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THE BEAR STEARNS FUNDS
LARGE CAP VALUE PORTFOLIO
SMALL CAP VALUE PORTFOLIO
INCOME PORTFOLIO
HIGH YIELD TOTAL RETURN PORTFOLIO
CLASS A, CLASS B, CLASS C AND CLASS Y
PART B
(STATEMENT OF ADDITIONAL INFORMATION)
October 16, 1998
as Supplemented May 18, 1999
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This Statement of Additional Information, which is not a prospectus,
supplements and should be read in conjunction with the current relevant
prospectus (the "Prospectus") dated October 16, 1998 of The Bear Stearns Funds
(the "Fund"), as each may be revised from time to time, offering shares of four
diversified portfolios (each, a "Portfolio"): Large Cap Value Portfolio and
Small Cap Value Portfolio (together, the "Equity Portfolios"), Income Portfolio
(the "Income Portfolio") and High Yield Total Return Portfolio (the "High Yield
Portfolio"). To obtain a free copy of such Prospectus, please write to the Fund
at PFPC Inc. ("PFPC"), Attention: [Name of Portfolio], P.O. Box 8960,
Wilmington, Delaware 19899-8960, call 1-800-447-1139 or call Bear, Stearns & Co.
Inc. ("Bear Stearns") at 1-800-766-4111.
Bear Stearns Asset Management Inc. ("BSAM" or the "Adviser"), a
wholly-owned subsidiary of The Bear Stearns Companies Inc., serves as each
Portfolio's investment adviser.
Bear Stearns Funds Management Inc. ("BSFM"), a wholly-owned subsidiary
of The Bear Stearns Companies Inc., is the administrator of the Portfolios. Bear
Stearns, an affiliate of BSAM, serves as distributor of each Portfolio's shares.
TABLE OF CONTENTS
Page
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Investment Objective and Management Policies........................... B-2
Management of the Fund................................................. B-34
Management Arrangements................................................ B-37
Purchase and Redemption of Shares...................................... B-43
Determination of Net Asset Value....................................... B-46
Dividends, Distributions and Taxes..................................... B-47
Portfolio Transactions................................................. B-55
Performance Information................................................ B-58
Code of Ethics......................................................... B-60
Information About the Fund............................................. B-61
Custodian, Transfer and Dividend Disbursing Agent,
Counsel and Independent Auditors..................................... B-65
Financial Statements................................................... B-66
Appendix............................................................... B-67
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
The following information supplements and should be read in conjunction
with the section in the Portfolios' Prospectus entitled "Description of the
Portfolios."
Portfolio Securities
Bank Obligations. (All Portfolios) Domestic commercial banks organized
under Federal law are supervised and examined by the Comptroller of the Currency
and are required to be members of the Federal Reserve System and to have their
deposits insured by the Federal Deposit Insurance Corporation (the "FDIC").
Domestic banks organized under state law are supervised and examined by state
banking authorities but are members of the Federal Reserve System only if they
elect to join. In addition, state banks whose certificates of deposit ("CDs")
may be purchased by each Portfolio are insured by the FDIC (although such
insurance may not be of material benefit to a Portfolio, depending on the
principal amount of the CDs of each bank held by such Portfolio) and are subject
to Federal examination and to a substantial body of Federal law and regulation.
As a result of Federal or state laws and regulations, domestic branches of
domestic banks whose CDs may be purchased by each Portfolio generally are
required, among other things, to maintain specified levels of reserves, are
limited in the amounts which they can loan to a single borrower and are subject
to other regulation designed to promote financial soundness. However, not all of
such laws and regulations apply to the foreign branches of domestic banks.
Obligations of foreign branches of domestic banks, foreign subsidiaries
of domestic banks and domestic and foreign branches of foreign banks, such as
CDs and time deposits ("TDs"), may be general obligations of the parent banks in
addition to the issuing branch, or may be limited by the terms of a specific
obligation and governmental regulation. Such obligations are subject to
different risks than are those of domestic banks. These risks include foreign
economic and political developments, foreign governmental restrictions that may
adversely affect payment of principal and interest on the obligations, foreign
exchange controls and foreign withholding and other taxes on interest income.
These foreign branches and subsidiaries are not necessarily subject to the same
or similar regulatory requirements that apply to domestic banks, such as
mandatory reserve requirements, loan limitations, and accounting, auditing and
financial record keeping requirements. In addition, less information may be
publicly available about a foreign branch of a domestic bank or about a foreign
bank than about a domestic bank.
Obligations of United States branches of foreign banks may be general
obligations of the parent bank in addition to the issuing branch, or may be
limited by the terms of a specific obligation or by Federal or state regulation
as well as governmental action in the country in which the foreign bank has its
head office. A domestic branch of a foreign bank with assets in excess of $1
billion may be subject to reserve requirements imposed by the Federal Reserve
System or by the state in which the branch is located if the branch is licensed
in that state.
In addition, Federal branches licensed by the Comptroller of the
Currency and branches licensed by certain states ("State Branches") may be
required to:
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(1) pledge to the regulator, by depositing assets with a designated bank within
the state, a certain percentage of their assets as fixed from time to time by
the appropriate regulatory authority; and (2) maintain assets within the state
in an amount equal to a specified percentage of the aggregate amount of
liabilities of the foreign bank payable at or through all of its agencies or
branches within the state. The deposits of Federal and State Branches generally
must be insured by the FDIC if such branches take deposits of less than
$100,000.
In view of the foregoing factors associated with the purchase of CDs
and TDs issued by foreign branches of domestic banks, by foreign subsidiaries of
domestic banks, by foreign branches of foreign banks or by domestic branches of
foreign banks, BSAM carefully evaluates such investments on a case-by-case
basis.
Bank Debt (High Yield Portfolio). The High Yield Portfolio may invest
in bank debt which includes interests in loans to companies or their affiliates
undertaken to finance a capital restructuring or in connection with
recapitalizations, acquisitions, leveraged buyouts, refinancings or other
financially leveraged transactions and may include loans which are designed to
provide temporary or "bridge" financing to a borrower pending the sale of
identified assets, the arrangement of longer-term loans or the issuance and sale
of debt obligations. These loans, which may bear fixed or floating rates, have
generally been arranged through private negotiations between a corporate
borrower and one or more financial institutions ("Lenders"), including banks.
The Portfolio's investment may be in the form of participations in loans
("Participations") or of assignments of all or a portion of loans from third
parties ("Assignments").
Participations differ both from the public and private debt securities
typically held by the Portfolio and from Assignments. In Participations, the
Portfolio has a contractual relationship only with the Lender, not with the
borrower. As a result, the Portfolio 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, the Portfolio
generally will have no 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 the Portfolio may not benefit directly from any
collateral supporting the loan in which it has purchased the Participation.
Thus, the Portfolio assumes the credit risk of both the borrower and the Lender
that is selling the Participation. In the event of the insolvency of the Lender,
the Portfolio may be treated as a general creditor of the Lender and may not
benefit from any set-off between the Lender and the borrower. In Assignments, by
contrast, the Portfolio acquires direct rights against the borrower, except that
under certain circumstances such rights may be more limited than those held by
the assigning Lender.
Investments in Participations and Assignments otherwise bear risks
common to other debt securities, including the risk of nonpayment of principal
and interest by the borrower, the risk that any loan collateral may become
impaired and that the Portfolio may obtain less than the full value for loan
interests sold because they are illiquid. The Portfolio may have difficulty
disposing of Assignments and Participations. Because the market for such
instruments is not highly liquid, the Portfolio anticipates that such
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instruments could be sold only to a limited number of institutional investors.
The lack of a highly liquid secondary market may have an adverse impact on the
value of such instruments and will have an adverse impact on the Portfolio's
ability to dispose of particular Assignments or Participations in response to a
specific economic event, such as deterioration in the creditworthiness of the
borrower. In addition to the creditworthiness of the borrower, the Portfolio's
ability to receive payment of principal and interest is also dependent on the
creditworthiness of any institution (i.e., the Lender) interposed between the
Portfolio and the borrower.
Mortgage-Related Securities
U.S. Government Agency Securities. (Income and High Yield Portfolios)
Mortgage-related securities issued by the Government National Mortgage
Association ("GNMA") include GNMA Mortgage Pass-Through Certificates (also known
as "Ginnie Maes") which are guaranteed as to the timely payment of principal and
interest by GNMA and such guarantee is backed by the full faith and credit of
the United States. GNMA is a wholly-owned U.S. Government corporation within the
Department of Housing and Urban Development. GNMA certificates also are
supported by the authority of GNMA to borrow funds from the U.S. Treasury to
make payments under its guarantee.
U.S. Government Related Securities. (Income and High Yield Portfolios)
Mortgage-related securities issued by the Federal National Mortgage Association
("FNMA") include FNMA Guaranteed Mortgage Pass-Through Certificates (also known
as "Fannie Maes") which are solely the obligations of the FNMA and are not
backed by or entitled to the full faith and credit of the United States. The
FNMA is a government-sponsored organization owned entirely by private
stockholders. Fannie Maes are guaranteed as to timely payment of principal and
interest by FNMA.
Mortgage-related securities issued by the Federal Home Loan Mortgage
Corporation ("FHLMC") include FHLMC Mortgage Participation Certificates (also
known as "Freddie Macs" or "PCs"). The FHLMC is a corporate instrumentality of
the United States created pursuant to an Act of Congress, which is owned
entirely by Federal Home Loan Banks. Freddie Macs are not guaranteed by the
United States or by any Federal Home Loan Bank and do not constitute a debt or
obligation of the United States or of any Federal Home Loan Bank. Freddie Macs
entitle the holder to timely payment of interest, which is guaranteed by the
FHLMC. The FHLMC guarantees either ultimate collection or timely payment of all
principal payments on the underlying mortgage loans. When the FHLMC does not
guarantee timely payment of principal, FHLMC may remit the amount due on account
of its guarantee of ultimate payment of principal at any time after default on
an underlying mortgage, but in no event later than one year after it becomes
payable.
Asset-Backed Securities (Income and High Yield Portfolios). Each
Portfolio may invest in asset-backed securities in accordance with its
investment objective and policies. Asset-backed securities represent an
undivided ownership interest in a pool of installment sales contracts and
installment loans collateralized by, among other things, credit card receivables
and automobiles. In general, asset-backed securities and the collateral
supporting them are of shorter maturity than mortgage loans. As a result,
investment in these securities should result in greater price stability for the
Portfolios.
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Asset-backed securities are often structured with one or more types of
credit enhancement. The Portfolios will not limit their investments to
asset-backed securities with credit enhancements. Although asset-backed
securities are not generally traded on a national securities exchange, such
securities are widely traded by brokers and dealers, and to such extent will not
be considered illiquid for the purposes of the Portfolios' limitation on
investment in illiquid securities.
Repurchase Agreements. (All Portfolios) Each Portfolio's custodian or
sub-custodian will have custody of, and will hold in a segregated account,
securities acquired by the Portfolio under a repurchase agreement. Repurchase
agreements are considered by the staff of the Securities and Exchange Commission
to be loans by the Portfolio. In an attempt to reduce the risk of incurring a
loss on a repurchase agreement, each Portfolio will enter into repurchase
agreements only with domestic banks with total assets in excess of one billion
dollars, or primary government securities dealers reporting to the Federal
Reserve Bank of New York, with respect to securities of the type in which each
Portfolio may invest, and will require that additional securities be deposited
with it if the value of the securities purchased should decrease below the
resale price. BSAM will monitor on an ongoing basis the value of the collateral
to assure that it always equals or exceeds the repurchase price. Each Portfolio
will consider on an ongoing basis the creditworthiness of the institutions with
which it enters into repurchase agreements.
Reverse Repurchase Agreements (Income and High Yield Portfolios). The
High Yield Portfolio may borrow by entering into reverse repurchase agreements.
Pursuant to such agreements, a Portfolio would sell portfolio securities to
financial institutions, such as banks and broker-dealers, and agree to
repurchase them at an agreed upon date, price and interest payment. When
effecting reverse repurchase transactions, securities of a dollar amount equal
in value to the securities subject to the agreement will be maintained in a
segregated account with the Portfolio's custodian. A reverse repurchase
agreement involves the risk that the market value of the portfolio securities
sold by the Portfolio may decline below the price of the securities the
Portfolio is obligated to repurchase, which price is fixed at the time the
Portfolio enters into such agreement.
Municipal Obligations. (Income and High Yield Portfolios) Municipal
obligations are classified as general obligation bonds, revenue bonds and notes.
General obligation bonds are secured by the issuer's pledge of its faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable from the revenue derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source, but not from the general taxing power. Industrial
development bonds, in most cases, are revenue bonds and generally do not carry
the pledge of the credit of the issuing municipality, but generally are
guaranteed by the corporate entity on whose behalf they are issued. Notes are
short-term instruments which are obligations of the issuing municipalities or
agencies and are sold in anticipation of a bond sale, collection of taxes or
receipt of other revenues. Municipal obligations include municipal
lease/purchase agreements which are similar to installment purchase contracts
for property or equipment issued by municipalities. Certain municipal
obligations are subject to redemption at a date earlier than their stated
maturity pursuant to call options, which may be separated from
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the related municipal obligation and purchased and sold separately. The Income
Portfolio will invest in municipal obligations, the ratings of which correspond
with the ratings of other permissible Income Portfolio investments.
Trade Claims. (High Yield Portfolio) The High Yield Portfolio may
invest in trade claims, which are non-securitized rights of payment arising from
obligations other than borrowed funds. Trade claims typically arise when, in the
ordinary course of business, vendors and suppliers extend credit to a company by
offering payment terms. Generally, when a company files for bankruptcy
protection, payments on trade claims cease and the claims are subject to
compromise along with the other debts of the company. Trade claims typically are
bought and sold at a discount reflecting the degree of uncertainty with respect
to the timing and extent of recovery. In addition to the risks otherwise
associated with low-quality obligations, trade claims have other risks,
including (i) the possibility that the amount of the claim may be disputed by
the obligor, (ii) the debtor may have a variety of defenses to assert against
the claim under the bankruptcy code, (iii) volatile pricing due to a less liquid
market, including a small number of brokers for trade claims and a small
universe of potential buyers, (iv) the possibility that the Portfolio may be
obligated to purchase a trade claim larger than initially anticipated, and (v)
the risk of failure of sellers of trade claims to indemnify the Portfolio
against loss due to the bankruptcy or insolvency of such sellers. The
negotiation and enforcement of rights in connection with trade claims may result
in higher legal expenses to the Portfolio, which may reduce return on such
investments. It is not unusual for trade claims to be priced at a discount to
publicly traded securities that have an equal or lower priority claim.
Additionally, trade claims may be treated as non-securities investments. As a
result, any gains may be considered "non-qualifying" under the Internal Revenue
Code of 1986, as amended (the "Code").
Securities of Financially and Operationally Troubled Issuers (High
Yield Portfolio). The High Yield Portfolio may invest in debt or equity
securities of financially troubled or bankrupt companies ("financially troubled
issuers") and in debt or equity securities of companies that in the view of BSAM
are currently undervalued, out-of-favor or price depressed relative to their
long-term potential for growth and income ("operationally troubled issuers")
(collectively "distressed securities").
The securities of financially and operationally troubled issuers may
require active monitoring and at times may require BSAM to participate in
bankruptcy or reorganization proceedings on behalf of the Portfolio. To the
extent BSAM becomes involved in such proceedings, the Portfolio may have a more
active participation in the affairs of the issuer than is generally assumed by
an investor and such participation may subject the Portfolio to the litigation
risks described below. However, the Portfolio does not invest in the securities
of financially or operationally troubled issuers for the purpose of exercising
day-to-day management of any issuer's affairs.
Bankruptcy and Other Proceedings - Litigation Risks. When a company
seeks relief under the Federal Bankruptcy Code (or has a petition filed against
it), an automatic stay prevents all entities, including creditors, from
foreclosing or taking other actions to enforce claims, perfect liens or reach
collateral securing such claims. Creditors who have claims against the company
prior to the date of the bankruptcy filing must petition the court to permit
them to
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take any action to protect or enforce their claims or their rights in any
collateral. Such creditors may be prohibited from doing so if the court
concludes that the value of the property in which the creditor has an interest
will be "adequately protected" during the proceedings. If the bankruptcy court's
assessment of adequate protection is inaccurate, a creditor's collateral may be
wasted without the creditor being afforded the opportunity to preserve it. Thus,
even if the Portfolio holds a secured claim, it may be prevented from collecting
the liquidation value of the collateral securing its debt, unless relief from
the automatic stay is granted by the court.
Security interests held by creditors are closely scrutinized and
frequently challenged in bankruptcy proceedings and may be invalidated for a
variety of reasons. For example, security interests may be set aside because, as
a technical matter, they have not been perfected properly under the Uniform
Commercial Code or other applicable law. If a security interest is invalidated,
the secured creditor loses the value of the collateral and because loss of the
secured status causes the claim to be treated as an unsecured claim, the holder
of such claim will almost certainly experience a significant loss of its
investment. While the Portfolio intends to scrutinize any security interests
that secure the debt it purchases, there can be no assurance that the security
interests will not be challenged vigorously and found defective in some respect,
or that the Portfolio will be able to prevail against the challenge.
Moreover, debt may be disallowed or subordinated to the claims of other
creditors if the creditor is found guilty of certain inequitable conduct
resulting in harm to other parties with respect to the affairs of a company
filing for protection from creditors under the Federal Bankruptcy Code.
Creditors' claims may be treated as equity if they are deemed to be
contributions to capital, or if a creditor attempts to control the outcome of
the business affairs of a company prior to its filing under the Bankruptcy Code.
If a creditor is found to have interfered with the company's affairs to the
detriment of other creditors or shareholders, the creditor may be held liable
for damages to injured parties. While the Portfolio will attempt to avoid taking
the types of action that would lead to equitable subordination or creditor
liability, there can be no assurance that such claims will not be asserted or
that the Portfolio will be able successfully to defend against them.
While the challenges to liens and debt described above normally occur
in a bankruptcy proceeding, the conditions or conduct that would lead to an
attack in a bankruptcy proceeding could in certain circumstances result in
actions brought by other creditors of the debtor, shareholders of the debtor or
even the debtor itself in other state or federal proceedings. As is the case in
a bankruptcy proceeding, there can be no assurance that such claims will not be
asserted or that the Portfolio will be able successfully to defend against them.
To the extent that the Portfolio assumes an active role in any legal proceeding
involving the debtor, the Portfolio may be prevented from disposing of
securities issued by the debtor due to the Portfolio's possession of material,
non-public information concerning the debtor.
Zero Coupon, Pay-In-Kind Or Deferred Payment Securities (Income and
High Yield Portfolios). The High Yield Portfolio may invest in zero coupon,
pay-in-kind or deferred payment securities. Zero coupon securities are
securities that are sold at a discount to par value and on which interest
payments are not made
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during the life of the security. Upon maturity, the holder is entitled to
receive the par value of the security. While interest payments are not made on
such securities, holders of such securities are deemed to have received annually
"phantom income." A Portfolio accrues income with respect to these securities
for federal income tax and accounting purposes prior to the receipt of cash
payments. Pay-in-kind securities are securities that have interest payable by
delivery of additional securities. Upon maturity, the holder is entitled to
receive the aggregate par value of the securities. Deferred payment securities
are securities that remain a zero coupon security until a predetermined date, at
which time the stated coupon rate becomes effective and interest becomes payable
at regular intervals. Zero coupon, pay-in-kind and deferred payment securities
may be subject to greater fluctuation in value and lesser liquidity in the event
of adverse market conditions than comparable rated securities paying cash
interest at regular intervals.
There are certain risks related to investing in zero coupon,
pay-in-kind and deferred payment securities. These securities generally are more
sensitive to movements in interest rates and are less liquid than comparably
rated securities paying cash interest at regular intervals. Consequently, such
securities may be subject to greater fluctuation in value. During a period of
severe market conditions, the market for such securities may become even less
liquid. In addition, as these securities do not pay cash interest, the
Portfolio's investment exposure to these securities and their risks, including
credit risk, will increase during the time these securities are held in a
Portfolio's portfolio. Further, to maintain its qualification for pass-through
treatment under the federal tax laws, each Portfolio is required to distribute
income to its shareholders and, consequently, may have to dispose of its
portfolio securities under disadvantageous circumstances to generate the cash,
or may have to leverage itself by borrowing the cash to satisfy these
distributions, as they relate to the distribution of "phantom income" and the
value of the paid-in-kind interest. The required distributions will result in an
increase in the Portfolios' exposure to such securities.
