, the holders of more than 50% of all the
shares of the funds as a group may elect all of the trustees of the Trust. The
shares of each series of the Trust will be voted separately, except when an
aggregate vote of all the series of the Trust is required by law.
The Trust does not hold annual meetings. Shareholders of record of no less
than two-thirds of the outstanding shares of the Trust may remove a trustee
through a declaration in writing or by vote cast in person or by proxy at a
meeting called for that purpose. A meeting will be called to vote on the removal
of a trustee at the written request of holders of 10% of the outstanding shares
of the Trust.
PRIOR NAMES. Prior to December 1, 1997, the Trust's name was "Managed
Accounts Services Portfolio Trust."
CUSTODIAN AND RECORDKEEPING AGENT; TRANSFER AND DIVIDEND AGENT. State
Street Bank and Trust Company, located at One Heritage Drive, North Quincy,
Massachusetts 02171, serves as custodian and recordkeeping agent for each fund
and employs foreign sub-custodians approved by the board in accordance with
applicable requirements under the Investment Company Act to provide custody of
the funds' foreign assets. PFPC Inc., a subsidiary of PNC Bank, N.A., serves as
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each fund's transfer and dividend disbursing agent. It is located at 400
Bellevue Parkway, Wilmington, DE 19809.
COUNSEL. The law firm Willkie Farr & Gallagher, 787 Seventh Avenue, New
York, New York serves as counsel to the Trust. Willkie Farr & Gallagher also
acts as counsel to PaineWebber and Mitchell Hutchins in connection with other
matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for the Trust.
FINANCIAL STATEMENTS
The Trust's Annual Report to Shareholders for its last fiscal year is a
separate document supplied with this SAI, and the financial statements,
accompanying notes and report of independent auditors appearing therein are
incorporated by this reference into the SAI.
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A-3
APPENDIX
RATINGS INFORMATION
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues; Aa. Bonds which are rated Aa
are judged to be of high quality by all standards. Together with the Aaa group
they comprise what are generally known as high grade bonds. They are rated lower
than the best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risk appear
somewhat larger than in Aaa securities; A. Bonds which are 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 which are rated Baa are considered
as medium-grade obligations, i.e., they are neither highly protected nor poorly
secured. Interest payment and principal security appear adequate for the present
but certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well; Ba. Bonds
which are 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 which are 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 which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest; Ca. Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings; C. Bonds which are rated C are the lowest rated class of
bonds, and issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
NOTE: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; A. An obligation rated A is
somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than obligations in higher rated categories. However, the
obligor's capacity to meet its financial commitment on the obligation is still
strong; BBB. An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation; BB, B, CCC, CC, C. Obligations rated BB, B, CCC, CC and C are
regarded as having significant speculative characteristics. BB indicates the
least degree of speculation and C the highest. While such obligations will
likely have some quality and protective characteristics, these may be outweighed
by large uncertainties or major exposures to adverse conditions; BB. An
obligation rated BB is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse
business, financial, or economic conditions which could lead to the obligor's
inadequate capacity to meet its financial commitment on the obligation; B. An
obligation rated B is more vulnerable to nonpayment than obligations rated BB,
but the obligor currently has the capacity to meet its financial commitment on
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the obligation. Adverse business, financial, or economic conditions will likely
impair the obligor's capacity or willingness to meet its financial commitment on
the obligation; CCC. An obligation rated CCC is currently vulnerable to
nonpayment and is dependent upon favorable business, financial and economic
conditions for the obligor to meet its financial commitment on the obligation.
In the event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the
obligation; CC. An obligation rated CC is currently highly vulnerable to
nonpayment; C. The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued; D. An obligation rated D is in payment default.
The D rating category is used when payments on an obligation are not made on the
date due even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
CI. The rating CI is reserved for income bonds on which no interest is
being paid.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
r. This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
PRIME-1. Issuers assigned this highest rating have a superior ability for
repayment of senior short-term debt obligations. Prime-1 repayment ability will
often be evidenced by the following characteristics: Leading market positions in
well established industries; high rates of return on funds employed;
conservative capitalization structures with moderate reliance on debt and ample
asset protection; broad margins in earnings coverage of fixed financial charges
and high internal cash generation; well established access to a range of
financial markets and assured sources of alternate liquidity.