Depository Receipts and Depository Shares (All Portfolios). Each
Portfolio may invest in American Depository Receipts ("ADRs") or other similar
securities, such as American Depository Shares and Global Depository Shares,
convertible into securities of foreign issuers. 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. Generally, ADRs
in registered form are designed for use in U.S. securities markets. As a result
of the absence of established securities markets and publicly-owned corporations
in certain foreign countries as well as restrictions on direct investment by
foreign entities, a Portfolio may be able to invest in such countries solely or
primarily through ADRs or similar securities and government approved investment
vehicles. The Adviser expects that the Portfolio, to the extent of its
investment in ADRs, will invest predominantly in ADRs sponsored by the
underlying issuers. Each Portfolio, however, may invest in unsponsored ADRs.
Issuers of the stock of unsponsored ADRs are not obligated to disclose material
information in the United States and, therefore, there may not be a correlation
between such information and the market value of such ADRs.
Securities of Foreign Issuers. (All Portfolios) Each Portfolio may
invest a portion of its assets in the securities of foreign issuers. Each Equity
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Portfolio may invest up to 10% of its total assets in foreign securities and the
High Yield Portfolio may invest up to 25% of its total assets in foreign
securities. American and global depository receipts are not included in this 25%
limitation.
The Portfolio believes that in many instances such foreign securities
may provide higher yields than securities of domestic issuers which have similar
maturities and quality. Many of these investments currently enjoy increased
liquidity, although, under certain market conditions, such securities may be
less liquid than the securities of United States corporations, and are certainly
less liquid than securities issued or guaranteed by the United States
Government, its instrumentalities or agencies.
Foreign investment involves certain risks, which should be considered
carefully by an investor in the Portfolio. These risks include political or
economic instability in the country of issue, the difficulty of predicting
international trade patterns and the possibility of imposition of exchange
controls. Such securities also may be subject to greater fluctuations in price
than securities issued by United States corporations or issued or guaranteed by
the United States Government, its instrumentalities or agencies. In addition,
there may be less publicly available information about a foreign company than
about a domestic company. Foreign companies generally are not subject to uniform
accounting, auditing and financial reporting standards comparable to those
applicable to domestic companies. There is generally less government regulation
of securities exchanges, brokers and listed companies abroad than in the United
States, and, with respect to certain foreign countries, there is a possibility
of expropriation or confiscatory taxation or diplomatic developments which could
affect investment in those countries. In the event of a default of any such
foreign debt obligations, it may be more difficult for the Portfolio to obtain
or to enforce a judgment against the issuers of such securities. Foreign
currency denominated securities may be affected favorably or unfavorably by
changes in currency rates and in exchange control regulations, and costs may be
incurred in connection with conversions between various currencies. It may not
be possible to hedge against the risks of currency fluctuations.
Emerging Market Securities (Income and High Yield Portfolios). The
Income and High Yield Portfolios may each invest in a limited extent in the
securities of issuers located in emerging market countries. "Emerging market
countries" are countries that are considered to be emerging or developing by the
World Bank, the International Finance Corporation, or the United Nations and its
authorities. A company is considered to be an emerging market company if (i) its
securities are principally traded in the capital markets of an emerging market
country; (ii) it derives at least 50% of its total revenue from either goods
produced or services rendered in emerging market countries or from sales made in
emerging
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market countries, regardless of where the securities of such companies are
principally traded; (iii) it maintains 50% or more of its assets in one or more
emerging market countries; or (iv) it is organized under the laws of, or has a
principal office in, an emerging market country.
The securities markets of certain emerging market countries are marked
by a high concentration of market capitalization and trading volume in a small
number of issuers representing a limited number of industries, as well as a high
concentration of ownership of such securities by a limited number of investors.
The markets for securities in certain emerging market countries are in the
earliest stages of their development. Even the markets for relatively widely
traded securities in emerging markets may not be able to absorb, without price
disruptions, a significant increase in trading volume or trades of a size
customarily undertaken by institutional investors in the securities markets of
developed countries. Additionally, market making and arbitrage activities are
generally less extensive in such markets, which may contribute to increased
volatility and reduced liquidity of such markets. The limited liquidity of
emerging markets may also affect the Portfolio's ability to accurately value its
portfolio securities or to acquire or dispose of securities at the price and
time it wishes to do so or in order to meet redemption requests.
Transaction costs, including brokerage commissions or dealer mark-ups,
in emerging market countries may be higher than in the United States and other
developed securities markets. In addition, existing laws and regulations are
often inconsistently applied. As legal systems in emerging market countries
develop, foreign investors may be adversely affected by new or amended laws and
regulations. In circumstances where adequate laws exist, it may not be possible
to obtain swift and equitable enforcement of the law.
Political and economic structures in many emerging market countries may
be undergoing significant evolution and rapid development, and emerging market
countries may lack the social, political and economic stability characteristic
of more developed countries. Certain emerging market countries may have in the
past failed to recognize private property rights and have at times nationalized
or expropriated the assets of private companies. As a result, the risks
described above, including the risks of nationalization or expropriation of
assets, may be heightened.
Certain emerging market countries require governmental approval prior
to investments by foreign persons or limit investment by foreign persons to only
a specified percentage of an issuer's outstanding securities or a specific class
of securities which may have less advantageous terms (including price) than
securities of the company available for purchase by nationals. In addition, the
repatriation of both investment income and capital from several of the emerging
market countries is subject to restrictions such as the need for certain
governmental consents. Even where there is no outright restriction on
repatriation of capital, the mechanics of repatriation may affect certain
aspects of the operation of the Portfolios. A Portfolio may be required to
establish special custodial or other arrangements before investing in certain
emerging market countries.
Emerging market countries may be subject to a greater degree of
economic, political and social instability than is the case in the United
States, Japan and most Western European countries. Such instability may result
from, among other things, the following: (i) authoritarian governments or
military involvement in political and economic decision making, including
changes or attempted changes in governments through extra-constitutional means;
(ii) popular unrest associated with demands for improved political, economic or
social conditions; (iii) internal insurgencies; (iv) hostile relations with
neighboring countries; and (v) ethnic, religious and racial disaffection or
conflict. Such economic, political and social instability could disrupt the
principal financial markets in which the Portfolios may invest and adversely
affect the value of the Portfolios' assets.
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The economies of emerging market countries may differ unfavorably from
the U.S. economy in such respects as growth of gross domestic product, rate of
inflation, capital reinvestment, resources, self-sufficiency and balance of
payments. Many emerging market countries have experienced in the past, and
continue to experience, high rates of inflation. In certain countries inflation
has at times accelerated rapidly to hyperinflationary levels, creating a
negative interest rate environment and sharply eroding the value of outstanding
financial assets in those countries. The economies of many emerging market
countries are heavily dependent upon international trade and are accordingly
affected by protective trade barriers and the economic conditions of their
trading partners. In addition, the economies of some emerging market countries
are vulnerable to weakness in world prices for their commodity exports.
A Portfolio's income and, in some cases, capital gains from foreign
stocks and securities will be subject to applicable taxation in certain of the
countries in which it invests, and treaties between the U.S. and such countries
may not be available in some cases to reduce the otherwise applicable tax rates.
Foreign markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
been unable to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. Such delays in settlement could result
in temporary periods when a portion of the assets of a Portfolio is uninvested
and no return is earned on such assets. The inability of a Portfolio to make
intended security purchases or sales due to settlement problems could result
either in losses to the Portfolio due to subsequent declines in value of the
portfolio securities or, if the Portfolio has entered into a contract to sell
the securities, could result in possible liability to the purchaser.
Brady Bonds (Income and High Yield Portfolios). Each Portfolio is
permitted to invest in debt obligations commonly known as "Brady Bonds" which
are created through the exchange of existing commercial bank loans to foreign
entities for new obligations in connection with debt restructurings under a plan
introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the
Brady Plan). Brady Bonds have been issued in connection with the restructuring
of the bank loans, for example, of the governments of Mexico, Venezuela and
Argentina.
Brady Bonds have been issued only recently, and, accordingly, do not
have a long payment history. They may be collateralized or uncollateralized and
issued in various currencies (although most are dollar-denominated) and they are
actively traded in the over-the-counter secondary market.
Dollar-denominated, collateralized Brady Bonds, which may be fixed rate
par bonds or floating rate discount bonds, are generally collateralized in full
as to principal due at maturity by U.S. Treasury zero coupon obligations which
have the same maturity as the Brady Bonds. Interest payments on these Brady
Bonds generally are collateralized by cash or securities in an amount that, in
the case of fixed rate bonds, is equal to at least one year of rolling interest
payments based on the applicable interest rate at that time and is adjusted at
regular intervals thereafter. Certain Brady Bonds are entitled to "value
recovery payments" in certain circumstances, which in effect constitute
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supplemental interest payments but generally are not collateralized. Brady Bonds
are often viewed as having three or four valuation components: (i) the
collateralized repayment of principal at final maturity; (ii) the collateralized
interest payments; (iii) the uncollateralized interest payments; and (iv) any
uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute the "residual risk"). 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 to 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 which would have then
been due on the Brady Bonds in the normal course. In addition, 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.
Commercial Paper and Other Short-Term Corporate Obligations. (All
Portfolios) Variable rate demand notes include variable amount master demand
notes, which are obligations that permit each Portfolio to invest fluctuating
amounts at varying rates of interest pursuant to direct arrangements between a
Portfolio, as lender, and the borrower. These notes permit daily changes in the
amounts borrowed. As mutually agreed between the parties, a Portfolio may
increase the amount under the notes at any time up to the full amount provided
by the note agreement, or decrease the amount, and the borrower may repay up to
the full amount of the note without penalty. Because these obligations are
direct lending arrangements between the lender and the borrower, it is not
contemplated that such instruments generally will be traded, and there generally
is no established secondary market for these obligations, although they are
redeemable at face value, plus accrued interest, at any time. Accordingly, where
these obligations are not secured by letters of credit or other credit support
arrangements, a Portfolio's right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. In connection with floating
and variable rate demand obligations, BSAM will consider, on an ongoing basis,
earning power, cash flow and other liquidity ratios of the borrower, and the
borrower's ability to pay principal and interest on demand. Such obligations
frequently are not rated by credit rating agencies, and a Portfolio may invest
in them only if at the time of an investment the borrower meets the criteria set
forth in the Portfolio's Prospectus for other commercial paper issuers.
Illiquid Securities. (All Portfolios) Each Portfolio may hold up to 15%
of its net assets in repurchase agreements that have a maturity of longer than
seven days or in other illiquid securities, including securities that are
illiquid by virtue of the absence of a readily available market (either within
or outside of the United States) or legal or contractual restrictions on resale.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
having a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer
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or in the secondary market. Mutual funds do not typically hold a significant
amount of these restricted or other illiquid securities because of the potential
for delays on resale and uncertainty in valuation. Limitations on resale may
have an adverse effect on the marketability of portfolio securities and a mutual
fund might be unable to dispose of restricted or other illiquid securities
promptly or at reasonable prices and might thereby experience difficulty
satisfying redemptions within seven days. A mutual fund might also have to
register such restricted securities in order to dispose of them resulting in
additional expense and delay. Adverse market conditions could impede such a
public offering of securities.
In recent years, however, a large institutional market has developed
for certain securities that are not registered under the Securities Act
including repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A establishes a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. BSAM anticipates that the market for certain
restricted securities such as institutional commercial paper and foreign
securities will expand further as a result of this regulation and the
development of 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.
Restricted securities eligible for resale pursuant to Rule 144A under
the Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. BSAM will monitor the liquidity of
such restricted securities subject to the supervision of the Board of Trustees.
In reaching liquidity decisions, BSAM will consider, inter alia, the following
factors: (1) the frequency of trades and quotes for the security; (2) the number
of dealers wishing to purchase or sell the security and the number of other
potential purchasers; (3) dealer undertakings to make a market in the security;
and (4) the nature of the security and the nature of the marketplace trades
(e.g., the time needed to dispose of the security, the method of soliciting
offers and the mechanics of the transfer). In addition, in order for commercial
paper that is issued in reliance on Section 4(2) of the Securities Act to be
considered liquid, (i) it must be rated in one of the two highest rating
categories by at least two nationally recognized statistical rating
organizations (NRSRO), or if only one NRSRO rates the securities, by that NRSRO,
or, if unrated, be of comparable quality in the view of BSAM; and (ii) it must
not be "traded flat" (i.e., without accrued interest) or in default as to
principal or interest. Repurchase agreements subject to demand are deemed to
have a maturity equal to the notice period.
The staff of the Securities and Exchange Commission has taken the
position that purchased over-the-counter (OTC) options and the assets used as
"cover" for written OTC options are illiquid securities unless the Portfolio and
the
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counterparty have provided for the Portfolio, at the Portfolio's election, to
unwind the OTC option. The exercise of such an option would ordinarily involve
the payment by the Portfolio of an amount designed to reflect the counterparty's
economic loss from an early termination, but does allow the Portfolio to treat
the securities used as "cover" as liquid.
Ratings of Debt. (Income Portfolio) Subsequent to its purchase by the
Income Portfolio, a debt issue may cease to be rated or its rating may be
reduced below the minimum required for purchase by the Income Portfolio. Neither
event will require the sale of such securities by the Income Portfolio, but BSAM
will consider such event in determining whether the Income Portfolio should
continue to hold the securities. To the extent that the ratings given by Moody's
Investors Service, Inc. ("Moody's"), Standard & Poor's Ratings Group, a division
of The McGraw-Hill Companies, Inc. ("S&P"), Fitch Investors Service, L.P.
("Fitch") or Duff & Phelps Credit Rating Co. ("Duff") may change as a result of
changes in such organizations or their rating systems, the Income Portfolio will
attempt to use comparable ratings as standards for its investments in accordance
with the investment policies contained in the Portfolio's Prospectus and this
Statement of Additional Information.
Management Policies
The Portfolios may engage in the following practices in furtherance of
their objectives.
Options Transactions. (All Portfolios). Each Portfolio may engage in
options transactions, such as purchasing or writing covered call or put options.
A Portfolio may purchase put and call options and write covered put and call
options on debt and equity securities, financial indices (including stock
indices), U.S. and foreign government debt securities and foreign currencies.
These may include options traded on U.S. or foreign exchanges and options traded
on U.S. or foreign over-the-counter markets ("OTC options"), including OTC
options with primary U.S. government securities dealers recognized by the
Federal Reserve Bank of New York.
The purchaser of a call option has the right, for a specified period of
time, to purchase the securities subject to the option at a specified price (the
"exercise price" or "strike price"). By writing a call option, a Portfolio
becomes obligated during the term of the option, upon exercise of the option, to
deliver the underlying securities or a specified amount of cash to the purchaser
against receipt of the exercise price. When the Portfolio writes a call option,
the Portfolio loses the potential for gain on the underlying securities in
excess of the exercise price of the option during the period that the option is
open.
The purchaser of a put option has the right, for a specified period of
time, to sell the securities subject to the option to the writer of the put at
the specified exercise price. By writing a put option, the Portfolio becomes
obligated during the term of the option, upon exercise of the option, to
purchase the securities underlying the option at the exercise price. The
Portfolio might, therefore, be obligated to purchase the underlying securities
for more than their current market price.
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The writer of an option retains the amount of the premium, although
this amount may be offset or exceeded, in the case of a covered call option, by
a decline and, in the case of a covered put option, by an increase in the market
value of the underlying security during the option period.
The principal reason for writing covered call options, which are call
options with respect to which a Portfolio owns the underlying security or
securities, is to realize, through the receipt of premiums, a greater return
than would be realized on a Portfolio's securities alone. In return for a
premium, the writer of a covered call option forfeits the right to any
appreciation in the value of the underlying security above the strike price for
the life of the option (or until a closing purchase transaction can be
effected). Nevertheless, the call writer retains the risk of a decline in the
price of the underlying security. Similarly, the principal reason for writing
covered put options is to realize income in the form of premiums. The writer of
a covered put option accepts the risk of a decline in the price of the
underlying security. The size of the premiums that a Portfolio may receive may
be adversely affected as new or existing institutions, including other
investment companies, engage in or increase their option-writing activities.
A Portfolio may wish to protect certain portfolio securities against a
decline in market value at a time when put options on those particular
securities are not available for purchase. A Portfolio may therefore purchase a
put option on other carefully selected securities, the values of which BSAM
expects will have a high degree of positive correlation to the values of such
portfolio securities. If BSAM's judgment is correct, changes in the value of the
put options should generally offset changes in the value of the portfolio
securities being hedged. If BSAM'S judgment is not correct, the value of the
securities underlying the put option may decrease less than the value of a
Portfolio's investments and therefore the put option may not provide complete
protection against a decline in the value of the Portfolio's investments below
the level sought to be protected by the put option.
A Portfolio may similarly wish to hedge against appreciation in the
value of securities that it intends to acquire at a time when call options on
such securities are not available. A Portfolio may, therefore, purchase call
options on other carefully selected securities the values of which BSAM expects
will have a high degree of positive correlation to the values of the securities
that the Portfolio intends to acquire. In such circumstances the Portfolio will
be subject to risks analogous to those summarized above in the event that the
correlation between the value of call options so purchased and the value of the
securities intended to be acquired by the Portfolio is not as close as
anticipated and the value of the securities underlying the call options
increases less than the value of the securities to be acquired by the Portfolio.
A Portfolio may write options on securities in connection with
buy-and-write transactions; that is, the Portfolio may purchase a security and
concurrently write a call option against that security. If the call option is
exercised, the Portfolio's maximum gain will be the premium it received for
writing the option, adjusted upwards or downwards by the difference between the
Portfolio's purchase price of the security and the exercise price of the option.
If the option is not exercised and the price of the underlying security
declines, the amount of the decline will be offset in part, or entirely, by the
premium received.
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The exercise price of a call option may be below ("in-the-money"),
equal to ("at-the-money") or above ("out-of-the-money") the current value of the
underlying security at the time the option is written. Buy-and-write
transactions using in-the-money call options may be used when it is expected
that the price of the underlying security will remain flat or decline moderately
during the option period. Buy-and-write transactions using at-the-money call
options may be used when it is expected that the price of the underlying
security will remain fixed or advance moderately during the option period. A
buy-and-write transaction using an out-of-the-money call option may be used when
it is expected that the premium received from writing the call option plus the
appreciation in the market price of the underlying security up to the exercise
price will be greater than the appreciation in the price of the underlying
security alone. If the call option is exercised in such a transaction, the
Portfolio's maximum gain will be the premium received by it for writing the
option, adjusted upwards or downwards by the difference between the Portfolio's
purchase price of the security and the exercise price of the option. If the
option is not exercised and the price of the underlying security declines, the
amount of the decline will be offset in part, or entirely, by the premium
received.
Options written by the Portfolios ordinarily will have expiration dates
between one and nine months from the date written. The exercise price of the
options may be below, equal to or above the market values of the underlying
securities at the time the options are written. In the case of call options,
these exercise prices are referred to as "in-the-money," "at-the-money" and
"out-of-the-money," respectively. Each Portfolio may write (a) in-the-money call
options when BSAM expects that the price of the underlying security will remain
stable or decline moderately during the option period, (b) at-the-money call
options when BSAM expects that the price of the underlying security will remain
stable or advance moderately during the option period and (c) out-of-the-money
call options when BSAM expects that the premiums received from writing the call
option plus the appreciation in market price of the underlying security up to
the exercise price will be greater than the appreciation in the price of the
underlying security alone. In these circumstances, if the market price of the
underlying security declines and the security is sold at this lower price, the
amount of any realized loss will be offset wholly or in part by the premium
received. Out-of-the-money, at-the-money and in-the-money put options (the
reverse of call options as to the relation of exercise price to market price)
may be utilized in the same market environments that such call options are used
in equivalent transactions.
So long as a Portfolio's obligation as the writer of an option
continues, such Portfolio may be assigned an exercise notice by the
broker-dealer through which the option was sold, requiring the Portfolio to
deliver, in the case of a call, or take delivery of, in the case of a put, the
underlying security against payment of the exercise price. This obligation
terminates when the option expires or a Portfolio effects a closing purchase
transaction. A Portfolio can no longer effect a closing purchase transaction
with respect to an option once it has been assigned an exercise notice.
While it may choose to do otherwise, each Portfolio generally will
purchase or write only those options for which BSAM believes there is an active
secondary market so as to facilitate closing transactions. There is no assurance
that sufficient trading interest to create a liquid secondary market
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on a securities exchange will exist for any particular option or at any
particular time, and for some options no such secondary market may exist. A
liquid secondary market in an option may cease to exist for a variety of
reasons. In the past, for example, higher than anticipated trading activity or
order flow, or other unforeseen events, at times have rendered certain clearing
facilities inadequate and resulted in the institution of special procedures,
such as trading rotations, restrictions on certain types of orders or trading
halts or suspensions in one or more options. There can be no assurance that
similar events, or events that otherwise may interfere with the timely execution
of customers' orders, will not recur. In such event, it might not be possible to
effect closing transactions in particular options. If as a covered call option
writer a Portfolio is unable to effect a closing purchase transaction in a
secondary market, it will not be able to sell the underlying security until the
option expires or it delivers the underlying security upon exercise or it
otherwise covers its position.