PRIME-2. Issuers assigned this rating have a strong ability for repayment
of senior short-term debt obligations. This will normally be evidenced by many
of the characteristics cited above, but to a lesser degree. Earnings trends and
coverage ratios, while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
PRIME-3. Issuers assigned this rating have an acceptable capacity for
repayment of senior short-term obligations. The effect of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
NOT PRIME. Issuers assigned this rating do not fall within any of the
Prime rating categories.
DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS
A-1. A short-term obligation rated A-1 is rated in the highest category by
S&P. The obligor's capacity to meet its financial commitment on the obligation
is strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong. A-2. A short-term
obligation rated A-2 is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rating categories. However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory. A-3. A short-term obligation rated
A-3 exhibits adequate protection parameters. However, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity of the obligor to meet its financial commitment on the obligation. B. A
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short-term obligation rated B is regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its financial
commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor's inadequate capacity to meet its financial
commitments on the obligation. C. A short-term obligation rated C is currently
vulnerable to nonpayment and is dependent upon favorable business, financial and
economic conditions for the obligor to meet its financial commitment on the
obligation. D. A short-term obligation rated D is in payment default. The D
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless S&P believes
that such payments will be made during such grace period. The D rating also will
be used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
DESCRIPTION OF MOODY'S MUNICIPAL BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues; Aa. Bonds which are rated Aa
are judged to be of high quality by all standards. Together with the Aaa group
they comprise what are generally known as high grade bonds. They are rated lower
than the best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risk appear
somewhat larger than in Aaa securities; A. Bonds which are 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 which are rated Baa are considered
as medium-grade obligations, i.e., they are neither highly protected nor poorly
secured. Interest payment and principal security appear adequate for the present
but certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well; Ba. Bonds
which are 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 which are 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 which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest; Ca. Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings; C. Bonds which are rated C are the lowest rated class of
bonds, and issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
DESCRIPTION OF S&P MUNICIPAL DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; A. An obligation rated A is
somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than obligations in higher rated categories. However, the
obligor's capacity to meet its financial commitment on the obligation is still
strong; BBB. An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation; BB, B, CCC, CC, C, D. Obligations rated BB, B, CCC, CC and C
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are regarded as having significant speculative characteristics. BB indicates the
least degree of speculation and C the highest. While such obligations will
likely have some quality and protective characteristics, these may be outweighed
by large uncertainties or major exposures to adverse conditions; BB. An
obligation rated BB is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse
business, financial, or economic conditions which could lead to the obligor's
inadequate capacity to meet its financial commitment on the obligation; B. An
obligation rated B is more vulnerable to nonpayment than obligations rated BB,
but the obligor currently has the capacity to meet its financial commitment on
the obligation. Adverse business, financial, or economic conditions will likely
impair the obligor's capacity or willingness to meet its financial commitment on
the obligation; CCC. An obligation rated CCC is currently vulnerable to
nonpayment and is dependent upon favorable business, financial and economic
conditions for the obligor to meet its financial commitment on the obligation.
In the event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the
obligation; CC. An obligation rated CC is currently highly vulnerable to
nonpayment; C. The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued; D. An obligation rated D is in payment default.
The D rating category is used when payments on an obligation are not made on the
date due even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
CI. The rating CI is reserved for income bonds on which no interest is
being paid.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF MOODY'S RATINGS OF SHORT-TERM OBLIGATIONS
There are three categories for short-term obligations that define an investment
grade situation. These are designated Moody's Investment Grade as MIG 1 (best
quality) through MIG-3. Short-term obligations of speculative quality are
designated SG.