Prior to being notified of the exercise of the option, the writer of an
exchange-traded option that wishes to terminate its obligation may effect a
"closing purchase transaction" by buying an option of the same series as the
option previously written. (Options of the same series are options with respect
to the same underlying security, having the same expiration date and the same
strike price.) The effect of the purchase is that the writer's position will be
canceled by the exchange's affiliated clearing organization. Likewise, an
investor who is the holder of an exchange-traded option may liquidate a position
by effecting a "closing sale transaction" by selling an option of the same
series as the option previously purchased. There is no guarantee that either a
closing purchase or a closing sale transaction can be effected.
Exchange-traded options are issued by a clearing organization
affiliated with the exchange on which the option is listed which, in effect,
gives its guarantee to every exchange-traded option transaction. In contrast,
OTC options are contracts between a Portfolio and its contra-party with no
clearing organization guarantee. Thus, when a Portfolio purchases an OTC option,
it relies on the dealer from which it has purchased the OTC option to make or
take delivery of the securities underlying the option. Failure by the dealer to
do so would result in the loss of the premium paid by the Portfolio as well as
the loss of the expected benefit of the transaction.
When a Portfolio writes an OTC option, it generally will be able to
close out the OTC option prior to its expiration only by entering into a closing
purchase transaction with the dealer to which the Portfolio originally wrote the
OTC option. While a Portfolio will enter into OTC options only with dealers
which agree to, and which are expected to be capable of, entering into closing
transactions with the Portfolio, there can be no assurance that the Portfolio
will be able to liquidate an OTC option at a favorable price at any time prior
to expiration. Until a Portfolio is able to effect a closing purchase
transaction in a covered OTC call option the Portfolio has written, it will not
be able to liquidate securities used as cover until the option expires or is
exercised or different cover is substituted. In the event of insolvency of the
contra-party, the Portfolio may be unable to liquidate an OTC option. See
"Illiquid Securities" below.
OTC options purchased by a Portfolio will be treated as illiquid
securities subject to any applicable limitation on such securities. Similarly,
the assets
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used to "cover" OTC options written by the Portfolio will be treated as illiquid
unless the OTC options are sold to qualified dealers who agree that the
Portfolio may repurchase any OTC options it writes for a maximum price to be
calculated by a formula set forth in the option Agreement. The "cover" for an
OTC 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. See "Illiquid Securities" below.
A Portfolio may write only "covered" options. This means that so long
as the Portfolio is obligated as the writer of a call option, it will own the
underlying securities subject to the option or an option to purchase the same
underlying securities, having an exercise price equal to or less than the
exercise price of the "covered" option, or will establish and maintain with its
custodian for the term of the option a segregated account consisting of cash,
U.S. Government securities, equity securities or other liquid, unencumbered
assets, marked-to-market daily, having a value equal to or greater than the
exercise price of the option. In the case of a straddle written by the
Portfolio, the amount maintained in the segregated account will equal the
amount, if any, by which the put is "in-the-money."
Stock Index Options. (Equity Portfolios and High Yield Portfolio) Each
Equity Portfolio and the High Yield Portfolio may purchase and write put and
call options on stock indexes listed on U.S. or foreign securities exchanges or
traded in the over-the-counter market. A stock index fluctuates with changes in
the market values of the stocks included in the index.
Options on stock indexes are similar to options on stock except that
(a) the expiration cycles of stock index options are generally monthly, while
those of stock options are currently quarterly, and (b) the delivery
requirements are different. Instead of giving the right to take or make delivery
of a stock at a specified price, an option on a stock index gives the holder the
right to receive a cash "exercise settlement amount" equal to (i) the amount, if
any, by which the fixed exercise price of the option exceeds (in the case of a
put) or is less than (in the case of a call) the closing value of the underlying
index on the date of exercise, multiplied by (ii) a fixed "index multiplier."
Receipt of this cash amount will depend upon the closing level of the stock
index upon which the option is based being greater than, in the case of a call,
or less than, in the case of a put, the exercise price of the option. The amount
of cash received will be equal to such difference between the closing price of
the index and the exercise price of the option expressed in dollars times a
specified multiple. The writer of the option is obligated, in return for the
premium received, to make delivery of this amount. The writer may offset its
position in stock index options prior to expiration by entering into a closing
transaction on an exchange or it may let the option expire unexercised.
When a Portfolio writes an option on a securities index, it will be
required to deposit with its custodian, and mark-to-market, eligible securities
equal in value to 100% of the exercise price in the case of a put, or the
contract value in the case of a call. In addition, where a Portfolio writes a
call option on a securities index at a time when the contract value exceeds the
exercise price, the Portfolio will segregate and mark-to-market, until the
option expires or is closed out, cash or cash equivalents equal in value to such
excess.
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Options on a securities index involve risks similar to those risks
relating to transactions in financial futures contracts described below. Also,
an option purchased by a Portfolio may expire worthless, in which case the
Portfolio would lose the premium paid therefor.
Risks of Options Transactions. An exchange-traded option position may
be closed out only on an exchange which provides a secondary market for an
option of the same series. Although the Portfolios will generally purchase or
write only those options for which there appears to be an active secondary
market, there is no assurance that a liquid secondary market on an exchange will
exist for any particular option at any particular time, and for some
exchange-traded options, no secondary market on an exchange may exist. In such
event, it might not be possible to effect closing transactions in particular
options, with the result that the Portfolio would have to exercise its
exchange-traded options in order to realize any profit and may incur transaction
costs in connection therewith. If a Portfolio as a covered call option writer is
unable to effect a closing purchase transaction in a secondary market, it will
not be able to sell the underlying security until the option expires or it
delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market on an exchange
include the following: (a) insufficient trading interest in certain options; (b)
restrictions on transactions imposed by an exchange; (c) trading halts,
suspensions or other restrictions imposed with respect to particular classes or
series of options or underlying securities; (d) interruption of the normal
operations on an exchange; (e) inadequacy of the facilities of an exchange or
clearinghouse, such as The Options Clearing Corporation (the "O.C.") to handle
current trading volume; or (f) a decision by one or more exchanges to
discontinue the trading of options (or a particular class or series of options),
in which event the secondary market on that exchange (or in that class or series
of options) would cease to exist, although outstanding options on that exchange
that had been issued by the O.C. as a result of trades on that exchange would
generally continue to be exercisable in accordance with their terms.
In the event of the bankruptcy of a broker through which a Portfolio
engages in options transactions, the Portfolio could experience delays and/or
losses in liquidating open positions purchased or sold through the broker and/or
incur a loss of all or part of its margin deposits with the broker. Similarly,
in the event of the bankruptcy of the writer of an OTC option purchased by a
Portfolio, the Portfolio could experience a loss of all or part of the value of
the option. Transactions are entered into by the Portfolio only with brokers or
financial institutions deemed creditworthy by BSAM.
The hours of trading for options may not conform to the hours during
which the underlying securities are traded. To the extent that the option
markets close before the markets for the underlying securities, significant
price and rate movements can take place in the underlying markets that cannot be
reflected in the option markets.
Risks of Options on Foreign Currencies. (All Portfolios) Options on
foreign currencies involve the currencies of two nations and therefore,
developments in either or both countries affect the values of options on foreign
currencies. Risks include government actions affecting currency valuation and
the
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movements of currencies from one country to another. The quantity of currency
underlying option contracts represent odd lots in a market dominated by
transactions between banks; this can mean extra transaction costs upon exercise.
Option markets may be closed while round-the-clock interbank currency markets
are open, and this can create price and rate discrepancies.
Futures Contracts and Options on Futures Contracts. (All Portfolios)
Each Portfolio may trade futures contracts and options on futures contracts in
U.S. domestic markets, such as the Chicago Board of Trade and the International
Monetary Market of the Chicago Mercantile Exchange, or, to the extent permitted
under applicable law, on exchanges located outside the United States, such as
the London International Financial Futures Exchange and the Sydney Futures
Exchange Limited. Foreign markets may offer advantages such as trading in
commodities that are not currently traded in the United States or arbitrage
possibilities not available in the United States.
A "purchase" of a futures contract (or a "long" futures position) means
the assumption of a contractual obligation to acquire a specified quantity of
the securities underlying the contract at a specified price at a specified
future date. A "sale" of a futures contract (or a "short" futures position)
means the assumption of a contractual obligation to deliver a specified quantity
of the securities underlying the contract at a specified price at a specified
future date.
Initially, when purchasing or selling futures contracts, a Portfolio
will be required to deposit with the Fund's custodian in the broker's name an
amount of cash or cash equivalents up to approximately 5% to 10% of the contract
amount. This amount is subject to change by the exchange or board of trade on
which the contract is traded and members of such exchange or board of trade may
impose their own higher requirements. This amount is known as "initial margin"
and is in the nature of a performance bond or good faith deposit on the contract
which is returned to the Portfolio upon termination of the futures position,
assuming all contractual obligations have been satisfied. Subsequent payments,
known as "variation margin," to and from the broker will be made daily as the
price of the index or securities underlying the futures contract fluctuates,
making the long and short positions in the futures contract more or less
valuable, a process known as "marking-to-market." At any time prior to the
expiration of a futures contract, the Portfolio may elect to close the position
by taking an opposite position, at the then prevailing price, which will operate
to terminate the Portfolio's existing position in the contract.
Some futures contracts by their terms may call for the actual delivery
or acquisition of the underlying assets and other futures contracts must be
"cash settled." In most cases the contractual obligation is extinguished before
the expiration of the contract by buying (to offset an earlier sale) or selling
(to offset an earlier purchase) an identical futures contract calling for
delivery or acquisition in the same month. The purchase (or sale) of an
offsetting futures contract is referred to as a "closing transaction."
Although each Portfolio intends to purchase or sell futures contracts
only if there is an active market for such contracts, no assurance can be given
that a liquid market will exist for any particular contract at any particular
time. Many futures exchanges and boards of trade limit the amount of fluctuation
permitted in futures contract prices during a single trading day.
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Once the daily limit has been reached in a particular contract, no
trades may be made that day at a price beyond that limit or trading may be
suspended for specified periods during the trading day. Futures contract prices
could move to the limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
potentially subjecting a Portfolio to substantial losses. If it is not possible,
or a Portfolio determines not, to close a futures position in anticipation of
adverse price movements, the Portfolio will be required to make daily cash
payments of variation margin. In such circumstances, an increase in the value of
the portion of the Portfolio being hedged, if any, may offset partially or
completely losses on the futures contract. However, no assurance can be given
that the price of the securities being hedged will correlate with the price
movements in a futures contract and thus provide an offset to losses on the
futures contract.
In addition, to the extent a Portfolio is engaging in a futures
transaction as a hedging device, due to the risk of an imperfect correlation
between securities owned by the Portfolio that are the subject of a hedging
transaction and the futures contract used as a hedging device, it is possible
that the hedge will not be fully effective in that, for example, losses on the
portfolio securities may be in excess of gains on the futures contract or losses
on the futures contract may be in excess of gains on the portfolio securities
that were the subject of the hedge. In futures contracts based on indexes, the
risk of imperfect correlation increases as the composition of a Portfolio's
investments varies from the composition of the index. In an effort to compensate
for the imperfect correlation of movements in the price of the securities being
hedged and movements in the price of futures contracts, a Portfolio may buy or
sell futures contracts in a greater or lesser dollar amount than the dollar
amount of the securities being hedged if the historical volatility of the
futures contract has been less or greater than that of the securities. Such
"over hedging" or "under hedging" may adversely affect a Portfolio's net
investment results if market movements are not as anticipated when the hedge is
established.
Upon exercise of an option on a futures contract, the writer of the
option will deliver to the holder of the option the futures position and the
accumulated balance in the writer's futures margin account, which 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 futures contract. The potential loss related to the purchase of options
on futures contracts is limited to the premium paid for the option (plus
transaction costs). Because the value of the option is fixed at the time of
sale, there are no daily cash payments to reflect changes in the value of the
underlying contract; however, the value of the option does change daily and that
change would be reflected in the net asset value of a Portfolio.
A Portfolio's ability to establish and close out positions in futures
contracts and options on futures contracts would be impacted by the liquidity of
these markets. Although a Portfolio generally would purchase or sell only those
futures contracts and options thereon for which there appeared to be a liquid
market, there is no assurance that a liquid market on an exchange will exist for
any particular futures contract or option at any particular time. In the event
no liquid market exists for a particular futures contract or option thereon in
which a Portfolio maintains a position, it would not be possible to
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effect a closing transaction in that contract or to do so at a satisfactory
price and the Portfolio would have to either make or take delivery under the
futures contract or, in the case of a written call option, wait to sell the
underlying securities until the option expired or was exercised, or, in the case
of a purchased option, exercise the option. In the case of a futures contract or
an option on a futures contract which the Portfolio had written and which the
Portfolio was unable to close, the Portfolio would be required to maintain
margin deposits on the futures contract or option and to make variation margin
payments until the contract is closed.
Risks inherent in the use of these strategies include (1) dependence on
BSAM's ability to predict correctly movements in the direction of interest
rates, securities prices and markets; (2) imperfect correlation between the
price of futures contracts and options thereon and movement in the prices of the
securities being hedged; (3) the fact that the skills needed to use these
strategies are different from those needed to select portfolio securities; (4)
the possible absence of a liquid secondary market for any particular instrument
at any time; (5) the possible need to defer closing out certain hedged positions
to avoid adverse tax consequences; and (6) the possible inability of the
Portfolio to sell a portfolio security at a time that otherwise would be
favorable for it to do so. In the event it did sell the security and eliminated
its "cover," it would have to replace its "cover" with an appropriate futures
contract or option or segregate securities with the required value, as described
below under "Limitations on the Purchase and Sale of Futures Contracts and
Related Options--Segregation Requirements."
Although futures prices themselves have the potential to be extremely
volatile, in the case of any strategy involving interest rate futures contracts
and options thereon when BSAM's expectations are not met, assuming proper
adherence to the segregation requirement, the volatility of a Portfolio as a
whole should be no greater than if the same strategy had been pursued in the
cash market.
Exchanges on which futures and related options trade may impose limits
on the positions that a Portfolio may take in certain circumstances. In
addition, the hours of trading of financial futures contracts and options
thereon may not conform to the hours during which the Portfolio may trade the
underlying securities. To the extent the futures markets close before the
securities markets, significant price and rate movements can take place in the
securities markets that cannot be reflected in the futures markets.
Pursuant to the requirements of the Commodity Exchange Act, as amended
(the "Commodity Exchange Act"), all futures contracts and options thereon must
be traded on an exchange. Since a clearing corporation effectively acts as the
counterparty on every futures contract and option thereon, the counter party
risk depends on the strength of the clearing or settlement corporation
associated with the exchange. Additionally, although the exchanges provide a
means of closing out a position previously established, there can be no
assurance that a liquid market will exist for a particular contract at a
particular time. In the case of options on futures, if such a market does not
exist, a Portfolio, as the holder of an option on futures contracts, would have
to exercise the option and comply with the margin requirements for the
underlying futures contract to utilize any profit, and if the Portfolio were the
writer of the option, its obligation would not terminate until the option
expired or the Portfolio was assigned an exercise notice.
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Limitations on the Purchase and Sale of Futures Contracts and Related Options.
CFTC Limits. In accordance with Commodity Futures Trading Commission
(CFTC) regulations, the Portfolios are not permitted to purchase or sell futures
contracts or options thereon for return enhancement or risk management purposes
if immediately thereafter the sum of the amounts of initial margin deposits on
the Portfolio's existing futures and premiums paid for options on futures exceed
5% of the liquidation value of such Portfolio's total assets (the "5% CFTC
limit"). This restriction does not apply to the purchase and sale of futures
contracts and options thereon for bona fide hedging purposes.
Segregation Requirements. To the extent a Portfolio enters into futures
contracts, it is required by the Securities and Exchange Commission to maintain
a segregated asset account with its custodian (or a futures commission merchant)
sufficient to cover the Portfolio's obligations with respect to such futures
contracts, which will consist of cash, U.S. government securities, or other
liquid, unencumbered assets marked-to-market daily, in an amount equal to the
difference between the fluctuating market value of such futures contracts and
the aggregate value of the initial margin deposited by the Portfolio with the
custodian (or a futures commission merchant) with respect to such futures
contracts. Offsetting the contract by another identical contract eliminates the
segregation requirement.
With respect to options on futures, there are no segregation
requirements for options that are purchased and owned by a Portfolio. However,
written options, since they involve potential obligations of a Portfolio, may
require segregation of Portfolio assets if the options are not "covered" as
described under "Options on Futures Contracts." If a Portfolio writes a call
option that is not "covered," it must segregate and maintain with the custodian
(or a futures commission merchant) for the term of the option cash or liquid
securities equal to the fluctuating value of the optioned futures. If a
Portfolio writes a put option that is not "covered," the segregated amount would
have to be at all times equal in value to the exercise price of the put (less
any initial margin deposited by the Portfolio with the custodian or a futures
commission merchant) with respect to such option.
Uses of Interest Rate Futures Contracts. Futures contracts will be used
for bona fide hedging, risk management and return enhancement purposes.
Position Hedging. A Portfolio might sell interest rate futures
contracts to protect the Portfolio against a rise in interest rates which would
be expected to decrease the value of debt securities which the Portfolio holds.
This would be considered a bona fide hedge and, therefore, is not subject to the
5% CFTC limit. For example, if interest rates are expected to increase, the
Portfolio might sell futures contracts on debt securities, the values of which
historically have correlated closely or are expected to correlate closely to the
values of the Portfolio's portfolio securities. Such a sale would have an effect
similar to selling an equivalent value of the Portfolio's portfolio securities.
If interest rates increase, the value of a Portfolio's portfolio securities will
decline, but the value of the futures contracts to the Portfolio will increase
at approximately an equivalent rate thereby keeping the net asset value of the
Portfolio from declining as much as it otherwise would have. A Portfolio could
accomplish similar results by selling debt
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securities with longer maturities and investing in debt securities with shorter
maturities when interest rates are expected to increase. However, since the
futures market may be more liquid than the cash market, the use of futures
contracts as a hedging technique would allow the Portfolio to maintain a
defensive position without having to sell portfolio securities. If in fact
interest rates decline rather than rise, the value of the futures contract will
fall but the value of the bonds should rise and should offset all or part of the
loss. If futures contracts are used to hedge 100% of the bond position and
correlate precisely with the bond position, there should be no loss or gain with
a rise (or fall) in interest rates. However, if only 50% of the bond position is
hedged with futures, then the value of the remaining 50% of the bond position
would be subject to change because of interest rate fluctuations. Whether the
bond positions and futures contracts correlate precisely is a significant risk
factor.
Anticipatory Position Hedging. Similarly, when it is expected that
interest rates may decline and a Portfolio intends to acquire debt securities,
the Portfolio might purchase interest rate futures contracts. The purchase of
futures contracts for this purpose would constitute an anticipatory hedge
against increases in the price of debt securities (caused by declining interest
rates) which the Portfolio subsequently acquires and would normally qualify as a
bona fide hedge not subject to the 5% CFTC limit. Since fluctuations in the
value of appropriately selected futures contracts should approximate that of the
debt securities that would be purchased, a Portfolio could take advantage of the
anticipated rise in the cost of the debt securities without actually buying
them. Subsequently, the Portfolio could make the intended purchases of the debt
securities in the cash market and concurrently liquidate the futures positions.
Risk Management and Return Enhancement. A Portfolio might sell interest
rate futures contracts covering bonds. This has the same effect as selling bonds
in the portfolio and holding cash and reduces the duration of the portfolio.
(Duration measures the price sensitivity of the portfolio to interest rates. The
longer the duration, the greater the impact of interest rate changes on the
portfolio's price.) This should lessen the risks associated with a rise in
interest rates. In some circumstances, this may serve as a hedge against a loss
of principal, but is usually referred to as an aspect of risk management.
A Portfolio might buy interest rate futures contracts covering bonds
with a longer maturity than its portfolio average. This would tend to increase
the duration and should increase the gain in the overall portfolio if interest
rates fall. This is often referred to as risk management rather than hedging
but, if it works as intended, has the effect of increasing principal value. If
it does not work as intended because interest rates rise instead of fall, the
loss will be greater than would otherwise have been the case. Futures contracts
used for these purposes are not considered bona fide hedges and, therefore, are
subject to the 5% CFTC limit.
Options on Futures Contracts. A Portfolio may enter into options on
futures contracts for certain bona fide hedging, risk management and return
enhancement purposes. This includes the ability to purchase put and call options
and write (i.e., sell) "covered" put and call options on futures contracts that
are traded on commodity and futures exchanges.
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If a Portfolio purchases an option on a futures contract, it has the
right but not the obligation, in return for the premium paid, to assume a
position in a futures contract (a long position if the option is a call or a
short position if the option is a put) at a specified exercise price at any time
during the option exercise period.
Unlike purchasing an option, which is similar to purchasing insurance
to protect against a possible rise or fall of security prices or currency
values, the writer or seller of an option undertakes an obligation upon exercise
of the option to either buy or sell the underlying futures contract at the
exercise price. A writer of a call option has the obligation upon exercise to
assume a short futures position and a writer of a put option has the obligation
to assume a long futures position. Upon exercise of the option, the assumption
of offsetting futures positions by the writer and holder of the option will be
accompanied by delivery of the accumulated cash balance in the writer's futures
margin account which represents the amount by which the market price of the
futures contract at exercise 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 futures contract. If
there is no balance in the writer's margin account, the option is "out of the
money" and will not be exercised. A Portfolio, as the writer, has income in the
amount it was paid for the option. If there is a margin balance, the Portfolio
will have a loss in the amount of the balance less the premium it was paid for
writing the option.
When a Portfolio writes a put or call option on futures contracts, the
option must either be "covered" or, to the extent not "covered," will be subject
to segregation requirements. A Portfolio will be considered "covered" with
respect to a call option it writes on a futures contract if the Portfolio owns
the securities or currency which is deliverable under the futures contract or an
option to purchase that futures contract having a strike price equal to or less
than the strike price of the "covered" option.
To the extent a Portfolio is not "covered" as described above with
respect to written options, it will segregate and maintain with its custodian
for the term of the option cash or liquid securities as described above under
"Limitations of the Purchase and Sale of the Futures Contracts and Related
Options--Segregation Requirements."
Uses of Options on Futures Contracts. Options on futures contracts
would be used for bona fide hedging, risk management and return enhancement
purposes.
Position Hedging. A Portfolio may purchase put options on interest rate
or currency futures contracts to hedge its portfolio against the risk of a
decline in the value of the debt securities it owns as a result of rising
interest rates.
Anticipatory Hedging. A Portfolio may also purchase call options on
futures contracts as a hedge against an increase in the value of securities the
Portfolio might intend to acquire as a result of declining interest rates.
Writing a put option on a futures contract may serve as a partial
anticipatory hedge against an increase in the value of debt securities the
Portfolio might intend to acquire. If the futures price at expiration of the
option is above the exercise price, the Portfolio retains the full amount of the
option premium which provides a partial hedge against any increase that
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may have occurred in the price of the debt securities the Portfolio intended to
acquire. If the market price of the underlying futures contract is below the
exercise price when the option is exercised, the Portfolio would incur a loss,
which may be wholly or partially offset by the decrease in the value of the
securities the Portfolio might intend to acquire.
Whether options on futures contracts are subject to or exempt from the
5% CFTC limit depends on whether the purposes of the options constitutes a bona
fide hedge.
Risk Management and Return Enhancement. Writing a put option that does
not relate to securities a Portfolio intends to acquire would be a return
enhancement strategy which would result in a loss if interest rates rise.
Similarly, writing a covered call option on a futures contract is also
a return enhancement strategy. If the market price of the underlying futures
contract at expiration of a written call is below the exercise price, the
Portfolio would retain the full amount of the option premium increasing the
income of the Portfolio. If the futures price when the option is exercised is
above the exercise price, however, the Portfolio would sell the underlying
securities which were the "cover" for the contract and incur a gain or loss
depending on the cost basis for the underlying asset.
Writing a covered call option as in any return enhancement strategy can
also be considered a partial hedge against a decrease in the value of a
Portfolio's portfolio securities. The amount of the premium received acts as a
partial hedge against any decline that may have occurred in the Portfolio's debt
securities.
There can be no assurance that a Portfolio's use of futures contracts
and related options will be successful and the Portfolios may incur losses in
connection with the purchase and sale of future contracts and related options.
Forward Foreign Currency Exchange Contracts. The Portfolios may enter
into forward foreign currency exchange contracts in several circumstances. When
a Portfolio enters into a contract for the purchase or sale of a security
denominated in a foreign currency, or when a Portfolio anticipates the receipt
in a foreign currency of dividends or interest payments on a security which it
holds, the Portfolio may desire to "lock-in" the U.S. dollar price of the
security or the U.S. dollar equivalent of such dividend or interest payment, as
the case may be. By entering into a forward contract for a fixed amount of
dollars, for the purchase or sale of the amount of foreign currency involved in
the underlying transactions, the Portfolio may be able to protect itself against
a possible loss resulting from an adverse change in the relationship between the
U.S. dollar and the foreign currency during the period between the date on which
the security is purchased or sold, or on which the dividend or interest payment
is declared, and the date on which such payments are made or received.
Additionally, when BSAM believes that the currency of a particular
foreign country may suffer a substantial decline against the U.S. dollar, a
Portfolio may enter into a forward contract for a fixed amount of dollars, to
sell the amount of foreign currency approximating the value of some or all of
the Portfolio's portfolio securities denominated in such foreign currency. The
precise matching of the forward contract amounts and the value of the
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securities involved will not generally be possible since the future value of
securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date on which the forward
contract is entered into and the date it matures. The projection of short-term
currency market movement is extremely difficult, and the successful execution of
a short-term hedging strategy is highly uncertain. If a Portfolio enters into a
position hedging transaction, the transaction will be covered by the position
being hedged or the Portfolio's custodian will place cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets in a
segregated account of the Portfolio (less the value of the "covering" positions,
if any) in an amount equal to the value of the Portfolio's total assets
committed to the consummation of the given forward contract. The assets placed
in the segregated account will be marked-to-market daily, and if the value of
the securities placed in the segregated account declines, additional cash or
securities will be placed in the account on a daily basis so that the value of
the account will, at all times, equal the amount of the Portfolio's net
commitment with respect to the forward contract.
A Portfolio generally will not enter into a forward contract with a
term of greater than one year. At the maturity of a forward contract, the
Portfolio may either sell the portfolio security and make delivery of the
foreign currency, or it may retain the security and terminate its contractual
obligation to deliver the foreign currency by purchasing an "offsetting"
contract with the same currency trader obligating it to purchase, on the same
maturity date, the same amount of the foreign currency.
It is impossible to forecast with absolute precision the market value
of a particular portfolio security at the expiration of the forward contract.
Accordingly, if a decision is made to sell the security and make delivery of the
foreign currency and if the market value of the security is less than the amount
of foreign currency that a Portfolio is obligated to deliver, then it would be
necessary for the Portfolio to purchase additional foreign currency on the spot
market (and bear the expense of such purchase).
If a Portfolio retains the portfolio security and engages in an
offsetting transaction, the Portfolio will incur a gain or a loss to the extent
that there has been movement in forward contract prices. Should forward contract
prices decline during the period between the Portfolio's entering into a forward
contract for the sale of a foreign currency and the date it enters into an
offsetting contract for the purchase of the foreign currency, the Portfolio will
realize a gain to the extent that the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should forward
contract prices increase, the Portfolio will suffer a loss to the extent that
the price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
A Portfolio's dealing in forward foreign currency exchange contracts
will generally be limited to the transactions described above. Of course, a
Portfolio is not required to enter into such transactions with regard to its
foreign currency-denominated securities. It also should be recognized that this
method of protecting the value of a Portfolio's portfolio securities against a
decline in the value of a currency does not eliminate fluctuations in the
underlying prices of the securities which are unrelated to exchange rates.
Additionally, although such contracts tend to minimize the risk of loss due to a
decline in the value of the hedged currency, at the same time they
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tend to limit any potential gain which might result should the value of such
currency increase.
Although the Portfolios value their assets daily in terms of U.S.
dollars, they do not intend physically to convert holdings of foreign currencies
into U.S. dollars on a daily basis. They will do so from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference (the spread) between the prices at which they are buying
and selling various currencies. Thus, a dealer may offer to sell a foreign
currency to the Portfolio at one rate, while offering a lesser rate of exchange
should the Portfolio desire to resell that currency to the dealer.
At or before the maturity of a forward contract, a Portfolio either may
sell a security and make delivery of the currency, or retain the security and
offset its contractual obligation to deliver the currency by purchasing a second
contract pursuant to which the Portfolio will obtain, on the same maturity date,
the same amount of the currency which it is obligated to deliver. If a Portfolio
retains the portfolio security and engages in an offsetting transaction, such
Portfolio, at the time of execution of the offsetting transaction, will incur a
gain or loss to the extent movement has occurred in forward contract prices.
Should forward prices decline during the period between the Portfolio's entering
into a forward contract for the sale of a currency and the date it enters into
an offsetting contract for the purchase of the currency, the Portfolio will
realize a gain to the extent the price of the currency it has agreed to sell
exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, the Portfolio will suffer a loss to the extent the price of the
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell.
The cost to each Portfolio of engaging in currency transactions varies
with factors such as the currency involved, the length of the contract period
and the market conditions then prevailing. Because transactions in currency
exchange usually are conducted on a principal basis, no fees or commissions are
involved. The use of forward currency exchange contracts does not eliminate
fluctuations in the underlying prices of the securities, but it does establish a
rate of exchange that can be achieved in the future. If a devaluation generally
is anticipated, a Portfolio may not be able to contract to sell the currency at
a price above the devaluation level it anticipates. The requirements for
qualification as a regulated investment company under the Internal Revenue Code
of 1986, as amended (the "Code"), may cause the Fund to restrict the degree to
which each Portfolio engages in currency transactions. See "Dividends,
Distributions and Taxes."
Lending Portfolio Securities. (All Portfolios) To a limited extent,
each Portfolio may lend its portfolio securities to brokers, dealers and other
financial institutions, provided it receives cash collateral which at all times
is maintained in an amount equal to at least 100% of the current market value of
the securities loaned. By lending its portfolio securities, a Portfolio can
increase its income through the investment of the cash collateral. For purposes
of this policy, a Portfolio considers collateral consisting of U.S. Government
securities or irrevocable letters of credit issued by banks whose securities
meet the standards for investment by such Portfolio to be the equivalent of
cash. From time to time, a Portfolio may return to the borrower or a third party
which is unaffiliated with such
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Portfolio, and which is acting as a "placing broker," a part of the interest
earned from the investment of collateral received for securities loaned.
The Securities and Exchange Commission currently requires that the
following conditions must be met whenever portfolio securities are loaned: (1)
each Portfolio must receive at least 100% cash collateral from the borrower; (2)
the borrower must increase such collateral whenever the market value of the
securities rises above the level of such collateral; (3) each Portfolio must be
able to terminate the loan at any time; (4) each Portfolio must receive
reasonable interest on the loan, as well as any dividends, interest or other
distributions payable on the loaned securities, and any increase in market
value; (5) each Portfolio may pay only reasonable custodian fees in connection
with the loan; and (6) while voting rights on the loaned securities may pass to
the borrower, the Fund's Board of Trustees must terminate the loan and regain
the right to vote the securities if a material event adversely affecting the
investment occurs. These conditions may be subject to future modification. The
Portfolios have appointed Custodial Trust Company (CTC) an affiliate of BSAM as
the Lending Agent. CTC received a fee for its services.
When-Issued and Delayed Delivery Securities (Income Portfolio and High
Yield Portfolio). From time to time, in the ordinary course of business, the
Income Portfolio and the High Yield Portfolio may purchase or sell securities on
a when-issued or delayed delivery basis, that is, delivery and payment can take
place a month or more after the date of the transaction. The purchase price and
the interest rate payable on the securities are fixed on the transaction date.
The securities so purchased are subject to market fluctuation, and no interest
accrues to the Portfolio until delivery and payment take place. At the time a
Portfolio makes the commitment to purchase securities on a when-issued or
delayed delivery basis, it will record the transaction and thereafter reflect
the value of such securities in determining its net asset value each day. The
Portfolio will make commitments for such when-issued transactions only with the
intention of actually acquiring the securities. A Portfolio's custodian will
maintain, in a separate account of the Portfolio, cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, having a value equal to or greater than such
commitments. If a Portfolio chooses to dispose of the right to acquire a
when-issued security prior to its acquisition, it could, as with the disposition
of any other portfolio security, incur a gain or loss due to market
fluctuations.
Currency Swaps, Mortgage Swaps, Index Swaps and Interest Rate Swaps,
Caps, Floors and Collars. (Income and High Yield Portfolios). Each Portfolio
may, with respect to up to 5% of its net assets, enter into currency swaps for
both hedging purposes and to seek to increase total return. In addition, a
Portfolio may, with respect to 5% of its net assets, enter into mortgage, index
and interest rate swaps and other interest rate swap arrangements such as rate
caps, floors and collars, for hedging purposes or to seek to increase total
return. Currency swaps involve the exchange by the Portfolio with another party
of their respective rights to make or receive payments in specified currencies.
Interest rate swaps involve the exchange by the Portfolio with another party of
their respective commitments to pay or receive interest, such as an exchange of
fixed rate payments for floating rate payments. Mortgage swaps are similar to
interest rate swaps in that they represent commitments to pay and receive
interest. The notional principal amount, however, is tied to a reference pool or
pools of mortgages. Index
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swaps involve the exchange by the Portfolio with another party of the respective
amounts payable with respect to a notional principal amount at interest rates
equal to two specified indices. The purchase of an interest rate cap entitles
the purchaser, to the extent that a specified index exceeds a predetermined
interest rate, to receive payment of interest on a notional principal amount
from the party selling such interest rate cap. The purchase of an interest rate
floor entitles the purchaser, to the extent that a specified index falls below a
predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling the interest rate floor. An interest
rate collar is the combination of a cap and a floor that preserves a certain
return within a predetermined range of interest rates.
A Portfolio will enter into interest rate, mortgage and index swaps
only on a net basis, which means that the two payment streams are netted out,
with the Portfolio receiving or paying, as the case may be, only the net amount
of the two payments. Interest rate, index and mortgage swaps do not involve the
delivery of securities, other underlying assets or principal. Accordingly, the
risk of loss with respect to interest rate, index and mortgage swaps is limited
to the net amount of interest payments that the Portfolio is contractually
obligated to make. If the other party to an interest rate, index or mortgage
swap defaults, the Portfolio's risk of loss consists of the net amount of
interest payments that the Portfolio is contractually entitled to receive. In
contrast, currency swaps usually involve the delivery of a gross payment stream
in one designated currency in exchange for the gross payment stream in another
designated currency. Therefore, the entire payment stream under a currency swap
is subject to the risk that the other party to the swap will default on its
contractual delivery obligations. To the extent that the net amount payable
under an interest rate, index or mortgage swap and the entire amount of the
payment stream payable by the Portfolio under a currency swap or an interest
rate floor, cap or collar is held in a segregated account consisting of cash or
liquid assets, BSAM believes that swaps do not constitute senior securities
under the 1940 Act and, accordingly, will not treat them as being subject to the
Portfolio's borrowing restrictions.
A Portfolio will not enter into swap transactions unless the unsecured
commercial paper, senior debt or claims paying ability of the other party
thereto is considered to be investment grade by BSAM.
The use of interest rate, mortgage, index and currency swaps, as well
as interest rate caps, floors and collars, is a highly specialized activity
which involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. If BSAM is incorrect in its
forecasts of market values, interest rates and currency exchange rates, the
investment performance of a Portfolio would be less favorable than it would have
been if this investment technique were not used. The staff of the Securities and
Exchange Commission currently take the position that swaps, caps, floors and
collars are illiquid and thus subject to the Portfolio's 15% limitation on
investments in illiquid securities.
B-30
<PAGE>
Investment Restrictions (Equity Portfolios and Income Portfolio). Each
Equity Portfolio and the Income Portfolio has adopted investment restrictions
numbered 1 through 10 as fundamental policies. These restrictions cannot be
changed, as to a Portfolio, without approval by the holders of a majority (as
defined in the Investment Company Act of 1940, as amended (the "1940 Act")) of
such Portfolio's outstanding voting shares. Investment restrictions numbered 11
through 16 are not fundamental policies and may be changed by vote of a majority
of the Trustees at any time. No Portfolio may:
1. Invest more than 25% of the value of its total assets in the
securities of issuers in any single industry, provided that there shall be no
limitation on the purchase of obligations issued or guaranteed by the U.S.
Government, its agencies or sponsored enterprises.
2. Invest more than 5% of its assets in the obligations of any single
issuer, except that up to 25% of the value of the Portfolio's total assets may
be invested, and securities issued or guaranteed by the U.S. Government, or its
agencies or sponsored enterprises may be purchased, without regard to any such
limitation.
3. Hold more than 10% of the outstanding voting securities of any
single issuer. This Investment Restriction applies only with respect to 75% of
the Portfolio's total assets.
4. Invest in commodities, except that each Portfolio may purchase and
sell options, forward contracts, futures contracts, including those relating to
indexes, and options on futures contracts or indexes.
5. Purchase, hold or deal in real estate, real estate limited
partnership interests, or oil, gas or other mineral leases or exploration or
development programs, but each Portfolio may purchase and sell securities that
are secured by real estate or issued by companies that invest or deal in real
estate or real estate investment trusts.
6. Borrow money, except to the extent permitted under the 1940 Act. The
1940 Act permits an investment company to borrow in an amount up to 33-1/3% of
the value of such company's total assets. For purposes of this Investment
Restriction, the entry into options, forward contracts, futures contracts,
including those relating to indexes, and options on futures contracts or indexes
shall not constitute borrowing.
7. Make loans to others, except through the purchase of debt
obligations and the entry into repurchase agreements. However, each Portfolio
may lend its portfolio securities in an amount not to exceed 33-1/3% of the
value of its total assets. Any loans of portfolio securities will be made
according to guidelines established by the Securities and Exchange Commission
and the Fund's Board of Trustees.
8. Act as an underwriter of securities of other issuers, except to the
extent each Portfolio may be deemed an underwriter under the Securities Act of
1933, as amended, by virtue of disposing of portfolio securities.
9. Issue any senior security (as such term is defined in Section 18(f)
of the 1940 Act).
B-31
<PAGE>
10. Purchase securities on margin, but each Portfolio may make margin
deposits in connection with transactions in options, forward contracts, futures
contracts, including those relating to indexes, and options on futures contracts
or indexes.
Non-Fundamental Restrictions.
11. Pledge, mortgage or hypothecate its assets, except to the extent
necessary to secure permitted borrowings and to the extent related to the
purchase of securities on a when-issued or forward commitment basis and the
deposit of assets in escrow in connection with writing covered put and call
options and collateral and initial or variation margin arrangements with respect
to options, forward contracts, futures contracts, including those relating to
indexes, and options on futures contracts or indexes.
12. Purchase, sell or write puts, calls or combinations thereof, except
as described in the Portfolios' Prospectus and Statement of Additional
Information.
13. Enter into repurchase agreements providing for settlement in more
than seven days after notice or purchase securities which are illiquid, if, in
the aggregate, more than 15% of the value of its net assets would be so
invested.
14. Purchase securities of other investment companies, except to the
extent permitted under the 1940 Act.
The following investment restrictions numbered 15 and 16, which are not
fundamental policies, apply only to the Equity Portfolios. Neither of these
Portfolios may:
15. Purchase securities of any company having less than three years'
continuous operations (including operations of any predecessor) if such purchase
would cause the value of the Equity Portfolio's investments in all such
companies to exceed 5% of the value of its total assets.
16. Invest in the securities of a company for the purpose of exercising
management or control, but each Equity Portfolio will vote the securities it
owns in its portfolio as a shareholder in accordance with its views.
Investment Restrictions (High Yield Portfolio). The High Yield
Portfolio has adopted investment restrictions numbered 1 through 7 as
fundamental policies. These restrictions cannot be changed, as to the Portfolio,
without approval by the holders of a majority (as defined in the 1940 Act of the
Portfolio's outstanding voting shares. Investment restrictions numbered 8
through 12 are not fundamental policies and may be changed by vote of a majority
of the Trustees at any time. The High Yield Portfolio may not:
B-32
<PAGE>
1. Issue any senior security (as such term is defined in Section 18(f)
of the 1940 Act) except that (a) the Portfolio may engage in transactions that
may result in the issuance of senior securities to the extent permitted under
applicable regulations and interpretations of the 1940 Act or an exemptive
order; (b) the Portfolio may acquire other securities, the acquisition of which
may result in the issuance of a senior security, to the extent permitted under
applicable regulations or interpretations of the 1940 Act; (c) subject to the
restrictions set forth below, the Portfolio may borrow money as authorized by
the 1940 Act.
2. Purchase any securities that would cause 25% or more of the value of
its total assets at the time of such purchase to be invested in the securities
of one or more issuers conducting their principal business activities in the
same industry, provided that there is no limitation with respect to investments
in U.S. Government securities.
3. Purchase, hold or deal in real estate, real estate limited
partnership interests, or oil, gas or other mineral leases or exploration or
development programs, but the Portfolio may purchase and sell securities that
are secured by real estate or issued by companies that invest or deal in real
estate or real estate investment trusts.