In the case of variable rate demand obligations (VRDOs), a two-component rating
is assigned. The first element represents an evaluation of the degree of risk
associated with scheduled principal and interest payments, and the other
represents an evaluation of the degree of risk associated with the demand
feature. The short-term rating assigned to the demand feature of a VRDO is
designated as VMIG. When either the long- or short-term aspect of a VRDO is not
rated, that piece is designated NR, e.g. Aaa/NR or NR/VMIG 1.
MIG ratings terminate at the retirement of the obligation, while a VMIG rating
expiration will be a function of each issue's specific structural or credit
features.
MIG-1/VMIG-1. This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or demonstrated
broad-based access to the market for refinancing. MIG-2/VMIG-2. This designation
denotes high quality. Margins of protection are ample although not so large as
in the preceding group. MIG-3/VMIG-3. This designation denotes favorable
quality. Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established. SG. This designation denotes
speculative quality. Debt Instruments in this category lack margins of
protection.
DESCRIPTION OF S&P'S RATINGS OF STATE AND MUNICIPAL NOTES AND OTHER SHORT-TERM
LOANS:
A S&P note rating reflects the liquidity concerns and market access risks unique
to notes. Notes due in 3 years or less will likely receive a note rating. Notes
maturing beyond 3 years will most likely receive a long-term debt rating. The
following criteria will be used in making the assessment.
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- --Amortization schedule (the larger the final maturity relative to other
maturities, the more likely it will be treated as a note).
- --Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
SP-1. Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation. SP-2.
Satisfactory capacity to pay principal and interest with some vulnerability to
adverse financial and economic changes over the term of the notes. SP-3.
Speculative capacity to pay principal and interest.
DESCRIPTION OF SHORT-TERM DEBT COMMERCIAL PAPER RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
PRIME-1. Issuers (or supporting institutions) assigned this highest rating
have a superior ability for repayment of senior short-term debt obligations.
Prime-1 repayment ability will often be evidenced by the following
characteristics: Leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation; well
established access to a range of financial markets and assured sources of
alternate liquidity.
PRIME-2. Issuers (or supporting institutions) assigned this rating have a
strong ability for repayment of senior short-term debt obligations. This will
normally be evidenced by many of the characteristics cited above, but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions.
Ample alternate liquidity is maintained.
PRIME-3. Issuers (or supporting institutions) assigned this rating have an
acceptable capacity for repayment of senior short-term obligations. The effect
of industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
NOT PRIME. Issuers assigned this rating do not fall within any of the
Prime rating categories.
Commercial paper rated by S&P have the following characteristics:
A-1. A short-term obligation rated A-1 is rated in the highest category by
S&P. The obligor's capacity to meet its financial commitment on the obligation
is strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong. A-2. A short-term
obligation rated A-2 is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rating categories. However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory. A-3. A short-term obligation rated
A-3 exhibits adequate protection parameters. However, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity of the obligor to meet its financial commitment on the obligation. B. A
short-term obligation rated B is regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its financial
commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor's inadequate capacity to meet its financial
commitments on the obligation. C. A short-term obligation rated C is currently
vulnerable to nonpayment and is dependent upon favorable business, financial and
economic conditions for the obligor to meet its financial commitment on the
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obligation. D. A short-term obligation rated D is in payment default. The D
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless S&P believes
that such payments will be made during such grace period. The D rating also will
be used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
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YOU SHOULD RELY ONLY ON THE
INFORMATION CONTAINED OR REFERRED TO
IN THE PROSPECTUS AND THIS STATEMENT
OF ADDITIONAL INFORMATION. THE FUNDS
AND THEIR DISTRIBUTOR HAVE NOT
AUTHORIZED ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THE
PROSPECTUS AND THIS STATEMENT OF
ADDITIONAL INFORMATION IS NOT AN OFFER
TO SELL SHARES OF THE FUNDS IN ANY
JURISDICTION WHERE THE FUNDS OR THEIR
DISTRIBUTOR MAY NOT LAWFULLY SELL
THOSE SHARES.
------------
PaineWebber PACE
Select Advisors Trust
--------------------------------------
Statement of Additional Information
December 1, 1999
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(C) 1999 PaineWebber Incorporated. All rights reserved. Member of SIPC.