4. Borrow money, except to the extent permitted under the 1940 Act. The
1940 Act permits an investment company to borrow in an amount up to 33-1/3% of
the value of such company's total assets. For purposes of this Investment
Restriction, the entry into options, forward contracts, futures contracts,
including those relating to indexes, and options on futures contracts or indexes
shall not constitute borrowing.
5. Make loans to others, except through the purchase of debt
obligations and the entry into repurchase agreements. The Portfolio, however,
may lend its portfolio securities in an amount not to exceed 33-1/3% of the
value of its total assets. Any loans of portfolio securities will be made
according to guidelines established by the Securities and Exchange Commission
and the Fund's Board of Trustees.
6. Act as an underwriter of securities of other issuers, except to the
extent the Portfolio may be deemed an underwriter under the Securities Act of
1933, as amended, by virtue of disposing of portfolio securities.
7. Invest in commodities, except that the Portfolio may purchase and
sell options, forward contracts, futures contracts, including those relating to
indexes, and options on futures contracts or indices.
Non-Fundamental Restrictions.
8. Knowingly invest more than 15% of the value of the Portfolio's
assets in securities that may be illiquid because of legal or contractual
restrictions on resale or securities for which there are no readily available
market quotations.
9. Purchase securities on margin, but the Portfolio may make margin
deposits in connection with transactions in options, forward contracts, futures
contracts, including those relating to indexes, and options on futures contracts
or indexes.
B-33
<PAGE>
10. Pledge, mortgage or hypothecate its assets, except to the extent
necessary to secure permitted borrowings and to the extent related to the
purchase of securities on a when-issued or forward commitment basis and the
deposit of assets in escrow in connection with writing covered put and call
options and collateral and initial or variation margin arrangements with respect
to options, forward contracts, futures contracts, including those relating to
indices, and options on futures contracts or indexes.
11. Purchase securities of other investment companies, except to the
extent permitted under the 1940 Act.
12. Make additional investments when borrowing exceeds 5% of Portfolio
assets.
If a percentage restriction is adhered to at the time of investment, a
later change in percentage resulting from a change in values or assets will not
constitute a violation of such restriction.
MANAGEMENT OF THE FUND
Trustees and officers of the Fund, together with information as to
their principal business occupations during at least the last five years, are
shown below. Each Trustee who is an "interested person" of the Fund, as defined
in the 1940 Act, is indicated by an asterisk.
<TABLE>
<CAPTION>
Name and Address Position Principal Occupation
(and age) with Fund During Past Five Years
<S> <C> <C>
Peter M. Bren (64) Trustee President of The Bren Co. since 1969;
126 East 56th Street President of Koll, Bren Realty
New York, NY 10021 Advisors and Senior Partner for
Lincoln Properties prior thereto.
Alan J. Dixon* (70) Trustee Partner of Bryan Cave, a law firm in
7535 Claymont Court St. Louis since January 1993; United
Apt. #2 States Senator of Illinois from 1981
Belleville, IL 62223 to 1993.
John R. McKernan, Jr. (50) Trustee Chairman and Chief Executive Officer
P.O. Box 15213 of McKernan Enterprises since January
Portland, ME 02110 1995; Governor of Maine prior thereto.
M.B. Oglesby, Jr. (56) Trustee Consultant since March 1998;
700 13th Street, N.W. President and Chief Executive
Suite 400 Officer. Association of American
Washington, D.C. 20005
B-34
<PAGE>
Railroads from June 1997 to March
1998; Vice Chairman of Cassidy &
Associates from February 1996 to June
1997; Senior Vice President of RJR
Nabisco, Inc. from April 1989 to
February 1996; Former Deputy Chief of
Staff-White House from 1988 to January
1989.
Michael Minikes* (56) Trustee Senior Managing Director of Bear
245 Park Avenue Chairman Sterns since September 1985; Chairman
New York, NY 10167 of BSFM since December 1997;
Treasurer of Bear Sterns since
January 1986; Treasurer of the Bear
Sterns Companies Inc. since September
1985; Director of The Bear Sterns
Companies Inc. since October 1989.
Doni L. Fordyce (39) President Senior Managing Director of Bear
575 Lexington Avenue Stearns since March 1996; previously
New York, NY 10022 Group, Vice President, Asset
Management Goldman Sachs from 1986 to
1996.
Barry Sommers (30) Executive Vice Managing Director and Head of
575 Lexington Avenue President President Marketing and Sales for Bear
New York, NY 10022 Sterns in Funds since March 1997; Vice
Mutual Fund Sales, Goldman, Sachs &
Co. from May 1995 to May 1997; Vice
President, Putnam Investments from May
1992 to May 1995.
Stephen A. Bornstein (55) Secretary Managing Director, Legal Department;
575 Lexington Avenue General Counsel, Bear Stearns Asset
New York, NY 10022 Management.
Frank J. Maresca (40) Vice President Managing Director of Bear Stearns since
575 Lexington Avenue and Treasurer September 1994; Chief Executive Officer
New York, NY 10022 and President of BSFM since December
1997; Associate Director of
B-35
<PAGE>
Bear Stearns from September 1993 to
September 1994; Vice President of Bear
Stearns from March 1992 to September
1993.
Vincent L. Pereira (33) Assistant Associate Director of Bear Stearns
575 Lexington Avenue Treasurer since September 1995; Treasurer and
New York, NY 10022 Vice Secretary of BSFM since December
1997; Vice President of Bear Stearns
from May 1993 to September 1995;
Assistant Vice President of Mitchell
Hutchins Asset Management Inc. from
October 1992 to May 1993.
</TABLE>
The Fund pays its non-affiliated Board members an annual retainer of
$5,000 and a per meeting fee of $500 and reimburses them for their expenses. The
Fund does not compensate its officers. The aggregate amount of compensation paid
to each Board member by the Fund and by all other funds in the Bear Stearns
Family of Funds for which such person is a Board member (the number of which is
set forth in parenthesis next to each Board member's total compensation) for the
fiscal year ended March 31, 1998 is as follows:
<TABLE>
<CAPTION>
(1) (2) (3) (4) (5)
Name of Board Aggregate Pension or Estimated Annual Total
Member Compensation Retirement Benefits Benefits Upon Compensation from
from Fund * Accrued as Part of Retirement Fund and Fund
Fund's Expenses Complex Paid to
Board Members
<S> <C> <C> <C> <C>
Peter M. Bren $8,000 None None $20,000 (2)
Alan J. Dixon $8,000 None None $ 8,000 (1)
John R. McKernan, Jr. $8,000 None None $20,000 (2)
M.B. Oglesby, Jr. $8,000 None None $20,000 (2)
Robert S. Reitzes** None None None None
Michael Minikes** None None None None
</TABLE>
- ----------
* Amount does not include reimbursed expenses for attending Board meetings,
which amounted to approximately $8,600 Board members of the Fund, as a
group.
** Robert S. Reitzes resigned as a Director to the Fund effective September 8,
1997. Michael Minikes was appointed as replacement for Mr. Reitzes
effective September 8, 1997.
Board members and officers of the Fund, as a group, owned less than 1%
of each Portfolio's shares outstanding on June 30, 1998.
For so long as the Plan described in the section captioned "Management
Arrangements--Distribution Plans" remains in effect, the Fund's Trustees who
B-36
<PAGE>
are not "interested persons" of the Fund, as defined in the 1940 Act, will be
selected and nominated by the Trustees who are not "interested persons" of the
Fund.
No meetings of shareholders of the Fund will be held for the sole
purpose of electing Trustees unless and until such time as less than a majority
of the Trustees holding office have been elected by shareholders, at which time
the Trustees then in office will call a shareholders' meeting for the election
of Trustees. Under the 1940 Act, shareholders of record of not less than
two-thirds of the outstanding shares of the Fund 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. Under the Fund's Agreement and Declaration of Trust, the
Trustees are required to call a meeting of shareholders for the purpose of
voting upon the question of removal of any such Trustee when requested in
writing to do so by the shareholders of record of not less than 10% of the
Fund's outstanding shares.
MANAGEMENT ARRANGEMENTS
The following information supplements and should be read in conjunction
with the section in the Portfolios' Prospectus entitled "Management of the
Portfolios."
General. On December 3, 1997, BSFM, the registered investment adviser
of the Portfolios, changed its name to BSAM. On December 4, 1997, BSFM formed a
new corporate entity under the laws of Delaware to conduct mutual fund
administrative work for The Bear Stearns Funds and other affiliated and
non-affiliated investment companies.
Investment Advisory Agreement. BSAM provides investment advisory
services to each Portfolio pursuant to Investment Advisory Agreements (each an
"Agreement") with the Fund. As to each Portfolio, each Agreement is subject to
annual approval by (i) the Fund's Board of Trustees or (ii) vote of a majority
(as defined in the 1940 Act) of the outstanding voting securities of the
Portfolio, provided that in either event the continuance also is approved by a
majority of the Board of Trustees who are not "interested persons" (as defined
in the 1940 Act) of the Fund or BSAM, by vote cast in person at a meeting called
for the purpose of voting on such approval. Each Agreement is terminable, as to
each Portfolio, without penalty, on 60 days' notice, by the Fund's Board of
Trustees or by vote of the holders of a majority of the Portfolio's shares, or,
on not less than 90 days' notice, by BSAM. As to the relevant Portfolio, each
Agreement will terminate automatically in the event of its assignment (as
defined in the 1940 Act).
BSAM is a wholly owned subsidiary of The Bear Stearns Companies Inc.
The following persons are directors and/or senior officers of BSAM: Mark A.
Kurland, President, Chairman of the Board and Director; Robert S. Reitzes,
B-37
<PAGE>
Executive Vice President and Director; Doni L. Fordyce, Vice President,
Chief Operating Officer and Director; Stephen A. Bornstein, Secretary; and
Warren J. Spector and Robert M. Steinberg, Directors.
BSAM provides investment advisory services to each Portfolio in
accordance with its stated policies, subject to the approval of the Board. BSAM
provides each Portfolio with a portfolio management team authorized by the Board
to execute purchases and sales of securities. All purchases and sales are
reported for the Board of Trustees' review at the meeting subsequent to such
transactions.
As compensation for BSAM's advisory services, each Equity Portfolio has
agreed to pay BSAM a monthly fee at the annual rate of 0.75 of 1% of the value
of such Equity Portfolio's average daily net assets. The Income Portfolio has
agreed to pay BSAM a monthly fee at the annual rate of 0.45 of 1% of the value
of the Income Portfolio's average daily net assets. The High Yield Portfolio has
agreed to pay BSAM a monthly fee at the annual rate of 0.60 of 1% of the
Portfolio's average daily net assets. For the fiscal year ended March 31, 1997,
the investment advisory fees payable by the Large Cap Value Portfolio, Small Cap
Value Portfolio and the Income Portfolio amounted to $151,578, $285,539 and
$98,957, respectively. For the fiscal year ended March 31, 1998, the investment
advisory fees payable by the Large Cap Value Portfolio, Small Cap Value
Portfolio and the Income Portfolio amounted to $140,641, $425,409 and $91,715,
respectively. These amounts were waived pursuant to an undertaking by BSAM,
resulting in no fees being paid by the Large Cap Value Portfolio, Small Cap
Value Portfolio and the Income Portfolio. In addition, BSAM reimbursed $161,196,
$86,666 and $280,261 for Large Cap Value Portfolio, Small Cap Value Portfolio
and the Income Portfolio, respectively, in order to maintain the voluntary
expense limitation for the fiscal year ended March 31, 1997. BSAM reimbursed
$185,275, $20,648 and $275,119 for Large Cap Value Portfolio, Small Cap Value
Portfolio and the Income Portfolio, respectively, in order to maintain the
voluntary expense limitation, for the fiscal year ended March 31, 1998. For the
period from January 2, 1998 (commencement of investment operations) through
March 31, 1998, the investment advisory fees payable amounted to $28,723. These
amounts were waived pursuant to a voluntary undertaking by BSAM, resulting in no
fees being paid by the High Yield Portfolio, respectively. In addition, the
Adviser reimbursed $41,870 in order to maintain the voluntary expense
limitation.
Administration Agreement. BSFM provides certain administrative services
to the Fund pursuant to the Administration Agreement dated February 22, 1995, as
revised April 11, 1995, June 2, 1997, September 8, 1997 and February 4, 1998
with the Fund. As to each Portfolio, the Administration Agreement will continue
until February 22, 1999 and thereafter will be subject to annual approval by (i)
the Fund's Board of Trustees or (ii) vote of a majority (as defined in the 1940
Act) of the outstanding voting securities of the Portfolio, provided that in
either event its continuance also is approved by a majority of the Fund's Board
members who are not "interested persons" (as defined in the 1940 Act) of the
Fund or BSFM, by vote cast in person at a meeting called for the purpose of
voting on such approval. The Administration Agreement is terminable, as to each
Portfolio, without penalty, on 60 days' notice, by the Fund's Board or by vote
of the holders of a majority of the
B-38
<PAGE>
Portfolio's shares or, upon not less than 90 days' notice, by BSFM. As to the
relevant Portfolio, the Administration Agreement will terminate automatically in
the event of its assignment (as defined in the 1940 Act).
As compensation for BSFM's administrative services, the Fund has agreed
to pay BSFM a monthly fee at the annual rate of 0.15 of 1% of each Portfolio's
average daily net assets. For the fiscal year ended March 31, 1997, the
administration fees amounted to $30,232, $57,108 and $32,986, respectively, for
the Large Cap Value Portfolio, Small Cap Value Portfolio and Income Portfolio.
For the fiscal year ended March 31, 1998, the administration fees accrued
amounted to $28,128, $85,085 and $30,572, respectively, for the Large Cap Value
Portfolio, Small Cap Value Portfolio and Income Portfolio. For the period from
January 2, 1998 (commencement of investment operations) through March 31, 1998
the administration fees payable by the High Yield Portfolio amounted to $7,181.
Administrative Services Agreement. PFPC provides certain administrative
services to the Fund pursuant to the Administrative Services Agreement dated
February 22, 1995, as revised September 8, 1997 with the Fund. The
Administrative Services Agreement is terminable upon 60 days notice by either
the Fund or PFPC. PFPC may assign its rights or delegate its duties under the
Administrative Services Agreement to any wholly-owned direct or indirect
subsidiary of PNC Bank, National Association or PNC Bank Corp., provided that
(i) PFPC gives the Fund 30 days notice; (ii) the delegate (or assignee) agrees
with PFPC and the Fund to comply with all relevant provisions of the 1940 Act;
and (iii) PFPC and such delegate (or assignee) promptly provide information
requested by the Fund in connection with such delegation.
As compensation for PFPC's administrative services, the Fund has agreed
to pay PFPC a monthly fee at the rate set forth in the Portfolios' Prospectus.
For the fiscal year ended March 31, 1997, the administrative services fees
payable by the Large Cap Value Portfolio, Small Cap Value Portfolio and Income
Portfolio amounted to $99,570, $119,822 and $99,469, respectively, as a result
of a waiver of fees by PFPC. For the fiscal year ended March 31, 1998, the
administrative services fees for the Large Cap Value Portfolio, Small Cap Value
Portfolio and Income Portfolio amounted to $100,107, $134,255 and $98,944,
respectively, as a result of a waiver of fees by PFPC.
Distribution Plans. Rule 12b-1 (the "Rule") adopted by the Securities
and Exchange Commission under the 1940 Act provides, among other things, that an
investment company may bear expenses of distributing its shares only pursuant to
a plan adopted in accordance with the Rule. The Fund's Board of Trustees has
adopted a distribution plan with respect to Class A, Class B and Class C shares
of each Portfolio (the "Distribution Plan"). The Fund's Board of Trustees
believes that there is a reasonable likelihood that the Distribution Plan will
benefit each Portfolio and the holders of its Class A, Class B and Class C
shares.
A quarterly report of the amounts expended under the Distribution Plan,
and the purposes for which such expenditures were incurred, must be made to the
Trustees for their review. In addition, the Distribution Plan provides that it
may not be amended to increase materially the costs which holders of a class of
shares may bear pursuant to such Plan without approval of such effected
shareholders and that other material amendments of the Plan must be approved by
the Board of Trustees, and by the Trustees who are neither
B-39
<PAGE>
"interested persons" (as defined in the 1940 Act) of the Fund nor have any
direct or indirect financial interest in the operation of the Plan or in the
related Plan agreements, by vote cast in person at a meeting called for the
purpose of considering such amendments. In addition, because Class B shares
automatically convert into Class A shares after eight years, the Fund is
required by a Securities and Exchange Commission rule to obtain the approval of
Class B as well as Class A shareholders for a proposed amendment to the
Distribution Plan that would materially increase the amount to be paid by Class
A shareholders under such Plan. Such approval must be by a "majority" of the
Class A and Class B shares (as defined in the 1940 Act), voting separately by
class. The Distribution Plan and related agreements is subject to annual
approval by such vote cast in person at a meeting called for the purpose of
voting on such Plan. The Distribution Plan was so approved on September 8, 1997,
February 4, 1998 and amended and restated on February 10, 1999. The Distribution
Plan is terminable at any time, as to each class of each Portfolio, by vote of a
majority of the Trustees who are not "interested persons" and who have no direct
or indirect financial interest in the operation of the Plan or in the Plan
agreements or by vote of holders of a majority of the relevant class' shares. A
Plan agreement is terminable, as to each class of each Portfolio, without
penalty, at any time, by such vote of the Trustees, upon not more than 60 days
written notice to the parties to such agreement or by vote of the holders of a
majority of the relevant class' shares. A Plan agreement will terminate
automatically, as to the relevant class of a Portfolio, in the event of its
assignment (as defined in the 1940 Act).
For the period from April 3, 1995 (commencement of operations) through
March 31, 1996, the Large Cap Value Portfolio, Small Cap Value Portfolio and
Income Portfolio paid Bear Stearns $13,300, $22,762 and $14,093, respectively,
with respect to Class A shares and $23,300, $37,577 and $11,638, respectively,
with respect to Class C shares under the Plan. Of such amounts, the following
amounts were paid as indicated for Class A and C shares of each Portfolio:
<TABLE>
<CAPTION>
Large Cap Value Portfolio Small Cap Value Portfolio Income Portfolio
------------------------- ------------------------- ----------------
Class A Class C Class A Class C Class A Class C
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Payments to
Brokers or Dealers $13,300 ---- $22,762 ---- $14,093 ----
Payments to ---- $23,300 ---- $37,577 ---- $11,638
Underwriters
</TABLE>
For period from January 2, 1998 (commencement of investment operations) through
March 31, 1998, the High Yield Portfolio paid Bear Stearns $8,354, $7,019 and
$13,194, respectively, with respect to Class A, B and C shares under the Plan.
Of such amounts, the following amounts were paid as indicated for Class A, B and
C shares of the High Yield Portfolio:
Class A Class B Class C
------- ------- -------
Payments to Brokers or Dealers $5,967 ---- ----
Payments to Underwriters $2,387 $7,019 $13,194
For the fiscal year ended March 31, 1997, the Large Cap Value
Portfolio, Small Cap Value Portfolio and Income Portfolio paid Bear Stearns
$27,440,
B-40
<PAGE>
$57,907 and $15,344, respectively, with respect to Class A shares and $37,332,
$111,111 and $12,483, respectively, with respect to Class C shares under the
Plan. Of such amounts, the following amounts were paid as indicated for Class A
and C shares of each Portfolio:
<TABLE>
<CAPTION>
Large Cap Value Portfolio Small Cap Value Portfolio Income Portfolio
------------------------- ------------------------- ----------------
Class A Class C Class A Class C Class A Class C
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Payments to
Brokers or Dealers $27,440 $15,234 $57,907 $30,062 $15,344 $6,904
Payments to ---- $22,098 $81,049 $81,049 ---- $5,579
Underwriters
</TABLE>
For the fiscal year ended March 31, 1998, the Large Cap Value
Portfolio, Small Cap Value Portfolio and Income Portfolio paid Bear Stearns
$32,237, $95,967 and $11,111, respectively, with respect to Class A shares,
$271, $830 and $21, respectively, with respect to Class B shares and $40,215,
$145,963 and $10,434, respectively, with respect to Class C shares under the
Plan. Of such amounts, the following amounts were paid as indicated for Class A,
B and C shares of each Portfolio:
<TABLE>
<CAPTION>
Large Cap Value Portfolio Small Cap Value Portfolio Income Portfolio
------------------------- ------------------------- ----------------
Class A Class B Class C Class A Class B Class C Class A Class B Class C
------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Payments to Brokers and $16,119 ---- $31,566 $47,984 ---- $95,103 $7,936 ---- $8,499
Dealers
Payments for Advertising, $16,119 ---- ---- $47,984 ---- ---- $3,175 ---- ----
Printing, Mailing of
Prospectuses to prospective
shareholders, compensation
to sales personnel, and
interest carrying, or other
financing charges
Payments to Underwriters ---- $271 $8,649 ---- $830 $50,860 ---- $21 $1,935
</TABLE>
B-41
<PAGE>
For period from January 2, 1998 (commencement of investment operations)
through March 31, 1998, the High Yield Portfolio paid Bear Stearns $8,354,
$7,019 and $13,194, respectively, with respect to Class A, B and C shares under
the Plan. Of such amounts, the following amounts were paid as indicated for
Class A, B and C shares of the High Yield Portfolio:
Class A Class B Class C
------- ------- -------
Payments to Brokers or Dealers $5,967 ---- ----
Payments to Underwriters $2,387 $7,019 $13,194
Shareholder Servicing Plan. The Fund has adopted a shareholder
servicing plan on behalf of the Portfolios' Class A, Class B and Class C shares
(the "Shareholder Servicing Plan"). In accordance with the Shareholder Servicing
Plan, the Fund may enter into shareholder service agreements under which a
Portfolio pays fees of up to 0.25% of the average daily net assets of Class A, B
or C shares of the Portfolio for fees incurred in connection with the personal
service and maintenance of accounts holding Portfolio shares for responding to
inquiries of, and furnishing assistance to, shareholders regarding ownership of
the shares or their accounts or similar services not otherwise provided on
behalf of the Portfolio. Prior to February, 1999 service fees were paid through
the Distribution Plan of Class A and C of the Income Portfolio and the Equity
Portfolios.
Expenses. All expenses incurred in the operation of the Fund are borne
by the Fund, except to the extent specifically assumed by BSAM. The expenses
borne by the Fund include: organizational costs, taxes, interest, loan
commitment fees, interest and distributions paid on securities sold short,
brokerage fees and commissions, if any, fees of Board members who are not
officers, directors, employees or holders of 5% or more of the outstanding
voting securities of BSAM or its affiliates, Securities and Exchange Commission
fees, state Blue Sky qualification fees, advisory, administrative and fund
accounting fees, charges of custodians, transfer and dividend disbursing agents'
fees, certain insurance premiums, industry association fees, outside auditing
and legal expenses, costs of maintaining the Fund's existence, costs of
independent pricing services, costs attributable to investor services
(including, without limitation, telephone and personnel expenses), costs of
shareholders' reports and meetings, costs of preparing and printing certain
prospectuses and statements of additional information, and any extraordinary
expenses. Expenses attributable to a particular portfolio are charged against
the assets of that portfolio; other expenses of the Fund are allocated among the
portfolios on the basis determined by the Board of Trustees, including, but not
limited to, proportionately in relation to the net assets of each Portfolio.
Expense Limitation. BSAM agreed that if, in any fiscal year, the
aggregate expenses of a Portfolio, exclusive of taxes, brokerage commissions,
interest on borrowings and (with prior written consent of the necessary state
securities commissions) extraordinary expenses, exceed the expense limitation of
any state having jurisdiction over the Portfolio, the Fund may deduct from the
payment to be made to BSAM, such excess expense to the extent required by state
law. Such deduction or payment, if any, will be estimated daily, and reconciled
and effected or paid, as the case may be, on a monthly basis. No such expense
limitations currently apply to any Portfolio.
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Activities of BSAM and its Affiliates and Other Accounts Managed by
BSAM. The involvement of BSAM, Bear Stearns and their affiliates in the
management of, or their interests in, other accounts and other activities of
BSAM and Bear Stearns may present conflicts of interest with respect to the
Portfolios or limit the Portfolios' investment activities. BSAM, Bear Stearns
and its affiliates engage in proprietary trading and advise accounts and funds
which have investment objectives similar to those of the Portfolios and/or which
engage in and compete for transactions in the same types of securities,
currencies and instruments as the Portfolios. BSAM, Bear Stearns and its
affiliates will not have any obligation to make available any accounts managed
by them, for the benefit of the management of the Portfolios. The results of the
Portfolios' investment activities, therefore, may differ from those of Bear
Stearns and its affiliates and it is possible that the Portfolios could sustain
losses during periods in which BSAM, Bear Stearns and its affiliates and other
accounts achieve significant profits on their trading for proprietary and other
accounts. From time to time, the Portfolios' activities may be limited because
of regulatory restrictions applicable to Bear Stearns and its affiliates, and/or
their internal policies designed to comply with such restrictions.
PURCHASE AND REDEMPTION OF SHARES
The following information supplements and should be read in conjunction
with the sections in the Portfolios' Prospectus entitled "How to Buy Shares" and
"How to Redeem Shares."
The Distributor. Bear Stearns serves as the Portfolios' distributor on
a best efforts basis pursuant to an agreement dated February 22, 1995, as
revised September 8, 1997 and February 4, 1998, which is renewable annually. For
the period April 3, 1995 (commencement of operations) through March 31, 1996,
Bear Stearns retained $72, $388 and $10,549 from the sales loads on Class A
shares of the Large Cap Value Portfolio, Small Cap Value Portfolio and the
Income Portfolio, respectively, and $110, $583 and $185 from contingent deferred
sales charges ("CDSC") on Class C shares of the Large Cap Value Portfolio, Small
Cap Value Portfolio and the Income Portfolio, respectively. For the fiscal year
ended March 31, 1997, Bear Stearns retained $68,262, $214,826 and $11,400 from
the sales loads on Class A shares of the Large Cap Value Portfolio, Small Cap
Value Portfolio and the Income Portfolio, respectively, and $552, $4,052 and
$100 from contingent deferred sales charges ("CDSC") on Class C shares of the
Large Cap Value Portfolio, Small Cap Value Portfolio and the Income Portfolio,
respectively. For the fiscal year ended March 31, 1998, Bear Stearns retained
$68,262, $214,826 and $11,400 from the sales loads on Class A shares of the
Large Cap Value Portfolio, Small Cap Value Portfolio and the Income Portfolio,
respectively, and $552, $4,052 and $100 from CDSC on Class C shares of the Large
Cap Value Portfolio, Small Cap Value Portfolio and the Income Portfolio,
respectively. For the period from December 29, 1997 (commencement of operations)
through March 31, 1998, Bear Stearns received $155,705 from the sales loads on
Class A shares of the High Yield Portfolio and $0 and $0 from contingent
deferred sales charges ("CDSC") on Class B and C shares of the High Yield
Portfolio. In some states, banks or other institutions effecting transactions in
Portfolio shares may be required to register as dealers pursuant to state law.
Purchase Order Delays. The effective date of a purchase order may be
delayed if PFPC, the Portfolios' transfer agent, is unable to process the
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purchase order because of an interruption of services at its processing
facilities. In such event, the purchase order would become effective at the
purchase price next determined after such services are restored.
Sales Loads--Class A. Set forth below is an example of the method of
computing the offering price of the Class A shares of each Portfolio. The
example assumes a purchase of Class A shares aggregating less than $50,000
subject to the schedule of sales charges set forth in the Prospectus at a price
based upon the net asset value of the Class A shares on March 31, 1998.
EQUITY PORTFOLIOS: Large Cap Value Small Cap Value
Portfolio Portfolio
--------- ---------
Net Asset Value per Share $ 20.83 $ 23.65
======= =======
Per Share Sales Charge - 5.50%
of offering price (5.82% of
net asset value per share) 1.21 1.38
------- -------
Per Share Offering Price to
the Public $ 22.04 $ 25.03
======= =======
INCOME PORTFOLIO:
Net Asset Value per Share 12.37
=======
Per Share Sales Charge - 4.50%
of offering price (4.71% of
net asset value per share) 0.58
-------
Per Share Offering Price to
the Public $ 12.95
=======
HIGH YIELD PORTFOLIO
Net Asset Value per Share $ 12.73
Per Share Sales Charge - 4.50%
of offering price ($5.81%) of
net asset value per share) 0.60
Per Share Offering Price to
the Public $ 13.33
=======
Redemption Commitment. Each Portfolio has committed itself to pay in
cash all redemption requests by any shareholder of record, limited in amount
during any 90-day period to the lesser of $250,000 or 1% of the value of the
Portfolio's net assets at the beginning of such period. Such commitment is
irrevocable without the prior approval of the Securities and Exchange
Commission. In the case of requests for redemption in excess of such amount, the
Board of Trustees reserves the right to make payments in whole or in part in
securities or other assets in case of an emergency or any time a cash
distribution would impair the liquidity of the Portfolio to the detriment of the
existing shareholders. In this event, the securities would be valued in
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the same manner as the Portfolio is valued. If the recipient sold such
securities, brokerage charges would be incurred.
Suspension of Redemptions. The right of redemption may be suspended or
the date of payment postponed (a) during any period when the New York Stock
Exchange is closed (other than customary weekend and holiday closings), (b) when
trading in the markets each Portfolio ordinarily utilizes is restricted, or when
an emergency exists as determined by the Securities and Exchange Commission so
that disposal of a Portfolio's investments or determination of its net asset
value is not reasonably practicable, or (c) for such other periods as the
Securities and Exchange Commission by order may permit to protect Portfolio
shareholders.
Alternative Sales Arrangements - Class A, Class B, Class C and Class Y
Shares. The availability of three classes of shares to individual investors
permits an investor to choose the method of purchasing shares that is more
beneficial to the investor depending on the amount of the purchase, the length
of time the investor expects to hold shares and other relevant circumstances.
Investors should understand that the purpose and function of the deferred sales
charge and asset-based sales charge with respect to Class B and Class C shares
are the same as those of the initial sales charge with respect to Class A
shares. Any salesperson or other person entitled to receive compensation for
selling Portfolio shares may receive different compensation with respect to one
class of shares than the other. Bear Stearns will not accept any order of
$500,000 or more of Class B shares or $1 million or more of Class C shares, on
behalf of a single investor (not including dealer "street name" or omnibus
accounts) because generally it will be more advantageous for that investor to
purchase Class A shares of a Portfolio instead. A fourth class of shares may be
purchased only by certain institutional investors at net asset value per share
(the "Class Y shares").
The four classes of shares each represent an interest in the same
portfolio investments of a Portfolio. However, each class has different
shareholder privileges and features. The net income attributable to Class B and
Class C shares and the dividends payable on Class B and Class C shares will be
reduced by incremental expenses borne solely by that class, including the
asset-based sales charge to which Class B and Class C shares are subject.
The methodology for calculating the net asset value, dividends and
distributions of each Portfolio's Class A, B, C and Y shares recognizes two
types of expenses. General expenses that do not pertain specifically to a class
are allocated pro rata to the shares of each class, based on the percentage of
the net assets of such class to the Portfolio's total assets, and then equally
to each outstanding share within a given class. Such general expenses include
(i) management fees, (ii) legal, bookkeeping and audit fees, (iii) printing and
mailing costs of shareholder reports, Prospectuses, Statements of Additional
Information and other materials for current shareholders, (iv) fees to
independent trustees, (v) custodian expenses, (vi) share issuance costs, (vii)
organization and start-up costs, (viii) interest, taxes and brokerage
commissions, and (ix) non-recurring expenses, such as litigation costs. Other
expenses that are directly attributable to a class are allocated equally to each
outstanding share within that class. Such expenses include (a) Distribution Plan
and Shareholder Servicing Plan fees, (b) incremental transfer and shareholder
servicing agent fees and expenses, (c) registration fees and (d) shareholder
meeting expenses, to the extent that
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such expenses pertain to a specific class rather than to the Portfolio as a
whole.
None of the instructions described elsewhere in the Prospectus or
Statement of Additional Information for the purchase, redemption, reinvestment,
exchange, or transfer of shares of a Portfolio, the selection of classes of
shares, or the reinvestment of dividends apply to Class Y shares.
DETERMINATION OF NET ASSET VALUE
The following information supplements and should be read in conjunction
with the section in the Portfolios' Prospectus entitled "How to Buy Shares."
Valuation of Portfolio Securities. Equity Portfolio securities,
including covered call options written by an Equity Portfolio, are valued at the
last sale price on the securities exchange or national securities market on
which such securities primarily are traded. Securities not listed on an exchange
or national securities market, or securities in which there were no
transactions, are valued at the average of the most recent bid and asked prices,
except in the case of open short positions where the asked price is used for
valuation purposes. Bid price is used when no asked price is available. Any
assets or liabilities initially expressed in terms of foreign currency will be
converted into U.S. dollars at the prevailing market rates for purposes of
calculating net asset value. Because of the need to obtain prices as of the
close of trading on various exchanges throughout the world for such foreign
securities, the calculation of net asset value does not take place
contemporaneously with the determination of prices of such securities. Forward
currency contracts will be valued at the current cost of offsetting the
contract. Short-term investments (investments with maturities of 60 days or
less) are carried at amortized cost, which approximates value. Any securities or
other assets for which recent market quotations are not readily available are
valued at fair value as determined in good faith by the Fund's Board of
Trustees. Expenses and fees, including the investment advisory, administration
and distribution fees, are accrued daily and taken into account for the purpose
of determining the net asset value of an Equity Portfolio's shares. Because of
the differences in operating expenses incurred by each class, the per share net
asset value of each class will differ.
Substantially all of the investments of the Income Portfolio and the
High Yield Portfolio (including short-term investments) are valued each business
day by one or more independent pricing services (the "Service") approved by the
Fund's Board of Trustees. Securities valued by the Service for which quoted bid
prices in the judgment of the Service are readily available and are
representative of the bid side of the market are valued at the mean between the
quoted bid prices (as obtained by the Service from dealers in such securities)
and asked prices (as calculated by the Service based upon its evaluation of the
market for such securities). Any assets or liabilities initially expressed in
terms of foreign currency will be converted into U.S. dollars at the prevailing
market rates for purposes of calculating net asset value. Because of the need to
obtain prices as of the close of trading on various exchanges throughout the
world for such foreign securities, the calculation of net asset value does not
take place contemporaneously with the determination of prices of such
securities. Other investments valued by the Service are carried at fair value as
determined by the Service, based on
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methods which include consideration of: yields or prices of securities of
comparable quality, coupon, maturity and type; indications as to values from
dealers; and general market conditions. Short-term investments (investments with
maturities of 60 days or less) which are not valued by the Service are carried
at amortized cost, which approximate value. Other investments that are not
valued by the Service are valued at the average of the most recent bid and asked
prices in the market in which such investments are primarily traded, or at the
last sales price for securities traded primarily on an exchange or the national
securities market. In the absence of reported sales of investments traded
primarily on an exchange or the national securities market, the average of the
most recent bid and asked prices is used. Bid price is used when no asked price
is available. Expenses and fees, including the investment advisory,
administration and distribution fees, are accrued daily and taken into account
for the purpose of determining the net asset value of the Income Portfolio's
shares. Because of the differences in operating expenses incurred by each class,
the per share net asset value of each class will differ.
Each Portfolio's restricted securities, as well as securities or other
assets for which market quotations are not readily available, or are not valued
by a pricing service approved by the Board of Trustees, are valued at fair value
as determined in good faith by the Board of Trustees. The Board of Trustees will
review the method of valuation on a current basis. In making their good faith
valuation of restricted securities, the Board of Trustees generally will take
the following factors into consideration: (i) restricted securities which are,
or are convertible into, securities of the same class of securities for which a
public market exists usually will be valued at market value less the same
percentage discount at which purchased (this discount will be revised
periodically by the Board of Trustees if the Board of Trustees believe that it
no longer reflects the value of the restricted securities); (ii) restricted
securities not of the same class as securities for which a public market exists
usually will be valued initially at cost; and (iii) any subsequent adjustment
from cost will be based upon considerations deemed relevant by the Board of
Trustees.
New York Stock Exchange Closings. The holidays (as observed) on which
the New York Stock Exchange is closed currently are: New Year's Day, Martin
Luther King Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving and Christmas.
DIVIDENDS, DISTRIBUTIONS AND TAXES
The following information supplements and should be read in conjunction
with the section in each Portfolio's Prospectus entitled "Dividends,
Distributions and Taxes."
The following is only a summary of certain additional federal income
tax considerations generally affecting the Portfolios and their shareholders
that are not described in the Prospectuses. No attempt is made to present a
detailed explanation of the tax treatment of the Portfolios or their
shareholders, and the discussions here and in the Prospectuses are not intended
as substitutes for careful tax planning.
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<PAGE>
Qualification as a Regulated Investment Company. Each Portfolio has
elected to be taxed as a regulated investment company under Subchapter M of the
Internal Revenue Code of 1986, as amended (the "Code"). As a regulated
investment company, a Portfolio is not subject to federal income tax on the
portion of its net investment income (i.e., taxable interest, dividends and
other taxable ordinary income, net of expenses) and capital gain net income
(i.e., the excess of capital gains over capital losses) that it distributes to
shareholders, provided that it distributes at least 90% of its investment
company taxable income (i.e., net investment income and the excess of net
short-term capital gain over net long-term capital loss) for the taxable year
(the "Distribution Requirement"), and satisfies certain other requirements of
the Code that are described below. Distributions by a Portfolio made during the
taxable year or, under specified circumstances, within twelve months after the
close of the taxable year, will be considered distributions of income and gains
of the taxable year and will, therefore, count toward satisfaction of the
Distribution Requirement.
In addition to satisfying the Distribution Requirement, a regulated
investment company must derive at least 90% of its gross income from dividends,
interest, certain payments with respect to securities loans, gains from the sale
or other disposition of stock or securities or foreign currencies (to the extent
such currency gains are directly related to the regulated investment company's
principal business of investing in stock or securities) and other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities or currencies (the "Income Requirement").
In general, gain or loss recognized by a Portfolio on the disposition
of an asset will be a capital gain or loss. In addition, gain will be recognized
as a result of certain constructive sales, including short sales "against the
box." However, gain recognized on the disposition of a debt obligation purchased
by a Portfolio at a market discount (generally, at a price less than its
principal amount) will be treated as ordinary income to the extent of the
portion of the market discount which accrued during the period of time the
Portfolio held the debt obligation. In addition, under the rules of Code section
988, gain or loss recognized on the disposition of a debt obligation denominated
in a foreign currency or an option with respect thereto (but only to the extent
attributable to changes in foreign currency exchange rates), and gain or loss
recognized on the disposition of a foreign currency forward contract, futures
contract, option or similar financial instrument, or of foreign currency itself,
except for regulated futures contracts or non-equity options subject to Code
section 1256 (unless the Portfolio elects otherwise), generally will be treated
as ordinary income or loss.
Further, the Code also treats as ordinary income a portion of the
capital gain attributable to a transaction where substantially all of the return
realized is attributable to the time value of a Portfolio's net investment in
the transaction and: (1) the transaction consists of the acquisition of property
by the Portfolio and a contemporaneous contract to sell substantially identical
property in the future; (2) the transaction is a straddle within the meaning of
section 1092 of the Code; (3) the transaction is one that was marketed or sold
to the Portfolio on the basis that it would have the economic characteristics of
a loan but the interest-like return would be taxed as capital gain; or (4) the
transaction is described as a conversion transaction in the Treasury
Regulations. The amount of the gain
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<PAGE>
recharacterized generally will not exceed the amount of the interest that would
have accrued on the net investment for the relevant period at a yield equal to
120% of the federal long-term, mid-term, or short-term rate, depending upon the
type of instrument at issue, reduced by an amount equal to: (1) prior inclusions
of ordinary income items from the conversion transaction and (2) the capitalized
interest on acquisition indebtedness under Code section 263(g). Built-in losses
will be preserved where a Portfolio has a built-in loss with respect to property
that becomes a part of a conversion transaction. No authority exists that
indicates that the converted character of the income will not be passed through
to a Portfolio's shareholders.
In general, for purposes of determining whether capital gain or loss
recognized by a Portfolio on the disposition of an asset is long-term or
short-term, the holding period of the asset may be affected if (1) the asset is
used to close a "short sale" (which includes for certain purposes the
acquisition of a put option) or is substantially identical to another asset so
used, (2) the asset is otherwise held by the Portfolio as part of a "straddle"
(which term generally excludes a situation where the asset is stock and the
Portfolio grants a qualified covered call option (which, among other things,
must not be deep-in-the-money) with respect thereto), or (3) the asset is stock
and the Portfolio grants an in-the-money qualified covered call option with
respect thereto. In addition, a Portfolio may be required to defer the
recognition of a loss on the disposition of an asset held as part of a straddle
to the extent of any unrecognized gain on the offsetting position. Any gain
recognized by a Portfolio on the lapse of, or any gain or loss recognized by the
Portfolio from a closing transaction with respect to, an option written by the
Portfolio will be treated as a short-term capital gain or loss.
Certain transactions that may be engaged in by a Portfolio (such as
regulated futures contracts, certain foreign currency contracts, and options on
stock indexes and futures contracts) will be subject to special tax treatment as
"Section 1256 contracts." Section 1256 contracts are treated as if they are sold
for their fair market value on the last business day of the taxable year, even
though a taxpayer's obligations (or rights) under such contracts have not
terminated (by delivery, exercise, entering into a closing transaction or
otherwise) as of such date. Any gain or loss recognized as a consequence of the
year-end deemed disposition of Section 1256 contracts is taken into account for
the taxable year together with any other gain or loss that was previously
recognized upon the termination of Section 1256 contracts during that taxable
year. Any capital gain or loss for the taxable year with respect to Section 1256
contracts (including any capital gain or loss arising as a consequence of the
year-end deemed sale of such contracts) is generally treated as 60% long-term
capital gain or loss and 40% short-term capital gain or loss. A Portfolio,
however, may elect not to have this special tax treatment apply to Section 1256
contracts that are part of a "mixed straddle" with other investments of the
Portfolio that are not Section 1256 contracts.
A Portfolio may purchase securities of certain foreign investment funds
or trusts which constitute passive foreign investment companies ("PFICs") for
federal income tax purposes. If a Portfolio invests in a PFIC, it has three
separate options. First, it may elect to treat the PFIC as a qualified electing
fund (a "QEF"), in which event the Portfolio will each year have ordinary income
equal to its pro rata share of the
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PFIC's ordinary earnings for the year and long-term capital gain equal to its
pro rata share of the PFIC's net capital gain for the year, regardless of
whether the Portfolio receives distributions of any such ordinary earnings or
capital gains from the PFIC. Second, a Portfolio that invests in stock of a PFIC
may make a mark-to-market election with respect to such stock. Pursuant to such
election, the Portfolio will include as ordinary income any excess of the fair
market value of such stock at the close of any taxable year over the Portfolio's
adjusted tax basis in the stock. If the adjusted tax basis of the PFIC stock
exceeds the fair market value of the stock at the end of a given taxable year,
such excess will be deductible as ordinary loss in an amount equal to the lesser
of the amount of such excess or the net mark-to-market gains on the stock that
the Portfolio included in income in previous years. The Portfolio's holding
period with respect to its PFIC stock subject to the election will commence on
the first day of the next taxable year. If a Portfolio makes the mark-to-market
election in the first taxable year it holds PFIC stock, it will not incur the
tax described below under the third option.
Finally, if a Portfolio does not elect to treat the PFIC as a QEF and
does not make a mark-to-market election, then, in general, (1) any gain
recognized by the Portfolio upon the sale or other disposition of its interest
in the PFIC or any "excess distribution" (as defined) received by the Portfolio
from the PFIC will be allocated ratably over the Portfolio's holding period of
its interest in the PFIC stock, (2) the portion of such gain or excess
distribution so allocated to the year in which the gain is recognized or the
excess distribution is received shall be included in the Portfolio's gross
income for such year as ordinary income (and the distribution of such portion by
the Portfolio to shareholders will be taxable as an ordinary income dividend,
but such portion will not be subject to tax at the Portfolio level), (3) the
Portfolio shall be liable for tax on the portions of such gain or excess
distribution so allocated to prior years in an amount equal to, for each such
prior year, (i) the amount of gain or excess distribution allocated to such
prior year multiplied by the highest tax rate (individual or corporate) in
effect for such prior year, plus (ii) interest on the amount determined under
clause (i) for the period from the due date for filing a return for such prior
year until the date for filing a return for the year in which the gain is
recognized or the excess distribution is received, at the rates and methods
applicable to underpayments of tax for such period, and (4) the distribution by
the Portfolio to its shareholders of the portions of such gain or excess
distribution so allocated to prior years (net of the tax payable by the
Portfolio thereon) will again be taxable to the shareholders as an ordinary
income dividend.
Treasury Regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain (i.e.,
the excess of net long-term capital gain over net short-term capital loss) for
any taxable year, to elect (unless it has made a taxable year election for
excise tax purposes as discussed below) to treat all or any part of any net
capital loss, any net long-term capital loss or any net foreign currency loss
(including, to the extent provided in Treasury Regulations, losses recognized
pursuant to the PFIC mark-to-market election) incurred after October 31 as if it
had been incurred in the succeeding year.
In addition to satisfying the requirements described above, each
Portfolio must satisfy an asset diversification test in order to qualify as a
regulated investment company. Under this test, at the close of each quarter of a
Portfolio's taxable year, at least 50% of the value of the Portfolio's
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assets must consist of cash and cash items, U.S. Government securities,
securities of other regulated investment companies, and securities of other
issuers (as to each of which the Portfolio has not invested more than 5% of the
value of the Portfolio's total assets in securities of such issuer and does not
hold more than 10% of the outstanding voting securities of such issuer), and no
more than 25% of the value of its total assets may be invested in the securities
of any one issuer (other than U.S. Government securities and securities of other
regulated investment companies), or in two or more issuers which the Portfolio
controls and which are engaged in the same or similar trades or businesses.
Generally, an option (call or put) with respect to a security is treated as
issued by the issuer of the security, not the issuer of the option. For purposes
of asset diversification testing, obligations issued or guaranteed by certain
agencies or instrumentalities of the U.S. Government, such as the Federal
Agricultural Mortgage Corporation, the Farm Credit System Financial Assistance
Corporation, a Federal Home Loan Bank, the Federal Home Loan Mortgage
Corporation, the Federal National Mortgage Association, the Government National
Mortgage Corporation and the Student Loan Marketing Association are treated as
U.S. Government Securities.
If for any taxable year a Portfolio does not qualify as a regulated
investment company, all of its taxable income (including its net capital gain)
will be subject to a tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable to the
shareholders as ordinary dividends to the extent of the Portfolio's current and
accumulated earnings and profits. Such distributions generally will be eligible
for the dividends-received deduction in the case of corporate shareholders.
Excise Tax on Regulated Investment Companies. A 4% non-deductible
excise tax is imposed on a regulated investment company that fails to distribute
in each calendar year an amount equal to 98% of its ordinary income for such
calendar year and 98% of its capital gain net income for the one-year period
ended on October 31 of such calendar year (or, at the election of a regulated
investment company having a taxable year ending November 30 or December 31, for
its taxable year (a "taxable year election")). The balance of such income must
be distributed during the next calendar year. For the foregoing purposes, a
regulated investment company is treated as having distributed any amount on
which it is subject to income tax for any taxable year ending in such calendar
year.
For purposes of calculating the excise tax, a regulated investment
company shall: (1) reduce its capital gain net income (but not below its net
capital gain) by the amount of any net ordinary loss for the calendar year and
(2) exclude foreign currency gains and losses and ordinary gains or losses
arising as a result of a PFIC mark-to-market election (or upon the actual
disposition of the PFIC stock subject to such election) incurred after October
31 of any year (or after the end of its taxable year if it has made a taxable
year election) in determining the amount of ordinary taxable income for the
current calendar year (and, instead, include such gains and losses in
determining ordinary taxable income for the succeeding calendar year).
Each Portfolio intends to make sufficient distributions or deemed
distributions of its ordinary taxable income and capital gain net income prior
to the end of each calendar year to avoid liability for the excise tax. However,
investors should note that a Portfolio may in certain circumstances
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be required to liquidate portfolio investments to make sufficient distributions
to avoid excise tax liability.
Portfolio Distributions. Each Portfolio anticipates distributing
substantially all of its investment company taxable income for each taxable
year. Such distributions will be taxable to shareholders as ordinary income and
treated as dividends for federal income tax purposes, but will qualify for the
70% dividends-received deduction for corporate shareholders only to the extent
discussed below.
A Portfolio may either retain or distribute to shareholders its net
capital gain for each taxable year. Each Portfolio currently intends to
distribute any such amounts. Net capital gain that is distributed and designated
as a capital gain dividend will be taxable to shareholders as long-term capital
gain, regardless of the length of time the shareholder has held his shares or
whether such gain was recognized by the Portfolio prior to the date on which the
shareholder acquired his shares. The Code provides, however, that under certain
conditions only 50% (58% for alternative minimum tax purposes) of the capital
gain recognized upon a Portfolio's disposition of domestic "small business"
stock will be subject to tax.
Conversely, if a Portfolio elects to retain its net capital gain, the
Portfolio will be taxed thereon (except to the extent of any available capital
loss carryovers) at the 35% corporate tax rate. If a Portfolio elects to retain
its net capital gain, it is expected that the Portfolio also will elect to have
shareholders of record on the last day of its taxable year treated as if each
received a distribution of his pro rata share of such gain, with the result that
each shareholder will be required to report his pro rata share of such gain on
his tax return as long-term capital gain, will receive a refundable tax credit
for his pro rata share of tax paid by the Portfolio on the gain, and will
increase the tax basis for his shares by an amount equal to the deemed
distribution less the tax credit.
Ordinary income dividends paid by a Portfolio with respect to a taxable
year will qualify for the 70% dividends-received deduction generally available
to corporations (other than corporations, such as S corporations, which are not
eligible for the deduction because of their special characteristics and other
than for purposes of special taxes such as the accumulated earnings tax and the
personal holding company tax) to the extent of the amount of qualifying
dividends received by the Portfolio from domestic corporations for the taxable
year. A dividend received by a Portfolio will not be treated as a qualifying
dividend (1) if it has been received with respect to any share of stock that the
Portfolio has held for less than 46 days (91 days in the case of certain
preferred stock), excluding for this purpose under the rules of Code section
246(c)(3)and (4) any period during which the Portfolio has an option to sell, is
under a contractual obligation to sell, has made and not closed a short sale of,
is the grantor of a deep-in-the-money or otherwise nonqualified option to buy,
or has otherwise diminished its risk of loss by holding other positions with
respect to, such (or substantially identical) stock; (2) to the extent that the
Portfolio is under an obligation (pursuant to a short sale or otherwise) to make
related payments with respect to positions in substantially similar or related
property; or (3) to the extent that the stock on which the dividend is paid is
treated as debt-financed under the rules of Code section 246A. The 46-day
holding period must be satisfied during the 90-day period beginning 45 days
prior to each applicable ex-
B-52
<PAGE>
dividend date; the 91-day holding period must be satisfied during the 180-day
period beginning 90 days before each applicable ex-dividend date. Moreover, the
dividends-received deduction for a corporate shareholder may be disallowed or
reduced (1) if the corporate shareholder fails to satisfy the foregoing
requirements with respect to its shares of a Portfolio or (2) by application of
Code section 246(b) which in general limits the dividends-received deduction to
70% of the shareholder's taxable income (determined without regard to the
dividends-received deduction and certain other items).
Alternative minimum tax ("AMT") is imposed in addition to, but only to
the extent it exceeds, the regular tax and is computed at a maximum marginal
rate of 28% for noncorporate taxpayers and 20% for corporate taxpayers on the
excess of the taxpayer's alternative minimum taxable income ("AMTI") over an
exemption amount. For purposes of the corporate AMT, the corporate
dividends-received deduction is not itself an item of tax preference that must
be added back to taxable income or is otherwise disallowed in determining a
corporation's AMTI. However, a corporate shareholder will generally be required
to take the full amount of any dividend received from a Portfolio into account
(without a dividends-received deduction) in determining its adjusted current
earnings, which are used in computing an additional corporate preference item
(i.e., 75% of the excess of a corporate taxpayer's adjusted current earnings
over its AMTI (determined without regard to this item and the AMT net operating
loss deduction)) includable in AMTI.
Investment income that may be received by a Portfolio from sources
within foreign countries may be subject to foreign taxes withheld at the source.
The United States has entered into tax treaties with many foreign countries
which entitle a Portfolio to a reduced rate of, or exemption from, taxes on such
income. It is impossible to determine the effective rate of foreign tax in
advance since the amount of a Portfolio's assets to be invested in various
countries is not known.
Distributions by a Portfolio that do not constitute ordinary income
dividends or capital gain dividends will be treated as a return of capital to
the extent of (and in reduction of) the shareholder's tax basis in his shares;
any excess will be treated as gain from the sale of his shares, as discussed
below.
Distributions by a Portfolio will be treated in the manner described
above regardless of whether such distributions are paid in cash or reinvested in
additional shares of the Portfolios or shares of another portfolio (or another
fund). Shareholders receiving a distribution in the form of additional shares
will be treated as receiving a distribution in an amount equal to the fair
market value of the shares received, determined as of the reinvestment date. In
addition, if the net asset value at the time a shareholder purchases shares of a
Portfolio reflects undistributed net investment income or recognized capital
gain net income, or unrealized appreciation in the value of the assets of the
Portfolio, distributions of such amounts will be taxable to the shareholder in
the manner described above, although they economically constitute a return of
capital to the shareholder.
Ordinarily, shareholders are required to take distributions by a
Portfolio into account in the year in which the distributions are made. However,
dividends declared in October, November or December of any year and payable to
shareholders of record on a specified date in such month will be
B-53
<PAGE>
deemed to have been received by the shareholders (and made by the Portfolio) on
December 31 of such calendar year if such dividends are actually paid in January
of the following year. Shareholders will be advised annually as to the U.S.
federal income tax consequences of distributions made (or deemed made) during
the year.
A Portfolio will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of ordinary income dividends and capital gain dividends,
and the proceeds of redemption of shares, paid to any shareholder (1) who has
failed to provide a correct taxpayer identification number, (2) who is subject
to backup withholding for failure to properly report the receipt of interest or
dividend income, or (3) who has failed to certify to the Portfolio that it is
not subject to backup withholding or that it is an exempt recipient (such as a
corporation).
Sale or Redemption of Shares. A shareholder will recognize gain or loss
on the sale or redemption of shares of a Portfolio in an amount equal to the
difference between the proceeds of the sale or redemption and the shareholder's
adjusted tax basis in the shares. All or a portion of any loss so recognized may
be disallowed if the shareholder purchases other shares of the Portfolio within
30 days before or after the sale or redemption. In general, any gain or loss
arising from (or treated as arising from) the sale or redemption of shares of a
Portfolio will be considered capital gain or loss and will be long-term capital
gain or loss if the shares were held for longer than one year. However, any
capital loss arising from the sale or redemption of shares held for six months
or less will be treated as a long-term capital loss to the extent of the amount
of capital gain dividends received on such shares. For this purpose, the special
holding period rules of Code section 246(c)(3) and (4) (discussed above in
connection with the dividends-received deduction for corporations) generally
will apply in determining the holding period of shares. Capital losses in any
year are deductible only to the extent of capital gains plus, in the case of a
noncorporate taxpayer, $3,000 of ordinary income.
If a shareholder (1) incurs a sales load in acquiring shares of a
Portfolio,(2) disposes of such shares less than 91 days after they are acquired,
and (3) subsequently acquires shares of the same or another Portfolio or another
fund at a reduced sales load pursuant to a right to reinvest at such reduced
sales load acquired in connection with the acquisition of the shares disposed
of, then the sales load on the shares disposed of (to the extent of the
reduction in the sales load on the shares subsequently acquired) shall not be
taken into account in determining gain or loss on the shares disposed of but
shall be treated as incurred on the acquisition of the shares subsequently
acquired.
Foreign Shareholders. Taxation of a shareholder who, as to the United
States, is a nonresident alien individual, foreign trust or estate, foreign
corporation, or foreign partnership ("foreign shareholder") depends on whether
the income from the Portfolio is "effectively connected" with a U.S. trade or
business carried on by such shareholder.
If the income from a Portfolio is not effectively connected with a U.S.
trade or business carried on by a foreign shareholder, ordinary income dividends
paid to a foreign shareholder will be subject to U.S. withholding tax at the
rate of 30% (or lower applicable treaty rate) upon the gross amount
B-54
<PAGE>
of the dividend. Such foreign shareholder would generally be exempt from U.S.
federal income tax on gains realized on the sale of shares of a Portfolio,
capital gain dividends, and amounts retained by a Portfolio that are designated
as undistributed capital gains.
If the income from a Portfolio is effectively connected with a U.S.
trade or business carried on by a foreign shareholder, then ordinary income
dividends, capital gain dividends, and any gains realized upon the sale of
shares of such Portfolio will be subject to U.S. federal income tax at the rates
applicable to U.S. citizens or domestic corporations.
In the case of foreign noncorporate shareholders, a Portfolio may be
required to withhold U.S. federal income tax at the rate of 31% on distributions
that are otherwise exempt from withholding tax (or taxable at a reduced treaty
rate) unless such shareholders furnish the Portfolio with proper notification of
their foreign status.
The tax consequences to a foreign shareholder entitled to claim the
benefits of an applicable tax treaty may be different from those described
herein. Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in a
Portfolio, including the applicability of foreign taxes.
Effect of Future Legislation; State and Local Tax Considerations. The
foregoing general discussion of U.S. federal income tax consequences is based on
the Code and the Treasury Regulations issued thereunder as in effect on the date
of this Statement of Additional Information. Future legislative or
administrative changes or court decisions may significantly change the
conclusions expressed herein, and any such changes or decisions may have a
retroactive effect.
Rules of state and local taxation of ordinary income dividends and
capital gain dividends from regulated investment companies may differ from the
rules for U.S. federal income taxation described above. Shareholders are urged
to consult their tax advisers as to the consequences of these and other state
and local tax rules affecting investment in the Portfolios.
PORTFOLIO TRANSACTIONS
BSAM assumes general supervision over placing orders on behalf of the
Income Portfolio for the purchase or sale of investment securities. Purchases
and sales of portfolio securities usually are principal transactions. Income
Portfolio securities ordinarily are purchased directly from the issuer or from
an underwriter or a market maker for the securities. Usually no brokerage
commissions are paid by the Income Portfolio for such purchases. Purchases of
portfolio securities from underwriters include a commission or concession paid
by the issuer to the underwriter and the purchase price paid to market makers
for the securities may include the spread between the bid and asked price.
Income Portfolio transactions are allocated to various dealers by the its
portfolio managers in their best judgment.
BSAM assumes general supervision over placing orders on behalf of each
Equity Portfolio for the purchase or sale of investment securities. Allocation
of brokerage transactions, including their frequency, is made in
B-55
<PAGE>
BSAM's best judgment and in a manner deemed fair and reasonable to shareholders.
The primary consideration is prompt execution of orders at the most favorable
net price. Subject to this consideration, the brokers selected will include
those that supplement BSAM's research facilities with statistical data,
investment information, economic facts and opinions. Information so received is
in addition to and not in lieu of services required to be performed by BSAM and
BSAM's fees are not reduced as a consequence of the receipt of such supplemental
information. A commission paid to such brokers may be higher than that which
another qualified broker would have charged for effecting the same transaction,
provided that BSAM, as applicable, determines in good faith that such commission
is reasonable in terms of the transaction or the overall responsibility of BSAM
to the Portfolio and its other clients and that the total commissions paid by
the Portfolio will be reasonable in relation to the benefits to the Portfolio
over the long-term.
Such supplemental information may be useful to BSAM in serving each
Equity Portfolio and the other funds which it advises and, conversely,
supplemental information obtained by the placement of business of other clients
may be useful to BSAM in carrying out its obligations to each Equity Portfolio.
Sales of Portfolio shares by a broker may be taken into consideration, and
brokers also will be selected because of their ability to handle special
executions such as are involved in large block trades or broad distributions,
provided the primary consideration is met. Large block trades may, in certain
cases, result from two or more funds advised or administered by BSAM being
engaged simultaneously in the purchase or sale of the same security. Certain of
BSAM's transactions in securities of foreign issuers may not benefit from the
negotiated commission rates available to each Equity Portfolio for transactions
in securities of domestic issuers. When transactions are executed in the
over-the-counter market, each Portfolio will deal with the primary market makers
unless a more favorable price or execution otherwise is obtainable. Foreign
exchange transactions of each Equity Portfolio are made with banks or
institutions in the interbank market at prices reflecting a mark-up or mark-down
and/or commission.
Portfolio turnover may vary from year to year as well as within a year.
The portfolio turnover rate for the Large Cap Value Portfolio, Small Cap Value
Portfolio and Income Portfolio for the period April 3, 1995 (commencement of
operations) through March 31, 1996 was 45%, 41% and 107%, respectively. The
portfolio turnover rate for the fiscal year ended March 31, 1997 was 137%, 57%
and 263%, respectively. The portfolio turnover rate for the High Yield Portfolio
for the period December 29, 1997 (commencement of operations) through March 31,
1998 was 139.61%. This portfolio turnover rate is significantly higher than the
portfolio turnover rates of other mutual funds that invest in equity securities.
A higher portfolio turnover rate means that the Portfolio will incur
substantially higher brokerage costs and may realize a greater amount of
short-term capital gains or losses. In periods in which extraordinary market
conditions prevail, BSAM will not be deterred from changing investment strategy
as rapidly as needed, in which case higher portfolio turnover rates can be
anticipated which would result in greater brokerage expenses. The overall
reasonableness of brokerage commissions paid is evaluated by BSAM based upon its
knowledge of available information as to the general level of commissions paid
by other institutional investors for comparable services.
B-56
<PAGE>
To the extent consistent with applicable provisions of the 1940 Act and
the rules and exemptions adopted by the Securities and Exchange Commission
thereunder, the Board of Trustees has determined that transactions for each
Portfolio may be executed through Bear Stearns if, in the judgment of BSAM, the
use of Bear Stearns is likely to result in price and execution at least as
favorable as those of other qualified broker-dealers, and if, in the
transaction, Bear Stearns charges the Portfolio a rate consistent with that
charged to comparable unaffiliated customers in similar transactions. In
addition, under rules recently adopted by the Securities and Exchange
Commission, Bear Stearns may directly execute such transactions for each
Portfolio on the floor of any national securities exchange, provided (i) the
Board of Trustees has expressly authorized Bear Stearns to effect such
transactions, and (ii) Bear Stearns annually advises the Board of Trustees of
the aggregate compensation it earned on such transactions. Over-the-counter
purchases and sales are transacted directly with principal market makers except
in those cases in which better prices and executions may be obtained elsewhere.
For the fiscal year ended March 31, 1997, Large Cap Value Portfolio and
Small Cap Value Portfolio paid total brokerage commissions of $59,523 and
$102,411, respectively, of which approximately $1,300 and $9,000 was paid to
Bear Stearns, respectively. The Large Cap Value Portfolio and Small Cap Value
Portfolio paid 2.18% and 8.79%, respectively, of its commissions to Bear
Stearns, and, with respect to all the securities transactions for each Equity
Portfolio, 2.93% and 8.89% of the transactions, respectively, involved
commissions being paid to Bear Stearns. No brokerage commissions were paid by
the Income Portfolio.
For the fiscal year ended March 31, 1998, Large Cap Value Portfolio and
Small Cap Value Portfolio paid total brokerage commissions of $26,799 and
$302,476, respectively, of which approximately $522 and $1,728, respectively,
was paid to Bear Stearns. The Large Cap Value Portfolio and Small Cap Value
Portfolio paid 1.95% and 0.57%, respectively, of its commissions to Bear
Stearns, and, with respect to all the securities transactions for each Equity
Portfolio, 1.89% and 1.15% of the transactions, respectively, involved
commissions being paid to Bear Stearns. For the fiscal year ended March 31,
1998, the Large Cap Value Portfolio and Small Cap Value Portfolio paid an
average commission rate per share of $0.0581 and $0.0557, respectively. The
percentage of commissions for which they received research services paid by the
Large Cap Value Portfolio and Small Cap Value Portfolio was 98.40% and 94.95%,
respectively, of the total brokerage commissions paid by each Portfolio.
B-57
<PAGE>
PERFORMANCE INFORMATION
The following information supplements and should be read in conjunction
with the section in the Portfolios' Prospectus entitled "Performance
Information."
Current yield for the 30-day period ended March 31, 1998 for Class A,
Class C and Class Y of the Income Portfolio was 5.86%, 5.21% and 6.21%,
respectively. The current yield for each class reflects the waiver and
reimbursement of certain fees and expenses by the investment adviser, without
which the Portfolio's current yield for such period would have been 3.87% for
Class A, 3.67% for Class C and 4.42% for Class Y. Current yield of the Income
Portfolio is computed pursuant to a formula which operates as follows: The
amount of the Income Portfolio's expenses accrued for the 30-day period (net of
reimbursements) is subtracted from the amount of the dividends and interest
earned by the Income Portfolio during the period. That result is then divided by
the product of: (a) the average daily number of shares outstanding during the
period that were entitled to receive dividends, and (b) the maximum offering
price per share on the last day of the period less any undistributed earned
income per share reasonably expected to be declared as a dividend shortly
thereafter. The quotient is then added to 1, and that sum is raised to the 6th
power, after which 1 is subtracted. The current yield is then arrived at by
multiplying the result by 2.
Average annual total return of each Portfolio is calculated by
determining the ending redeemable value of an investment purchased at net asset
value (maximum offering price in the case of Class A) per share with a
hypothetical $1,000 payment made at the beginning of the period (assuming the
reinvestment of dividends and distributions), dividing by the amount of the
initial investment, taking the "n"th root of the quotient (where "n" is the
number of years in the period) and subtracting 1 from the result. A class'
average annual total return figures calculated in accordance with such formula
assume that in the case of Class A the maximum sales load has been deducted from
the hypothetical initial investment at the time of purchase or in the case of
Class B the maximum applicable CDSC has been paid upon redemption at the end of
the period.
Total return of each Portfolio is calculated by subtracting the amount
of the Portfolio's net asset value (maximum offering price in the case of Class
A) per share at the beginning of a stated period from the net asset value per
share at the end of the period (after giving effect to the reinvestment of
dividends and distributions during the period and any applicable CDSC), and
dividing the result by the net asset value (maximum offering price in the case
of Class A) per share at the beginning of the period. Total return also may be
calculated based on the net asset value per share at the beginning of the period
instead of the maximum offering price per share at the beginning of the period
for Class A shares or without giving effect to any applicable CDSC at the end of
the period for Class B and C shares. In such cases, the calculation would not
reflect the deduction of the sales load with respect to Class A shares or any
applicable CDSC with respect to Class B and C shares, which, if reflected, would
reduce the performance quoted.
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<PAGE>
The chart below sets forth average annual total return from inception*
through March 31, 1998 and total return for one-year and inception* through
March 31, 1998 for Class A, Class C and Class Y:
<TABLE>
Total return - inception* through March 31, 1998
<CAPTION>
Class A Class B Class C Class Y
-------------------------------- -------------------------------- -------------------------- ------------
Based on Maximum Based on Net Based on Maximum Based on Net Based on Based on Net Based on Net
Name of Portfolio Offering Price Asset Value Offering Price Asset Value Maximum CDSC Asset Value Asset Value
- ----------------- ---------------- ------------ ---------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Large Cap Value 100.86% 110.90% 8.04% 13.70% N/A 107.85% 83.29%
Portfolio
Small Cap Value 109.93% 120.43% 11.83% 17.69% N/A 116.88% 104.44%
Portfolio
Income Portfolio 19.32% 24.00% (5.04%) (0.04%) N/A 22.47% 18.39%
</TABLE>
<TABLE>
Total return - one-year ended March 31, 1998
<CAPTION>
Class A Class B Class C Class Y
-------------------------------- -------------------------------- -------------------------- ------------
Based on Maximum Based on Net Based on Maximum Based on Net Based on Based on Net Based on Net
Name of Portfolio Offering Price Asset Value Offering Price Asset Value Maximum CDSC Asset Value Asset Value
- ----------------- ---------------- ------------ ---------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Large Cap Value 37.69% 44.59% N/A N/A N/A 43.94% 45.27%
Portfolio
Small Cap Value 39.90% 46.86% N/A N/A N/A 46.10% 47.54%
Portfolio
Income Portfolio 5.31% 9.43% N/A N/A N/A 8.92% 9.81%
</TABLE>
<TABLE>
Average annual total return - inception* through March 31, 1998
<CAPTION>
Class A Class B Class C Class Y
-------------------------------- -------------------------------- -------------------------- ------------
Based on Maximum Based on Net Based on Maximum Based on Net Based on Based on Net Based on Net
Name of Portfolio Offering Price Asset Value Offering Price Asset Value Maximum CDSC Asset Value Asset Value
- ----------------- ---------------- ------------ ---------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Large Cap Value 26.20% 28.27% N/A N/A N/A 27.65% 26.75%
Portfolio
Small Cap Value 28.07% 30.18% N/A N/A N/A 29.47% 29.36%
Portfolio
Income Portfolio 6.08% 7.45% N/A N/A N/A 7.01% 6.81%
</TABLE>
- ----------
* Class A and Class C shares of Large Cap Value Portfolio commenced
investment operations on April 4, 1995. Class A and Class C shares of Small
Cap Value Portfolio commenced investment operations on April 3, 1995. Class
A and Class C shares of the Income Portfolio commenced investment
operations on April 5, 1995. The initial public offering of the Class Y
shares of Large Cap Value Portfolio, Small Cap Value Portfolio and Income
Portfolio commenced on September 11, June 22, and September 8, 1995,
respectively.
No Average Annual Returns for High Yield Portfolio. The total return
for Class A (at maximum offering price) for the fiscal year ended March 31, 1998
was 3.39%. Based on net asset value per share, the total return for Class A was
8.30% for this period. The total return for Class B and C was
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<PAGE>
8.13% and 8.13%, respectively. (With CDSC, the total return for Class B and C
was 3.13% and 7.13%, respectively).
CODE OF ETHICS
BSAM and the Fund, on behalf of each Portfolio, has adopted a Code of
Ethics (each a "Code of Ethics"), that establishes standards by which certain
access persons of the Fund must abide relating to personal securities trading
conduct. Under each Code of Ethics, access persons which include, among others,
trustees and officers of the Fund and employees of the Fund and BSAM, are
prohibited from engaging in certain conduct, including: (1) the purchase or sale
of any security for his or her account or for any account in which he or she has
any direct or indirect beneficial interest, without prior approval by the Fund
or without the applicability of certain exemptions; (2) the recommendation of a
securities transaction without disclosing his or her interest in the security or
issuer of the security; (3) the commission of fraud in connection with the
purchase or sale of a security held by or to be acquired by each Portfolio; and
(4) the purchase of any securities in an initial public offering or private
placement transaction eligible for purchase or sale by each Portfolio without
prior approval by the Fund. Certain transactions are exempt from item (1) of the
previous sentence, including: (1) any securities transaction, or series of
related transactions, involving 500 or fewer shares of (i) an issuer with an
average monthly trading volume of 100 million shares or more, or (ii) an issuer
that has a market capitalization of $1 billion or greater; and (2) transactions
in exempt securities or the purchase or sale of securities purchased or sold in
exempt transactions.
The Code of Ethics specifies that access persons shall place the
interests of the shareholders of each Portfolio first, shall avoid potential or
actual conflicts of interest with each Portfolio, and shall not take unfair
advantage of their relationship with each Portfolio. Under certain
circumstances, the Adviser to each Portfolio may aggregate or bunch trades with
other clients provided that no client is materially disadvantaged. Access
persons are required by the Code of Ethics to file quarterly reports of personal
securities investment transactions. However, an access person is not required to
report a transaction over which he or she had no control. Furthermore, a trustee
of the Fund who is not an "interested person" (as defined in the 1940 Act) of
the Fund is not required to report a transaction if such person did not know or,
in the ordinary course of his duties as a Trustee of the Fund, should have
known, at the time of the transaction, that, within a 15 day period before or
after such transaction, the security that such person purchased or sold was
either purchased or sold, or was being considered for purchase or sale, by each
Portfolio. The Code of Ethics specifies that certain designated supervisory
persons and/or designated compliance officers shall supervise implementation and
enforcement of the Code of Ethics and shall, at their sole discretion, grant or
deny approval of transactions required by the Code of Ethics.
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<PAGE>
INFORMATION ABOUT THE FUND
The following information supplements and should be read in conjunction
with the section in the Portfolios' Prospectus entitled "General Information."
Each Portfolio share has one vote and, when issued and paid for in
accordance with the terms of the offering, is fully paid and non-assessable.
Portfolio shares have no preemptive, subscription or conversion rights and are
freely transferable.
The Fund will send annual and semi-annual financial statements to all
its shareholders.
As of May 14, 1999, the following shareholders owned, directly or
indirectly, 5% or more of the indicated class of the Portfolio's shares.
Percent of Large Cap
Name and Address Class A Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 18.2%
FBO 200-40406-10
1 Metrotech Center North
Brooklyn, NY 11201-3859
Percent of Large Cap
Name and Address Class B Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 5.3%
FBO 905-98627-15
1 Metrotech Center North
Brooklyn, NY 11201-3859
Raymond James Assoc. Inc. 5.7%
Edward D. Walsh Jr. IRA
6 Standish Cir.
Andover, MA 01810
Raymond James Assoc. Inc. 8.0%
Larry A. Lafranchi IRA
14 Wabanki Way
Andover, MA 01810
B-61
<PAGE>
Percent of Large Cap
Name and Address Class C Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 6.9%
FBO 220-43167-11
1 Metrotech Center North
Brooklyn, NY 11201-3859
Percent of Large Cap
Name and Address Class Y Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 7.1%
FBO 039-54877-13
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 5.4%
FBO 039-54877-13
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 6.5%
FBO 051-37142-12
1 Metrotech Center North
Brooklyn, NY 11201-3859
Strafe & Co. FAO Trust 14.3%
FBO Danielle Young
DTD 8/21/90 6863471800
P.O. Box 160
Westerville, OH 43086
Percent of Small Cap
Name and Address Class A Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 5.4%
FBO 049-40985-10
1 Metrotech Center North
Brooklyn, NY 11201-3859
B-62
<PAGE>
Percent of Small Cap
Value Portfolio
Name and Address Class B Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 5.1%
FBO 984-13624-25
1 Metrotech Center North
Brooklyn, NY 01201-3859
Percent of Small Cap
Value Portfolio
Name and Address Class Y Shares Outstanding
- ---------------- --------------------------
Custodial Trust Company 24.0%
101 Carnegie Center
Princeton, NJ 08540
Bear Stearns Securities Corp. 8.8%
FBO 049-40880-16
1 Metrotech Center North
Brooklyn, NY 01201-3859
Percent of Income
Portfolio
Name and Address Class A Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 17.7%
FBO 051-29339-12
1 Metrotech Center North
Brooklyn, NY 11201-3859
Dorothy J. Pintar 5.3%
140 Country View Drive
Robinson Twp., PA 15136-1251
Percent of Income
Portfolio
Name and Address Class B Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 7.2%
FBO 420-28188-13
1 Metrotech Center North
Brooklyn, NY 01201-3859
Robert W. Baird Co. Inc. 7.8%
A C 1171-7740
777 East Wisconsin Ave.
Milwaukee, WI 53202-5391
B-63
<PAGE>
Bear, Stearns Securities Corp. 6.0%
FBO 963-95024-19
1 Metrotech Center North
Brooklyn, NY 11201-3859
Wexford Cleaning Services Corp. 8.0%
FBO UA DTD 03 07 96
22960 Cass Ave.
Woodland Hills, CA 91364-3917
Percent of Income
Portfolio
Name and Address Class C Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 9.0%
FBO 498-00055-18
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 5.1%
FBO 220-43671-10
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 5.7%
FBO 498-00056-17
1 Metrotech Center North
Brooklyn, NY 11201-3859
Percent of Income
Portfolio
Name and Address Class Y Shares Outstanding
- ---------------- --------------------------
Bear, Stearns Securities Corp. 11.6%
FBO 049-40503-13
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 11.4%
FBO 051-98474-12
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 9.2%
FBO 046-03216-15
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 6.5%
FBO 049-40716-16
1 Metrotech Center North
Brooklyn, NY 11201-3859
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Bear, Stearns Securities Corp. 9.9%
FBO 051-35282-16
1 Metrotech Center North
Brooklyn, NY 11201-3859
Bear, Stearns Securities Corp. 15.7%
FBO 049-40863-17
1 Metrotech Center North
Brooklyn, NY 11201-3859
Percent of High Yield
Portfolio Class A
Name and Address Shares Outstanding
- ---------------- ---------------------
Bear, Stearns Securities Corp. 7.9%
FBO 220-23312-17
One Metrotech Center North
Brooklyn, NY 11201-3859
Mark Pinto 10.2%
Trst Fox & Co.
DTD 12/16/67
P.O. Box 976
New York, NY 10268
Percent of High Yield
Portfolio Class C
Name and Address Shares Outstanding
- ---------------- ---------------------
Bear, Stearns Securities Corp. 6.3%
FBO 720-57204-15
One Metrotech Center North
Brooklyn, NY 11201-3859
A shareholder who beneficially owns, directly or indirectly, more than
25% of a Portfolio's voting Securities may be deemed a "control person" (as
defined in the 1940 Act) of a Portfolio.
CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT, COUNSEL
AND INDEPENDENT AUDITORS
Custodial Trust Company ("CTC"), 101 Carnegie Center, Princeton, New
Jersey 08540, an affiliate of Bear Stearns, is each Portfolio's custodian. Under
a custody agreement with each Portfolio, CTC holds each Portfolio's securities
and keeps all necessary accounts and records. For its services, CTC receives
from each Portfolio an annual fee of the greater of 0.015% of the value of the
domestic assets held in custody or $5,000, such fee to be payable monthly based
upon the total market value of such assets, as determined on the last business
day of the month. In addition, CTC receives certain securities
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transactions charges which are payable monthly. PFPC, Bellevue Corporate Center,
400 Bellevue Parkway, Wilmington, Delaware 19809, is each Portfolio's transfer
agent, dividend disbursing agent and registrar. Neither CTC nor PFPC has any
part in determining the investment policies of any Portfolio or which securities
are to be purchased or sold by any Portfolio.
Kramer Levin Naftalis & Frankel LLP, 919 Third Avenue, New York, New
York 10022, as counsel for the Fund, has provided legal advice as to certain
legal matters regarding the shares of beneficial interest being sold pursuant to
the Portfolios' Prospectus.
Deloitte & Touche LLP, Two World Financial Center, New York, New York
10281-1434, independent auditors, have been selected as auditors of the Fund.
FINANCIAL STATEMENTS
The Portfolios' annual report to shareholders for the fiscal year ended
March 31, 1998 is a separate document supplied with this Statement of Additional
Information, and the financial statements, accompanying notes and report of
independent auditors appearing therein are incorporated by reference into this
Statement of Additional Information.
APPENDIX
Description of certain ratings assigned by S&P, Moody's, Fitch and
Duff:
S&P
Bond Ratings
- ------------
AAA
Bonds rated AAA have the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
AA
Bonds rated AA have a very strong capacity to pay interest and repay
principal and differ from the highest rated issues only in small degree.
A
Bonds rated A have a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rated categories.
BBB
Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
bonds in this category than for bonds in higher rated categories.
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S&P's letter ratings may be modified by the addition of a plus (+) or
minus (-) sign designation, which is used to show relative standing within the
major rating categories, except in the AAA (Prime Grade) category.
Commercial Paper Rating
The designation A-1 by S&P indicates that the degree of safety
regarding timely payment is either overwhelming or very strong. Those issues
determined to possess overwhelming safety characteristics are denoted with a
plus sign (+) designation. Capacity for timely payment on issues with an A-2
designation is strong. However, the relative degree of safety is not as high as
for issues designated A-1.
Moody's
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 edge." 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 generally are known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A
Bonds 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 payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Moody's applies the numerical modifiers 1, 2 and 3 to show relative
standing within the major rating categories, except in the Aaa category. The
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modifier 1 indicates a ranking for the security in the higher end of a rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates a ranking in the lower end of a rating category.
Commercial Paper Rating
The rating Prime-1 (P-1) is the highest commercial paper rating
assigned by Moody's. Issuers of P-1 paper must have a superior capacity for
repayment of short-term promissory obligations, and ordinarily will be evidenced
by 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, and well established access
to a range of financial markets and assured sources of alternate liquidity.
Issuers (or relating supporting institutions) rated Prime-2 (P-2) have
a strong capacity for repayment of short-term promissory obligations. This
ordinarily will 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.
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Fitch
Bond Ratings
- ------------
The ratings represent Fitch's assessment of the issuer's ability to
meet the obligations of a specific debt issue or class of debt. The ratings take
into consideration special features of the issue, its relationship to other
obligations of the issuer, the current financial condition and operative
performance of the issuer and of any guarantor, as well as the political and
economic environment that might affect the issuer's future financial strength
and credit quality.
AAA
Bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA
Bonds rated AA are considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because bonds
rated in the AAA and AA categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is generally
rated F-1+.
A
Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is considered
to be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB
Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds and, therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
Plus (+) and minus (-) signs are used with a rating symbol to indicate
the relative position of a credit within the rating category.
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Short-Term Ratings
- ------------------
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
Although the credit analysis is similar to Fitch's bond rating
analysis, the short-term rating places greater emphasis than bond ratings on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
F-1+
Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1
Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
F-2
Good Credit Quality. Issues carrying this rating have a satisfactory
degree of assurance for timely payments, but the margin of safety is not as
great as the F-1+ and F-1 categories.
Duff
Bond Ratings
- ------------
AAA
Bonds rated AAA are considered highest credit quality. The risk factors
are negligible, being only slightly more than for risk-free U.S. Treasury debt.
AA
Bonds rated AA are considered high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
A
Bonds rated A have protection factors which are average but adequate.
However, risk factors are more variable and greater in periods of economic
stress.
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BBB
Bonds rated BBB are considered to have below average protection factors
but still considered sufficient for prudent investment. Considerable variability
in risk during economic cycles.
Plus (+) and minus (-) signs are used with a rating symbol (except AAA)
to indicate the relative position of a credit within the rating category.
Commercial Paper Rating
- -----------------------
The rating Duff-1 is the highest commercial paper rating assigned by
Duff. Paper rated Duff-1 is regarded as having very high certainty of timely
payment with excellent liquidity factors which are supported by ample asset
protection. Risk factors are minor. Paper rated Duff-2 is regarded as having
good certainty of timely payment, good access to capital markets and sound
liquidity factors and company fundamentals. Risk factors are small.
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